Federal Reserve System: Opportunities Exist to Strengthen Policies and Processes for Managing Emergency Assistance
Highlights
The Dodd-Frank Wall Street Reform and Consumer Protection Act directed GAO to conduct a one-time audit of the emergency loan programs and other assistance authorized by the Board of Governors of the Federal Reserve System (Federal Reserve Board) during the recent financial crisis. This report examines the emergency actions taken by the Federal Reserve Board from December 1, 2007, through July 21, 2010. For each of these actions, where relevant, GAO's objectives included a review of (1) the basis and purpose for its authorization, as well as accounting and financial reporting internal controls; (2) the use, selection, and payment of vendors; (3) management of conflicts of interest; (4) policies in place to secure loan repayment; and (5) the treatment of program participants. To meet these objectives, GAO reviewed program documentation, analyzed program data, and interviewed officials from the Federal Reserve Board and Reserve Banks (Federal Reserve System).
On numerous occasions in 2008 and 2009, the Federal Reserve Board invoked emergency authority under the Federal Reserve Act of 1913 to authorize new broad-based programs and financial assistance to individual institutions to stabilize financial markets. Loans outstanding for the emergency programs peaked at more than $1 trillion in late 2008. The Federal Reserve Board directed the Federal Reserve Bank of New York (FRBNY) to implement most of these emergency actions. In a few cases, the Federal Reserve Board authorized a Reserve Bank to lend to a limited liability corporation (LLC) to finance the purchase of assets from a single institution. In 2009 and 2010, FRBNY also executed large-scale purchases of agency mortgage-backed securities to support the housing market. The Reserve Banks' and LLCs' financial statements, which include the emergency programs' accounts and activities, and their related financial reporting internal controls, are audited annually by an independent auditing firm. These independent financial statement audits, as well as other audits and reviews conducted by the Federal Reserve Board, its Inspector General, and the Reserve Banks' internal audit function, did not report any significant accounting or financial reporting internal control issues concerning the emergency programs. The Reserve Banks, primarily FRBNY, awarded 103 contracts worth $659.4 million from 2008 through 2010 to help carry out their emergency activities. A few contracts accounted for most of the spending on vendor services. For a significant portion of the fees, program recipients reimbursed the Reserve Banks or the fees were paid from program income. The Reserve Banks relied more extensively on vendors for programs that assisted a single institution than for broad-based programs. Most of the contracts, including 8 of the 10 highest-value contracts, were awarded noncompetitively, primarily due to exigent circumstances. These contract awards were consistent with FRBNY's acquisition policies, but the policies could be improved by providing additional guidance on the use of competition exceptions, such as seeking as much competition as practicable and limiting the duration of noncompetitive contracts to the exigency period. To better ensure that Reserve Banks do not miss opportunities to obtain competition and receive the most favorable terms for services acquired, GAO recommends that they revise their acquisition policies to provide such guidance. FRBNY took steps to manage conflicts of interest for its employees, directors, and program vendors, but opportunities exist to strengthen its conflict policies. In particular, FRBNY expanded its guidance and monitoring for employee conflicts, but new roles assumed by FRBNY and its employees during the crisis gave rise to potential conflicts that were not specifically addressed in the Code of Conduct or other FRBNY policies. For example, FRBNY's existing restrictions on its employees' financial interests did not specifically prohibit investments in certain nonbank institutions that received emergency assistance. To manage potential conflicts related to employees' holdings of such investments, FRBNY relied on provisions in its code that incorporate requirements of a federal criminal conflict of interest statute and its regulations. GAO makes seven recommendations to the Federal Reserve Board to strengthen policies for managing noncompetitive vendor selections, conflicts of interest, risks related to emergency lending, and documentation of emergency program decisions. The Federal Reserve Board agreed that GAO's recommendations would benefit its response to future crises and agreed to strongly consider how best to respond to them.
Recommendations
Recommendations for Executive Action
| Agency Affected | Recommendation | Status |
|---|---|---|
| Board of Governors | While creating control systems at the same time that the emergency programs were being designed and implemented posed unique challenges, the recent crisis provided invaluable experience that the Federal Reserve System can apply in the future should the use of these authorities again become warranted. Going forward, to further strengthen policies for selecting vendors, ensuring the transparency and consistency of decision making involving the implementation of any future emergency programs, and managing risks related to these programs, the Chairman of the Federal Reserve Board should direct Federal Reserve Board and Reserve Bank staff to revise Reserve Banks' formal acquisition policies and procedures to provide additional guidance on the steps staff should follow in exigent circumstances, specifically to address soliciting as much competition as possible, limiting the duration of noncompetitive contracts to the period of the exigency, and documenting efforts to promote competition. |
The Federal Reserve Board has revised the formal acquisition policy for Federal Reserve Banks to provide additional guidance on the steps staff should follow in exigent circumstances. The guidelines addressed several items, including the need for Reserve Banks to take appropriate steps within the time available to evaluate the Bank?s options for sourcing the required goods, services, software, or construction, the duration of such contracts, the circumstances under which such contracts can be continued, and the need to document justification for using procedures other than those for competitive proposals and any efforts it made to promote competition in the acquisition process. The revised "Model for Acquisition Guidelines for Federal Reserve Banks" were approved by the Conference of First Vice Presidents in June 2013.
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| Board of Governors | While creating control systems at the same time that the emergency programs were being designed and implemented posed unique challenges, the recent crisis provided invaluable experience that the Federal Reserve System can apply in the future should the use of these authorities again become warranted. Going forward, to further strengthen policies for selecting vendors, ensuring the transparency and consistency of decision making involving the implementation of any future emergency programs, and managing risks related to these programs, the Chairman of the Federal Reserve Board should direct Federal Reserve Board and Reserve Bank staff, as part of the Federal Reserve System's planned review of the Reserve Banks' codes of conduct given their expanded statutory authority under the Dodd-Frank Act, to consider how Reserve Banks' experience managing employee conflicts of interest, including those related to certain nonbank institutions that participated in the emergency programs, could inform the need for changes to the Reserve Banks' conflict policies. |
In July 2011, the Federal Reserve revised its policies regarding stock ownership by Federal Reserve Bank directors and by Federal Reserve System staff to reflect the Federal Reserve's expanded supervisory authority under the Dodd-Frank Act. For example, Federal Reserve System employees -- other than those involved in banking supervision and regulation -- may not own stock in most savings and loan holding companies, and those involved in banking supervision and regulation may not own stock in any savings and loan holding companies. In addition, Federal Reserve Board staff noted that Reserve Bank employees receive regular training on the Reserve Bank Code of Conduct and federal conflicts of interest statutes, and supervision employees' assignments are screened through a conflicts of interest database to help ensure that appropriate recusals are in place.
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| Board of Governors | While creating control systems at the same time that the emergency programs were being designed and implemented posed unique challenges, the recent crisis provided invaluable experience that the Federal Reserve System can apply in the future should the use of these authorities again become warranted. Going forward, to further strengthen policies for selecting vendors, ensuring the transparency and consistency of decision making involving the implementation of any future emergency programs, and managing risks related to these programs, the Chairman of the Federal Reserve Board should direct Federal Reserve Board and Reserve Bank staff to finalize a comprehensive policy for FRBNY's management of risks related to vendor conflicts of interest that formalizes FRBNY practices and lessons learned from the crisis. This policy could include guidance on when to include contract protections that were not always found in FRBNY's vendor contracts, such as requirements for higherrisk vendor firms to provide a written conflict remediation plan and certify compliance with this plan. |
The Federal Reserve Bank of New York has revised its Acquisition Policy, which became effective August 5, 2013. The revised policy corrected some deficiencies noted in the acquisition policy that was in place during the financial crisis. The 2013 acquisition policy broadened guidance on acquisitions during exigent circumstances, such as including a duration limit for the contract and recommending that contracts include a provision that allows for termination for convenience to allow for re-evaluation of the contract after the exigent circumstances have subsided.
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| Board of Governors | While creating control systems at the same time that the emergency programs were being designed and implemented posed unique challenges, the recent crisis provided invaluable experience that the Federal Reserve System can apply in the future should the use of these authorities again become warranted. Going forward, to further strengthen policies for selecting vendors, ensuring the transparency and consistency of decision making involving the implementation of any future emergency programs, and managing risks related to these programs, the Chairman of the Federal Reserve Board should direct Federal Reserve Board and Reserve Bank staff to strengthen procedures in place to guide Reserve Banks' efforts to manage emergency program access for higher-risk borrowers by providing more specific guidance on how Reserve Bank staff should exercise discretion and document decisions to restrict or deny program access for depository institutions and primary dealers that would otherwise be eligible for emergency assistance. |
The Federal Reserve established emergency lending facilities in response to the COVID-19 pandemic. For each of these facilities, there are eligibility requirements and terms that could not vary by participant. The Federal Reserve published term sheets that set out the eligibility criteria for participants, restrictions, and other terms. According to Federal Reserve officials, the Reserve Banks establish and operate the facilities in accordance with the criteria stipulated in the term sheets and do not have discretion to operate or approve transactions that fall outside of the scope of the term sheets. Because the Federal Reserve does not have discretion to waive borrowers' eligibility requirements, there is no risk of inconsistent treatment of program participants because all interested participants in a facility must meet the same terms and requirements for that facility. Therefore, the Federal Reserve's actions effectively address the intent of our 2011 recommendation that the Federal Reserve strengthen procedures pertaining to exercising discretion in managing program access for higher-risk borrowers.
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| Board of Governors | While creating control systems at the same time that the emergency programs were being designed and implemented posed unique challenges, the recent crisis provided invaluable experience that the Federal Reserve System can apply in the future should the use of these authorities again become warranted. Going forward, to further strengthen policies for selecting vendors, ensuring the transparency and consistency of decision making involving the implementation of any future emergency programs, and managing risks related to these programs, the Chairman of the Federal Reserve Board should direct Federal Reserve Board and Reserve Bank staff to document a plan for estimating and tracking losses that could occur under more adverse economic conditions within and across all emergency lending activities and for using this information to inform policy decisions, such as decisions to limit risk exposures through program design or restrictions applied to eligible borrowing institutions. |
For the lending facilities established in response to the COVID-19 pandemic, the Federal Reserve has taken steps, including following the approach for estimating losses documented in its Financial Accounting Manual (FAM) for Federal Reserve Banks, to monitor and limit risk exposures through estimating and tracking losses across facilities. The general policy for evaluating loan losses that is documented in the FAM requires a quarterly evaluation of loan losses, including that each Reserve Bank must submit a quarterly loan loss evaluation to the Federal Reserve Board. According to Board staff, the specific approach to determining loan loss allowances for each emergency lending facility will be consistent with the FAM policy, but may vary based on the nature of the assets held by each facility, which is noted in each facility's audited financial statements. In the design phase, the Federal Reserve conducted scenario-based analyses as part of designing the facilities to assess the extent of possible losses in a range of scenarios--including severely adverse scenarios. After the facilities were implemented, the Federal Reserve also monitors and reports on the facilities' usage. Federal Reserve officials said that the Reserve Banks responsible for administering the facilities may hire vendors with expertise in modeling losses as further support for their risk monitoring. Further, for financial reporting purposes, the Reserve Banks estimate losses from loan defaults on an aggregated basis across the Federal Reserve System to determine allowances for loan and lease losses. Moreover, information on the extent to which the Federal Reserve has assessed risk monitoring on an aggregated, system-wide basis is presented in the Federal Reserve's and each facility's year-end financial statements. The Federal Reserve also has used this information from estimating and tracking losses to inform policy decisions in different phases of the facilities' operations. In the design phase, the scenario-based analyses to assess the extent of possible losses was used in determining the size of Treasury's equity investment in the facilities. After the facilities were implemented, the scenario-based analyses informed adjustments to facilities' terms--such as lowering some Main Street facilities' minimum loan size from $250,000 to $100,000--to help enhance program features. After the facilities stopped purchasing assets or extending credit, Reserve Banks continue to monitor for potential losses and record loan loss allowance in the financial statements. Taken collectively, these actions have addressed our recommendation.
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| Board of Governors | While creating control systems at the same time that the emergency programs were being designed and implemented posed unique challenges, the recent crisis provided invaluable experience that the Federal Reserve System can apply in the future should the use of these authorities again become warranted. Going forward, to further strengthen policies for selecting vendors, ensuring the transparency and consistency of decision making involving the implementation of any future emergency programs, and managing risks related to these programs, the Chairman of the Federal Reserve Board should direct Federal Reserve Board and Reserve Bank staff, in drafting regulations to establish the policies and procedures governing emergency lending under section 13(3) of the Federal Reserve Act, to set forth the Federal Reserve Board's process for documenting, to the extent not otherwise required by law, its justification for each use of this authority. |
Enacted in July 2011, the Dodd-Frank Wall Street Reform and Consumer Protection Act included new requirements for the Federal Reserve Board to report to Congress on any loan or financial assistance authorized under section 13(3), including the justification for the exercise of authority; the identity of the recipient; the date, amount, and form of the assistance; and the material terms of the assistance. In December 2015, the Federal Reserve Board finalized a rule implementing these requirements. The relevant sections of this rule will help ensure that the Federal Reserve Board consistently and comprehensively documents the justification and relevant details around future uses of its emergency authority under Section 13(3). Further, by outlining how this information will be reported to Congress, they will help to ensure transparency and accountability around future uses of Section 13(3) authority.
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| Board of Governors | While creating control systems at the same time that the emergency programs were being designed and implemented posed unique challenges, the recent crisis provided invaluable experience that the Federal Reserve System can apply in the future should the use of these authorities again become warranted. Going forward, to further strengthen policies for selecting vendors, ensuring the transparency and consistency of decision making involving the implementation of any future emergency programs, and managing risks related to these programs, the Chairman of the Federal Reserve Board should direct Federal Reserve Board and Reserve Bank staff to document the Federal Reserve Board's guidance to Reserve Banks on types of emergency program decisions and risk events that require approval by or consultation with the Board of Governors, the Federal Open Market Committee, or other designated groups or officials at the Federal Reserve Board. |
We most recently sought information from the Board of Governors of the Federal Reserve System in June 2021 regarding the status of the recommendation but did not receive any new information. Therefore, the recommendation remains open.
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