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entitled 'Federal Reserve System: Opportunities Exist to Strengthen
Policies and Processes for Managing Emergency Assistance' which was
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United States Government Accountability Office:
GAO:
Report to Congressional Addressees:
July 2011:
Federal Reserve System:
Opportunities Exist to Strengthen Policies and Processes for Managing
Emergency Assistance:
GAO-11-696:
GAO Highlights:
Highlights of GAO-11-696, a report to congressional addressees.
Why GAO Did This Study:
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).
What GAO Found:
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 table below provides an overview of
all emergency actions covered by this report. 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. Given the magnitude of the assistance and the
public’s heightened attention to the appearance of conflicts related
to Reserve Banks’ emergency actions, existing standards for managing
employee conflicts may not be sufficient to avoid the appearance of a
conflict in all situations. As the Federal Reserve System considers
revising its conflict policies given its new authority to regulate
certain nonbank institutions, GAO recommends it consider how potential
conflicts from emergency lending could inform any changes. FRBNY
managed vendor conflict issues through contract protections and
actions to help ensure compliance with relevant contract provisions,
but these efforts had limitations. For example, while FRBNY negotiated
important contract protections, such as requirements for ethical
walls, it lacked written guidance on protections that should be
included to help ensure vendors fully identify and remediate
conflicts. Further, FRBNY’s on-site reviews of vendor compliance in
some instances occurred as far as 12 months into a contract. FRBNY
implemented a new vendor management policy but has not yet finalized
another new policy with comprehensive guidance on vendor conflict
issues. GAO recommends FRBNY finalize this new policy to reduce the
risk that vendors may not be required to take steps to fully identify
and mitigate all conflicts.
While the Federal Reserve System took steps to mitigate risk of losses
on its emergency loans, opportunities exist to strengthen risk
management practices for future crisis lending. The Federal Reserve
Board approved program terms and conditions designed to mitigate risk
of losses and one or more Reserve Banks were responsible for managing
such risk for each program. Reserve Banks required borrowers under
several programs to post collateral in excess of the loan amount. For
programs that did not have this requirement, Reserve Banks required
borrowers to pledge assets with high credit ratings as collateral. For
loans to specific institutions, Reserve Banks negotiated loss
protections with the private sector and hired vendors to help oversee
the portfolios that collateralized loans. The emergency programs that
have closed have not incurred losses and FRBNY does not project any
losses on its outstanding loans. To manage risks posed by these new
lending activities, Reserve Banks implemented new controls and FRBNY
strengthened its risk management function. In mid-2009, FRBNY created
a new risk management division and enhanced its risk analytics
capabilities. But neither FRBNY nor the Federal Reserve Board tracked
total exposure and stressed losses that could occur in adverse
economic scenarios across all emergency programs. Further, the Federal
Reserve System’s procedures for managing borrower risks did not
provide comprehensive guidance for how Reserve Banks should exercise
discretion to restrict program access for higher-risk borrowers that
were otherwise eligible for the Term Auction Facility (TAF) and
emergency programs for primary dealers. To strengthen practices for
managing risk of losses in the event of a future crisis, GAO
recommends that the Federal Reserve System document a plan for more
comprehensive risk tracking and strengthen procedures to manage
program access for higher-risk borrowers.
While the Federal Reserve System took steps to promote consistent
treatment of eligible program participants, it did not always document
processes and decisions related to restricting access for some
institutions. Reserve Banks generally offered assistance on the same
terms to institutions that met announced eligibility requirements. For
example, all eligible borrowers generally could borrow at the same
interest rate and against the same types of eligible collateral.
Reserve Banks retained and exercised discretion to restrict or deny
program access for institutions based on supervisory or other
concerns. For example, due to concerns about their financial
condition, Reserve Banks restricted TAF access for at least 30
institutions. Further, in a few programs, FRBNY placed special
restrictions, such as borrowing limits, on eligible institutions that
posed higher risk of loss. Because Reserve Banks lacked specific
procedures that staff should follow to exercise discretion and
document actions to restrict higher-risk eligible borrowers for a few
programs, the Federal Reserve System lacked assurance that Reserve
Banks applied such restrictions consistently. Also, the Federal
Reserve Board did not fully document its justification for extending
credit on terms similar to the Primary Dealer Credit Facility (PDCF)
to affiliates of a few PDCF-eligible institutions and did not provide
written guidance to Reserve Banks on types of program decisions that
would benefit from consultation with the Federal Reserve Board. In
2009, FRBNY allowed one entity to continue to issue to the Commercial
Paper Funding Facility, even though a change in program terms by the
Federal Reserve Board likely would have made it ineligible. FRBNY
staff said they consulted the Federal Reserve Board regarding this
situation, but did not document this consultation and did not have any
formal guidance as to whether such continued use required approval by
the Federal Reserve Board. To better ensure an appropriate level of
transparency and accountability for decisions to extend or restrict
access to emergency assistance, GAO recommends that the Federal
Reserve Board set forth its process for documenting its rationale for
emergency authorizations and document its guidance to Reserve Banks on
program decisions that require consultation with the Federal Reserve
Board.
Table: List of Federal Reserve Emergency Programs and Assistance
Covered by this GAO Review:
Broad-based programs:
Programs and Assistance: TAF - Term Auction Facility (Dec. 12, 2007–
Mar. 8, 2010);
Peak dollar amount outstanding: $493 billion;
Balance as of 6/29/11: $0;
Description: Auctioned one-month and three-month discount window loans
to eligible depository institutions.
Programs and Assistance: Dollar Swap Lines (Dec. 12, 2007–Feb. 1,
2010[A]);
Peak dollar amount outstanding: $586 billion;
Balance as of 6/29/11: $0;
Description: Exchanged dollars with foreign central banks for foreign
currency to help address disruptions in dollar funding markets abroad.
Programs and Assistance: TSLF - Term Securities Lending Facility (Mar.
11, 2008–Feb. 1, 2010);
Peak dollar amount outstanding: $236 billion;
Balance as of 6/29/11: $0;
Description: Auctioned loans of U.S. Treasury securities to primary
dealers against eligible collateral.
Programs and Assistance: PDCF - Primary Dealer Credit Facility (Mar.
16, 2008–Feb. 1, 2010);
Peak dollar amount outstanding: $130 billion;
Balance as of 6/29/11: $0;
Description: Provided overnight cash loans to primary dealers against
eligible collateral.
Programs and Assistance: AMLF - Asset-Backed Commercial Paper Money
Market Mutual Fund Liquidity Facility (Sept. 19, 2008–Feb. 1, 2010);
Peak dollar amount outstanding: $152 billion;
Balance as of 6/29/11: $0;
Description: Provided loans to depository institutions and their
affiliates to finance purchases of eligible asset-backed commercial
paper from money market mutual funds.
Programs and Assistance: CPFF - Commercial Paper Funding Facility
(Oct. 7, 2008–Feb. 1, 2010);
Peak dollar amount outstanding: $348 billion;
Balance as of 6/29/11: $0;
Description: Provided loans to a special purpose vehicle to finance
purchases of new issues of asset-backed commercial paper and unsecured
commercial paper from eligible issuers.
Programs and Assistance: MMIFF - Money Market Investor Funding
Facility (Oct. 21, 2008 but never used);
Peak dollar amount outstanding: No loans provided;
Balance as of 6/29/11: $0;
Description: Created to finance the purchase of eligible short-term
debt obligations held by money market mutual funds.
Programs and Assistance: TALF - Term Asset-Backed Securities Loan
Facility (Nov. 25, 2008–June 30, 2010);
Peak dollar amount outstanding: $48 billion;
Balance as of 6/29/11: $13 billion;
Description: Provided loans to eligible investors to finance purchases
of eligible asset-backed securities.
Assistance to Individual Institutions:
Programs and Assistance: Bear Stearns Companies, Inc. acquisition by
JP Morgan Chase & Co. (JPMC): Bridge Loan (Mar. 14, 2008–Mar. 17,
2008);
Peak dollar amount outstanding: $13 billion;
Balance as of 6/29/11: $0;
Description: Overnight loan provided to JPMC subsidiary, with which
this subsidiary made a direct loan to Bear Stearns Companies, Inc.
Programs and Assistance: Bear Stearns Companies, Inc. acquisition by
JP Morgan Chase & Co. (JPMC): Maiden Lane (Mar. 16, 2008);
Peak dollar amount outstanding: $29 billion;
Balance as of 6/29/11: $22 billion;
Description: Special purpose vehicle created to purchase approximately
$30 billion of Bear Stearns’s mortgage-related assets.
Programs and Assistance: AIG Assistance: Revolving Credit Facility
(Sept. 16, 2008–Jan. 14, 2011);
Peak dollar amount outstanding: $72 billion;
Balance as of 6/29/11: $0;
Description: Revolving loan for the general corporate purposes of AIG
and its subsidiaries, and to pay obligations as they came due.
Programs and Assistance: AIG Assistance: Securities Borrowing Facility
(Oct. 8, 2008–Dec. 12, 2008);
Peak dollar amount outstanding: $21 billion;
Balance as of 6/29/11: $0;
Description: Provided collateralized cash loans to reduce pressure on
AIG to liquidate residential mortgage-backed securities (RMBS) in its
securities lending portfolio.
Programs and Assistance: AIG Assistance: Maiden Lane II (Nov. 10,
2008);
Peak dollar amount outstanding: $20 billion;
Balance as of 6/29/11: $9 billion;
Description: Special purpose vehicle created to purchase RMBS from
securities lending portfolios of AIG subsidiaries.
Programs and Assistance: AIG Assistance: Maiden Lane III (Nov. 10,
2008);
Peak dollar amount outstanding: $24 billion;
Balance as of 6/29/11: $12 billion;
Special purpose vehicle created to purchase collateralized debt
obligations on which AIG Financial Products had written credit default
swaps.
Programs and Assistance: AIG Assistance: Life Insurance Securitization
(March 2, 2009 but never implemented);
Peak dollar amount outstanding: Not used;
Balance as of 6/29/11: $0;
Description: Authorized to provide credit to AIG that would be repaid
with cash flows from its life insurance businesses.
Programs and Assistance: Loans to affiliates of some primary dealers
(Sept. 21, 2008–Feb. 1, 2010);
Peak dollar amount outstanding: $41 billion;
Balance as of 6/29/11: $0;
Description: Loans provided to broker-dealer affiliates of four
primary dealers on terms similar to those for PDCF.
AIG Assistance: Citigroup Inc. lending commitment (Nov. 23, 2008–Dec.
2009);
Peak dollar amount outstanding: No loans provided;
Balance as of 6/29/11: $0;
Description: Commitment to provide non-recourse loan to Citigroup
against ring-fence assets if losses on asset pool reached $56.2
billion.
AIG Assistance: Bank of America Corporation lending commitment (Jan.
16, 2009–Sept. 2009).
Peak dollar amount outstanding: No loans provided.
Balance as of 6/29/11: $0.
Description: Commitment to provide non-recourse loan facility to Bank
of America if losses on ring fence assets exceeded $18 billion
(agreement never finalized).
Open Market Operations:
AIG Assistance: Agency Mortgage-Backed Securities purchase program
(Nov. 25, 2008–Mar. 31, 2010);
Peak dollar amount outstanding: $1.250 trillion total purchases;
Balance as of 6/29/11: $909 billion (remaining principal balance);
Description: Purchased agency mortgage-backed securities to provide
support to mortgage and housing markets and to foster improved
conditions in the financial markets more generally.
Source: Federal Reserve Board Statistical Release
H.4.1 and Federal Reserve Board documents.
Note: Dates in parentheses are the program announcement dates, and
where relevant, the date the program or assistance was closed or
terminated. On October 3, 2008, the Federal Reserve Board authorized
the Direct Money Market Mutual Fund Lending Facility (DMLF)and
rescinded this authorization one week later. DMLF was not implemented.
[A] Some dollar swap lines reopened in May 2010.
[End of section]
What GAO Recommends:
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.
View [hyperlink, http://www.gao.gov/products/GAO-11-696] or key
components. For more information, contact Orice Williams Brown, 202-
512-8678 or williamso@gao.gov.
[End of section]
Contents:
Letter:
Scope and Methodology:
Background:
Overview of the Federal Reserve System:
Financial Crisis:
The Federal Reserve Board Used Emergency and Other Authorities to
Authorize Liquidity Programs to Stabilize Markets and Institutions:
In December 2007, the Federal Reserve Board Created TAF and Opened
Swap Lines under Nonemergency Authorities to Address Global Strains in
Interbank Lending Markets:
In March 2008, the Federal Reserve Board Invoked Emergency Authority
to Facilitate Sale of Bear Stearns and Expansion of Liquidity Support
to Primary Dealers:
In Fall 2008, the Federal Reserve Board Modified Existing Programs and
Launched Additional Programs to Support Other Key Markets:
In Late 2008 and Early 2009, the Federal Reserve Board Announced Its
Participation in Government Assistance to Individual Institutions:
In 2009 and 2010, FRBNY Executed Large-Scale Purchases of Agency MBS
to Provide Broader Support to the Economy:
Most Programs Were Extended a Few Times before Closing in Early 2010:
The Federal Reserve System and Its Emergency Activities Were Subject
to Multiple Audits and Reviews:
The Emergency Programs Have All Been Subject to Audits and Reviews:
Audits and Reviews Have Not Identified Significant Accounting or
Financial Reporting Internal Control Issues Concerning the Emergency
Programs:
The Federal Reserve System's External Auditor Revised the Approach and
Scope of Its Audits to Address the Emergency Programs:
Reserve Banks Would Benefit From Strengthening Guidance for
Noncompetitive Contracts Awarded in Exigent Circumstances:
Reserve Banks Relied Extensively on Vendors to Establish and Operate
the Emergency Programs, Particularly Those Designed to Assist Single
Institutions:
Reserve Banks Awarded Largest Contracts Noncompetitvely and Would
Benefit From Additional Guidance on Seeking Competition:
Vendor Fees Generally Came from Program Income or Participants:
While FRBNY Took Steps to Manage Conflicts of Interest for Employees,
Directors, and Program Vendors, Opportunities Exist to Strengthen
Conflict Policies:
During the Crisis, FRBNY Expanded Its Efforts to Manage Employee
Conflicts:
FRBNY Primarily Used Contract Protections to Manage Risks Related to
Vendor Conflicts, and the Lack of a Comprehensive Policy Created
Certain Limitations:
Reserve Bank Directors Are Generally Subject to the Same Conflict
Rules as Federal Employees and a Few Directors Played a Limited Role
in Risk Oversight of the Programs:
Opportunities Exist to Strengthen Risk Management Policies and
Practices for Future Emergency Programs:
Programs Contained Multiple Loss Protection Features Aimed at
Balancing Loss Protections with Financial Stability Goals:
Emergency Programs That Have Closed Have Not Incurred Losses and the
Federal Reserve Board Expects No Losses on Those With Outstanding
Balances:
While Reserve Banks Strengthened Controls and Risk Management over
Time, Opportunities Exist to Further Strengthen Policies for Future
Emergency Programs:
While Emergency Programs and Assistance Impact Excess Earnings to
Treasury, the Federal Reserve Board Does Not Formally Make Projections
for Several Reasons:
While the Federal Reserve Board Took Steps to Promote Consistent
Treatment of Participants, It Lacked Guidance and Documentation for
Some Access Decisions:
The Federal Reserve Board Designed Program Eligibility Requirements to
Target Assistance to Groups of Institutions Facing Liquidity Strains:
While Reserve Banks Generally Offered the Same Terms to Eligible
Participants, Some Programs Lacked Documented Procedures to
Systematically Apply Special Restrictions:
The Federal Reserve Board Did Not Fully Document the Basis for
Extending Credit to a Few Affiliates of Primary Dealers:
The Federal Reserve Board Generally Has Not Provided Documented
Guidance to Reserve Banks on Types of Program Decisions That Require
Consultation with the Federal Reserve Board:
The Federal Reserve Board Took Steps to Prevent Use that Would Be
Inconsistent with Its Policy Objectives:
Conclusions:
Recommendations for Executive Action:
Agency Comments and Our Evaluation:
Appendix I: Agency Mortgage-Backed Securities Purchase Program:
Appendix II: Asset-Backed Commercial Paper Money Market Mutual Fund
Liquidity Facility:
Appendix III: Assistance to American International Group, Inc.
Appendix IV: Assistance to Facilitate Private Sector Acquisition of
Bear Stearns Companies, Inc.
Appendix V: Bank of America Corporation Lending Commitment:
Appendix VI: Citigroup Inc. Lending Commitment:
Appendix VII: Commercial Paper Funding Facility:
Appendix VIII: Direct Money Market Mutual Fund Lending Facility:
Appendix IX: Dollar Swap Lines with Foreign Central Banks:
Appendix X: Money Market Investor Funding Facility:
Appendix XI: Primary Dealer Credit Facility and Credit Extensions for
Affiliates of Primary Dealers:
Appendix XII: Term Asset-Backed Securities Loan Facility:
Appendix XIII: Term Auction Facility:
Appendix XIV: Term Securities Lending Facility:
Appendix XV: Comments from the Board of Governors of the Federal
Reserve System:
Appendix XVI: GAO Contact and Staff Acknowledgments:
Glossary of Terms:
Related GAO Products:
Tables:
Table 1: List of Federal Reserve Emergency Programs and Assistance
Covered by Our Review:
Table 2: Summary of Extensions for Broad-Based Emergency Programs:
Table 3: COSO's Internal Control Framework:
Table 4: Number of Contracts and Fees Paid, By Emergency Program,
Calendar Years 2008-2010:
Table 5: Summary of Terms and Conditions for TAF, TSLF, and PDCF:
Table 6: Summary of Terms and Conditions for AMLF, MMIFF, CPFF, and
TALF:
Table 7: Summary of Reserve Bank Practices for Applying Special
Restrictions to Some Borrowers:
Table 8: Institutions with Largest Total Transaction Amounts (Not Term-
Adjusted) across Broad-Based Emergency Programs (Borrowing Aggregated
by Parent Company and Includes Sponsored ABCP Conduits), December 1,
2007 through July 21, 2010:
Table 9: Institutions with Largest Total Term-Adjusted Borrowing
across Broad-Based Emergency Programs, December 1, 2007 through July
21, 2010:
Table 10: Total Agency MBS Purchases by Investment Manager, January
2009-July 2010:
Table 11: Vendors for Agency MBS Program that Earned Fees Greater than
$1 Million, 2008-2010:
Table 12: Largest AMLF Borrowers by Total Dollar Amount of Loans:
Table 13: Largest MMMF (Aggregated by Fund Family) Sellers of Asset-
Backed Commercial Paper through AMLF:
Table 14: Vendors for AIG RCF that Earned Fees Greater than $1
Million, 2008-2010:
Table 15: Vendors for Maiden Lane II LLC that Earned Fees Greater than
$1 Million, 2008-2010:
Table 16: Vendors for Maiden Lane III LLC that Earned Fees Greater
than $1 Million, 2008-2010:
Table 17: Vendors for Maiden Lane LLC that Earned Fees Greater than $1
Million, 2008-2010:
Table 18: Vendors for Bank of America Lending Commitment that Earned
Fees Greater than $1 Million, 2008-2010:
Table 19: Vendors for Citigroup Inc. Lending Commitment that Earned
Fees Greater than $1 Million, 2008-2010:
Table 20: Top 25 Largest CPFF Borrowers:
Table 21: Interest rates for CPFF:
Table 22: Vendors for Commercial Paper Funding Facility That Earned
Fees Greater than $1 Million:
Table 23: Announcement Dates for FRBNY's Dollar Swap Lines with
Foreign Central Banks:
Table 24: Foreign Central Banks' Use of Dollar Swap Lines by Aggregate
Dollar Transactions:
Table 25: Largest PDCF Borrowers by Total Dollar Amount of Loans:
Table 26: Total Amounts Borrowed by London-based Affiliates of Primary
Dealers:
Table 27: Top 20 Largest TALF Borrowers:
Table 28: TALF Haircuts by Asset Class:
Table 29: Vendors for TALF That Earned Fees Greater than $1 Million:
Table 30: Top 25 Largest TAF Borrowers at the Parent Company Level:
Table 31: Largest TSLF Borrowers by Total Dollar Amount of Loans
(Includes TOP Loans):
Figures:
Figure 1: Timeline of Federal Reserve Emergency Actions, December 2007-
June 2010:
Figure 2: Financial Reporting of the Federal Reserve's Emergency
Programs:
Figure 3: Audit and Review Coverage of the Emergency Programs:
Figure 4: Number of Contracts and Fees Paid, by Procurement Method,
2008-2010:
Figure 5: Comparison of the Transaction Structures for Maiden Lane
LLC, Maiden Lane II LLC, and Maiden Lane III LLC:
Figure 6: Coverage Ratios for Maiden Lane, Maiden Lane II, and Maiden
Lane III, July 2008-June 29, 2011:
Figure 7: Organizational Structure of FRBNY's Financial Risk
Management Division, as of January 2011:
Figure 8: Risk Escalation Protocols for Oversight of Maiden Lane
Portfolios, as of June 2010:
Figure 9: Federal Reserve Board Excess Earnings Distributed to
Treasury, 2001-2010:
Figure 10: Total Transaction Amount by Parent Company Country of
Domicile for TAF and CPFF:
Figure 11: Total Loans Outstanding for Broad-Based Programs, December
1, 2007-June 29, 2011:
Figure 12: Overview of Agency MBS Program:
Figure 13: Changes in Agency MBS Spreads (Fannie Mae) and 30-Year
Mortgage Rates, September 2008-September 2010:
Figure 14: Overview of AMLF:
Figure 15: Structure of the AMLF:
Figure 16: FRBNY Revolving Credit Facility Balance Owed and Total
Amount Available, October 2008-December 1, 2010:
Figure 17: Overview of AIG SBF:
Figure 18: Maiden Lane II LLC Transaction:
Figure 19: Maiden Lane III LLC Transaction:
Figure 20: FRBNY Bridge Loan to Bear Stearns:
Figure 21: Maiden Lane LLC Transaction:
Figure 22: Structure of Loss Sharing Agreement with Citigroup:
Figure 23: Overview of CPFF:
Figure 24: Structure of CPFF:
Figure 25: Overview of Dollar Swap Lines with Foreign Central Banks:
Figure 26: Dollar Swap Line Transaction:
Figure 27: Five MMIFF SPVs and Approved Financial Institutions for
Each:
Figure 28: Structure of the MMIFF:
Figure 29: Overview of PDCF and Credit Extensions for Affiliates of
Primary Dealers:
Figure 30: Structure of the PDCF:
Figure 31: Overview of TALF:
Figure 32: Overview of TAF:
Figure 33: Bid Coverage Ratio for TAF Auctions, December 2007-March
2010:
Figure 34: Overview of TSLF:
Figure 35: Structure of the TSLF:
Abbreviations:
ABCP: asset-backed commercial paper:
Agency MBS program: Agency Mortgage-Backed Securities Purchase Program:
AIG: American International Group, Inc.
AIGFP: AIG Financial Products Corp.
AMLF: Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity
Facility:
Bank of America: Bank of America Corporation:
Bear Stearns: Bear Stearns Companies, Inc.
Citigroup: Citigroup Inc.
CDO: collateralized debt obligation:
COSO: Committee of Sponsoring Organizations of the Treadway Commission:
CPFF: Commercial Paper Funding Facility:
CRM: Credit Risk Management group:
Deloitte: Deloitte & Touche LLP:
DENTS: Dollars at risk in Event of Need to Terminate under Stress:
DMLF: Direct Money Market Mutual Fund Lending Facility:
Dodd-Frank Act: Dodd-Frank Wall Street Reform and Consumer Protection
Act:
FAR: Federal Acquisition Regulation:
FDIC: Federal Deposit Insurance Corporation:
Federal Reserve Board: Board of Governors of the Federal Reserve
System:
FOMC: Federal Open Market Committee:
FRBB: Federal Reserve Bank of Boston:
FRBNY: Federal Reserve Bank of New York:
FRBR: Federal Reserve Bank of Richmond:
GAAP: U.S. generally accepted accounting principles:
GE: General Electric Company:
Goldman Sachs: Goldman Sachs Group Inc.
JPMC: JP Morgan Chase & Co.
KPMG: KPMG LLP:
Lehman Brothers: Lehman Brothers Holdings Inc.
LLC: limited liability corporation:
MBS: mortgage-backed securities:
Merrill Lynch: Merrill Lynch & Co.
MMIFF: Money Market Investor Funding Facility:
MMMF: money market mutual fund:
NRSRO: Nationally Recognized Statistical Rating Organization:
OIG: Federal Reserve Board Office of the Inspector General:
PDCF: Primary Dealer Credit Facility:
PIMCO: Pacific Investment Management Company LLC:
RCF: revolving credit facility:
RFP: request-for-proposal:
RBOPS: Reserve Bank Operations and Payment Systems:
SBF: securities borrowing facility:
SPV: special purpose vehicle:
TAF: Term Auction Facility:
TALF: Term Asset-Backed Securities Loan Facility:
TARP: Troubled Asset Relief Program:
TLGP: Temporary Liquidity Guarantee Program:
TSLF: Term Securities Lending Facility:
Treasury: Department of the Treasury:
[End of section]
United States Government Accountability Office:
Washington, DC 20548:
July 21, 2011:
Congressional Addressees:
The Federal Reserve System, which consists of the Board of Governors
of the Federal Reserve System (Federal Reserve Board)--a federal
agency--and 12 regional Reserve Banks, played a key role in the U.S.
government's policy responses to the financial crisis that began in
summer 2007.[Footnote 1] From late 2007 through mid-2010, Reserve
Banks provided more than a trillion dollars in emergency loans to the
financial sector to address strains in credit markets and to avert
failures of individual institutions believed to be a threat to the
stability of the financial system. The scale and nature of this
assistance amounted to an unprecedented expansion of the Federal
Reserve System's traditional role as lender-of-last-resort to
depository institutions. In March 2008, the Federal Reserve Board
cited "unusual and exigent circumstances" in invoking its emergency
authority under section 13(3) of the Federal Reserve Act of 1913 to
authorize a Reserve Bank to extend credit to nondepository
institutions and for the first time since the Great Depression, a
Reserve Bank extended credit under this authority. The Federal Reserve
Board would invoke this authority on three other occasions within that
month, including in connection with facilitating the sale of Bear
Stearns Companies, Inc. (Bear Stearns), and on several occasions in
late 2008 when the failure of Lehman Brothers Holdings Inc. (Lehman
Brothers) triggered a severe intensification of the financial crisis
[Footnote 2]. Many of the emergency programs established under this
authority were intended to address unprecedented disruptions in key
nonbank funding markets that together had come to rival the banking
sector in facilitating loans to consumers and businesses. The Federal
Reserve Bank of New York (FRBNY), which operated most of these
programs under authorization from the Federal Reserve Board, faced a
number of unique operational challenges related to implementation and
oversight for numerous emergency programs, many of which required
large vendor procurements to fill gaps in Federal Reserve System
expertise. To date, most of the Reserve Banks' emergency loans have
been repaid, and FRBNY projects repayment on all outstanding loans.
During and after the crisis, some members of Congress and others
expressed concern that certain details of the Federal Reserve System's
emergency lending activities, including the names of borrowers
receiving loans, were kept confidential.[Footnote 3] In addition,
certain ties between Reserve Banks and financial institutions, such as
those with a director on a Reserve Bank's board of directors, raised
questions about whether the Federal Reserve System took appropriate
steps to prevent favoritism and mitigate conflicts of interest. Title
XI of the Dodd-Frank Wall Street Reform and Consumer Protection Act
(Dodd-Frank Act) contains provisions intended to enhance transparency
and accountability related to the Federal Reserve System's emergency
lending activities.[Footnote 4] The Dodd-Frank Act granted us new
authority to audit certain Federal Reserve System lending activities
and required us to conduct a one-time audit of emergency loans and
other assistance provided by the Federal Reserve System from December
1, 2007, through July 21, 2010, the enactment date of the act.
Specifically, the Dodd-Frank Act directed us to review all programs
created as a result of section 13(3) of the Federal Reserve Act as
well as specified programs authorized under other Federal Reserve Act
provisions. It did not grant us authority to review discount window
loans made before enactment. Accordingly, this report does not cover
the Federal Reserve System's discount window lending during the recent
financial crisis.[Footnote 5] Table 1 lists all programs covered by
our review, including the broad-based programs and assistance extended
to individual institutions.
Table 1: List of Federal Reserve Emergency Programs and Assistance
Covered by Our Review:
Broad-based programs:
Programs and assistance: Term Auction Facility (Dec. 12, 2007);
Status: Closed on March 8, 2010;
Description: Auctioned one-month and three-month discount window loans
to eligible depository institutions.
Programs and assistance: Dollar Swap Lines (Dec. 12, 2007);
Closed on February 1, 2010 (some reopened in May 2010);
Description: Exchanged dollars with foreign central banks for foreign
currency to help address disruptions in dollar funding markets abroad.
Programs and assistance: Term Securities Lending Facility (Mar. 11,
2008);
Status: Closed on February 1, 2010;
Description: Auctioned loans of U.S. Treasury securities to primary
dealers against eligible collateral.
Programs and assistance: Primary Dealer Credit Facility (Mar. 16,
2008);
Status: Closed on February 1, 2010;
Description: Provided overnight cash loans to primary dealers against
eligible collateral.
Programs and assistance: Asset-Backed Commercial Paper Money Market
Mutual Fund Liquidity Facility (Sept. 19, 2008);
Status: Closed on February 1, 2010;
Description: Provided loans to depository institutions and their
affiliates to finance purchases of eligible asset-backed commercial
paper from money market mutual funds.
Programs and assistance: Commercial Paper Funding Facility (Oct. 7,
2008);
Status: Closed on February 1, 2010;
Description: Provided loans to a special purpose vehicle to finance
purchases of new issues of asset-backed commercial paper and unsecured
commercial paper from eligible issuers.
Programs and assistance: Money Market Investor Funding Facility (Oct.
21, 2008, but never used);
Status: Closed on October 30, 2009;
Description: Created to finance the purchase of eligible short-term
debt obligations held by money market mutual funds.
Programs and assistance: Term Asset-Backed Securities Loan Facility
(Nov. 25, 2008);
Status: Closed; $13 billion outstanding;
Description: Provided loans to eligible investors to finance purchases
of eligible asset-backed securities.
Assistance to individual institutions:
Bear Stearns Companies, Inc. acquisition by JP Morgan Chase & Co.:
Bridge Loan (Mar. 14, 2008);
Status: Repaid on March 17, 2008;
Description: Overnight loan provided to JP Morgan Chase & Co. bank
subsidiary, with which this subsidiary made a direct loan to Bear
Stearns Companies, Inc.
Bear Stearns Companies, Inc. acquisition by JP Morgan Chase & Co.:
Maiden Lane (Mar. 16, 2008);
Status: $22 billion outstanding;
Description: Special purpose vehicle created to purchase approximately
$30 billion of Bear Stearns's mortgage-related assets.
American International Group, Inc. (AIG):
Programs and assistance: Revolving Credit Facility (Sept. 16, 2008);
Status: Repaid on January 14, 2011;
Description: Revolving loan for the general corporate purposes of AIG
and its subsidiaries, and to pay obligations as they came due.
Programs and assistance: Securities Borrowing Facility (Oct. 8, 2008);
Status: Closed on December 12, 2008;
Description: Provided collateralized cash loans to reduce pressure on
AIG to liquidate residential mortgage-backed securities (RMBS) in its
securities lending portfolio.
Programs and assistance: Maiden Lane II (Nov.10, 2008);
Status: $9 billion outstanding;
Description: Special purpose vehicle created to purchase RMBS from the
securities lending portfolio of AIG subsidiaries.
Programs and assistance: Maiden Lane III (Nov.10, 2008);
Status: $12 billion outstanding;
Description: Special purpose vehicle created to purchase
collateralized debt obligations on which AIG Financial Products had
written credit default swaps.
Programs and assistance: Life Insurance Securitization; (March 2,
2009, but never used);
Status: Never used;
Description: Authorized to provide credit to AIG that would be repaid
with cash flows from its life insurance businesses.
Programs and assistance: Credit extensions to affiliates of some
primary dealers (Sept. 21, 2008);
Status: Closed on February 1, 2010;
Description: Loans provided to broker-dealer affiliates of four
primary dealers on terms similar to those for Primary Dealer Credit
Facility.
Programs and assistance: Citigroup lending commitment (Nov. 23, 2008);
Status: Terminated in December 2009;
Description: Commitment to provide nonrecourse loan to Citigroup
against ring-fence assets if losses on asset pool reached $56.2
billion.
Programs and assistance: Bank of America lending commitment (Jan. 16,
2009);
Status: Terminated in September 2009;
Description: Commitment to provide nonrecourse loan facility to Bank
of America if losses on ring-fence assets exceeded $18 billion
(agreement never finalized).
Open market operations:
Programs and assistance: Agency Mortgage-Backed Securities Purchase
Program (Nov. 25, 2008);
Status: Closed; $909 billion (remaining principal balance);
Description: Purchased agency mortgage-backed securities to provide
support to mortgage and housing markets and to foster improved
conditions in the financial markets more generally.
Source: Federal Reserve Board Statistical Release H.4.1 and Federal
Reserve Board documents.
Note: Dates in parentheses are the dates the programs were announced.
The outstanding balances for TALF, Maiden Lane, Maiden Lane II, Maiden
Lane III, and the Agency Mortgage-Back Security purchase program are
as reported in the Federal Reserve Board Statistical Release H.4.1 as
of June 29, 2011. Outstanding balances for the Maiden Lanes include
outstanding principal and accrued interest. On October 3, 2008, the
Federal Reserve Board authorized the Direct Money Market Mutual Fund
Lending Facility and rescinded this authorization 1 week later. This
program was not implemented.
[End of table]
Accordingly, for each of the emergency programs or actions, where
relevant, the objectives of this report are to: (1) describe the basis
and purpose for the establishment of the program; (2) assess the
Reserve Banks' controls over financial reporting and accounting; (3)
evaluate the Reserve Banks' policies and practices for the use,
selection, and payment of vendors; (4) evaluate the effectiveness of
policies and practices for identifying and managing conflicts of
interest for Reserve Bank employees, Reserve Bank vendors, and members
of Reserve Banks' boards of directors; (5) assess the effectiveness of
security and collateral policies in place to mitigate risk of losses;
and (6) examine the extent to which program implementation resulted in
consistent and equitable treatment of eligible participants.
Scope and Methodology:
To describe the basis and purpose for the establishment of the
programs, we reviewed documentation supporting the Federal Reserve
Board's authorizations for the emergency programs, Federal Reserve
System documents and press releases describing the purpose of the
programs, and other relevant program documentation, including
announced terms and conditions. We interviewed Federal Reserve System
officials and staff to obtain their perspectives on the basis and
purpose for each program. To illustrate financial and economic
conditions at the time these programs were authorized, we reviewed our
work on the financial crisis and reports and studies by the Federal
Reserve System, the Congressional Budget Office, the Congressional
Research Service, and others.
To assess Reserve Banks' controls over financial reporting and
accounting, we developed an audit strategy designed to leverage, to
the extent possible, the audit work performed by the Federal Reserve
System's external and internal auditors specific to the emergency
programs. To understand the audit coverage, including audit
requirements and audit oversight, of the accounting and financial
reporting internal controls over the emergency programs, we reviewed
relevant legislation and Federal Reserve System documentation. We also
interviewed Federal Reserve System officials, the Federal Reserve
Board's Office of the Inspector General (OIG), and internal and
external audit staff. To determine the extent of the audit coverage
over these programs, we evaluated the internal and external auditors'
scope of work. We reviewed relevant external audit reports, including
those issued by the Reserve Banks' independent external auditor,
Deloitte & Touche LLP (Deloitte), and GAO. We also reviewed relevant
reports issued by the Federal Reserve Board, Reserve Bank internal
audit functions, and OIG. To determine whether Deloitte's audit
conclusions pertaining to the accounting and financial reporting
internal controls over the emergency programs were appropriately
supported, we reviewed Deloitte's key audit documentation, including
audit strategy, planning, and accounting memoranda; internal control
and account balance testing audit procedures and results; and summary
memorandums. We evaluated the quality of this documentation against
relevant auditing standards. Our review was specific to the audit
documentation pertaining to the accounting and financial reporting
internal controls related to the emergency programs. We also reviewed
independent service auditors' reports on the internal controls over
the vendor organizations that provided custodial, administrative, or
accounting services to FRBNY for certain of its emergency programs and
determined whether FRBNY and Deloitte considered the results of the
independent service auditors' reports in planning and conducting their
audits and reviews.
To evaluate the Reserve Banks' policies and practices for the use,
selection, and payment of vendors, we analyzed acquisition policies
and guidance for FRBNY, the Federal Reserve Bank of Boston (FRBB), and
the Federal Reserve Bank of Richmond (FRBR) to understand how the
Reserve Banks used, selected, and paid vendors for the emergency
programs. We obtained and analyzed contract and vendor payment
information and interviewed Reserve Bank staff to determine the extent
to which the Reserve Banks used vendors for each program and the
services provided. We excluded some contracts for routine data
subscriptions and registration fees. We determined, based on
discussions with Reserve Bank staff and comparisons to other
information sources, that the data were sufficiently reliable for the
purposes of our review. To determine the processes and criteria for
selecting vendors, we interviewed bank staff and obtained and analyzed
source selection documents for significant contracts--defined as
contracts of more than $500,000 or that included work significant to
the creation or operation of each program. Finally, we obtained and
reviewed significant contracts and vendor payment information for all
contracts to determine the total amount and structure of vendor
payments and the source of funds used to pay vendors.
To evaluate the effectiveness of Reserve Bank polices and practices
for managing conflicts of interest, we reviewed information about the
roles played by Reserve Bank management and employees, vendors, and
Reserve Bank directors to identify relevant types of conflicts of
interest created by the establishment and operation of the emergency
programs. We reviewed relevant statutory prohibitions on conflicts of
interest that apply to federal government and Federal Reserve System
employees and federal government guidance for agencies' management of
employee conflicts of interest. Our review of conflict issues for
Reserve Bank employees and vendors focused on FRBNY, which implemented
most of the emergency actions. To determine how FRBNY mitigated
conflicts for its management and staff, we obtained and reviewed its
relevant policies, including its Code of Conduct, and steps it took to
help ensure compliance with these policies. Specifically, we reviewed
the extent to which FRBNY implemented additional guidance, training,
or other new practices to help ensure identification and management of
conflicts arising from its employees' involvement in the emergency
programs. We also obtained and reviewed documentation of the basis for
decisions on any waiver requests to allow FRBNY officials, staff, or
vendors to participate in decisions related to the programs that might
otherwise present a conflict of interest. We did not review
documentation related to employees' decisions to recuse themselves
from matters due to conflicts because such documentation is not
required by law or regulation. To determine steps taken by FRBNY to
ensure that its vendors identified and mitigated conflicts related to
their roles in helping to administer the emergency assistance, we
reviewed relevant vendor contract provisions, written vendor plans
documenting steps to identify and manage relevant conflicts,
documentation of on-site reviews of vendor firms to help ensure
compliance with conflict policies, and other relevant documentation.
We compared FRBNY's management of vendor conflicts issues to actions
taken by the Department of the Treasury (Treasury) to manage risks
related to vendor conflicts for its largest financial stability
program, the Troubled Asset Relief Program. We reviewed FRBNY's
conflict of interest policies to determine the extent to which these
policies have been revised to address any lessons learned from the
crisis. We also interviewed FRBNY's Ethics Officer and other staff on
the application of conflict of interest policies.
To assess the effectiveness of security and collateral policies in
place to mitigate risk of losses, we reviewed relevant documentation
and interviewed Federal Reserve System officials to identify key
features of security and collateral policies and determine how these
policies were designed to mitigate risk of losses for each emergency
program. We obtained and analyzed financial data to describe the level
of income and losses from the programs. We reviewed and corroborated
internal and external audit findings related to the effectiveness of
operational controls related to security and collateral policies and
reviewed the steps taken by the Reserve Banks to address any
recommendations based on these findings. For two programs, the Term
Auction Facility (TAF) and the Primary Dealer Credit Facility (PDCF),
we obtained and analyzed detailed collateral data to determine
compliance with program requirements for collateral. For example, we
examined the consistency of prices and haircuts applied to TAF and
PDCF collateral. For PDCF collateral data, the lack of sufficiently
detailed data documentation for some key pricing variables made it
difficult to draw reliable conclusions about whether assets pledged to
the PDCF as collateral were priced consistently. More broadly, we
obtained and analyzed documentation of steps taken by the Reserve
Banks to develop risk governance structures and practices needed to
manage the risks associated with the emergency programs and
assistance. For example, we reviewed relevant documentation and
interviewed Federal Reserve System officials to determine the extent
to which the Federal Reserve System estimated and monitored potential
losses from the emergency lending activities and documented its
procedures for managing program access for higher-risk borrowers.
Finally, given the impact of these activities on excess earnings that
the Federal Reserve Board remits to Treasury from its emergency
programs, we obtained and reviewed relevant documentation and
interviewed Federal Reserve Board staff. In addition, to determine the
broader implications of the Federal Reserve Board's practices for
projecting future excess earnings, we interviewed Treasury staff who
project the Federal Reserve Board's excess earnings. The scope of our
review of the security and collateral policies included the broad-
based programs and the loans provided to avert the failures of
specific institutions determined to be systemically significant. Our
scope for this objective did not include the Agency Mortgage-Backed
Securities Purchase Program (Agency MBS program), which did not
provide loans, and therefore required no collateral.
To examine the extent to which program implementation resulted in
consistent and equitable treatment of eligible participants, we
reviewed and analyzed documentation of the basis for the Federal
Reserve Board's decisions about which types of institutions would be
eligible to participate in the emergency programs. To determine the
extent to which the Reserve Banks offered the same terms and
conditions to all participants, which for some programs included
financial institutions affiliated with Reserve Bank directors, we
reviewed documentation of program terms and conditions and obtained
and analyzed program transaction data. Specifically, we reviewed
Reserve Banks' documentation of restrictions put in place for specific
institutions and analyzed program transaction data to determine the
extent to which other borrowing institutions received loans on terms
that deviated from the announced terms and conditions. For example, we
reviewed Reserve Bank documentation of the processes and basis for
exercising discretion about whether to restrict or deny program access
for some institutions to determine what steps were taken to help
ensure this discretion was exercised consistently. To assess whether
program use was consistent with the Federal Reserve Board's announced
policy objectives, we analyzed program transaction data to identify
significant trends in the use of the programs and reviewed relevant
studies by the Federal Reserve System and others to identify factors
that likely contributed to these trends. To understand factors
contributing to such trends, we also interviewed Federal Reserve
System staff and industry associations representing types of
institutions that were eligible to participate in the programs. To
identify the largest participants across the emergency programs, we
aggregated dollar transaction amounts for borrowing entities at the
parent company level. To account for differences in the terms over
which loans were outstanding, we multiplied each loan amount by the
number of days the loan was outstanding and divided this amount by the
number of days in a year (365). Our scope for this objective included
the broad-based programs and did not include the special assistance
provided to avert the failures of specific individual institutions.
For parts of our methodology that involved the analysis of computer-
processed data, we assessed the reliability of these data and
determined that they were sufficiently reliable for our purposes. Data
sets for which we conducted data reliability assessments include
Federal Reserve Board transaction data for the emergency programs and
assistance, data from releases of the Federal Reserve Board's weekly
statistical release H.4.1, FRBB data on the Asset-Backed Commercial
Paper Money Market Mutual Fund Liquidity Facility (AMLF), and FRBNY
data on other programs and assistance. To assess the reliability of
these data, we obtained written responses from the Reserve Banks to
questions about how they collected and maintained the integrity of
these data. For some program data, we interviewed Federal Reserve
System staff about steps they took to maintain the integrity and
reliability of program data. We believe that these data are
sufficiently reliable for the purpose of our analysis.
We conducted this performance audit from August 2010 to July 2011 in
accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe
that the evidence obtained provides a reasonable basis for our
findings and conclusions based on our audit objectives.
Background:
Overview of the Federal Reserve System:
The Federal Reserve Act of 1913 established the Federal Reserve System
as the country's central bank. The Federal Reserve Act made the
Federal Reserve System an independent, decentralized bank to better
ensure that monetary policy would be based on a broad economic
perspective from all regions of the country. The Federal Reserve Board
has defined the term "monetary policy" as the actions undertaken by a
central bank, such as the Federal Reserve System, to influence the
availability and cost of money and credit to help promote national
economic goals. The Federal Reserve Act of 1913, as amended, gave the
Federal Reserve System responsibility for setting monetary policy. The
Federal Reserve System consists of the Federal Reserve Board located
in Washington, D.C.; 12 Reserve Banks, which have 24 branches located
throughout the nation; and the Federal Open Market Committee (FOMC),
which is composed of the Board of Governors, as well as five Reserve
Bank presidents, serving on a rotating basis.
The Federal Reserve Board is a federal agency that is responsible for
maintaining the stability of financial markets; supervising financial
and bank holding companies, state-chartered banks that are members of
the Federal Reserve System, and the U.S. operations of foreign banking
organizations; and supervising the operations of the Reserve
Banks.[Footnote 6] The top officials of the Federal Reserve Board are
the seven members of the Board of Governors who are appointed by the
President and confirmed by the U.S. Senate. Although the Federal
Reserve Board is required to report to Congress on its activities, its
decisions do not have to be approved by either the President or
Congress.
Unlike the Federal Reserve Board, the Reserve Banks are not federal
agencies. Each Reserve Bank is a federally chartered corporation with
a board of directors. The membership of each Reserve Bank board of
directors is determined by a process intended to ensure that each bank
board represents the public and member banks in its district.[Footnote
7] Under the Federal Reserve Act, Reserve Banks are subject to the
general supervision of the Federal Reserve Board. The Federal Reserve
Board has delegated some of its responsibilities such as supervision
and regulation to the Reserve Banks. The Federal Reserve Act
authorizes the Reserve Banks to make discount window loans, execute
monetary policy operations at the direction of the FOMC, and examine
bank holding companies and member banks under rules and regulations
prescribed by the Federal Reserve Board. The Reserve Banks also
provide payment services, such as check clearing and wire transfers,
to depository institutions, Treasury, and government agencies.
The FOMC plays a central role in the execution of the Federal Reserve
System's monetary policy mandate to promote price stability and
maximum employment. The FOMC consists of the seven members of the
Board of Governors, the President of FRBNY, and four other Reserve
Bank presidents who serve on a rotating basis. The FOMC is responsible
for directing open market operations to influence the total amount of
money and credit available in the economy. FRBNY carries out FOMC
directives on open market operations by engaging in purchases or sales
of certain securities, typically U.S. government securities, in the
secondary market. FRBNY conducts these transactions through primary
dealers, a designated group of broker-dealers and banks that transact
with FRBNY in its conduct of open market operations. For example,
FRBNY purchases of U.S. government securities from a primary dealer
increase the supply of reserves in the banking system, which can lower
the federal funds rate--the interest rate that depository institutions
pay when they borrow unsecured loans of reserve balances overnight
from each other. FRBNY's sales of U.S. government securities to
primary dealers reduce the supply of reserves and can increase the
federal funds rate. Changes in the federal funds rate can have a
strong impact on other short-term interest rates.
Unlike federal agencies funded through congressional appropriations,
the Federal Reserve Board and the Reserve Banks are self-funded
entities that deduct their expenses from their revenue and transfer
the remaining amount to Treasury.[Footnote 8] Although the Federal
Reserve Board's primary mission is to support a stable economy, not to
maximize the amount transferred to Treasury, the Federal Reserve
System revenues contribute to total U.S. revenues, and deductions from
System revenues thus represent an indirect cost to U.S. taxpayers. As
discussed later in this report, the Federal Reserve System revenues
transferred to Treasury have increased substantially in recent years,
chiefly as a result of interest income earned from the Federal Reserve
System's large-scale emergency programs. To the extent that Reserve
Banks suffer losses on emergency loans, these losses would be deducted
from the excess earnings transferred to Treasury. If such losses were
to exceed a Reserve Bank's earnings, a Reserve Bank could reduce its
remittances to Treasury to zero. According to Federal Reserve System
officials, under an extreme scenario under which a Reserve Bank's
losses eroded all of its capital, a Reserve Bank could, in its
financial accounting, claim reductions in future remittances to
Treasury as an addition to current capital.[Footnote 9] Another option
for a Reserve Bank to replenish capital would be to request that its
member banks purchase additional stock in the Reserve Bank beyond the
amount required for membership in the Federal Reserve System under the
Federal Reserve Act.
Financial Crisis:
The recent financial crisis was the most severe that the United States
has experienced since the Great Depression. The dramatic decline in
the U.S. housing market that began in 2006 precipitated a decline in
the price of financial assets around mid-2007 that were associated
with housing, particularly mortgage-related assets based on subprime
loans. Some institutions found themselves so exposed that they were
threatened with failure--and some failed--because they were unable to
raise the necessary capital as the value of their portfolios declined.
Other institutions, ranging from government-sponsored enterprises such
as Fannie Mae and Freddie Mac to large securities firms, were left
holding "toxic" mortgages or mortgage-related assets that became
increasingly difficult to value, were illiquid, and potentially had
little worth. Moreover, investors not only stopped buying securities
backed by mortgages but also became reluctant to buy securities backed
by many other types of assets. Because of uncertainty about the
financial condition and solvency of financial entities, the prices
banks charged each other for funds rose dramatically, and interbank
lending effectively came to a halt. The resulting liquidity and credit
crisis made the financing on which businesses and individuals depend
increasingly difficult to obtain as cash-strapped banks held on to
their assets. By late summer of 2008, the potential ramifications of
the financial crisis included the continued failure of financial
institutions, increased losses of individual wealth, reduced corporate
investments, and further tightening of credit that would exacerbate
the emerging global economic slowdown that was beginning to take shape.
During the crisis, Congress, the President, federal regulators, and
others undertook a number of steps to facilitate financial
intermediation by banks and the securities markets. In addition to the
Federal Reserve Board's emergency programs, significant policy
interventions led by others included, but were not limited to, the
following:
* Troubled Asset Relief Program. On October 3, 2008, Congress passed
and the President signed the Emergency Economic Stabilization Act of
2008, which authorized Treasury to establish the Troubled Asset Relief
Program (TARP). Treasury's Capital Purchase Program was the primary
initiative under TARP for stabilizing the financial markets and
banking system. Treasury created the program in October 2008 to
stabilize the financial system by providing capital to qualifying
regulated financial institutions through the purchase of senior
preferred shares and subordinated debt.[Footnote 10] On October 14,
2008, Treasury allocated $250 billion of the $700 billion in overall
TARP funds for the Capital Purchase Program but adjusted its
allocation to $218 billion in March 2009 to reflect lower estimated
funding needs based on actual participation and the expectation that
institutions would repay their investments. The program was closed to
new investments on December 31, 2009, and, in total, Treasury invested
$205 billion in 707 financial institutions over the life of the
program.
* Temporary Liquidity Guarantee Program. In October 2008, the Federal
Deposit Insurance Corporation (FDIC) created the Temporary Liquidity
Guarantee Program (TLGP) to complement the Capital Purchase Program
and the Federal Reserve Board's Commercial Paper Funding Facility
(CPFF) and other liquidity programs in restoring confidence in
financial institutions and repairing their capacity to meet the credit
needs of American households and businesses.[Footnote 11] TLGP's Debt
Guarantee Program was designed to improve liquidity in term-funding
markets by guaranteeing certain newly issued senior unsecured debt of
financial institutions and their holding companies. Under the Debt
Guarantee Program, FDIC guaranteed more than $600 billion of newly
issued senior unsecured debt for insured depository institutions,
their holding companies, and qualified affiliates and provided
temporary unlimited coverage for certain non-interest-bearing
transaction accounts at insured institutions. TLGP's debt guarantee
program ceased issuing new guarantees on October 31, 2009.
The Federal Reserve Board Used Emergency and Other Authorities to
Authorize Liquidity Programs to Stabilize Markets and Institutions:
Between late 2007 and early 2009, the Federal Reserve Board created
more than a dozen new emergency programs to stabilize financial
markets and provided financial assistance to avert the failures of a
few individual institutions. The Federal Reserve Board authorized most
of this emergency assistance under emergency authority contained in
section 13(3) of the Federal Reserve Act.[Footnote 12] Three of the
programs covered by this review--TAF, dollar swap lines with foreign
central banks, and the Agency MBS program--were authorized under other
provisions of the Federal Reserve Act that do not require a
determination that emergency conditions exist, although the swap lines
and the Agency MBS program did require authorization by the FOMC. In
many cases, the decisions by the Federal Reserve Board, the FOMC, and
the Reserve Banks about the authorization, initial terms of, and
implementation of the Federal Reserve System's emergency assistance
were made over the course of only days or weeks as the Federal Reserve
Board sought to act quickly to address rapidly deteriorating market
conditions. FRBNY implemented most of these emergency activities under
authorization from the Federal Reserve Board. In 2009, FRBNY, at the
direction of the FOMC, began large-scale purchases of mortgage-backed
securities (MBS) issued by the housing government-sponsored
enterprises, Fannie Mae and Freddie Mac, or guaranteed by Ginnie
Mae.[Footnote 13] Purchases of these agency MBS were intended to
provide support to the mortgage and housing markets and to foster
improved conditions in financial markets more generally. Most of the
Federal Reserve Board's broad-based emergency programs closed on
February 1, 2010. Figure 1 provides a timeline for the establishment,
modification, and termination of Federal Reserve System emergency
programs subject to this review.
Figure 1: Timeline of Federal Reserve Emergency Actions, December 2007-
June 2010:
[Refer to PDF for image: timeline]
12/12/2007:
Announced creation of Term Auction Facility (TAF) and swap lines with
European Central Bank and Swiss National Bank.
12/17/207:
First TAF auction.
3/11/2008: Announced creation of Term Securities Lending Facility
(TSLF).
3/14/2008:
Bridge loan to Bear Stearns.
3/16/2008:
Announced $30B commitment to lend against Bear Stearns assets, and
creation of Primary Dealer Credit Facility (PDCF).
3/24/2008:
Announced revised structure for $29.8B loan to finance purchase of
Bear Stearns assets.
3/27/2008:
First TSLF auction.
5/2/2008:
Federal Reserve Board and Federal Open Market Committee (FOMC)
authorized expansion of TSLF collateral to include ABS receiving the
highest credit rating.
6/26/2008:
Maiden Lane transaction closed.
7/30/2008:
Federal Reserve Board and FOMC announced TSLF Options Program.
9/14/2008:
Eligible collateral expanded for both PDCF and TSLF.
9/16/2008:
Announced Revolving Credit Facility for AIG (AIG RCF).
9/18/2008::
FOMC authorized swap lines with Japan, United Kingdom, and Canada.
9/19/2008::
Announced creation of ABCP MMMF Liquidity Facility (AMLF).
9/24/2008::
Announced swap lines with Australia, Sweden, Norway, and Denmark.
10/6/2008::
Authorized Securities Borrowing Facility for AIG (AIG SBF).
10/7/2008::
Announced creation of Commercial Paper Funding Facility (CPFF).
10/21/2008::
Announced creation of Money Market Investor Funding Facility (MMIFF).
10/27/2008::
CPFF began purchases of commercial paper.
10/29/2008::
Announced swap lines with Brazil, Mexico, South Korea, and Singapore.
11/10/2008::
Federal Reserve Board announced restructuring of assistance to AIG,
resulting in Maiden Lane II and III.
11/23/2008::
Federal Reserve Board, Treasury, and FDIC announced lending commitment
for Citigroup, Inc. (Citigroup).
11/24/2008::
MMIFF became operational.
11/25/2008::
Announced creation of Term Asset-Backed Securities Loan Facility
(TALF) and agency mortgage-backed securities purchase program.
1/5/2009:
FRBNY began purchases of agency mortgage-backed securities.
1/15/2009:
FRBNY finalized agreement with Citigroup and Board authorized lending
commitment for Bank of America through FRB Richmond.
3/3/2009:
TALF launched.
6/25/2009:
AMLF rules amended to include redemption threshold for money market
funds.
10/30/2009:
MMIFF expired (MMIFF was never used).
2/1/2010:
Federal Reserve Board closed TSLF, PDCF, CPFF, and AMLF.
3/8/2010:
Final TAF auction.
3/31/2010:
TALF closed for all asset classes except commercial mortgage-backed
securities.
FRBNY completed the purchase phase of the agency MBS program.
5/10/2010:
Announced reestablishment of swap line with Japan.
5/11/2010:
Announced reestablishment of swap lines with the European Central
Bank, Switzerland, and the United Kingdom.
6/30/2010:
TALF closed for all asset classes.
Source: Federal Reserve System documents and press releases.
[End of figure]
In December 2007, the Federal Reserve Board Created TAF and Opened
Swap Lines under Nonemergency Authorities to Address Global Strains in
Interbank Lending Markets:
In the months before the authorization of TAF and new swap line
arrangements, which were the first of the emergency programs subject
to this review, the Federal Reserve Board took steps to ease emerging
strains in credit markets through its traditional monetary policy
tools. In late summer 2007, sudden strains in term interbank lending
markets emerged primarily due to intensifying investor concerns about
commercial banks' actual exposures to various mortgage-related
securities. The cost of term funding (loans provided at terms of 1
month or longer) spiked suddenly in August 2007, and commercial banks
increasingly had to borrow overnight to meet their funding needs.
[Footnote 14] The Federal Reserve Board feared that the disorderly
functioning of interbank lending markets would impair the ability of
commercial banks to provide credit to households and businesses. To
ease stresses in these markets, on August 17, 2007, the Federal
Reserve Board made two temporary changes to the terms at which Reserve
Banks extended loans through the discount window. First, it approved
the reduction of the discount rate--the interest rate at which the
Reserve Banks extended collateralized loans at the discount window--by
50 basis points.[Footnote 15] Second, to address specific strains in
term-funding markets, the Federal Reserve Board approved extending the
discount window lending term from overnight to up to 30 days, with the
possibility of renewal. According to a Federal Reserve Board study,
this change initially resulted in little additional borrowing from the
discount window.[Footnote 16] In addition to the discount window
changes, starting in September 2007, the FOMC announced a series of
reductions in the target federal funds rate--the FOMC-established
target interest rate that banks charge each other for loans. In
October 2007, tension in term funding subsided temporarily. However,
issues reappeared in late November and early December, possibly driven
in part by a seasonal contraction in the supply of year-end funding.
Term Auction Facility:
On December 12, 2007, the Federal Reserve Board announced the creation
of TAF to address continuing disruptions in U.S. term interbank
lending markets. The Federal Reserve Board authorized Reserve Banks to
extend credit through TAF by revising the regulations governing
Reserve Bank discount window lending. TAF was intended to help provide
term funding to depository institutions eligible to borrow from the
discount window.[Footnote 17] In contrast to the traditional discount
window program, which loaned funds to individual institutions at the
discount rate, TAF was designed to auction loans to many eligible
institutions at once at a market-determined interest rate (for a more
detailed explanation of TAF, see appendix XIII). Federal Reserve Board
officials noted that one important advantage of this auction approach
was that it could address concerns among eligible borrowers about the
perceived stigma of discount window borrowing.[Footnote 18] Federal
Reserve Board officials noted that an institution might be reluctant
to borrow from the discount window out of concern that its creditors
and other counterparties might become aware of its discount window use
and perceive it as a sign of distress. The auction format allowed
banks to approach the Reserve Banks collectively rather than
individually and obtain funds at an interest rate set by auction
rather than at a premium set by the Federal Reserve Board.[Footnote
19] Additionally, whereas discount window loan funds could be obtained
immediately by an institution facing severe funding pressures, TAF
borrowers did not receive loan funds until 3 days after the auction.
For these reasons, TAF-eligible borrowers may have attached less of a
stigma to auctions than to traditional discount window borrowing. The
first TAF auction was held on December 17, 2007, with subsequent
auctions occurring approximately every 2 weeks until the final TAF
auction on March 8, 2010.
Dollar Swap Lines:
Concurrent with the announcement of TAF, the FOMC announced the
establishment of dollar swap arrangements with two foreign central
banks to address similar disruptions in dollar funding markets abroad.
In a typical swap line transaction, FRBNY exchanged dollars for the
foreign central bank's currency at the prevailing exchange rate, and
the foreign central bank agreed to buy back its currency (to "unwind"
the exchange) at this same exchange rate at an agreed upon future date
(for a more detailed explanation, see appendix IX).[Footnote 20] The
market for interbank funding in U.S. dollars is global, and many
foreign banks hold U.S.-dollar-denominated assets and fund these
assets by borrowing in U.S. dollars. In contrast to U.S. commercial
banks, foreign banks did not hold significant U.S.-dollar deposits,
and as a result, dollar funding disruptions were particularly acute
for many foreign banks during the recent crisis. In December 2007, the
European Central Bank and Swiss National Bank requested dollar swap
arrangements with the Federal Reserve System to increase their ability
to provide U.S. dollar loans to banks in their jurisdictions. Federal
Reserve Board staff memoranda recommending that the FOMC approve these
swap arrangements noted that continuing tension in dollar funding
markets abroad could further exacerbate tensions in U.S. funding
markets.[Footnote 21] On December 6, 2007, the FOMC approved requests
from the European Central Bank and Swiss National Bank and authorized
FRBNY to establish temporary swap lines under section 14 of the
Federal Reserve Act.[Footnote 22] During 2008, the FOMC approved
temporary swap lines with 12 other foreign central banks.[Footnote 23]
FRBNY's swap lines with the 14 central banks closed on February 1,
2010. In May 2010, to address the re-emergence of strains in dollar
funding markets, FRBNY reopened swap lines with the Bank of Canada,
the Bank of England, the European Central Bank, the Bank of Japan, and
the Swiss National Bank through January 2011. On December 21, 2010,
the FOMC announced an extension of these lines through August 1, 2011.
On June 29, 2011, the Federal Reserve Board announced an extension of
these swap lines through August 1, 2012.
In March 2008, the Federal Reserve Board Invoked Emergency Authority
to Facilitate Sale of Bear Stearns and Expansion of Liquidity Support
to Primary Dealers:
In early March 2008, the Federal Reserve Board observed growing
tension in the repurchase agreement markets--large, short-term
collateralized funding markets--that many financial institutions rely
on to finance a wide range of securities. Under a repurchase
agreement, a borrowing institution generally acquires funds by selling
securities to a lending institution and agreeing to repurchase the
securities after a specified time at a given price. The securities, in
effect, are collateral provided by the borrower to the lender. In the
event of a borrower's default on the repurchase transaction, the
lender would be able to take (and sell) the collateral provided by the
borrower. Lenders typically will not provide a loan for the full
market value of the posted securities, and the difference between the
values of the securities and the loan is called a margin or haircut.
This deduction is intended to protect the lenders against a decline in
the price of the securities provided as collateral.[Footnote 24] In
early March, the Federal Reserve Board found that repurchase agreement
lenders were requiring higher haircuts for loans against a range of
securities and were becoming reluctant to lend against mortgage-
related securities. As a result, many financial institutions
increasingly had to rely on higher-quality collateral, such as U.S.
Treasury securities, to obtain cash in these markets, and a shortage
of such high-quality collateral emerged.[Footnote 25] In March 2008,
the Federal Reserve Board cited "unusual and exigent circumstances" in
invoking section 13(3) of the Federal Reserve Act to authorize FRBNY
to implement four emergency actions to address deteriorating
conditions in these markets: (1) TSLF, (2) a bridge loan to Bear
Stearns, (3) a commitment to lend up to $30 billion against Bear
Stearns assets that resulted in the creation of Maiden Lane LLC, and
(4) PDCF.
Term Securities Lending Facility:
On March 11, 2008, the Federal Reserve Board announced the creation of
the Term Securities Lending Facility (TSLF) to auction 28-day loans of
U.S. Treasury securities to primary dealers to increase the amount of
high-quality collateral available for these dealers to borrow against
in the repurchase agreement markets. Through competitive auctions that
allowed dealers to bid a fee to exchange harder-to-finance collateral
for easier-to-finance Treasury securities, TSLF was intended to
promote confidence among lenders and to reduce the need for dealers to
sell illiquid assets into the markets, which could have further
depressed the prices of these assets and contributed to a downward
price spiral.[Footnote 26] TSLF auctioned loans of Treasury securities
against two schedules of collateral. Schedule 1 collateral included
Treasury securities, agency debt, and agency MBS collateral that FRBNY
accepted in repurchase agreements for traditional open market
operations with primary dealers.[Footnote 27] Schedule 2 included
schedule 1 collateral as well as a broader range of assets, including
highly rated mortgage-backed securities.[Footnote 28] The Federal
Reserve Board determined that providing funding support for private
mortgage-backed securities through the schedule 2 auctions fell
outside the scope of FRBNY's authority to conduct its securities
lending program under section 14 of the Federal Reserve Act.
Accordingly, for the first time during this crisis, the Federal
Reserve Board invoked section 13(3) of the Federal Reserve Act to
authorize the extension of credit, in this case in the form of
Treasury securities, to nondepository institutions--in this case, the
primary dealers. As discussed later in this section, the Federal
Reserve Board later expanded the range of collateral eligible for TSLF
as the crisis intensified. TSLF closed on February 1, 2010. See
appendix XIV for a more detailed explanation of this program.
Bridge Loan to Bear Stearns:
Shortly following the announcement of TSLF, the Federal Reserve Board
invoked its emergency authority for a second time to authorize an
emergency loan to avert a disorderly failure of Bear Stearns.[Footnote
29] TSLF was announced on March 11, 2008, and the first TSLF auction
was held on March 27, 2008. Federal Reserve Board officials noted that
although TSLF was announced to address market tensions impacting many
firms, some market participants concluded that its establishment was
driven by specific concerns about Bear Stearns. Over a few days, Bear
Stearns experienced a run on its liquidity as many of its lenders grew
concerned that the firm would suffer greater losses in the future and
stopped providing funding to the firm, even on a fully secured basis
with high-quality assets provided as collateral.[Footnote 30] Late on
Thursday, March 13, 2008, the senior management of Bear Stearns
notified FRBNY that it would likely have to file for bankruptcy
protection the following day unless the Federal Reserve Board provided
the firm with an emergency loan. The Federal Reserve Board feared that
the sudden failure of Bear Stearns could have serious adverse impacts
on markets in which Bear Stearns was a significant participant,
including the repurchase agreements market. In particular, a Bear
Stearns failure may have threatened the liquidity and solvency of
other large institutions that relied heavily on short-term secured
funding markets. On Friday, March 14, 2008, the Federal Reserve Board
voted to authorize FRBNY to provide a $12.9 billion loan to Bear
Stearns through JP Morgan Chase Bank, National Association, the
largest bank subsidiary of JP Morgan Chase & Co. (JPMC), and to accept
$13.8 billion of Bear Stearns's assets as collateral.[Footnote 31]
Appendix IV includes more information about this back-to-back loan
transaction, which was repaid on Monday, March 17, 2008, with almost
$4 million of interest. This emergency loan enabled Bear Stearns to
avoid bankruptcy and continue to operate through the weekend. This
provided time for potential acquirers, including JPMC, to assess Bear
Stearns's financial condition and for FRBNY to prepare a new liquidity
program, PDCF, to address strains that could emerge from a possible
Bear Stearns bankruptcy announcement the following Monday. Federal
Reserve Board and FRBNY officials hoped that bankruptcy could be
averted by the announcement that a private sector firm would acquire
Bear Stearns and stand behind its liabilities when the markets
reopened on the following Monday.
Maiden Lane LLC:
On Sunday, March 16, 2008, the Federal Reserve Board announced that
FRBNY would lend up to $30 billion against certain Bear Stearns's
assets to facilitate JPMC's acquisition of Bear Stearns. Over the
weekend, JPMC had emerged as the only viable acquirer of Bear Stearns.
In congressional testimony, Timothy Geithner, who was the President of
FRBNY in March 2008, provided the following account:
Bear approached several major financial institutions, beginning on
March 13. Those discussions intensified on Friday and Saturday. Bear's
management provided us with periodic progress reports about a possible
merger. Although several different institutions expressed interest in
acquiring all or part of Bear, it was clear that the size of Bear, the
apparent risk in its balance sheet, and the limited amount of time
available for a possible acquirer to conduct due diligence compounded
the difficulty. Ultimately, only JPMorgan Chase was willing to
consider an offer of a binding commitment to acquire the firm and to
stand behind Bear's substantial short-term obligations.[Footnote 32]
According to FRBNY officials, on the morning of Sunday, March 16,
2008, JPMC's Chief Executive Officer told FRBNY that the merger would
only be possible if certain mortgage-related assets were taken off
Bear Stearns's balance sheet. Negotiations between JPMC and FRBNY
senior management resulted in a preliminary agreement under which
FRBNY would make a $30 billion nonrecourse loan to JPMC collateralized
by these Bear Stearns assets. A March 16, 2008, letter from then-FRBNY
President Geithner to JPMC's Chief Executive Officer documented the
terms of the preliminary agreement.[Footnote 33]
Significant issues that threatened to unravel the merger agreement
emerged soon after the announcement. Bear Stearns board members and
shareholders thought JPMC's offer to purchase the firm at $2 per share
was too low and threatened to vote against the merger. Perceived
ambiguity in the terms of the merger agreement raised further concerns
that JPMC could be forced to stand behind Bear Stearns's obligations
even in the event that the merger was rejected. Moreover, some Bear
Stearns counterparties stopped trading with Bear Stearns because of
uncertainty about whether JPMC would honor certain Bear Stearns
obligations. FRBNY also had concerns with the level of protection
provided under the preliminary lending agreement, under which FRBNY
had agreed to lend on a nonrecourse basis against risky collateral.
The risks of an unraveled merger agreement included a possible Bear
Stearns bankruptcy and losses for JPMC, which might have been legally
required to stand behind the obligations of a failed institution.
Recognizing the risk that an unraveled merger posed to JPMC and the
broader financial markets, FRBNY officials sought to renegotiate the
lending agreement.
During the following week, the terms of this agreement were
renegotiated, resulting in the creation of a new lending structure in
the form of Maiden Lane LLC. From March 17 to March 24, 2008, FRBNY,
JPMC, and Bear Stearns engaged in dual track negotiations to address
each party's concerns with the preliminary merger and lending
agreements. On March 24, 2008, FRBNY and JPMC agreed to a new lending
structure that incorporated greater loss protections for FRBNY.
Specifically, FRBNY created a special purpose vehicle (SPV), Maiden
Lane LLC, that used proceeds from a $28.82 billion FRBNY senior loan
and a $1.15 billion JPMC subordinated loan to purchase Bear Stearns's
assets. A more detailed discussion of the security and collateral
policies for Maiden Lane LLC appears later in this report and appendix
IV includes more details about the Maiden Lane LLC transaction.
Primary Dealer Credit Facility:
While one team of Federal Reserve Board and FRBNY staff worked on
options to avert a Bear Stearns failure, another team worked to ready
PDCF for launch by Monday, March 17, 2008, when Federal Reserve Board
officials feared a Bear Stearns bankruptcy announcement might trigger
runs on the liquidity of other primary dealers. As noted previously,
the liquidity support from TSLF would not become available until the
first TSLF auction later in the month. On March 16, 2008, the Federal
Reserve Board announced the creation of PDCF to provide overnight
collateralized cash loans to the primary dealers. FRBNY quickly
implemented PDCF by leveraging its existing legal and operational
infrastructure for its existing repurchase agreement relationships
with the primary dealers.[Footnote 34] Although the Bear Stearns
bankruptcy was averted, PDCF commenced operation on March 17, 2008,
and in its first week extended loans to 10 primary dealers. Bear
Stearns was consistently the largest PDCF borrower until June 2008.
Eligible PDCF collateral initially included collateral eligible for
open-market operations as well as investment-grade corporate
securities, municipal securities, and asset-backed securities,
including mortgage-backed securities. As discussed later, the Federal
Reserve Board authorized an expansion of collateral types eligible for
PDCF loans later in the crisis. This program was terminated on
February 1, 2010. See appendix XI for additional details about this
program.
In Fall 2008, the Federal Reserve Board Modified Existing Programs and
Launched Additional Programs to Support Other Key Markets:
In September 2008, the bankruptcy of Lehman Brothers triggered an
intensification of the financial crisis, and the Federal Reserve Board
modified the terms for its existing liquidity programs to address
worsening conditions. On September 14, 2008, shortly before Lehman
Brothers announced it would file for bankruptcy, the Federal Reserve
Board announced changes to TSLF and PDCF to provide expanded liquidity
support to primary dealers. Specifically, the Federal Reserve Board
announced that TSLF-eligible collateral would be expanded to include
all investment-grade debt securities and PDCF-eligible collateral
would be expanded to include all securities eligible to be pledged in
the tri-party repurchase agreements system, including noninvestment
grade securities and equities.[Footnote 35] In addition, TSLF schedule
2 auctions would take place weekly rather than only bi-weekly. On
September 21, 2008, the Federal Reserve Board announced that it would
extend credit--on terms similar to those applicable for PDCF loans--to
the U.S. and London broker-dealer subsidiaries of Merrill Lynch & Co.
(Merrill Lynch), Goldman Sachs Group Inc. (Goldman Sachs), and Morgan
Stanley to provide support to these subsidiaries as they became part
of bank holding companies that would be regulated by the Federal
Reserve System.[Footnote 36] On September 29, 2008, the Federal
Reserve Board also announced expanded support through TAF and the
dollar swap lines. Specifically, the Federal Reserve Board doubled the
amount of funds that would be available in each TAF auction cycle from
$150 billion to $300 billion, and the FOMC authorized a $330 billion
expansion of the swap line arrangements with foreign central banks.
In the months following Lehman's bankruptcy, the Federal Reserve Board
authorized several new liquidity programs under section 13(3) of the
Federal Reserve Act to provide support to other key funding markets,
such as the commercial paper and the asset-backed security markets. In
contrast to earlier emergency programs that represented relatively
modest extensions of established Federal Reserve System lending or
open market operation activities, these newer programs incorporated
more novel design features and targeted new market participants with
which the Reserve Banks had not historically transacted. As was the
case with the earlier programs, many of these newer programs were
designed and launched under extraordinary time constraints as the
Federal Reserve Board sought to address rapidly deteriorating market
conditions. In order of their announcement, these programs included:
(1) AMLF to provide liquidity support to money market mutual funds
(MMMF) in meeting redemption demands from investors and to foster
liquidity in the asset-backed commercial paper (ABCP) markets, (2)
CPFF to provide a liquidity backstop to eligible issuers of commercial
paper, (3) the Money Market Investor Funding Facility (MMIFF) to serve
as an additional backstop for MMMFs, and (4) the Term Asset-Backed
Securities Loan Facility (TALF) to assist certain securitization
markets that supported the flow of credit to households and businesses.
Asset-backed Commercial Paper Money Market Mutual Fund Liquidity
Facility:
On September 19, 2008, the Federal Reserve Board authorized FRBB to
establish AMLF to provide liquidity support to MMMFs facing redemption
pressures.[Footnote 37] According to FRBB staff, the processes and
procedures to implement AMLF were designed over the weekend before
FRBB commenced operation of AMLF on September 22, 2008. MMMFs were a
major source of short-term credit for financial institutions,
including through MMMFs' purchases and holdings of ABCP. ABCP
continued to be an important source of funding for many
businesses.[Footnote 38] Following the announcement that a large MMMF
had "broken the buck"--net asset value fell below $1 per share--as a
result of losses on Lehman's commercial paper, other MMMFs faced a
large wave of redemption requests as investors sought to limit their
potential exposures to the financial sector. The Federal Reserve Board
was concerned that attempts by MMMFs to raise cash through forced
sales of ABCP and other assets into illiquid markets could further
depress the prices of these assets and exacerbate strains in short-
term funding markets. AMLF's design, which relied on intermediary
borrowers to use Reserve Bank loans to fund the same-day purchase of
eligible ABCP from MMMFs, reflected the need to overcome practical
constraints in lending to MMMFs directly. According to Federal Reserve
System officials, MMMFs would have had limited capacity to borrow
directly from the Reserve Banks in amounts that would be sufficient to
meet redemption requests because of statutory and fund-specific
limitations on fund borrowing. To quickly support the MMMF market, the
Federal Reserve Board authorized loans to entities that conduct
funding and custodial activities with MMMFs to fund the purchase of
ABCP from MMMFs. Eligible borrowers were identified as discount-window-
eligible depository institutions (U.S. depository institutions and
U.S. branches and agencies of foreign banks) and U.S. bank holding
companies and their U.S. broker-dealer affiliates.[Footnote 39] The
interest rate on AMLF loans was lower than the returns on eligible
ABCP, providing incentives for eligible intermediary borrowers to
participate. AMLF closed on February 1, 2010. See appendix II for more
detail on AMLF.
Commercial Paper Funding Facility:
On October 7, 2008, the Federal Reserve Board announced the creation
of CPFF to provide a liquidity backstop to U.S. issuers of commercial
paper. Commercial paper is an important source of short-term funding
for U.S. financial and nonfinancial businesses.[Footnote 40] CPFF
became operational on October 27, 2008, and was operated by FRBNY. In
establishing CPFF, FRBNY created an SPV that was to directly purchase
new issues of eligible ABCP and unsecured commercial paper with the
proceeds of loans it received from FRBNY for that purpose.[Footnote
41] In the weeks leading up to CPFF's announcement, the commercial
paper markets showed clear signs of strain: the volume of commercial
paper outstanding declined, interest rates on longer-term commercial
paper increased significantly, and increasing amounts of commercial
paper were issued on an overnight basis as money-market funds and
other investors became reluctant to purchase commercial paper at
longer-dated maturities.[Footnote 42] As discussed previously, during
this time, MMMFs faced a surge of redemption demands from investors
concerned about losses on presumably safe instruments. The Federal
Reserve Board concluded that disruptions in the commercial paper
markets, combined with tension in other credit markets, threatened the
broader economy as many large commercial paper issuers promoted the
flow of credit to households and businesses. By standing ready to
purchase eligible commercial paper, CPFF was intended to eliminate
much of the risk that commercial paper issuers would be unable to
issue new commercial paper to replace their maturing commercial paper
obligations. By reducing this risk, CPFF was expected to encourage
investors to continue or resume their purchases of commercial paper at
longer maturities. CPFF closed on February 1, 2010. For more detail on
CPFF, see appendix VII.
Money Market Investor Funding Facility:
On October 21, 2008, the Federal Reserve Board authorized FRBNY to
work with the private sector to create MMIFF to serve as an additional
backstop for MMMFs. MMIFF complemented AMLF by standing ready to
purchase a broader range of short-term debt instruments held by MMMFs,
including certificates of deposit and bank notes. MMIFF's design
featured a complex lending structure through which five SPVs would
purchase eligible instruments from eligible funds. In contrast to
other Federal Reserve Board programs that created SPVs, MMIFF SPVs
were set up and managed by private sector entities. According to FRBNY
staff, JPMC, in collaboration with other firms that sponsored large
MMMFs, brought the idea for an MMIFF-like facility to FRBNY in early
October 2008. For reasons discussed later in this report's section on
FRBNY's use of vendors, FRBNY worked with JPMC to set up the MMIFF
SPVs but did not contract directly with JPMC or the firm that managed
the MMIFF program. While MMIFF became operational in late November
2008, it was never used. For more detail on MMIFF, see appendix X.
Term Asset-Backed Securities Loan Facility:
In November 2008, the Federal Reserve Board authorized FRBNY to create
TALF to reopen the securitization markets in an effort to improve
access to credit for consumers and businesses.[Footnote 43] During the
recent financial crisis, the value of many asset-backed securities
(ABS) dropped precipitously, bringing originations in the
securitization markets to a virtual halt. Problems in the
securitization markets threatened to make it more difficult for
households and small businesses to access the credit that they needed
to, among other things, buy cars and homes and expand inventories and
operations.[Footnote 44] TALF provided nonrecourse loans to eligible
U.S. companies and individuals in return for collateral in the form of
securities that could be forfeited if the loans were not repaid.
[Footnote 45] TALF was one of the more operationally complex programs,
and the first TALF subscription was not held until March 2009. In
contrast to other programs that had been launched in days or weeks,
TALF required several months of preparation to refine program terms
and conditions and consider how to leverage vendor firms to best
achieve TALF policy objectives. TALF closed on June 30, 2010. For more
detail on TALF, see appendix XII.
In Late 2008 and Early 2009, the Federal Reserve Board Announced Its
Participation in Government Assistance to Individual Institutions:
In late 2008 and early 2009, the Federal Reserve Board again invoked
its authority under section 13(3) of the Federal Reserve Act to
authorize assistance to avert the failures of three institutions that
it determined to be systemically significant: (1) American
International Group, Inc. (AIG); (2) Citigroup, Inc. (Citigroup); and
(3) Bank of America Corporation (Bank of America).
AIG:
In September 2008, the Federal Reserve Board and the Treasury
determined through analysis of information provided by AIG and
insurance regulators, as well as publicly available information, that
market events could have caused AIG to fail, which would have posed
systemic risk to financial markets. The Federal Reserve Board and
subsequently Treasury took steps to ensure that AIG obtained
sufficient liquidity and could complete an orderly sale of its
operating assets and continue to meet its obligations. On September
16, 2008, one day after the Lehman Brothers bankruptcy announcement,
the Federal Reserve Board authorized FRBNY to provide a revolving
credit facility (RCF) of up to $85 billion to help AIG meet its
obligations. The AIG RCF was created to provide AIG with a revolving
loan that AIG and its subsidiaries could use to address strains on
their liquidity. The announcement of this assistance followed a
downgrade of the firm's credit rating, which had prompted collateral
calls by its counterparties and raised concerns that a rapid failure
of the company would further destabilize financial markets. Two key
sources of AIG's difficulties were AIG Financial Products Corp.
(AIGFP) and a securities lending program operated by certain insurance
subsidiaries of AIG.[Footnote 46] AIGFP faced growing collateral calls
on credit default swaps it had written on collateralized debt
obligations (CDO).[Footnote 47] Meanwhile, AIG faced demands on its
liquidity from securities lending counterparties who were returning
borrowed securities and demanding that AIG return their cash
collateral. Despite the announcement of the AIG RCF, AIG's condition
continued to decline rapidly in fall 2008.
On subsequent occasions, the Federal Reserve Board invoked section
13(3) of Federal Reserve Act to authorize either new assistance or a
restructuring of existing assistance to AIG.
* First, in October 2008, the Federal Reserve Board authorized the
creation of the securities borrowing facility (SBF) to provide up to
$37.8 billion of direct funding support to a securities lending
program operated by certain AIG domestic insurance companies. From
October 8, 2008, through December 11, 2008, FRBNY provided cash loans
to certain AIG domestic life insurance companies, collateralized by
investment grade debt obligations.
* In November 2008, as part of plans to restructure the assistance to
AIG to further strengthen its financial condition, and once again
avert the failure of the company, the Federal Reserve Board and
Treasury restructured AIG's debt. Under the restructured terms,
Treasury purchased $40 billion in shares of AIG preferred stock and
the cash from the sale was used to pay down a portion of AIG's
outstanding balance from the AIG RCF. The limit on the facility also
was reduced to $60 billion, and other changes were made.
* Also in November 2008, the Federal Reserve Board authorized the
creation of two SPVs--Maiden Lane II LLC and Maiden Lane III LLC--to
purchase certain AIG-related assets. Similar to Maiden Lane LLC, these
SPVs funded most of these asset purchases with a senior loan from
FRBNY.[Footnote 48] Maiden Lane II replaced the AIG SBF and served as
a longer-term solution to the liquidity problems facing AIG's
securities lending program. Maiden Lane III purchased the underlying
CDOs from AIG counterparties in connection with the termination of
credit default swap contracts issued by AIGFP and thus the elimination
of the liquidity drain from collateral calls on the credit default
swaps sold by AIGFP.
* In March 2009, the Federal Reserve Board and Treasury announced
plans to further restructure AIG's assistance. According to the
Federal Reserve Board, debt owed by AIG on the AIG RCF would be
reduced by $25 billion in exchange for FRBNY's receipt of preferred
equity interests totaling $25 billion in two SPVs. AIG created both
SPVs to hold the outstanding common stock of two life insurance
company subsidiaries--American Life Insurance Company and AIA Group
Limited.[Footnote 49]
* Also in March 2009, the Federal Reserve Board authorized FRBNY to
provide additional liquidity to AIG by extending credit by purchasing
a contemplated securitization of income from certain AIG life
insurance operations. FRBNY staff said this life insurance
securitization option was abandoned for a number of reasons, including
that it would have required FRBNY to manage a long-term exposure to
life insurance businesses with which it had little experience.
For more detail on the assistance to AIG, see appendix III.[Footnote
50]
Citigroup:
On November 23, 2008, the Federal Reserve Board authorized FRBNY to
provide a lending commitment to Citigroup as part of a package of
coordinated actions by Treasury, FDIC, and the Federal Reserve Board
to avert a disorderly failure of the company.[Footnote 51] As
discussed in our April 2010 report on Treasury's use of the systemic
risk determination, Treasury, FDIC, and the Federal Reserve Board said
they provided emergency assistance to Citigroup because they were
concerned that the failure of a firm of Citigroup's size and
interconnectedness would have had systemic implications.[Footnote 52]
FRBNY agreed to lend against the residual value of approximately $300
billion of Citigroup assets if losses on these assets exceeded certain
thresholds. Based on analyses by the various parties and an outside
vendor, FRBNY determined that it would be unlikely that losses on the
Citigroup "ring-fence" assets would reach the amount at which FRBNY
would be obligated to provide a loan.[Footnote 53] At Citigroup's
request, Treasury, FDIC, and FRBNY agreed to terminate this loss-
sharing agreement in December 2009. As part of the termination
agreement, Citigroup agreed to pay a $50 million termination fee to
FRBNY. FRBNY never provided a loan to Citigroup under this lending
commitment.[Footnote 54] See appendix VI for more detail.
Bank of America:
On January 15, 2009, the Federal Reserve Board authorized FRBR to
provide a lending commitment to Bank of America. As with Citigroup,
the Federal Reserve Board authorized this assistance as part of a
coordinated effort with Treasury and FDIC to assist an institution
that the agencies determined to be systemically important. The
circumstances surrounding the agencies' decision to provide this
arrangement for Bank of America, however, were somewhat different and
were the subject of congressional hearings.[Footnote 55] While the
Citigroup loss-sharing agreement emerged during a weekend over which
the agencies attempted to avert an impending failure of the firm, the
agencies' discussions with Bank of America about a possible similar
arrangement occurred over several weeks during which Bank of America
was not facing imminent failure. According to Federal Reserve Board
officials, possible assistance for Bank of America was first discussed
in late December 2008 when Bank of America management raised concerns
about the financial impact of completing the merger with Merrill
Lynch, which was expected at the time to announce larger-than-
anticipated losses (and did in fact announce these losses the
following month). Following the January 1, 2009, completion of Bank of
America's acquisition of Merrill Lynch, the Federal Reserve Board and
the other agencies agreed to provide a loss-sharing agreement on
selected Merrill Lynch and Bank of America assets to assure markets
that unusually large losses on these assets would not destabilize Bank
of America. On September 21, 2009, the agencies and FRBR terminated
the agreement in principle to enter into a loss-sharing agreement with
Bank of America. The agreement was never finalized, and FRBR never
provided a loan to Bank of America under this lending commitment. As
part of the agreement to terminate the agreement in principle, Bank of
America paid a $57 million to FRBR in compensation for out-of-pocket
expenses incurred by FRBR and an amount equal to the commitment fees
required by the agreement. See appendix V for more detail.
In 2009 and 2010, FRBNY Executed Large-Scale Purchases of Agency MBS
to Provide Broader Support to the Economy:
On November 25, 2008, the FOMC announced that FRBNY would purchase up
to $500 billion of agency mortgage-backed securities to support the
housing market and the broader economy.[Footnote 56] The FOMC
authorized the Agency MBS program under its authority to direct open
market operations under section 14 of Federal Reserve Act. By
purchasing MBS securities with longer maturities, the Agency MBS
program was intended to lower long-term interest rates and to improve
conditions in mortgage and other financial markets. The Agency MBS
program commenced purchases on January 5, 2009, a little more than a
month after the initial announcement. FRBNY staff noted that a key
operational challenge for the program was its size. As discussed later
in this report, FRBNY hired external investment managers to provide
execution support and advisory services needed to help execute
purchases on such a large scale. In March 2009, the FOMC increased the
total amount of planned purchases from $500 billion to up to $1.25
trillion. The program executed its final purchases in March 2010 and
settlement was completed in August 2010. See appendix I for more
detail.
Most Programs Were Extended a Few Times before Closing in Early 2010:
On several occasions, the Federal Reserve Board authorized extensions
of its emergency loan programs, and most of these programs closed on
February 1, 2010. For example, AMLF, PDCF, and TSLF were extended
three times. The Federal Reserve Board cited continuing disruptions in
financial markets in announcing each of these extensions. Table 2
provides a summary of the extensions for the emergency programs.
Table 2: Summary of Extensions for Broad-Based Emergency Programs:
Programs extended: AMLF, PDCF, and TSLF;
Date extension announced: December 2, 2008;
Term of extension:
Original expiration: January 30, 2009;
New expiration: April 30, 2009.
Programs extended: AMLF, CPFF, MMIFF, PDCF, TSLF, and swap lines with
foreign central banks;
Date extension announced: February 3, 2009;
Term of extension:
Planned expiration: April 30, 2009;
New expiration: October 30, 2009.
Programs extended: AMLF, CPFF, PDCF, TSLF, and swap lines with foreign
central banks;
Date extension announced: June 25, 2009;
Term of extension:
Planned expiration: October 30, 2009;
New expiration: February 1, 2010.
Source: GAO analysis of Federal Reserve Board press releases and
program terms and conditions.
Note: MMIFF was never used and the Federal Reserve Board allowed it to
expire on October 30, 2009. In November 2008, TALF was authorized to
make new loans until December 31, 2009, and the Federal Reserve Board
later authorized an extension for new loans against most eligible
collateral until March 31, 2010, and against one eligible collateral
type until June 30, 2010. Other extensions of swap line arrangements
were announced on May 2, 2008 and September 29, 2008. As noted earlier
in this section, in May 2010, FRBNY reopened swap lines with the Bank
of Canada, the Bank of England, the European Central Bank, the Bank of
Japan, and the Swiss National Bank. These swap lines were initially
set to expire on August 1, 2011. On June 29, 2011, the Federal Reserve
Board announced an extension of these swap lines through August 1,
2012.
[End of table]
The Federal Reserve System and Its Emergency Activities Were Subject
to Multiple Audits and Reviews:
The Emergency Programs Have All Been Subject to Audits and Reviews:
The Federal Reserve Act requires the Federal Reserve Board to order an
annual independent audit of the financial statements of each of the 12
Reserve Banks.[Footnote 57] Each Reserve Bank prepares annual
financial statements that reflect its financial position as of the end
of the calendar year and its related income and expenses for the year.
The Federal Reserve Board also prepares combined financial statements
of the Reserve Banks, which include the accounts and results of
operations of the 12 Reserve Banks. As shown in figure 2, the loans
and other financial assistance provided through the Federal Reserve's
emergency programs are recorded in the Reserve Banks' publicly
reported financial statements. Most of the activity pertaining to the
emergency programs is recorded exclusively in FRBNY's financial
statements, including several SPVs that have been consolidated in
FRBNY, including Maiden Lane LLC, Maiden Lane II LLC, Maiden Lane III
LLC, CPFF LLC, and TALF LLC (LLCs).[Footnote 58] The emergency
programs that are not recorded exclusively in FRBNY's financial
statements include:
* financial transactions of AMLF, which are reported in FRBB's
financial statements;
* financial transactions of TSLF, the dollar swap lines, and the
Agency MBS program which are allocated on a percentage basis to each
Reserve Bank;
* financial transactions of TAF, which are reported in the financial
statements of each Reserve Bank that made a TAF loan; and:
* financial transaction of the Bank of America program, which was
reported in FRBR's financial statements.[Footnote 59]
Figure 2: Financial Reporting of the Federal Reserve's Emergency
Programs:
[Refer to PDF for image: illustration]
Reserve Banks Combined Financial Statements:
* FRB Boston:
- TAF;
- Agency MBS;
- Swap Lines;
- AMLF;
- TSLF.
* FRB New York: (receive financial statements from the following LLCS:
Maiden Lane, Maiden Lane II, Maiden Lane III, TALF, CRFF);
- TAF;
- Agency MBS;
- Swap Lines;
- PDCF[A];
- TALF Loans;
- AIG[B];
- TSLF;
- Citigroup;
- MMIFF.
* FRB Atlanta:
- TAF;
- Agency MBS;
- Swap Lines;
- TSLF.
* FRB Chicago:
- TAF;
- Agency MBS;
- Swap Lines;
- TSLF.
* FRB Cleveland:
- TAF;
- Agency MBS;
- Swap Lines;
- TSLF.
* FRB Dallas:
- TAF;
- Agency MBS;
- Swap Lines;
- TSLF.
* FRB Kansas City:
- TAF;
- Agency MBS;
- Swap Lines;
- TSLF.
* FRB Minneapolis:
- TAF;
- Agency MBS;
- Swap Lines;
- TSLF.
* FRB Philadelphia:
- TAF;
- Agency MBS;
- Swap Lines;
- TSLF.
* FRB Richmond:
- TAF;
- Agency MBS;
- Swap Lines;
- TSLF.
* FRB San Francisco:
- TAF;
- Agency MBS;
- Swap Lines;
- TSLF.
* FRB St. Louis:
Source: GAO analysis of Reserve Banks annual reports.
[A] Includes the credit extensions to affiliates of some primary
dealers.
[B] Includes the AIG RCF, AIG SBF, and Life Insurance Securitization.
[End of figure]
The Reserve Banks have voluntarily adopted the internal control
reporting requirements of the Sarbanes-Oxley Act of 2002[Footnote 60]
and provide an assessment of the effectiveness of their internal
control over financial reporting annually to their boards of
directors.[Footnote 61] Internal control over financial reporting
includes those policies and procedures that (1) pertain to the
maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the
entity; (2) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in
accordance with accounting principles, and that receipts and
expenditures of the entity are being made only in accordance with
authorizations of management and directors; and (3) provide reasonable
assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the entity's assets that could
have a material effect on the financial statements.
The management of each Reserve Bank assesses its internal control over
financial reporting as it relates to the financial statements based
upon the criteria established in the Internal Control-Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO) (see table 3).[Footnote 62] Similarly, in
2009, the LLCs began providing an assessment of their internal
controls over financial reporting annually to the Board of Directors
of FRBNY using the COSO framework and criteria.
Table 3: COSO's Internal Control Framework:
Component: Control environment;
Description: Sets the tone of the organization, influencing the
control consciousness of its people. It is the foundation for all
other components of internal control, providing discipline and
structure. Control environment factors include the integrity, ethical
values, and competence of the entity's people; management's philosophy
and operating style; the way management assigns authority and
responsibility, and organizes and develops its people; and the
attention and direction provided by the board of directors.
Component: Risk assessment;
Description: Refers to the organization's identification and analysis
of risks relevant to achieving its objectives, forming a basis for
determining how the risks should be managed. Because economic,
industry, regulatory and operating conditions will continue to change,
mechanisms are needed to identify and deal with the special risks
associated with change.
Component: Control activities;
Description: The policies and procedures that help ensure that
management's directives are carried out. They help ensure that
necessary actions are taken to address risks to achievement of the
entity's objectives. Control activities occur throughout the
organization, at all levels and in all functions. They include a range
of activities as diverse as approvals, authorizations, verifications,
reconciliations, reviews of operating performance, security of assets
and segregations of duties.
Component: Information and communication;
Description: The identification, capture, and communication of
information in a form and time frame that enable people to carry out
their responsibilities.
Component: Monitoring;
Description: A process that assesses the quality of internal control
performance over time. This is accomplished through ongoing monitoring
of activities, separate evaluations or a combination of the two.
Source: COSO's Internal Control-Integrated Framework.
[End of table]
Since 2007, Deloitte has been the independent external auditor for the
Federal Reserve System. Accordingly, Deloitte performs the audits of
the individual and combined financial statements of the Reserve Banks
and those of the consolidated LLCs. Deloitte also provides opinions on
the effectiveness of each Reserve Bank's internal control over
financial reporting. In 2009, Deloitte began providing opinions on the
effectiveness of each LLC's internal control over financial
reporting.[Footnote 63] To help ensure auditor independence, the
Federal Reserve Board requires that its external auditor be
independent in all matters relating to the audits. Specifically,
Deloitte may not perform services for the Reserve Banks or others that
would place it in a position of auditing its own work, making
management decisions on behalf of the Reserve Banks, or in any other
way impairing its audit independence.
FRBNY management also engaged external firms to review certain aspects
of the emergency programs. For example, FRBNY engaged the auditing
firm KPMG LLP (KPMG) to assist FRBNY in developing a conflict of
interest inspection and fraud-review program for certain programs
created in response to the financial crisis. In 2009 and 2010, KPMG
executed reviews of vendors and agents supporting the Agency MBS
program, Maiden Lane LLC, Maiden Lane II LLC, Maiden Lane III LLC,
TALF, and CPFF. The scope of this work covered an evaluation of the
vendors' and agents' adherence to their own conflict of interest
policies and more program-specific provisions contained within their
engagement agreement with FRBNY. These reviews are discussed in
greater detail later in this report. In 2009, FRBNY contracted with a
management consulting firm, Oliver Wyman, to conduct an independent
review of the governance and management infrastructure surrounding its
new market facilities and emergency programs created throughout 2008.
This review was specifically focused on the three Maiden Lane LLCs,
CPFF, and MMIFF and included an examination of internal reporting and
management updates, business and strategic plans for relevant Reserve
Bank functions, internal risk assessments, Reserve Bank policies and
procedures, committee charters, and organizational summaries.
In addition to external audits and reviews, the Federal Reserve System
has a number of internal entities that conduct audits and reviews of
the Reserve Banks, including the emergency programs. For example, each
Reserve Bank has an internal audit function that conducts audits and
other reviews to evaluate the adequacy of the Reserve Bank's internal
controls, the extent of compliance with established procedures and
regulations, and the effectiveness of the Reserve Bank's operations.
The internal audit function conducts audits in accordance with the
International Standards for the Professional Practice of Internal
Auditing and maintains organizational independence from management by
reporting directly to the audit committee of the Reserve Bank's board
of directors.[Footnote 64] During the period from 2008 through 2010,
FRBNY's internal audit function conducted audits pertaining to the
Agency MBS program, TSLF, Swap Lines, TAF, CPFF, TALF, and PDCF, as
well as the three Maiden Lane LLCs. In 2008 and 2009, the FRBB's
internal audit function performed an audit of AMLF. The objectives and
scope of these audits varied, but included such areas as the adequacy
and effectiveness of internal controls, vendor management, governance,
lending and collateral processes, and information technology. The
FRBNY and FRBB internal audit functions provided recommendations to
Reserve Bank management to address any findings.
Also, the Reserve Banks and emergency programs, including the LLCs,
are subject to oversight by the Federal Reserve Board. The Federal
Reserve Board's Division of Reserve Bank Operations and Payment
Systems (RBOPS) performs annual Reserve Bank examinations that include
a wide range of oversight activities. RBOPS monitors the activities of
each Reserve Bank and LLC on an ongoing basis, and conducts a
comprehensive on-site review of each Reserve Bank at least once every
3 years. The reviews also include an assessment of each Reserve Bank's
internal audit function's efficiency and conformance to the
International Standards for the Professional Practice of Internal
Auditing and applicable policies and procedures. In addition, RBOPS
formed special program-related review teams and conducted risk-based
reviews of most of the Federal Reserve's emergency programs. RBOPS
uses the COSO framework as criteria in reviewing Reserve Banks,
including emergency programs and LLC operations. RBOPS also assesses
compliance with FOMC policies by annually reviewing the accounts and
holdings of the Reserve Banks' domestic and foreign currency open
market accounts, which include transactions executed as part of the
Agency MBS and swap line programs.
During 2009 and 2010, RBOPS conducted reviews of the following
emergency programs: TSLF, PDCF, CPFF, AIG RCF, dollar swap lines,
Maiden Lane, Maiden Lane II, Maiden Lane III, TALF, and the Agency MBS
program. The scope of these reviews varied but primarily focused on
the programs' implementation and administration, including evaluating
the effectiveness of controls and determining whether the operations
of the programs were consistent with Federal Reserve Board
authorizations. RBOPS reported the results of these reviews along with
any recommendations to improve operations to FRBNY's management. In
follow-up reviews, RBOPS officials found that FRBNY had satisfactorily
addressed the issues found during the initial reviews; therefore,
RBOPS closed many of the recommendations.
The OIG also conducts audits, reviews, and investigations related to
the Federal Reserve Board's programs and operations, including those
programs and operations that have been delegated to the Reserve Banks
by the Federal Reserve Board. The OIG is required to submit a
semiannual report to the Chairman of the Federal Reserve Board and to
Congress. In November 2010, the OIG reported on its review of six of
the emergency programs: TSLF, PDCF, MMIFF, TALF, CPFF, and AMLF. The
OIG stated that the purpose of its review was to determine the
function and status of these programs and to identify risks in each of
the programs to assist the Federal Reserve Board in its general
supervision and oversight of the Reserve Banks.[Footnote 65]
Figure 3 provides an overview of audit and review coverage of the
emergency programs since 2008.
Figure 3: Audit and Review Coverage of the Emergency Programs:
[Refer to PDF for image: illustrated table]
Program: Agency MBS;
External auditor[A]: [Check];
Internal audit function: [Check];
Reserve Bank Operations and Payment Systems: [Check];
Office of Inspector General: [Empty].
Program: AIG[B];
External auditor[A]: [Check];
Internal audit function: [Empty];
Reserve Bank Operations and Payment Systems: [Check];
Office of Inspector General: [Empty].
Program: AMLF;
External auditor[A]: [Check];
Internal audit function: [Check];
Reserve Bank Operations and Payment Systems: [Empty];
Office of Inspector General: [Check].
Program: Bank of America Corporation;
External auditor[A]: [Check];
Internal audit function: [Empty];
Reserve Bank Operations and Payment Systems: [Empty];
Office of Inspector General: [Empty].
Program: Citigroup, Inc.
External auditor[A]: [Check];
Internal audit function: [Empty];
Reserve Bank Operations and Payment Systems: [Empty];
Office of Inspector General: [Empty].
Program: CPFF;
External auditor[A]: [Check];
Internal audit function: [Check];
Reserve Bank Operations and Payment Systems: [Check];
Office of Inspector General: [Check].
Program: Swap Lines;
External auditor[A]: [Check];
Internal audit function: [Check];
Reserve Bank Operations and Payment Systems: [Check];
Office of Inspector General: [Empty].
Program: Maiden Lane LLC;
External auditor[A]: [Check];
Internal audit function: [Check];
Reserve Bank Operations and Payment Systems: [Check];
Office of Inspector General: [Empty].
Program: Maiden Lane II LLC;
External auditor[A]: [Check];
Internal audit function: [Check];
Reserve Bank Operations and Payment Systems: [Check];
Office of Inspector General: [Empty].
Program: Maiden Lane III LLC;
External auditor[A]: [Check];
Internal audit function: [Check];
Reserve Bank Operations and Payment Systems: [Check];
Office of Inspector General: [Empty].
Program: MMIFF;
External auditor[A]: [Check];
Internal audit function: [Empty];
Reserve Bank Operations and Payment Systems: [Empty];
Office of Inspector General: [Check].
Program: PDCF[C];
External auditor[A]: [Check];
Internal audit function: [Check];
Reserve Bank Operations and Payment Systems: [Check];
Office of Inspector General: [Check].
Program: TAF;
External auditor[A]: [Check];
Internal audit function: [Check];
Reserve Bank Operations and Payment Systems: [Empty];
Office of Inspector General: [Empty].
Program: TALF;
External auditor[A]: [Check];
Internal audit function: [Check];
Reserve Bank Operations and Payment Systems: [Check];
Office of Inspector General: [Check].
Program: TSLF;
External auditor[A]: [Check];
Internal audit function: [Check];
Reserve Bank Operations and Payment Systems: [Check];
Office of Inspector General: [Check].
Source: GAO analysis of audit reports and reviews.
Note: This figure does not include the Bear Stearns bridge loan, which
was a one-time loan and was not a program.
[A] Audit coverage was provided as a part of the overall audit of the
Reserve Bank or LLC financial statements.
[B] Includes the AIG RCF, AIG SBF, and Life Insurance Securitization.
[C] Includes the credit extensions to affiliates of some primary
dealers.
[End of figure]
Audits and Reviews Have Not Identified Significant Accounting or
Financial Reporting Internal Control Issues Concerning the Emergency
Programs:
The Reserve Banks and LLCs Received "Clean" Opinions on their
Financial Statements:
Deloitte rendered unqualified (clean) opinions on the individual and
combined Reserve Banks' financial statements for the years 2007, 2008,
2009, and 2010. As described earlier in this report, the Reserve
Banks' financial statements include the activity pertaining to the
emergency programs, including the accounts and operations of the LLCs,
which are consolidated into FRBNY's financial statements. Deloitte
also has rendered clean opinions on the financial statements of each
LLC beginning with the creation of Maiden Lane LLC in 2008. A clean
opinion indicates that the financial statements prepared by management
are free of material misstatements and are presented fairly in
accordance with U.S. generally accepted accounting principles (GAAP)
or, in the case of the Reserve Banks, accounting principles
established by the Federal Reserve Board, which is a comprehensive
basis of accounting other than GAAP.[Footnote 66]
The independent external auditor conducted its financial statement
audits of the Reserve Banks and LLCs in accordance with U.S. generally
accepted auditing standards as established by the Auditing Standards
Board and in accordance with the auditing standards of the Public
Company Accounting Oversight Board.[Footnote 67] These standards
require that the auditor plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free
of material misstatement and whether effective internal control over
financial reporting was maintained in all material respects. The
audits of the Reserve Banks' and LLCs' financial statements included
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management, and
evaluating the overall financial statement presentation.
Audits and Reviews Did Not Identify Any Significant Issues Related to
the Reserve Banks' or LLCs' Internal Control over Financial Reporting:
Since the development and implementation of the emergency programs,
the independent external auditor's internal control opinions related
to the Reserve Banks and LLCs have all been clean, indicating that
these entities have maintained, in all material respects, effective
internal control over financial reporting. As noted previously, FRBNY
is responsible for administering each of the emergency programs,
except for AMLF, which was administered by FRBB; TAF, which was
administered by each Reserve Bank that issued TAF loans; and the Bank
of America program, which was administered by FRBR. As administrator
of the programs, management at each Reserve Bank is responsible for
establishing and maintaining effective internal control over financial
reporting as it relates to the preparation of the financial
statements, which include the activities of the emergency programs. A
clean opinion on internal control is not a guarantee that internal
controls are effective because of the possibility of collusion or
improper management override of controls; however, it does provide
reasonable assurance with respect to financial reporting.
Deloitte conducted its audits of each Reserve Bank's and LLC's
internal control over financial reporting in accordance with auditing
standards of the Public Company Accounting Oversight Board. Those
standards require that the auditor obtain an understanding of internal
control over financial reporting, assess the risk that a material
weakness exists, and test and evaluate the design and operating
effectiveness of internal control based on the assessed risk.[Footnote
68] Deloitte assessed the Reserve Banks' and LLCs' internal control
over financial reporting against criteria established by COSO, which,
as discussed earlier, are the same criteria Reserve Bank management
used for its assessment of internal control.
In the course of conducting its audits of the Reserve Banks and LLCs,
the independent external auditor identified internal control
deficiencies affecting financial reporting; however, these
deficiencies were not considered significant deficiencies or material
weaknesses, and therefore would not likely lead to a material
misstatement in financial reporting.[Footnote 69] Nonetheless, the
external auditor communicated these control deficiencies, along with
any observations and recommendations for improving operational or
administrative efficiency and for improving internal control, to the
management of the Reserve Banks and LLCs.
As mentioned in the previous section, in addition to the independent
external auditor, the Reserve Banks' internal audit function, RBOPS,
and the OIG performed audits and reviews of the emergency programs.
Similar to the external audits, the audits and reviews conducted by
these other groups did not report any significant accounting or
financial reporting internal control issues.
The Federal Reserve System's External Auditor Revised the Approach and
Scope of Its Audits to Address the Emergency Programs:
Since the beginning of the financial market turmoil in 2007 and the
implementation of the emergency programs, the Federal Reserve System's
balance sheet has grown in size and has changed in composition. For
example, total combined assets of the Reserve Banks have increased
significantly from more than $914 billion as of December 31, 2007, to
more than $2.4 trillion as of December 31, 2010. From 2007 through
2008, assets increased to more than $2.2 trillion. This increase in
assets was, in part, the result of a large increase in loans to
depository institutions including TAF loans and other loans made
through TSLF, AMLF, PDCF, and AIG RCF; a large increase in the use of
the Swap Lines program; and the inclusion of investments held by the
consolidated LLCs. As of December 31, 2010, although many of the
emergency programs were winding down activities, Reserve Bank assets
were more than $2.4 trillion. The assets remained elevated from pre-
emergency program levels, in part because of the increased holdings of
agency MBS.
The size and complexity of these emergency programs and their rapid
implementation increased the external auditor's risks for the audit of
the Reserve Banks' and LLCs' financial statements. For example, the
emergency programs, including the LLCs, created accounting risks
because of the complexities of using different accounting principles
for FRBNY's consolidated financial statements (which, as described
earlier in this report, are prepared in accordance with accounting
principles established by the Federal Reserve Board) and for the LLCs'
financial statements (which are prepared in accordance with GAAP).
Accounting complexities also existed in determining the proper method
of accounting for loans under AMLF and the proper treatment of the
loan restructuring pertaining to the AIG RCF.
The economic environment at the time of the creation of these new
emergency programs also increased audit risk concerning asset
valuation and the establishment of an allowance for loan losses for
some of these programs. Furthermore, attention to these new programs
also increased audit risk associated with determining the adequacy of
financial statement disclosures, both in terms of required disclosures
and disclosures to provide transparency over the emergency programs'
financial transactions.
In addition, the financial stability measures implemented by the
Federal Reserve Board also increased the audit risk pertaining to
assessing the design and effectiveness of internal controls that were
established for the new programs. Specifically, while many of the
transactions associated with the emergency programs were executed
under existing internal control processes, some of the programs
required the Reserve Banks to develop new policies and procedures and
design specific financial reporting internal control processes for the
transactions. However, the rapid implementation of the new programs
also required the Reserve Banks to execute these transactions at the
same time they were developing and documenting accounting policies and
control processes for these transactions, thereby increasing the risk
that transactions related to these programs may not be processed
properly. Audit risk pertaining to internal controls was further
increased because of the Reserve Banks' and LLCs' significant use of
third-party vendors, also referred to as service organizations, for
custodial, administrative, or accounting services pertaining to the
investment portfolios of certain emergency programs The service
organizations perform these services under their own internal control
policies and procedures, which introduce an additional element of risk
to the Reserve Banks' internal control systems.
In response to the development and implementation of the emergency
programs and the risks associated with these programs, for its 2008
audits of the Reserve Banks and LLCs, the external auditor revised its
audit approach and scope to (1) address the accounting complexities
and other accounting issues resulting from these new emergency
programs, (2) provide additional audit coverage of the Reserve Banks'
and LLCs' financial reporting internal controls, and (3) provide
testing of the financial transactions of the new emergency programs.
Beginning with the 2008 audits, a key area of focus for the external
auditor was FRBNY's monitoring controls over the service organizations
and the results of the independent service auditors' reports provided
on the service organizations' internal controls.[Footnote 70] For its
2009 and 2010 audits, the external auditor continued to consider the
audit risks associated with the emergency programs when developing its
audit approach. For example, for the 2009 audits, the external auditor
adjusted its audit scope to include testing of TALF, which was created
late in 2008 and, as anticipated, had a full year of transactions in
2009. For its 2010 audits of the Reserve Banks and LLCs, the external
auditor's audit plan took into consideration the changes in the level
of transactions pertaining to some of the emergency programs, such as
the lower level of activity in TALF and the effect of the
discontinuance of TAF on loans to depository institutions.
In addition, to the extent possible, the external auditor leveraged
relevant internal control work performed by the Reserve Banks'
management and internal audit function in forming an opinion on the
effectiveness of internal control over financial reporting.
Specifically, the external auditor:
* reviewed management's documentation of the internal control
processes and the results of management's testing and monitoring of
internal controls,
* assessed the competence and objectivity of the internal auditors and
reviewed the internal auditors' audit documentation and results,
* reperformed management's tests of internal controls on a sample
basis or accepted management's results in cases where internal
controls were not considered to be key or high risk,
* performed its own independent audit tests in cases where the
internal control was considered to be key or high risk to financial
reporting objectives, and:
* considered the results of the Reserve Bank reviews performed by
RBOPS to determine whether the results of these reviews had an impact
on the Reserve Banks' financial statements.
Reserve Banks Would Benefit From Strengthening Guidance for
Noncompetitive Contracts Awarded in Exigent Circumstances:
The Reserve Banks, primarily FRBNY, awarded 103 contracts worth $659.4
million from 2008 through 2010 to help carry out their emergency
lending activities. A few contracts accounted for most of the spending
on vendor services. The Reserve Banks relied more on vendors more
extensively for programs that provided assistance to single
institutions than for broad-based programs. Most of the contracts,
including 8 of the 10 highest-value contracts, were awarded
noncompetitively due to exigent circumstances as permitted under
FRBNY's acquisition policies. FRBNY is not subject to the Federal
Acquisition Regulation (FAR) and its acquisition policies lack some of
the details found in that regulation. For example, FRBNY's policies
lack guidance on the use of competition exceptions, such as seeking as
much competition as is practicable or limiting the duration of
noncompetitive contracts to the period of the exigency. Without such
guidance, FRBNY may be missing opportunities to obtain competition and
help ensure that it receives the most favorable terms for the goods
and services it acquires. The vast majority of the vendor fees were
paid directly from program income, or program recipients reimbursed
the Reserve Banks for vendor fees.
Reserve Banks Relied Extensively on Vendors to Establish and Operate
the Emergency Programs, Particularly Those Designed to Assist Single
Institutions:
From 2008 through 2010, vendors were paid $659.4 million across 103
contracts to help establish and operate the Reserve Banks' emergency
programs. The 10 largest contracts accounted for 74 percent of the
total amount paid to all vendors.[Footnote 71] When the Reserve Banks
used vendors, most of the spending on services for each emergency
program or assistance was for one or two vendors. For example, FRBNY
used 19 vendors for the AIG RCF at a cost of $212.9 million, yet two
contracts accounted for $175.3 million (82 percent) of that total.
[Footnote 72] Similarly, the Pacific Investment Management Company LLC
(PIMCO) CPFF investment management contract accounted for $33.6
million (77 percent) of the $43.4 million that all five CPFF vendors
were paid. The Agency MBS program was one notable exception to this
pattern. Under the Agency MBS program, FRBNY used four separate
investment managers with identical responsibilities and compensation
and no single vendor dominated the program. FRBNY was responsible for
creating and operating all but two emergency programs and assistance
and therefore awarded nearly all of the contracts.[Footnote 73] See
table 4 for the total number and value of contracts for the emergency
programs and assistance.
Table 4: Number of Contracts and Fees Paid, By Emergency Program,
Calendar Years 2008-2010:
Broad-based programs:
Program: Agency MBS program;
Number of contracts[A]: 6;
Total fees paid: $81.4 million.
Program: AMLF;
Number of contracts[A]: 1;
Total fees paid: $0.025 million.
Program: CPFF;
Number of contracts[A]: 5;
Total fees paid: $43.4 million.
Program: MMIFF;
Number of contracts[A]: 1;
Total fees paid: $0.4 million.
Program: TALF;
Number of contracts[A]: 18;
Total fees paid: $29.2 million.
Programs that assisted a single institution:
Program: AIG Revolving Credit Facility;
Number of contracts[A]: 19;
Total fees paid: $212.9 million.
Program: Bank of America lending commitment;
Number of contracts[A]: 3;
Total fees paid: $22.8 million.
Program: Citigroup lending commitment;
Number of contracts[A]: 3;
Total fees paid: $21.4 million.
Program: Maiden Lane (Bear Stearns);
Number of contracts[A]: 42;
Total fees paid: $158.4 million.
Program: Maiden Lane II (AIG);
Number of contracts[A]: 9;
Total fees paid: $27.9 million.
Program: Maiden Lane III (AIG);
Number of contracts[A]: 12;
Total fees paid: $57.0 million.
Program: General[B];
Number of contracts[A]: 4;
Total fees paid: $4.5 million.
Total;
Number of contracts[A]: 103;
Total fees paid: $659.4 million.
Source: GAO analysis of Reserve Bank data.
Note: Reserve Bank programs and assistance listed include only those
for which the Reserve Banks used vendors.
[A] Because some contracts included work on multiple programs, the sum
of the contracts for each program is greater than the 103 total
contracts identified in the table. Also, 36 subvendors were paid $3.3
million for the three Maiden Lane programs, CPFF, and TALF. The table
does not include fees for subcontracts.
[B] Of the four general contracts, two were for advisory services
related to how FRBNY managed the emergency programs overall. The other
two included work on multiple programs, but FRBNY could not separate
out what proportion of the total fees was assigned to each program.
[End of table]
As shown in table 4, the Reserve Banks relied on vendors more
extensively for programs that assisted single institutions than for
broad-based emergency programs. The six programs that provided
assistance to single institutions accounted for more than 75 percent
of both the number and value of emergency program contracts. Vendors
were paid more for services related to both the AIG RCF and the first
Maiden Lane than for all of the broad-based programs combined. The
types of services that the Reserve Banks acquired for the single-
institution programs were distinctly different than the services
acquired for the broad-based programs.
Assistance to Single Institutions:
The Reserve Banks relied on vendors to help assess and manage the
diverse and complex pools of assets that secured assistance to single
institutions. Under section 13(3) of the Federal Reserve Act, the
loans Reserve Banks made pursuant to Federal Reserve Board
authorizations of the various emergency programs and assistance were
to be secured to the Reserve Banks' satisfaction. The assistance
provided to individual institutions was generally secured by existing
assets that either belonged to or were purchased from the institution,
its subsidiaries, or counterparties.[Footnote 74] The Reserve Banks
did not have sufficient expertise available to evaluate these assets
and therefore used vendors to do so. For example, loans FRBNY agreed
to extend to AIG under the AIG RCF were secured by a range of assets,
including the equity of AIG's regulated and nonregulated subsidiaries
and secured guarantees of many of AIG's primary nonregulated
subsidiaries. FRBNY hired Morgan Stanley to evaluate various
divestiture scenarios. The Reserve Banks also relied extensively on
vendors to manage the assets for the three Maiden Lane LLCs. FRBNY
selected BlackRock as the investment manager for these programs and
the company was paid $181.8 million for a variety of services
including valuing assets, disposing of securities, and negotiating
with counterparties.
Broad-Based Emergency Programs:
For the broad-based emergency programs, FRBNY hired vendors primarily
for transaction-based services and collateral monitoring. Under these
programs, the Reserve Banks purchased assets or extended loans in
accordance with each program's terms and conditions. Because of this,
the services that vendors provided for these programs were focused
more on providing liquidity (purchasing assets or extending loans)
than analyzing and managing securities, as was the case for the single
institution assistance. FRBNY hired investment managers for the Agency
MBS and CPFF programs, but the vendors were primarily tasked with
purchasing assets and their role was fundamentally different than the
investment manager services provided under the single institution
assistance. For TALF, vendors primarily provided collateral
monitoring, custodial, and administrative services. The Reserve Banks
did not use vendors, or used only a single vendor for TAF, TSLF, PDCF,
the dollar swap lines, and AMLF. These programs were primarily short-
term emergency lending programs against traditional collateral and
were thus similar to the Reserve Banks' traditional open market
operations.
Nonvendors Working on Emergency Programs:
FRBNY did not have contracts with the firms that helped operate PDCF,
TSLF, TALF, and MMIFF. PDCF and TSLF relied on two clearing banks,
JPMC and Bank of New York Mellon, to execute transactions between
FRBNY and program recipients (primary dealers).[Footnote 75]
Agreements between the clearing banks and FRBNY identified eligible
collateral and other program terms, but the clearing banks were paid
by program participants and Reserve Bank officials did not know what
fees the clearing banks were paid. Similarly, TALF relied on TALF
agents that represented program participants rather than FRBNY.
Program participants had to go through a TALF agent to participate in
the program and the agents were responsible for conducting due
diligence on potential borrowers and identifying and mitigating
conflicts of interest. However, the TALF agents were not FRBNY vendors.
A group of private companies led by JPMC designed the MMIFF program
and presented it to FRBNY as a backstop for MMMFs. Under the proposal,
FRBNY was to extend loans to five LLCs that would purchase short-term
debt instruments. The program was created and operated by service
providers that did not have contracts with FRBNY. For example, the
private companies determined that JPMC should be responsible for
setting up the program, registering eligible participants, soliciting
sellers, and ensuring that purchases were within program investment
limits. JPMC and all other MMIFF vendors had contracts with each of
the five LLCs rather than with FRBNY, although FRBNY officials noted
that the loan agreements between FRBNY and the LLCs gave FRBNY many
contractual rights, including the ability to remove vendors and review
fees.[Footnote 76] FRBNY never extended loans under MMIFF, however,
because no recipients signed up for the program.
Reserve Banks Awarded Largest Contracts Noncompetitvely and Would
Benefit From Additional Guidance on Seeking Competition:
Although FRBNY awarded contracts both competitively and
noncompetitively for the emergency programs, the highest-value
contracts were awarded noncompetitively due to exigent circumstances.
FRBNY awarded almost two-thirds of its contracts noncompetitively,
which accounted for 79 percent of all vendor compensation (see figure
4). Eight of the 10 largest contracts were awarded noncompetitively.
The largest noncompetitive contract was valued at more than $108.4
million, while the largest competitive contract was valued at $26.6
million.
Figure 4: Number of Contracts and Fees Paid, by Procurement Method,
2008-2010:
[Refer to PDF for image: stacked vertical bar graph]
Total fees paid: $654.2 million;
Competitive contracts: $130.3 million; 19.8%;
Noncompetitive contracts: $523.9 million; 79.5%.
Number of contracts: 101;
Competitive contracts: 34; 33%;
Noncompetitive contracts: 67; 65%.
Source: GAO analysis of Reserve Bank data.
Notes:
1. Total fees paid does not add to $659.4 million as shown in table 4
because we excluded two contracts for which competition was not
applicable. For example, Deloitte provided audit services for the
emergency programs, but the work was performed under an existing
contract with the Federal Reserve Board rather than contracts with
individual Reserve Banks.
2. FRBNY entered into 25 contracts that were valued under the small
purchase threshold of $100,000 set in Operating Bulletin 10. As small
purchases, FRBNY was not required to engage in full competition for
these contracts. FRBNY competitively awarded three contracts and
noncompetitively awarded 22 contracts. Small purchases are included in
the graph.
[End of figure]
Vendor Selection Process:
FRBNY awarded contracts in accordance with its acquisition policy,
which applied to all services associated with the emergency programs
and single-institution assistance. FRBNY is a private corporation
created by statute and is not subject to the FAR. Instead, FRBNY
developed its own acquisition policy, called Operating Bulletin
10.[Footnote 77] FRBNY relies on decentralized acquisition processes
in which individual business areas, such as the Capital Markets Group
or the Financial Risk Management Group, are responsible for acquiring
goods and services but may draw on the knowledge and experience of
other business areas such as the legal, credit, or accounting groups.
Operating Bulletin 10 does not address how or when to use vendors but
provides detailed guidance on awarding contracts competitively and on
special circumstances permitting noncompetitive awards. Under the
competitive request-for-proposal (RFP) process, Operating Bulletin 10
provides guidance on how to create and maintain potential vendor lists
for competitive procurements. FRBNY distributes RFPs to as many
prospective vendors as practical. The number of vendors that receive
an RFP varies depending on the good or service being procured. For
example, FRBNY solicited proposals from 62 vendors when selecting the
TALF collateral monitors and 6 vendors when selecting a Maiden Lane
custodian. In some cases, in order to meet policy objectives, FRBNY
expedited the RFP process to award competitive contracts quickly. To
do so, FRBNY shortened the amount of time potential vendors had to
submit proposals. FRBNY also conducted initial assessments of the
received proposals to reduce the number of vendors that were invited
for further evaluation. For the Agency MBS program, FRBNY completed
the RFP process and awarded contracts in as few as 4 weeks.
Operating Bulletin 10 states that business areas may use
noncompetitive processes in special circumstances, such as when a
service is available from only one vendor or in exigent circumstances.
FRBNY cited exigent circumstances for the majority of the
noncompetitive contract awards.[Footnote 78] In their justification
memorandum, FRBNY officials stated that they did not believe there was
adequate time to award contracts competitively and had to use the
exigent circumstances exception. FRBNY officials said that the success
of a program was often dependent on having vendors in place quickly to
begin setting up the operating framework for the program. For example,
FRBNY noncompetitively selected PIMCO as the CPFF investment manager 1
day after announcing the program. Though PIMCO's final contract was
not signed until 3 weeks later, the company immediately began working
to set up CPFF infrastructure and registering program participants so
that the program would be fully operational when it began.
A guiding principle of the FAR, which applies to all executive
agencies, not to the Reserve Banks, is to ensure that agencies are
able to deliver the best value product or service in a timely manner
while fulfilling agencies' policy objectives. Similarly, Operating
Bulletin 10 provides a framework for acquiring goods and services at
the most favorable terms. However, while the FAR requires certain
activities for noncompetitive awards and identifies specific steps to
take, Operating Bulletin 10 does not. Without similar guidance, FRBNY
could be missing opportunities to enhance competition and provide the
best value service in noncompetitive awards. Examples of activities
required or restricted by the FAR include the following:
* Soliciting multiple bids. The FAR requires contracting officers to
solicit as many offers as is practicable in the absence of full and
open competition.[Footnote 79] FRBNY officials stated that in
noncompetitive circumstances business areas are encouraged to collect
a reasonable number of competitive quotations and noted that, in at
least some cases, staff members contacted multiple vendors before
awarding contracts noncompetitively. However, FRBNY did not contact
multiple vendors before awarding some of the largest noncompetitive
emergency program and assistance contracts.[Footnote 80]
* Restrictions on contract duration and scope. Operating Bulletin 10
does not place any limits or restrictions on the duration of a
noncompetitive contract, nor does it require subsequent competition.
In contrast, the FAR generally limits the duration of contracts
awarded under "exigent circumstances" to the time necessary to meet
the unusual and compelling requirements and award a new contract using
competitive procedures, and such contracts may generally not exceed 1
year.[Footnote 81] FRBNY's longest and most expensive contracts were
awarded noncompetitively and lasted more than 2 years and, in some
cases, could potentially last as long as 10 years.[Footnote 82] Some
of these contracts included distinct services that, while related,
were needed at different times and with different degrees of urgency.
FRBNY officials said that in some cases they think there would be
limited benefits to opening noncompetitive contracts to competition.
FRBNY held subsequent competitions for competitively awarded Agency
MBS program and TALF contracts when the terms of the programs changed.
* Justifying noncompetitive procedures. Operating Bulletin 10 requires
business areas to draft a memorandum that includes sufficient
documentation to justify the noncompetitive acquisition. However,
Operating Bulletin 10 does not provide guidance on what information
should be included in the memorandum. FRBNY justification memoranda
typically included background information on the emergency program,
vendor scope of work, vendor selection factors, and an explanation of
the special circumstances necessitating noncompetitive awards. The
memoranda did not typically identify efforts made to promote
competition, which the FAR requires.
Vendor Selection Criteria:
FRBNY considered a number of factors when selecting vendors for both
competitive and noncompetitive contract awards, including a vendor's
knowledge and expertise and ability to meet program requirements.
FRBNY also considered a vendor's previous working relationship with
FRBNY or program participants as part of the selection criteria for
competitively and noncompetitively awarded contracts. FRBNY selected
vendors that had previous working relationships with FRBNY and the
program recipients so that it could leverage that familiarity to
shorten the vendor's learning curve or ramp-up time. For example,
FRBNY noncompetitively selected BlackRock as the investment manager
for Maiden Lanes II and III because BlackRock had already evaluated
the underlying assets pursuant to an engagement with AIG prior to the
extension of credit by FRBNY. FRBNY also was more likely to award
subsequent competitive and noncompetitive contracts to vendors that
were already providing services for a different emergency program or
individual-institution assistance because of the vendor's familiarity
and positive performance. For example, Ernst & Young was awarded a
$10.7 million noncompetitive contract to conduct due diligence for
Maiden Lane. Later, Ernst & Young received another noncompetitive
contract ultimately worth $70.9 million to provide similar services
for the AIG programs and Maiden Lane II and III. Ernst & Young also
received two competitive contracts worth $1.4 million to provide
services for TALF and Maiden Lane.
The Reserve Banks also considered potential conflicts of interest,
institutional capacity, and expertise when selecting vendors both
competitively and noncompetitively and weighted each factor
differently depending on their requirements. In addition, FRBNY
reviewed cost in some competitive procurements that it was responsible
for, but cost generally was not the determining factor. FRBNY
considered low cost as an additional benefit but selected vendors
based on consideration of a number of the above-mentioned factors.
* Conflicts of interest. The Reserve Banks reduced their potential
vendor pool, in some cases, by removing vendors that may have had
perceived or actual conflicts of interest for both competitive and
noncompetitive contracts. For example, FRBR did not consider BlackRock
as a service provider for the Bank of America lending commitment
because Bank of America owned a significant stake in BlackRock.
* Institutional capacity. FRBNY determined a vendor's institutional
capacity by evaluating the size of the firm and its ability to devote
resources, both personnel and financial, to the program. FRBNY sought
vendors that had sufficiently large businesses, as determined by
assets under management or market share, to support the needs of the
emergency programs and individual-institution assistance. FRBNY also
was sensitive to the amount of work that a vendor was performing for
it and was cautious about exceeding a vendor's operational capacity.
* Expertise. FRBNY sought to hire the most expert firms both
competitively and noncompetitively. FRBNY sought to hire vendors that
had extensive experience and were well respected in the industry. For
example, FRBNY competitively selected TREPP LLC, a leading provider of
commercial mortgage-backed securities analytics, as the collateral
monitor for commercial mortgage-backed securities for TALF.
Vendor Fees Generally Came from Program Income or Participants:
From 2008 through 2010, vendors were paid $659.4 million through a
variety of fee structures. The Reserve Banks generally used
traditional market conventions when determining fee structures. For
example, investment managers were generally paid a percentage of the
portfolio value and law firms were generally paid an hourly rate. Fees
for these contracts were subject to negotiation between the Reserve
Banks and vendors. For some of the large contracts that were awarded
noncompetitively, FRBNY offered vendors a series of counter proposals
and was able to negotiate lower fees than initially proposed. FRBNY
staff assessed fee proposals for several of these larger contracts
that were awarded noncompetitively. Reserve Bank staff compared
vendors' fee proposals to fees that other institutions paid for
similar services. However, Reserve Bank staff could not always find
comparable portfolios on which to evaluate fee proposals. When
determining fees, the Reserve Banks did not always know how much work
a vendor would perform under a contract because of uncertainty about
the size and duration of the emergency programs, so it used varying
fee structures to address this uncertainty. For example, FRBNY
officials said that they were not certain how extensively CPFF would
be used. Compensation based solely on basis points could have resulted
in low fees if the program was not widely used or high fees if it was
used extensively. After considering various scenarios, FRBNY and
PIMCO, the CPFF investment manager, negotiated a fixed quarterly fee
of $3 million plus a variable fee of 0.25 basis points on the
outstanding amount of commercial paper.[Footnote 83] Participation in
CPFF peaked in January 2009 at nearly $350 billion and then fell
rapidly so PIMCO's compensation came primarily from the variable
portion of its fee early in the program and from the fixed portion of
its fee later in the program.
The Reserve Banks used different funding sources to pay vendor fees.
The Reserve Banks generally paid vendor fees one of three ways
depending on program terms:[Footnote 84]
* Reserve Banks paid vendors directly and were not reimbursed. For the
Agency MBS program, AMLF, and TALF, the Reserve Banks paid vendors
directly and were not reimbursed. However, as of May 31, 2011, income
to date from each of these programs has exceeded vendor fees.
* Reserve Banks paid vendors and were reimbursed. Under the terms of
the AIG, Citigroup, and Bank of America assistance, the companies were
required to reimburse the Reserve Banks for the $257.2 million in
vendor fees that the Reserve Banks paid vendors for services related
to those programs.[Footnote 85]
* Vendors were paid according to a financial structure known as a
"waterfall." For five programs--CPFF, TALF, and the three Maiden Lane
programs--vendors were paid according to a "waterfall" structure in
which program cash flows were used to pay vendors before FRBNY and its
counterparties were repaid.[Footnote 86] Vendor fees reduced the
income that FRBNY received from these programs. According to the
waterfall structure, FRBNY received all or most of residual income
from the programs after expenses, loans, and interest were repaid.
While FRBNY Took Steps to Manage Conflicts of Interest for Employees,
Directors, and Program Vendors, Opportunities Exist to Strengthen
Conflict Policies:
During the crisis, FRBNY took steps to manage conflicts of interest
related to the emergency programs for its employees, program vendors,
and members of its Board of Directors, but opportunities exist to
strengthen its conflicts policies. FRBNY expanded its guidance and
monitoring for employee conflicts of interest based on existing
provisions in its Code of Conduct that incorporate the requirements of
a federal criminal conflict of interest statute and its regulations.
The code also includes a general prohibition on employee ownership of
certain debt or equity interests. However, additional provisions
concerning prohibited financial interests could help to ensure that
conflicts are appropriately identified and managed for employees
involved in decisions relating to emergency assistance. In addition,
FRBNY managed vendor conflict issues through contract protections,
established practices to perform onsite reviews and request conflict
remediation plans, and implemented a new vendor management policy.
However, the new policy does not provide comprehensive guidance on
managing vendor conflict issues. FRBNY staff stated they are
developing an additional vendor management policy that formalizes
practices used during the crisis. FRBNY could use this opportunity to
provide detailed guidance on steps FRBNY staff should take to manage
vendor conflicts. Finally, while Reserve Bank directors did not have
responsibility for authorizing the emergency assistance, some
directors had a limited role in overseeing how the Reserve Banks
managed the assistance and programs once they were established. Like
employees, all directors were subject to statutory requirements
governing conflicts of interest.
During the Crisis, FRBNY Expanded Its Efforts to Manage Employee
Conflicts:
Historically, FRBNY has managed potential and actual conflicts of
interest for its employees primarily through enforcement of its Code
of Conduct, which outlines broad principles for ethical behavior and
specific restrictions on financial interests and other activities,
such as restrictions on employees' investments in depository
institutions and bank holding companies. A personal conflict of
interest can result from an employee having financial or other
interests that conflict with the interests of the Reserve Bank. During
the crisis, new roles and responsibilities assumed by FRBNY and its
employees and interaction with nonbank entities gave rise to potential
conflicts of interest that were not specifically addressed, as they
were for investments in depository institutions. However, according to
FRBNY officials, the Code of Conduct, which incorporates the
requirements of a federal criminal statute and its regulations, along
with the statute itself, generally prohibits any FRBNY employee from
working on a matter related to an institution in which the employee
has financial interests, such as investments in the institution.
During the crisis, FRBNY expanded its efforts to address personal
conflicts for its employees by (1) providing additional training and
guidance on existing policies governing conflicts of interest,
including the Code of Conduct; (2) implementing program-specific
information barriers and ethical guidelines to limit sharing of
sensitive program information within and outside FRBNY; and (3)
expanding guidance on prohibited financial interests and increasing
the monitoring of compliance with these restrictions for some
employees.
Expanded Training and Guidance on Existing Conflict Policies:
During the crisis, FRBNY provided its employees with additional
training and guidance on its existing conflict of interest policies.
FRBNY's Code of Conduct outlines ethical standards that broadly
require employees to avoid any situation that might give rise to an
actual conflict of interest or the appearance of a conflict of
interest. In addition, to prevent the occurrence of certain actual
conflicts of interest, the Code of Conduct includes specific
restrictions on employees' financial holdings and other activities.
Moreover, FRBNY employees are subject to the criminal conflict of
interest restrictions in section 208 of title 18 of the U.S. Code,
which FRBNY has incorporated into its Code of Conduct. Section 208
generally prohibits employees from participating personally and
substantially in their official capacities in any matter in which, to
their knowledge, they have a financial interest, if the particular
matter will have a direct and predictable effect on that
interest.[Footnote 87] According to FRBNY's Code of Conduct, it is the
responsibility of employees to use their judgment to inform FRBNY's
Ethics Office in the event that a potential or actual conflict of
interest might impact their ability to participate in a particular
matter. The financial crisis resulted in an increased volume of ethics-
related inquiries, particularly at FRBNY, which led FRBNY to
strengthen its training and communication systems related to its Code
of Conduct. On its intranet, FRBNY launched an ethics Web site
featuring a Web-based version of its Code of Conduct and special
guidance for employees. Special guidance included investment guidance
bulletins issued in response to the crisis and guidance for staff
members in Bank Supervision and those with access to monetary policy
information. FRBNY also took additional steps to limit access to
nonpublic information--such as program-specific information or
information received as a result of market outreach--to employees on a
need-to-know basis. The Ethics Office issued general guidance to all
Bank staff on the handling of material nonpublic information. This
guidance was supplemental to FRBNY's existing Code of Conduct and a
policy designed to protect the handling, custody, and release of
supervisory information. FRBNY also introduced a quarterly lunch
session to introduce its new staff, many of whom were hired to
implement the emergency programs, to its ethics rules.
Program-Specific Information Barriers and Ethical Guidelines:
In addition to promoting awareness of existing conflict policies,
FRBNY issued new ethical guidance and information barrier policies to
address specific conflicts that could arise in some of its emergency
programs. Before the crisis, FRBNY policies were in place to limit
access to sensitive information, such as supervisory information about
the financial condition of depository institutions. These policies
served to reduce the possibility that an employee could share
sensitive information with others who could profit by trading on this
information. As a result of their involvement in FRBNY's emergency
activities, many employees required access to new types of sensitive
information that were not explicitly covered by FRBNY's information
access and disclosure policies. For CPFF and MMIFF, FRBNY staff
responsible for managing the risks of the programs needed access to
confidential information about the financial condition of eligible
issuers of commercial paper and their related borrowing amounts and
the types and amounts of an eligible seller's money market instruments
sold into the program, respectively. In addition, TALF and the Agency
MBS program presented additional ethics issues arising from overall
program activity that could influence the value of an employee's
financial assets whose ownership was not already prohibited by FRBNY's
Code of Conduct.
FRBNY implemented program-specific information barriers for CPFF and
MMIFF and ethical guidelines for TALF and the Agency MBS program.
Information barriers for CPFF and MMIFF restricted access to nonpublic
information about program registrants and sellers to FRBNY program
staff on a need-to-know basis and required these employees to remove
the identity of program participants in written materials providing
program updates and metrics to FRBNY management and other staff.
Furthermore, these information barriers restricted staff over the wall
responsible for conducting monetary policy from receiving information
about how the program's asset manager could invest program cash flows
in U.S. government securities, which could impact monetary policy. The
information barrier policy required assigned FRBNY program staff to
disclose their financial holdings related to each borrower and seller
and restricted staff from transacting in securities of the borrower
and seller for the duration of the program and 90 days thereafter. For
TALF and the Agency MBS program, FRBNY set forth ethical guidelines
that specified prohibited financial interests for assigned program
staff. Specifically, FRBNY staff were advised to avoid having
financial interests in program-eligible securities such as ABS, agency
MBS, commercial MBS, any investment fund concentrated in any one of
these securities, and any debt or equity interest in any of the
government-sponsored enterprises. Lastly, FRBNY staff working on these
programs were advised to discuss potential exemptions of existing
investments with FRBNY's Ethics Office and to avoid new purchases or
sales of related investments for the duration of the program and 90
days thereafter.
Expanded Guidance for Prohibited Financial Interests and Management of
Conflicts:
FRBNY's Code of Conduct included restrictions on financial interests
that were intended to prevent personal conflicts that could arise in
the conduct of FRBNY's traditional activities, which included
supervising and making discount window loans to depository
institutions and conducting monetary policy operations with primary
dealers. For example, the existing Code of Conduct includes a
provision that specifically prohibits FRBNY employees from holding
certain debt or equity interests in depository institutions or their
affiliates. However, the Code of Conduct was not written to include
specific restrictions on employees' holdings of certain financial
interests that could potentially be affected by an employee's
participation in matters concerning FRBNY's recent emergency
activities. These financial interests include the debt or equity of
some nondepository institutions that received emergency assistance, or
certain types of securities actively traded or purchased through an
emergency program. FRBNY staff said that the Code of Conduct and 18
U.S.C. § 208 broadly prohibit employees who worked on the emergency
programs from holding investments that could have been affected by
their participation in matters concerning those programs. According to
FRBNY staff, absent a waiver, employees were prohibited from working
on an emergency program while holding investments that would be
affected by their participation in matters concerning those programs.
During the crisis, FRBNY took steps to help identify and manage new
potential personal conflicts that could arise from employees' new
roles with respect to the emergency programs. FRBNY used its financial
disclosure requirements to help identify potential conflicts.
According to FRBNY officials, the ethical guidelines discussed
previously gave rise to employee self-disclosures of program-eligible
securities. Furthermore, according to FRBNY officials, employees
working on TALF, the Agency MBS program, and other programs including
CPFF and MMIFF were required to disclose their financial holdings with
greater frequency outside of FRBNY's annual disclosure process. In
addition, effective fall 2008, FRBNY prohibited all employees from
making new investments in certain nonbank holding companies, while
employees in the Capital Markets Group were already prohibited from
holding investments related to primary dealers.
For matters where FRBNY identified the possibility of a conflict
related to an employee's financial interests, according to FRBNY
staff, its Ethics Office made a determination as to whether a conflict
existed. In cases where a conflict was determined to exist, FRBNY's
Ethics Office generally advised divestiture or recusal or granted a
waiver allowing the employee to continue to hold the relevant
investment.[Footnote 88] FRBNY staff said that out of 12 self-
disclosures of related program-eligible securities sent to the Ethics
Office, 4 disclosures resulted in the employee being required to
divest related assets. According to FRBNY staff, some FRBNY employees
recused themselves from involvement in discussions in cases where they
believed their participation would have been in violation of section
208.
According to FRBNY staff, in cases where FRBNY did not require an
employee to divest or recuse, its Ethics Office determined either that
no conflict of interest existed based on statutory standards or that a
waiver was appropriate. According to FRBNY staff, in determining
whether to recommend a waiver, the Ethics Office followed the
regulations and guidance issued by the Office of Government Ethics.
FRBNY waiver recommendations cited the following reasons for granting
waivers: (1) the criticality of the employee's services; (2) the
insubstantial value of the employees' stock interest, which generally
represented less than 2 to 5 percent of their investment portfolio or
net worth; (3) the limited role designated to the employee for their
responsibilities relating to the personal financial interest; (4) a
determination that forced divestiture would lead to an appearance of a
conflict; and (5) a determination that the investments did not exceed
a de minimis threshold of $15,000 as set forth in the Office of
Government Ethics regulations, and in the Code, as an exemption for
interests in securities.[Footnote 89]
Our review of several recommendations for waivers granted from
September 19, 2008, through March 31, 2010, indicated that FRBNY
employees who requested waivers were generally allowed to continue to
retain their related personal financial investments. Most of the
financial interests were in institutions receiving emergency
assistance, including AIG, Bank of America, Citigroup, General
Electric Company (GE), and JPMC. For example, on September 19, 2008--3
days after the Federal Reserve Board authorized FRBNY to assist AIG--
the then-FRBNY President granted, under authority delegated by the
FRBNY Board of Directors, a waiver to a senior management official
with financial interests in AIG and GE who was involved in decision
making related to these two companies.[Footnote 90] Similar to
criteria noted previously, the waiver recommendation from FRBNY's
Chief Ethics Officer cited reasons based on (1) the criticality of the
official's responsibilities, (2) the combined value of the official's
interests comprising less than 5 percent of the official's total
financial holdings, and (3) the de minimis nature of the official's
investment in AIG. Specifically, the waiver recommendation from
FRBNY's Chief Ethics Officer noted that the official's participation
in decisions related to AIG and GE was critical to the official's
senior-level responsibilities. In addition, in this recommendation,
the Chief Ethics Officer expressed concern that the official's
divestiture of the holdings could violate securities laws because of
the official's access to material, nonpublic information. Furthermore,
the waiver recommendation noted that should FRBNY's actions impact the
equity of either company, divestiture by the official could have
created the appearance of a conflict. The waiver recommendation
further noted that while this official would be permitted to provide
advice on decisions about assistance to AIG and GE, FRBNY's president
would make final decisions on these issues. We did not assess the
appropriateness of FRBNY's decisions to grant waivers and recognize
that these decisions are case-specific and necessarily require
subjective judgments. The challenge of applying such judgments is
highlighted by guidance from the Office of Government Ethics, which
notes that while a waiver analysis usually requires the consideration
of several competing factors, appearance concerns will always play an
important role in the decision whether to grant a waiver.
FRBNY Has Not Revised Its Code of Conduct to Reflect Expanded Role:
While the crisis highlighted the potential for Reserve Banks to
provide emergency assistance to a broad range of institutions, FRBNY
has not revised its conflict policies and procedures to more fully
reflect potential conflicts that could arise with this expanded role.
For example, specific investment restrictions in FRBNY's Code of
Conduct continue to focus on traditional Reserve Bank counterparties--
depository institutions or their affiliates and the primary dealers--
and have not been expanded to further restrict employees' financial
interests in certain nonbank institutions that have participated in
FRBNY emergency programs and could become eligible for future ones, if
warranted.
As discussed earlier in this report, the management of each Reserve
Bank assesses their internal controls based upon the criteria
established in the Internal Control-Integrated Framework issued by
COSO.[Footnote 91] These standards state that because economic,
industry, regulatory, and operating conditions will continue to
change, mechanisms are needed to identify and deal with the special
risks associated with change. Circumstances for which an internal
control system originally was designed also may change, causing the
system to be less able to warn of the risks brought by new conditions.
Accordingly, management needs to determine whether the internal
control system continues to be relevant and able to address new risks.
Federal Reserve Board and FRBNY staff told us that the Federal Reserve
System plans to review and update the Reserve Banks' Codes of Conduct
as needed given the Federal Reserve System's recently expanded role in
regulating systemically significant financial institutions. These
reviews present an opportunity to also consider how FRBNY's experience
managing employee conflicts of interest related to its emergency
programs could inform efforts to update the Reserve Banks' conflict of
interest policies.
FRBNY staff told us that although FRBNY's Code of Conduct did not
include specific restrictions that would have addressed all potential
conflicts for employees that arose during the crisis, they believe the
Code of Conduct and 18 U.S.C. § 208 provided the flexibility needed to
address such conflicts. Furthermore, Federal Reserve Board staff said
that expanding the list of restricted investments to address all
potential conflicts would be difficult because anticipating which
nondepository entities would participate in an emergency program
during a crisis is not possible. However, given the public's
heightened attention to conflicts of interest related to the Federal
Reserve System's emergency programs, Reserve Banks' continued reliance
on their existing standards for managing employee conflicts of
interest may not be sufficient to avoid situations in which
significant appearance concerns must be weighed against--and possibly
judged to be outweighed by--other factors, such as the criticality of
an official's services. Office of Government Ethics regulations state
that one of many factors to weigh in determining whether a
disqualifying financial interest is sufficiently substantial to be
deemed likely to affect the integrity of the employee's services to
the government is the sensitivity of the matter. Office of Government
Ethics guidance notes that where the particular matter is
controversial or sensitive, the wisdom of granting a waiver can be
questionable.[Footnote 92] The case of a senior Reserve Bank official
holding investments in an institution receiving substantial emergency
assistance highlights the potential for appearance concerns even in
cases when the employee's investments come under a regulatory de
minimis exemption or comprise a small percentage of the employee's
total investments. While we recognize that the current codes of
conduct provide flexibility to address unanticipated conflicts, a
crisis situation may not provide time for formal review of a potential
conflict before key decisions must be made. Without additional
provisions in conflicts policies and procedures, the Reserve Banks
risk being exposed to the appearance of conflicts and to questions
about the integrity of their decisions and actions.
FRBNY Primarily Used Contract Protections to Manage Risks Related to
Vendor Conflicts, and the Lack of a Comprehensive Policy Created
Certain Limitations:
FRBNY managed risks related to vendor conflicts of interest primarily
through contract protections and oversight of vendor compliance with
these contracts. However, FRBNY's efforts to manage these risks had
some limitations. In implementing the emergency programs, FRBNY used
vendors on a scale unprecedented for a Reserve Bank. When the crisis
began, FRBNY's policies for managing vendor relationships did not
include comprehensive guidance on steps FRBNY staff should take to
help ensure that vendor conflicts were identified and mitigated.
During the crisis, FRBNY established practices for managing vendor
relationships and vendor conflicts. While not part of a formal policy,
FRBNY's Legal Division negotiated contract provisions intended to help
ensure that vendors took appropriate steps to mitigate conflicts of
interest related to the services they provided for FRBNY. In addition,
FRBNY's Compliance Division identified higher-risk vendors and
provided greater attention to potential conflicts related to these
vendors' activities. However, FRBNY continues to lack a policy to
guide communication efforts between its Legal and Compliance divisions.
Although we did not identify any instances in which a conflict
compromised achievement of policy goals, we found that in some cases
FRBNY could have taken additional steps to provide greater assurance
that vendor conflicts were identified and mitigated. First, FRBNY
generally did not contractually require vendors to demonstrate they
had taken action to help ensure that they identified and took steps to
manage conflicts on an ongoing basis. FRBNY staff said they had
regular conversations with vendors about steps the vendors were taking
to identify and mitigate conflicts, but FRBNY required few vendors to
provide a written conflict mitigation plan. Second, FRBNY performed on-
site reviews to check for vendor compliance with contract provisions
related to conflicts mitigation, but some of these reviews occurred 12
months into a contract or later. As discussed below, although FRBNY is
taking steps, it has not yet finalized a comprehensive conflict policy
to help ensure that its future management of risks related to vendor
conflicts incorporates both best practices and lessons learned from
the recent crisis.
FRBNY's Legal Division negotiated provisions in its vendor contracts
that were intended to help ensure that vendors took steps to mitigate
conflicts of interest related to the services they provided to FRBNY.
Similar to the potential for personal conflicts for FRBNY employees, a
personal conflict for a vendor employee could arise if an employee's
personal financial interests or activities conflicted with the vendor
employee's responsibilities in connection with the services provided
to FRBNY. In addition, FRBNY recognized that organizational conflicts
of interest could arise to the extent that a vendor firm's financial
interest in providing services to its other clients could conflict
with its duties to FRBNY. FRBNY staff noted that some types of vendor
services, such as asset management services, presented greater risks
related to conflicts of interest than other types of services, such as
legal or administrative services. For example, conflicts of interest
are inherent in asset management because firms may manage similar
assets for different clients with competing interests. Specifically,
BlackRock and PIMCO managed similar assets for both FRBNY and other
clients that may have had competing interests. In addition, the
potential for conflicts existed for vendor firms and employees of
these firms that had access to nonpublic FRBNY program information
that could be used for vendor or vendor employee gain. Examples of
contract provisions FRBNY applied to help ensure these conflicts were
mitigated included, but were not limited to, provisions that required
the vendor firm to:
* enforce confidentiality and nondisclosure agreements that imposed
additional requirements on the vendor firm regarding the handling of
confidential information received in connection with the vendor's
duties to FRBNY;
* limit access to confidential information on a "need to know" basis
by identifying a list of "restricted" employees with access to
confidential information relevant to FRBNY program-specific operations;
* implement an ethical "wall" to physically separate FRBNY program-
specific team members from non-FRBNY operations, including moving
these members to another floor or building with electronic access
restrictions;
* monitor e-mails for improper communication of trading activity,
ideas, and the sharing of nonpublic information;
* impose restrictions on personal financial transactions to restrict
employees from participating in or conducting trading for program-
specific related assets;
* engage in discussions with individuals in the vendor's Legal and
Compliance divisions prior to accepting new assignments in connection
with services provided for FRBNY; and:
* establish incident reporting procedures to disclose any potential or
actual conflicts and request waivers from FRBNY, if necessary.
FRBNY staff said that attorneys from FRBNY's Legal and Compliance
divisions advised on the inclusion of these types of contract
protections based on the nature of the vendors' services. During the
crisis, while FRBNY developed certain contractual provisions that it
used repeatedly in its vendor contracts for mitigation of conflicts of
interest, it did not create new comprehensive guidelines on the types
of conflict mitigation protections that should be included in vendor
contracts. In contrast, Treasury, which also employed a number of
vendors as it implemented TARP, issued new interim guidelines for its
management of TARP vendor conflicts of interest in January 2009,
following our December 2008 recommendation that Treasury develop a
comprehensive system to ensure that vendor conflicts would be fully
identified and appropriately addressed. In our recommendation to
Treasury we noted that without a comprehensive system to monitor
conflicts of interest, the potential exists for gaps in internal
controls as a result of the need to begin program activities before
policies and procedures have been fully developed and implemented.
Treasury's interim guidelines provided for the inclusion of some types
of conflict protections that FRBNY did not always include in its
contracts but generally included for some high-risk vendors. These
included requiring the vendor firm to:
* provide Treasury with sufficient information to evaluate any
organizational and personal conflicts of interest, including a
detailed, written plan to mitigate organizational conflicts of
interest;
* certify that information provided to Treasury related to the
conflict mitigation plan was complete and accurate in all material
respects; and:
* subsequently notify Treasury of any new conflicts that emerged
during the term of the contract and to periodically recertify the
completeness and accuracy of information provided related to conflicts.
Rather than requiring written conflict remediation plans that were
specific to the services provided for FRBNY, FRBNY generally reviewed
and allowed its vendors to rely on their existing enterprisewide
policies for identifying conflicts of interest. However, in some
situations, FRBNY requested that additional program-specific controls
be developed. Without program-specific remediation plans from its
vendors, FRBNY lacked assurance that vendor conflicts would be fully
identified and appropriately addressed.
FRBNY's Chief Ethics Officer told us that FRBNY reviewed our 2008
recommendation on Treasury's management of vendor conflicts and took
steps to implement this recommendation in part by requesting conflict
remediation plans from some of its vendors. In December 2008, FRBNY
sent a letter to thirteen vendors requesting in writing that they (1)
disclose any actual or potential conflicts of interest related to
their services for FRBNY and (2) for any such conflicts, provide a
comprehensive conflict mitigation plan. FRBNY received written
responses from five of these vendors and only a few of these responses
were accompanied by a detailed conflict mitigation plan. Two of the
responding vendors identified potential or actual conflicts and said
that they would rely on their firm's existing conflict mitigation
policies and seek waivers, as needed, to mitigate these conflicts. The
other three vendor responses indicated that these firms were not aware
of any potential or actual conflicts. One of these vendors, which
provided custodial services for multiple FRBNY programs, submitted an
identical response for its engagement in two of the programs. Although
this firm represented that it was not aware of any potential conflicts
for itself or its affiliates, one of its affiliates later borrowed
from one of the programs beginning in December 2008. FRBNY's Ethics
Officer did not become aware of the vendor's affiliate's use of the
program until he reviewed the Federal Reserve Board's public
disclosure of the borrowers' names on December 1, 2010. FRBNY staff
noted that the vendor firm had information barriers in place to
prevent sharing of sensitive program information with this borrowing
affiliate. An FRBNY official told us that due to the nature of the
vendor's responsibilities, which were primarily administrative, FRBNY
considered the engagement of this vendor to present a low risk of a
material conflict of interest.
For vendors posing greater risks related to conflicts of interest,
FRBNY staff told us that they had early and ongoing conversations and
reviewed the vendor's conflict policies and procedures. For example,
FRBNY staff noted that they had early and ongoing discussions with
BlackRock that helped assure them that BlackRock had implemented
ethical walls and taken other steps to mitigate potential conflicts of
interest. For BlackRock and other vendors with which FRBNY had
frequent communications about conflict mitigation, FRBNY staff said
they did not require additional program-specific conflict remediation
plans because they considered the policies and procedures put in place
by the vendors to be sufficient. Nevertheless, as discussed below,
during KPMG's on-site conflict of interest reviews of some FRBNY
vendors, KPMG recommended that FRBNY require a few of these vendors
consider implementing program-specific mitigation plans.
FRBNY completed on-site reviews of many significant program vendors in
2009 and 2010, and in some cases, these reviews were not timely. In
early 2009, FRBNY drafted a schedule for both high-level and in-depth
reviews to be performed primarily for investment managers across the
emergency programs to assess their performance and compliance with
contract obligations. In June 2009, FRBNY sent a request for proposal
to several audit firms to assist it in developing a conflict of
interest inspection and fraud review program for its critical vendors
given FRBNY's limited internal capacity. KPMG, the winning bidder,
performed its reviews as the utilization of the programs was generally
slowing down. Generally these reviews were designed to help ensure
conflict of interest policies and procedures including ethical walls
and information barriers met FRBNY's requirements for vendors, to
determine whether the emergency program included testing over existing
controls and to complete a risk-based assessment of the vendor's
compliance control environment as it related to contractual
provisions, among other things. The reviews were conducted across
three categories of vendors--investment managers, collateral monitors,
and transaction agents--and generally excluded reviews of less
critical vendors who performed custodial and administrative services.
FRBNY relied on its own resources to oversee compliance of custodial
and administrative service vendors while focusing additional on-site
reviews on operational, financial, and information security risks to
the Reserve Bank.
These reviews of vendor performance and contract compliance were, in
some instances, performed 12 to 14 months into a vendor's contract
with FRBNY. The reviews generally indicated that the vendors had
adopted and implemented comprehensive, enterprisewide compliance
programs. During the reviews, KPMG made critical risk observations for
FRBNY's consideration in conducting future vendor contract
negotiations. In several cases, because of the timing of KPMG's
review, critical findings of noncompliance with relevant contract
provisions were left undetected until late in the operation of the
emergency programs. For some vendors, these reviews found that:
* vendors relied on existing information barriers to mitigate
conflicts of interest as opposed to implementing FRBNY program-
specific "ethical wall" barriers to help manage organizational
conflicts of interest,
* opportunities existed for vendors to improve access restrictions for
information systems and to conduct periodic reviews to limit the
sharing of nonpublic information, and:
* opportunities existed for vendors to review restrictions on employee
personal trading activities related to the eligible assets of the
emergency programs to better ensure there was no improper trading
activity.
At the conclusion of these reviews, FRBNY held meetings with vendor
senior management to share the results and in certain cases received
follow-up documentation on how the vendor planned to remediate
critical findings. Before engaging KPMG, FRBNY's Compliance Division
began to develop internal capacity to conduct its own vendor reviews.
In January 2010, the Assurance and Advisory Services unit, a newly
formed team within FRBNY's compliance function, assumed responsibility
for conducting vendor and third-party reviews, including reviews of
vendor and third-party compliance with conflict mitigation plans they
submitted to FRBNY.
In May 2010, FRBNY implemented a new vendor management policy to serve
as a framework to minimize reputational, operational, credit, and
market risks associated with its use of vendors. The policy requires
the business manager assigned to a particular program to provide a
risk assessment for that program's service providers, taking into
consideration the nature, scope, and cost of the vendors' services.
The risk level assigned determines the frequency at which FRBNY staff
managing vendors should report and review the vendors' performance,
perform on-site reviews, and escalate and communicate respective risk
events to FRBNY. Furthermore, the policy provides that a plan be
developed and documented for all of the steps for its high risk
vendors. This new policy immediately began covering high risk vendor
relationships that resulted from FRBNY's emergency programs. Before
May 2010, according to FRBNY staff, some FRBNY business areas, such as
the Investment Support Office with respect to the Maiden Lane
facilities and the Markets Group with respect to broad-based programs,
had implemented vendor oversight programs that included procedures for
performing risk-based reviews of vendors' significant processes,
walkthroughs and testing of key internal controls, and assessments of
contract compliance.
While FRBNY's vendor management policy incorporates some lessons
learned from the crisis, it does not provide detailed guidance on
steps FRBNY staff should take to ensure that vendors mitigate
conflicts, such as types of protections that should be included in
vendor contracts to help ensure that vendors provide information
needed by FRBNY to evaluate potential and actual conflicts of
interest. FRBNY staff told us that they are developing a vendor
conflict policy that formalizes the practices it used during the
financial crisis. A more comprehensive policy that formalizes
practices FRBNY had in place and incorporates additional protections,
as appropriate, could enable FRBNY to more fully identify and
appropriately manage vendor conflicts of interest.
Reserve Bank Directors Are Generally Subject to the Same Conflict
Rules as Federal Employees and a Few Directors Played a Limited Role
in Risk Oversight of the Programs:
Individuals serving on the boards of directors of the Reserve Banks
are generally subject to the same conflict of interest statute and
regulations as federal employees. As with other employees, 18 U.S.C. §
208 generally prohibits Reserve Bank directors from participating
personally and substantially in their official capacities in any
matter in which, to their knowledge, they have a financial interest,
if the particular matter will have a direct and predictable effect on
that interest.[Footnote 93] In addition, all Reserve Bank boards of
directors are subject to a Federal Reserve Board policy on conflicts
of interest for which they receive annual training. There are three
classes of Reserve Bank directors: Class A directors are elected by
banks that are members of the Federal Reserve System in their
respective regions and represent these banks, Class B directors are
elected by banks to represent the public, and Class C directors are
appointed by the Federal Reserve Board to represent the public with
due consideration to the interests of agriculture, commerce, industry,
services, labor, and consumers. Class B and C directors are not
allowed to be officers, directors, or employees of any bank. Class C
directors are prohibited from owning shares of a bank.
A number of Reserve Bank directors were affiliated with institutions
that borrowed from the emergency programs, but Reserve Bank directors
did not participate directly in making decisions about authorizing,
setting the terms, or approving a borrower's participation in the
emergency programs. As noted previously, the Federal Reserve Board,
and in some cases, the FOMC, authorized the creation and modification
of most of the emergency programs under authorities granted by the
Federal Reserve Act. FRBNY's Board of Directors assisted the Reserve
Bank in helping ensure risks were managed through FRBNY's Audit and
Operational Risk Committee.[Footnote 94] During the crisis, at least
one Class A director served on the Audit and Operational Risk
Committee at any given time. According to FRBNY officials, FRBNY's
Reserve Bank Directors' limited role in assessing the effectiveness of
the Bank's management of operational risk for the emergency programs
gave rise to limited waiver requests or recusals. We plan to explore
these relationships in greater detail in our study on Reserve Bank
governance.[Footnote 95]
In their role as market participants, Reserve Bank directors engaged
in consultations with FRBNY management and staff. According to FRBNY
officials, a director providing information to FRBNY management and
staff in his or her role as chief executive officer of an institution
does not equate to "participating personally and substantially"--as
defined by 18 U.S.C. § 208--because the director is not playing a
direct role with respect to approving a program or providing a
recommendation. According to FRBNY officials, FRBNY's Capital Markets
Group contacted representatives from primary dealers, and commercial
paper issuers, and other institutions to gain a sense of how to design
and calibrate some of its emergency programs. FRBNY contacted
institutions for this purpose irrespective of whether one of FRBNY's
directors was affiliated with an institution. Some of these
institutions that borrowed from the emergency programs also had senior
executives that served on FRBNY's board of directors. For example,
JPMC was extensively involved in the emergency programs as both a
borrower and a vendor at the same time its Chief Executive Officer
served as a Class A FRBNY director. According to the Federal Reserve
Board officials, the Federal Reserve Board allowed borrowers to access
its emergency programs only if they satisfied publicly announced
eligibility criteria. Thus, Reserve Banks granted access to borrowing
institutions affiliated with Reserve Bank directors only if these
institutions satisfied the proper criteria, regardless of potential
director-affiliated outreach or whether the institution was affiliated
with a director. Similarly, Lehman Brothers' Chief Executive Officer
served on the FRBNY board and while Lehman Brothers' primary dealer
participated in PDCF, the firm was not provided individual assistance
to avert its failure.
As discussed later in this report, our review of the implementation of
several program requirements did not find evidence that appeared to
indicate a systemic bias towards favoring one or more eligible
institutions. While some institutions that borrowed from these
programs were affiliated with a Class A director, these institutions
were subject to the same terms and conditions as those that were not
affiliated with Reserve Bank directors. According to our review of
minutes from meetings of FRBNY and FRBB boards of directors,
discussions of emergency programs during board meetings generally
occurred after the programs were publicly announced and generally
covered explanations of the related emergency lending authority,
administration of the program, and descriptive information about the
programs' operations and risks, and the impact on the Reserve Banks'
balance sheets. In addition, all Reserve Bank directors are prohibited
from disclosing nonpublic information related to the programs and such
disclosures may risk violating insider trading laws. Effective
December 16, 2010, FRBNY revised its bylaws and committee charters
governing the activities of its Board of Directors. Specifically,
FRBNY implemented Dodd-Frank Act amendments to the Federal Reserve Act
concerning Reserve Bank governance while imposing additional controls
to enhance its corporate governance policies.[Footnote 96] One of
these revisions permits only two out of five Audit and Operational
Risk Committee members to be Class A directors.[Footnote 97] These
enhanced standards by FRBNY, although implemented after the unwinding
of many of the emergency programs, helped mitigate the appearance of
actual and potential director conflicts. As noted earlier, a
forthcoming report on Reserve Bank governance issues will include
additional discussion of conflicts of interest for Reserve Bank
directors.
Opportunities Exist to Strengthen Risk Management Policies and
Practices for Future Emergency Programs:
The Federal Reserve Board approved key program terms and conditions
that served to mitigate risk of losses and delegated responsibility to
one or more Reserve Banks for executing each emergency lending program
and managing its risk of losses. For several programs, the Federal
Reserve Board required borrowers to post collateral in excess of the
loan amount. For programs that did not have this requirement, Reserve
Banks required borrowers to pledge highly-rated assets as collateral.
Also, for assistance to specific institutions, the Reserve Banks
negotiated loss protections with the institutions and hired vendors to
help oversee the portfolios collateralizing loans. As of July 2011,
most of the Federal Reserve Board's emergency loan programs have
closed and all of those that have closed have closed without losses.
Moreover, currently, the Federal Reserve Board does not project any
losses on FRBNY's outstanding loans to TALF borrowers and the Maiden
Lane SPVs. To manage risks posed by the emergency programs, Reserve
Banks developed new controls and FRBNY strengthened its risk
management practices over time. For example, FRBNY expanded its risk
management function and enhanced its risk reporting and risk analytics
capabilities. Although FRBNY has improved its ability to monitor and
manage risks from its emergency lending, opportunities exist for FRBNY
and the Federal Reserve System as a whole to strengthen risk
management procedures and practices for any future emergency lending.
Specifically, neither FRBNY nor the Federal Reserve Board tracked
total potential exposures in adverse economic scenarios across all
emergency programs. Moreover, the Federal Reserve System's existing
procedures lack specific guidance on how Reserve Banks should exercise
discretion to restrict or deny program access to higher-risk borrowers
that otherwise met program eligibility requirements. Without enhanced
risk tracking and risk management procedures, the Federal Reserve
System could lack important tools needed to comprehensively manage
risk exposure in the event of a future crisis.
Programs Contained Multiple Loss Protection Features Aimed at
Balancing Loss Protections with Financial Stability Goals:
The Federal Reserve System sought to balance loss protections with its
financial stability goals in designing security and collateral
policies to help mitigate the risk of losses for its emergency lending
programs.[Footnote 98] The context for the Federal Reserve System's
management of risk of losses on its loans differed from that for
private sector institutions. In contrast to private banks that seek to
maximize profits on their lending activities, the Federal Reserve
System stood ready to accept risks that the market participants were
not willing to accept to help stabilize markets. When authorizing each
program, the Federal Reserve Board generally established the key
program terms and conditions according to which a Reserve Bank could
make emergency loans. The Reserve Bank was responsible for developing
and implementing procedures and practices to execute and manage the
risks of the program subject to the Federal Reserve Board's program
design. As noted earlier in this report, section 13(3) of the Federal
Reserve Act establishes a broad criterion that emergency loans must be
secured to the satisfaction of the individual Reserve Bank making the
loans. In setting program terms and conditions, the Federal Reserve
Board sought to make loans available on terms that would be effective
in addressing market strains during crisis conditions but onerous
compared to terms available during normal market conditions.
For the purpose of considering the Federal Reserve System's security
and collateral policies, its emergency lending activities can be
grouped into three broad categories:
* overcollateralized loans to institutions facing liquidity
challenges--that is, loans that were backed by collateral in excess of
the loan value;[Footnote 99]
* broad-based liquidity programs that made loans to intermediary
entities (eligible financial institutions or newly-created LLCs) to
finance purchases of debt instruments in key credit markets; and:
* Loans and commitments to provide loans collateralized by asset
portfolios of specific institutions.
Overcollateralized Loan Programs and Loans to Specific Institutions:
The Federal Reserve Board's early broad-based lending programs--TAF,
TSLF, and PDCF--made overcollateralized loans to institutions facing
liquidity pressures and contained similar sets of features intended to
mitigate risk of losses:
* Borrower eligibility requirements. The Federal Reserve Board
generally limited access to these programs to U.S. institutions that
were regulated by U.S. federal financial regulators and met certain
regulatory standards for financial soundness. For example, TAF
eligibility was limited to U.S. depository institutions (which include
U.S. branches and agencies of foreign banks) that were eligible for
primary credit at the discount window and expected by their local
Reserve Bank to remain primary-credit-eligible during the term the TAF
loan would be outstanding.[Footnote 100] Moreover, primary dealers
were the only eligible participants for TSLF and PDCF. According to
FRBNY staff, a firm's continued designation as a primary dealer
depended, among other things, on its continuing to meet minimum
capital and other requirements set forth by FRBNY. The next section of
this report discusses the borrower eligibility requirements for these
lending programs in greater detail.
* Collateral eligibility and haircut requirements. The Federal Reserve
Board defined types of assets that would be eligible as collateral and
required loans under these programs to be overcollateralized. In the
event that a borrower defaulted on a loan, the Reserve Bank would have
had rights to seize the assets posted as collateral. To help ensure
that the value recovered from the collateral would be sufficient to
avoid losses on the loan, the Federal Reserve Board placed limits on
the types of assets eligible as collateral and required borrowers to
overcollateralize by pledging collateral with a total market value
greater than the loan amount. The difference between the market value
of an asset pledged as collateral and the amount that could be
borrowed against this asset is called the margin or haircut. The
Reserve Banks applied schedules of haircuts that were designed to
apply higher haircuts to higher-risk asset types. For example, the
programs applied higher haircuts to MBS collateral (approximately 7
percent) than to short-term U.S. Treasury collateral (approximately 1
percent). As discussed in the next section, some asset types were
required to have certain minimum credit ratings from at least two
Nationally Recognized Statistical Rating Organizations (NRSROs, or
rating agencies).
[Text box: Credit Ratings and the Rating Agencies; A credit rating is
an assessment of the creditworthiness of an obligor as an entity or
with respect to specific securities or investment instruments. In the
past few decades, credit ratings have assumed increased importance in
the financial markets, in large part due to their use in law and
regulation. In 1975, the Securities and Exchange Commission (SEC)
first used NRSRO to describe those rating agencies whose ratings could
be relied upon to determine capital charges for different types of
securities broker-dealers held that are registered with SEC. Since
then, SEC has used the NRSRO designation in a number of regulations,
and the term has been widely embedded in numerous federal and state
laws and regulations as well as in investment guidelines and private
contracts. The ratings produced by the NRSROs generally are letter-
based symbols intended to reflect assessments of credit risk for
entities issuing securities in public markets. Typically, credit
rating agencies designate issuers or securities considered investment-
grade, or lower risk, with higher letter ratings, and issuers or
securities considered speculative-grade, or higher risk, with lower
letter ratings. For example, Standard & Poor's and Fitch Ratings
designate investment-grade, long-term debt with ratings of AAA, AA, A,
and BBB, and speculative-grade, long-term debt with ratings of BB, B,
CCC, CC, and C. The rating scale that a ratings agency uses to assign
short-term obligations may differ from the scale it uses for long-term
obligations. For example, the highest rating assigned to short-term
commercial paper obligations is A-1, P-1, or F-1, depending on the
NRSRO assigning the rating. Source: Based on GAO-10-782. End of text
box]
* Recourse to borrower's assets. Loans under some programs were made
with recourse to the borrowing institution's assets. In the event of a
default on a recourse loan, the Reserve Bank would have a claim on the
borrower's assets that could allow it to recover all or part of any
shortfall arising from the liquidation of the collateral pledged by
the borrower.
* Monitoring program use and financial condition for eligible
borrowers. Reserve Banks had discretion to restrict access to
otherwise eligible institutions that they determined to pose greater
risk of loss. For TAF, Federal Reserve System staff said that they
recognized that supervisory ratings, which were a factor considered in
determining primary credit and TAF eligibility, might not reflect
recent adverse changes in an institution's financial
condition.[Footnote 101] Accordingly, FRBNY staff told us that FRBNY
and the other Reserve Banks coordinated with bank examiners and
monitored market-based indicators to gain additional insights into the
soundness of TAF borrowers. Similarly, for PDCF and TSLF, FRBNY staff
told us that FRBNY closely monitored the financial condition of
primary dealers as part of its efforts to manage the risks of PDCF and
TSLF lending.
Table 5 provides an overview of the key loss protection features for
the Federal Reserve Board's overcollateralized lending programs.
Table 5: Summary of Terms and Conditions for TAF, TSLF, and PDCF:
Category: Eligible borrowers;
TAF: Discount window primary-credit eligible institutions;
TSLF: Primary dealers;
PDCF: Primary dealers.
Category: Collateral eligibility;
TAF: Discount window collateral;
TSLF:
* Schedule 1: Collateral eligible for open market operations with
FRBNY (U.S. Treasury securities, agency debt securities, and agency
MBS);
* Schedule 2: Initially included all Schedule 1 collateral, and highly
rated MBS; over time, expanded to include other highly rated ABS and
investment grade securities;
PDCF: Initially included investment grade securities and was expanded
to include all assets eligible for tri-party repurchase agreements
with the two major clearing banks, including noninvestment grade
securities and stocks.
Category: Haircuts;
TAF: Yes;
TSLF: Yes;
PDCF: Yes.
Category: Recourse to borrower's assets;
TAF: Yes;
TSLF: Yes;
PDCF: Yes.
Category: Term;
TAF: 28 or 84 days;
TSLF: 28 days;
PDCF: Overnight.
Source: GAO analysis based on Federal Reserve Board terms and
conditions for TAF, TSLF, and PDCF.
[End of table]
The collateral eligibility and haircut requirements for TAF were based
on discount window requirements. The Federal Reserve Board approved
adjustments to the collateral requirements for TSLF and PDCF over time
to address changing conditions in the repurchase agreements markets.
Federal Reserve System staff said that haircuts for eligible
collateral were generally set to be higher than haircuts that private
lenders would require under normal market conditions and lower than
prevailing haircuts during crisis conditions.
* TAF. TAF loan terms of 28 and 84 days increased risk of loss
relative to the traditional discount window program, through which
Reserve Banks extended overnight loans. Although market practice
generally entails applying higher haircuts for longer loan terms, the
Federal Reserve Board did not increase discount window haircuts for
TAF to account for potential changes in collateral value or the
borrower's financial condition. FRBNY staff said that the Reserve
Banks' practice of repricing collateral daily mitigated the risk that
deterioration of collateral value over longer loan terms would
increase the risk of loss. This is because if on any particular day
the collateral value fell below the amount needed to secure a loan
based on haircut requirements, the Reserve Bank could require a
borrower to pledge more collateral. Moreover, for 84-day TAF loans,
the Federal Reserve Board directed Reserve Banks to require borrowing
institutions to have additional collateral pledged to the discount
window beyond the collateral needed based on the discount window
haircut schedule.[Footnote 102]
* TSLF and PDCF. TSLF, which extended term loans of Treasury
securities against eligible collateral, initially accepted only
collateral eligible for open market operations and private MBS
receiving the highest rating from at least two rating agencies. PDCF,
which made overnight cash loans against eligible collateral (in the
form of a repurchase agreement transaction), accepted all collateral
eligible for TSLF as well as a range of investment-grade securities.
The initial haircut schedules for TSLF and PDCF were generally based
on FRBNY's existing open market operations practices.[Footnote 103]
According to FRBNY staff, haircuts for assets that were not eligible
for open market operations were calculated based in part on discount
window margins. Similar to TAF, TSLF also had daily repricing
practices to help mitigate risk. PDCF was an overnight operation and
to the extent a primary dealer requested a new loan on the day that an
old loan matured, the collateral was priced and haircuts were applied
on the day of the new loan. In September 2008, the Federal Reserve
Board expanded the collateral eligibility requirements for TSLF to
include investment-grade securities and for PDCF to include all assets
eligible for borrowing in the tri-party repurchase agreement system.
The collateral eligibility expansion for PDCF allowed FRBNY to lend to
primary dealers in exchange for riskier forms of collateral, including
stocks and noninvestment grade bonds.
Some of the emergency assistance FRBNY provided to avert the failures
of Bear Stearns and AIG also took the form of overcollateralized loans:
* Bridge loan to Bear Stearns. FRBNY's $12.9 billion bridge loan to
Bear Stearns (through a JPMC bank subsidiary) was an overnight loan
collateralized by $13.8 billion of Bear Stearns collateral. According
to FRBNY staff, JPMC's bank subsidiary applied haircuts to the Bear
Stearns collateral to determine the amount that could be loaned
against the collateral (known as "lendable value") and FRBNY's
Financial Institution Supervision Group reviewed these haircuts.
According to an FRBNY document, types of collateral pledged by Bear
Stearns included, but were not limited to, common stock, convertible
bonds, and municipal bonds. FRBNY's loan to the JPMC subsidiary was
made without recourse to this subsidiary's assets as its role was to
serve as a conduit for lending to Bear Stearns. In the event of
default, FRBNY would have had recourse to Bear Stearns.
* AIG SBF. Through the AIG SBF, FRBNY provided loans to AIG that were
collateralized by investment grade debt obligations. These loans were
made with recourse to AIG's assets beyond the assets pledged as
collateral and FRBNY generally applied higher haircuts than it
required for these collateral types in PDCF.
* AIG RCF. Under FRBNY's credit agreement with AIG (and related
security agreement), amounts borrowed by AIG under the AIG RCF were
secured by a substantial portion of the assets of AIG and its primary
nonregulated subsidiaries, including AIG's ownership interest in its
regulated U.S. and foreign subsidiaries. This credit agreement
included provisions intended to help ensure that the proceeds AIG
received from planned AIG assets sales would be used to permanently
repay outstanding balances under the AIG RCF. In addition, the
security agreement provided for AIG's borrowings under this facility
to be guaranteed by each of AIG's domestic, nonregulated subsidiaries
that had more than $50 million in assets. As a condition of providing
this loan, FRBNY also created a trust to receive AIG preferred stock
for the benefit of the U.S. Treasury. On January 14, 2011, as part of
the recapitalization, the trust exchanged these preferred shares for
about 562.9 million shares of AIG common stock, which was transferred
subsequently to Treasury.
Broad-Based Liquidity Programs that Made Loans to Intermediary
Entities:
The Federal Reserve Board's broad-based programs launched in late 2008
and early 2009 employed more novel lending structures to provide
liquidity support to a broader range of key credit markets. These
broad-based liquidity programs included AMLF, CPFF, MMIFF, and TALF.
Through these programs, the Reserve Banks generally extended loans to
an intermediary entity--a financial institution or an SPV--to fund the
entity's purchases of assets from eligible sellers in strained funding
markets. In contrast to earlier programs, the Reserve Banks provided
loans to these intermediary entities to help channel support to
strained funding markets rather than to address the entities'
liquidity needs. The assets purchased by the intermediary entity
served as collateral for the loan from the Reserve Bank. These
liquidity programs, with the exception of TALF, did not
overcollateralize loans through haircuts. In addition, if a Reserve
Bank could not recover the full value of a loan from collateral seized
in the event of a default, except as noted below, the Reserve Bank
generally would not have had recourse to other assets of a borrowing
institution under these programs. To help mitigate the risk of losses,
TALF, as well as the programs that did not require
overcollateralization, accepted only highly-rated assets as
collateral. In addition, CPFF, MMIFF, and TALF incorporated various
security features, such as the accumulation of excess interest and fee
income to absorb losses, to provide additional loss protection. Table
6 provides an overview of the security and collateral features for
these broad-based liquidity programs.
Table 6: Summary of Terms and Conditions for AMLF, MMIFF, CPFF, and
TALF:
Category: Eligible borrowers;
AMLF; U.S. depository institutions and their broker-dealer affiliates
and holding companies;
MMIFF: MMIFF SPVs;
CPFF: CPFF LLC, which used FRBNY loans to purchase new issues of ABCP
and commercial paper from U.S. issuers of highly rated commercial
paper;
TALF[A]: U.S. companies without foreign government control.
Category: Collateral eligibility;
AMLF; Selected U.S. dollar-denominated ABCP rated not lower than A-1/P-
1/F-1;
MMIFF: U.S. dollar-denominated certificates of deposit, bank notes,
and commercial paper issued by selected institutions with a short-term
debt rating not lower than A-1/P-1/F-1;
CPFF: 3-month U.S. dollar-denominated commercial paper (including
ABCP) rated not lower than A-1/P-1/F-1;
TALF[A]: Selected triple-A ABS.
Category: Haircuts[B];
AMLF; No;
MMIFF: No;
CPFF: No;
TALF[A]: Yes.
Category: Recourse to borrower's assets[C];
AMLF; No;
MMIFF: Recourse to SPVs only;
CPFF: Recourse to CPFF LLC only;
TALF[A]: No.
Category: Interest rate;
AMLF; Primary credit rate;
MMIFF: Primary credit rate;
CPFF: Overnight indexed swap rate + 300 basis points for ABCP;
overnight indexed swap rate + 100 basis points for unsecured
commercial paper;
TALF[A]: Interest rates vary by collateral types and the terms of the
loans.
Category: Other (fees or surcharges);
AMLF; None;
MMIFF: None;
CPFF: Registration fee; for unsecured commercial paper issues,
surcharge of 100 basis points[D];
TALF[A]: Administrative fee of 10 basis points for non-mortgage-
related MBS and 20 basis points for commercial MBS.
Category: Term;
AMLF; Up to 120 days or 270 days;
MMIFF: 7 to 90 days;
CPFF: 90 days;
TALF[A]: 3 or 5 years.
Source: GAO analysis based on Federal Reserve Board terms and
conditions for AMLF, MMIFF, CPFF, and TALF.
[A] The administrative fee for TALF nonmortgage-related ABS was
initially 5 basis points and was later increased to 10 basis points
for nonmortgage-related MBS and 20 basis points for commercial MBS.
TALF 5-year loans were available only on commercial MBS and ABS backed
by student loans and Small Business Administration loans.
[B] The MMIFF was designed to achieve overcollateralization by
requiring participating MMMFs to fund 10 percent of the purchase price
of eligible assets in the form of a subordinated note.
[C] If an AMLF or TALF borrower was found to have materially
misrepresented its compliance with program requirements, the relevant
Reserve Bank may have had recourse to its assets to recover any losses
under the terms of the borrowing agreement. According to FRBNY staff,
depending on the particular commercial paper in question, the CPFF SPV
may have had various levels of recourse against the issuer of the
commercial paper.
[D] Unsecured commercial paper issues that were guaranteed by the
FDIC's TLGP were exempt from the surcharge requirement. According to
FRBNY, the fees and surcharges also constituted collateral.
[End of table]
AMLF. Through AMLF, the Federal Reserve Board authorized FRBB to make
loans to intermediary borrowers that were secured by highly-rated ABCP
purchased from money market funds. If an AMLF borrower defaulted, FRBB
would have attempted to recover losses through its claim on the assets
collateralizing the ABCP. As discussed earlier, AMLF was created to
provide liquidity support to MMMFs and its less traditional lending
structure reflected practical constraints in lending directly to these
funds and the need to encourage participation by intermediary
borrowers. AMLF did not apply haircuts and accepted only highly-rated
ABCP as collateral.[Footnote 104] Federal Reserve System staff said
that requiring overcollateralization for AMLF loans would have been
inconsistent with policy objectives to effectively provide liquidity
support to MMMFs. If MMMFs sold assets to the intermediary borrowers
through AMLF at less than book value to fund redemption requests from
MMMF shareholders, they would have incurred losses to the detriment of
remaining MMMF shareholders, creating further incentives for MMMF
shareholders to redeem shares, which would have further exacerbated
strains on their liquidity. Accordingly, the Federal Reserve Board
sought to help fund purchases of MMMF assets at book value. Therefore,
it authorized loans to intermediary borrowers that were equal to the
book value of the ABCP to provide adequate incentives to these
borrowers to participate. Upon providing an AMLF loan, FRBB accepted
the risk of credit loss on the ABCP securing the loan. Applying
haircuts to AMLF loans would have reduced the economic incentives for
eligible borrowers to participate as they would have had to fund part
of the ABCP purchases on their own.[Footnote 105] Furthermore, the
Federal Reserve Board authorized nonrecourse lending to increase
incentives for intermediary borrowers to participate. In the event of
losses on the ABCP collateral, the borrower could surrender the ABCP
to FRBB and choose not to repay its loan. However, under the terms of
the AMLF program lending agreement, the nonrecourse provisions of the
loan could be voided, giving FRBB full recourse to recover any losses
from a borrower's assets, if the borrower was found to have
misrepresented compliance with AMLF requirements.
CPFF. Through CPFF, FRBNY extended loans to a newly created SPV that
purchased (and held as collateral) new issues of eligible ABCP and
unsecured commercial paper, which then served as collateral for the
FRBNY loan.[Footnote 106] The Federal Reserve Board restricted the SPV
to purchases of ABCP and unsecured commercial paper that received the
highest rating from at least one major credit rating agency and, if
rated by multiple major credit rating agencies, received the highest
rating by two or more of them. FRBNY conducted additional monitoring
of the financial condition of participating ABCP conduits and
corporate issuers to manage the risks posed by issuers at higher risk
of default. The loans to the SPV were collateralized by the assets of
the SPV. The assets of the SPV consisted of (1) the purchased ABCP,
which was itself secured by the assets backing such ABCP; (2) the
purchased unsecured commercial paper; (3) program fees, including
registration fees and surcharges on unsecured commercial paper issuers
that wanted to participate in the program; and (4) other assets, such
as income from the SPV's investment of the fees. To secure purchases
of commercial paper that were not backed by collateral, the Federal
Reserve Board required issuers of unsecured paper to pay surcharges on
the face value of the commercial paper that collectively would serve
as an insurance fund to absorb potential losses. The Federal Reserve
Board set the level of this surcharge at 100 basis points per annum to
the face value of the commercial paper based on an analysis of
historical loss rates on unsecured paper. Unsecured commercial paper
issues that were guaranteed by the FDIC's TLGP were exempt from the
surcharge requirement. All CPFF borrowers were required to pay a one-
time registration fee.[Footnote 107] The CPFF SPV accumulated
surcharges on unsecured paper, registration fees, and interest earned
in excess of the target Federal Funds rate the SPV paid on loans from
FRBNY. At FRBNY's direction, this "excess income" was invested in
permitted investments as these investments and any return they
generated also served as collateral for the loans extended by FRBNY to
the SPV. The amount of these investments provided a cushion against
potential losses. Finally, the Federal Reserve Board generally limited
each participant's CPFF borrowings to the maximum amount of paper it
had outstanding between January and August 2008.[Footnote 108] This
participation limit served to prevent excessive program use and to
limit FRBNY's possible exposure to a single institution.
MMIFF. MMIFF employed a relatively complex lending structure intended
to facilitate additional liquidity support for MMMFs while building in
additional loss protection through a new subordinated note feature.
Unlike AMLF, which made loans to intermediary borrowers to finance
purchases of highly-rated ABCP, MMIFF created five SPVs that would use
FRBNY loans to help finance purchases of a broader range of eligible
assets from MMMFs. MMIFF-eligible assets included short-term debt
obligations of 50 financial institutions that were determined to be
broadly held by many MMMFs. FRBNY would have funded 90 percent of each
SPV's purchases of eligible MMIFF assets with a senior loan. The
remaining 10 percent of MMIFF purchases would have been funded by a
subordinated note issued by the MMIFF SPV to the selling MMMF. The
first 10 percent of any losses on assets held by a MMIFF SPV would
have been absorbed by the subordinated note holders. This would have
provided for overcollateralization of FRBNY's loans to the SPV. MMIFF
was never used. Feedback FRBNY received from MMMFs indicated that they
viewed MMIFF as a backstop that they would access only as a last
resort.[Footnote 109]
TALF. TALF borrowers served as intermediaries that used TALF loans
from FRBNY to finance the purchase ABS, which served as collateral for
the TALF loans. Borrowers requested TALF loans through primary dealers
and a few other firms that served as TALF agents. To increase the
support that TALF borrowers could provide to the securitization
markets, the Federal Reserve Board set borrower eligibility
requirements to permit broad participation by U.S. entities. TALF
loans were made without recourse to borrowers' assets beyond the ABS
collateral. TALF contained multiple layers of loss protection:
* First, the Federal Reserve Board required TALF collateral to be
rated AAA or its equivalent by two of the rating agencies that it
deemed eligible to provide credit ratings for TALF.[Footnote 110] The
rating requirement helped to ensure that the securities TALF accepted
as collateral presented minimal credit risks. Due diligence performed
on securities to be purchased served as another pillar of loss
protection. FRBNY, with the support of vendors, reviewed the credit
risks related to individual ABS that FRBNY might consider accepting as
TALF collateral.[Footnote 111]
* Second, the Federal Reserve Board required TALF loans to be
overcollateralized through haircut requirements. FRBNY officials said
that TALF haircuts were designed to approximate multiples of stressed
historical impairment rates for ABS. These haircut requirements
determined the amount of a TALF borrower's equity in the ABS
collateral. This equity represented the amount of money that a TALF
borrower would lose by surrendering the collateral and not repaying
the loan.
* Third, an SPV created by FRBNY--TALF LLC--received a portion of the
interest income earned by FRBNY on TALF loans and if a TALF borrower
chose to not repay its loan, this accumulated excess interest income
could be used by TALF LLC to purchase collateral surrendered by the
borrower from FRBNY.
* Finally, if the excess interest income accumulated in TALF LLC was
insufficient to purchase the surrendered collateral, Treasury
initially committed to lend up to $20 billion of TARP funds to TALF
LLC for any such purchases. The Federal Reserve Board authorized FRBNY
to lend up to $180 billion for any purchases exceeding this maximum
TARP commitment.[Footnote 112] Both loans would be secured by the
assets of TALF LLC, and FRBNY's loan, if made, would be senior to
Treasury's loan.
Maiden Lane Portfolios and Lending Commitments for Citigroup and Bank
of America:
FRBNY took similar steps to mitigate its risk of losses from its loan
to Maiden Lane, the SPV created to purchase and hold Bear Stearns's
assets; and its loans to Maiden Lanes II and III, the SPVs created to
purchase and hold certain assets related to AIG. In each case, FRBNY
extended a senior loan to the SPV and this loan was collateralized by
the portfolio of assets held by the SPV. Figure 5 illustrates the
lending structures and certain aspects of the loss protection features
for the Maiden Lane transactions. These features included:
* First loss positions for JPMC and AIG. For Maiden Lane, JPMC agreed
to take a first loss position by making a $1.15 billion subordinated
loan to help finance the SPV's $30 billion purchase of the Bear
Stearns asset portfolio. JPMC would begin to receive payments on this
subordinated loan only after FRBNY received the full principal and
interest on its $28.8 billion senior loan to the SPV. This lending
structure protects FRBNY from up to $1.15 billion in losses on the
portfolio. AIG agreed to assume a similar first loss position for
Maiden Lanes II and III. For Maiden Lane II, AIG's insurance
subsidiaries agreed to sell residential mortgage-backed securities
valued at $20.5 billion to the SPV for $19.5 billion, accepting the $1
billion discount as a fixed deferred purchase price. The AIG
subsidiaries would receive payments on this fixed deferred purchase
price, plus interest, only after full repayment of the interest and
principal on FRBNY's loan. Finally, for Maiden Lane III, AIG agreed to
take a $5 billion equity interest in the SPV to help fund Maiden Lane
III's $29.3 billion purchase of CDOs.
* Asset selection and filters. The broad categories of assets selected
for inclusion in these portfolios were based on the policy objectives
of the transaction, but FRBNY specified certain asset filters, or
criteria, that were intended to exclude certain higher-risk assets.
For example, FRBNY accepted only U.S. dollar denominated assets into
the three portfolios to avoid the complexities of managing currency
exposures from foreign currency assets. In addition, for Maiden Lane,
FRBNY agreed to accept only commercial and residential loans that were
"performing," or no more than 30 days past due, as of March 14, 2008,
the date of the bridge loan to Bear Stearns. For Maiden Lane III,
FRBNY did not accept synthetic CDO exposures that were derivative
instruments rather than cash securities.[Footnote 113]
* Valuation and due diligence. FRBNY hired vendors to help verify the
value of the assets in these portfolios and to conduct due diligence
to exclude assets that were proposed for inclusion but did not meet
the specified asset filters or lacked documentation. The purchase
price for the Maiden Lane assets was based on Bear Stearns's recorded
values for these assets as of March 14, 2008. FRBNY hired an external
audit firm, Ernst & Young, to conduct due diligence for all three
portfolios and to help ensure the accuracy of settlement amounts for
Maiden Lanes II and III.
* Portfolio management. For each portfolio, FRBNY retained sole
discretion over the decisions about how to manage the assets to
maximize the value recovered on FRBNY's senior loan. FRBNY hired
BlackRock to manage these portfolios and to advise on a strategy for
investing and disposing of the assets. For Maiden Lane, FRBNY agreed
to a 2-year reinvestment period during which all cash income from the
portfolio (net of expenses) would be reinvested in relatively low-risk
investments, and FRBNY would not be permitted to receive repayment on
its loan prior to the ending of the reinvestment period unless the
JPMC loan was repaid in full. According to FRBNY staff, JPMC requested
this reinvestment period out of concern that FRBNY could sell
portfolio assets at prices that would recover value for FRBNY but
incur losses for JPMC. FRBNY staff said FRBNY agreed to this
reinvestment strategy because it would not increase risk of loss on
its senior loan. FRBNY hired other vendors to help oversee and manage
the risks of specific asset classes included in the Maiden Lane
portfolio. For example, FRBNY hired vendors to advise on the risks
posed by commercial real estate loans.
Figure 5: Comparison of the Transaction Structures for Maiden Lane
LLC, Maiden Lane II LLC, and Maiden Lane III LLC:
[Refer to PDF for image: illustration]
Private institutions selling assets to the LLC: Bear Stearns
Companies, Inc. ($30 billion in Bear Stearns assets to Maiden Lane
LLC);
Assets and liabilities: Maiden Lane LLC ($30 billion cash to Bear
Stearns):
Assets:
Agency MBS ($10.1 billion);
Commercial whole loans ($8.2 billion);
Nonagency RMBS ($5.1 billion);
Derivatives ($3.7 billion);
Residential whole loans ($1.6 billion);
Other ($1.3 billion);
Liabilities:
FRBNY senior loan;
JPMC subordinated loan;
Sources of funding for LLC’s purchase of assets:
FRBNY: $28.8 billion;
JP Morgan Chase: $1.2 billion;
Waterfall payments from LLC: Closing costs, operating expenses, and
reserve account.
Private institutions selling assets to the LLC: AIG subsidiaries
($20.5 billion assets to Maiden Lane II LLC);
Assets and liabilities: Maiden Lane II LLC ($19.5 billion cash to AIG
subsidiaries);
Assets:
Residential mortgage-backed securities;
Liabilities:
FRBNY senior loan;
$1.0 billion deferred purchase price by AIG subsidiaries;
Sources of funding for LLC’s purchase of assets:
FRBNY: $19.5 billion;
Waterfall payments from LLC:
Principal and interest on FRBNY loan;
Payments to JPMC or AIG.
Private institutions selling assets to the LLC: AIGFP; AIGFP
counterparties ($29.3 billion (CDOs underlying CDS contracts to Maiden
Lane III LLC);
Assets and liabilities: Maiden Lane III LLC ($29.3 billion cash to
AIGFP ($2.5 billion) and AIGFP counterparties($26.8 billion));
Assets:
Collateralized debt obligations;
Liabilities:
FRBNY senior loan;
AIG equity interest;
Sources of funding for LLC’s purchase of assets:
FRBNY: $24.3 billion;
AIG: $5.0 billion;
Waterfall payments from LLC: Residual
- ML: 100% to FRBNY;
- ML II: 5/6 to FRBNY;
- ML III: 2/3 to FRBNY.
Source: GAO analysis of FRBNY information.
[End of figure]
For the assistance provided to Citigroup and Bank of America, FRBNY
and FRBR, respectively, coordinated with Treasury and FDIC to
negotiate similar types of loss protections. In contrast to the Maiden
Lane transactions, FRBNY and FRBR agreed to provide loans under
certain circumstances but did not anticipate having to lend--and
ultimately did not lend--to these institutions under these agreements.
Specifically, in each case, as part of a loss-sharing agreement on a
designated portfolio of assets, the Reserve Bank agreed to provide a
loan to be collateralized by assets remaining in the portfolio if cash
losses on these assets exceeded certain thresholds. Citigroup and Bank
of America agreed to a first-loss position, and Treasury and FDIC
agreed to share losses in second-and third-loss positions,
respectively. The FRBNY loan would have been a one-time, all or
nothing loan secured by a first priority perfected security interest
in all of the remaining assets at the time that the loan was
triggered.[Footnote 114] Based on analysis conducted by BlackRock,
FRBNY concluded that losses on the Citigroup assets reaching the point
at which FRBNY could be required to lend were unlikely. FRBR staff
said that they reached a similar conclusion on Bank of America based
on analysis performed by PIMCO. In both cases, the Reserve Banks hired
external audit firms to conduct due diligence on the asset portfolios.
FRBNY did not complete its due diligence before signing a final
lending agreement with Citigroup in January 2009 but incorporated
protections into this agreement that allowed FRBNY to reject specific
assets based on additional due diligence. Following approximately 11
months of due diligence by FRBNY's vendor, FRBNY, Treasury, FDIC, and
Citigroup agreed to a final set of assets to be included in the
portfolio. As discussed earlier, Bank of America requested a
termination of the term sheet before a final agreement was executed
among the parties.
Emergency Programs That Have Closed Have Not Incurred Losses and the
Federal Reserve Board Expects No Losses on Those With Outstanding
Balances:
The Federal Reserve System earned $19.9 billion in revenue from the
broad-based programs and did not incur losses on any of the programs
that have closed. As noted earlier, financial stability--rather than
profit maximization--was the Federal Reserve Board's primary objective
when designing these programs. TALF, under which FRBNY made $71.1
billion of loans for terms of 3 or 5 years, is the only broad-based
program with loans outstanding. As of April 27, 2011, the Federal
Reserve Board reported that no TALF borrowers had chosen to surrender
their collateral instead of repaying their loans. As of June 29, 2011,
approximately $13 billion of TALF loans remained outstanding out of
$71.1 billion in total TALF lending. The Federal Reserve Board does
not project any losses from TALF.
FRBNY loans to the Maiden Lanes remain outstanding and FRBNY projects
full repayment of these loans. For the three portfolios, figure 6
illustrates the coverage ratio, or the ratio of the value of the
assets in the portfolios to the amount outstanding on FRBNY's senior
loan, over time. In the months following these transactions, each
portfolio experienced declines that brought the portfolio value below
the amount owed to FRBNY. However, as market conditions improved in
late 2009 and 2010, the value of these portfolios increased and as of
June 29, 2011, all three had a positive coverage ratio. Until the
assets in these portfolios mature or are sold, FRBNY remains exposed
to the risk of losses. The Federal Reserve Board does not project any
losses on FRBNY's loans to the Maiden Lanes.
Figure 6: Coverage Ratios for Maiden Lane, Maiden Lane II, and Maiden
Lane III, July 2008-June 29, 2011:
[Refer to PDF for image]
[End of figure]
In March 2011, FRBNY announced that it had declined a $15.7 billion
conditional offer from AIG to purchase the Maiden Lane II assets. On
March 30, 2011, FRBNY announced that it would sell these assets
individually and in segments over time through a competitive process.
The Federal Reserve Board has reported that as of June 9, 2011, FRBNY
had sold approximately $10 billion of these assets in competitive
auctions. According to FRBNY, it continues to evaluate market
conditions to assess the appropriate timing and method of asset
dispositions out of Maiden Lane and Maiden Lane III. While no large
scale disposition has been announced to date, FRBNY noted that some
opportunistic sales have occurred in these portfolios.
While Reserve Banks Strengthened Controls and Risk Management over
Time, Opportunities Exist to Further Strengthen Policies for Future
Emergency Programs:
In deploying large new emergency programs, often under severe time
constraints, the Reserve Banks faced challenges in establishing
controls and risk governance structures to keep pace with the
associated risks. FRBNY, which implemented most of the programs, took
steps to enhance controls over time, in many cases in response to
recommendations from external and internal auditors. Although some
control weaknesses were not remediated until late in a program's life,
these weaknesses generally do not appear to have impacted loan
performance. In addition, FRBNY took steps during the crisis to
enhance its risk management, including by expanding its capabilities
to perform risk analytics and reporting needed to support risk
management decisions for its emergency programs. However, the Federal
Reserve System's existing policies for operating a few programs
continue to lack specific guidance that would help ensure Reserve Bank
management and staff take appropriate steps to manage and mitigate
risks posed by higher-risk depository institutions and primary dealers
in the event of a future crisis.
Internal Controls over Compliance with Program Requirements Improved
over Time:
To help ensure compliance with program rules and requirements
established to mitigate risk of losses, the Reserve Banks leveraged
existing control processes and developed new controls for new
activities. According to Reserve Bank staff, to the extent possible,
the Reserve Banks relied on existing discount window systems and
procedures to monitor compliance with program requirements. For
example, for TAF, which functioned as an extension of the discount
window, Reserve Banks relied on existing discount window systems for
processing TAF loans and monitoring compliance with requirements
related to collateralization and minimum supervisory ratings. For both
TAF and TSLF, FRBNY staff implemented new procedures to help ensure
compliance with auction rules and requirements. For several other
broad-based programs, FRBNY and FRBB staff said they used existing
systems to monitor compliance with some program requirements but had
to develop new procedures and practices to monitor data and activities
not captured by these systems. For example, FRBB staff explained that
while they used the Federal Reserve System's existing loan-processing
application to process AMLF loans and track AMLF loan data, they had
to create a new database to track data fields not tracked by this
application, including the amortized cost of the ABCP. In addition,
over time, FRBNY developed procedures to help ensure that vendors and
other third parties implemented key program requirements correctly.
[Footnote 115] For PDCF and TSLF, for example, FRBNY staff conducted
checks of clearing bank data from the preceding day's loan activity
(ex-post) to provide assurance that clearing banks were correctly
implementing collateral requirements. Similarly, for CPFF and TALF,
FRBNY developed new procedures and guidance to help ensure that
vendors and other third parties complied with program rules and
requirements.
Our review identified weaknesses in controls over security and
collateral policies for some programs, and these weaknesses were also
identified by the external auditor, Reserve Bank internal audit, or
RBOPS. The Reserve Banks generally remediated these weaknesses within
a year of their identification, and these weaknesses do not appear to
have impacted loan performance. Examples of control weaknesses include
the following:
* PDCF and TSLF collateral-management processes. FRBNY initially
lacked processes to help ensure that primary dealers did not pledge
"close-linked" collateral--that is, assets whose returns were closely
linked with the financial performance of the borrowing dealer. The
initial bilateral agreements with primary dealers did not prohibit
primary dealers from pledging close-linked collateral. The bilateral
agreements were later amended to prohibit such collateral from being
pledged. In addition, FRBNY did not initially monitor whether the
clearing banks allowed primary dealers to provide their own prices for
assets pledged as collateral. For TSLF, the tri-party agreements among
FRBNY, each primary dealer, and its clearing bank expressly prohibited
the clearing bank from using a primary dealer's prices for collateral
provided by that primary dealer. For PDCF, which used the legacy tri-
party agreements in place for traditional open market operations,
there was no such express prohibition. FRBNY later agreed with each
clearing bank that the clearing bank would not use a dealer's prices
for collateral pledged by that dealer.
* Validating vendor and clearing bank valuations of collateral. During
much of the crisis, FRBNY did not take certain steps to validate
collateral valuation and pricing performed by vendors for some
programs until late in the program's operation. For example, FRBNY did
not begin validating BlackRock's valuations of the Maiden Lane
portfolio until the second quarter of 2009. In addition, FRBNY staff
told us that while they did ex-post checks of the clearing banks'
application of haircut and collateral-eligibility requirements for
PDCF and TSLF, they did not systematically check the reasonableness of
the prices clearing banks applied to the primary dealers' collateral.
According to FRBNY staff, for TSLF, they implemented a program to
check the clearing banks' pricing for collateral towards the end of
the TSLF program. As discussed in the next section, in summer 2009,
FRBNY enhanced its in-house capabilities to perform financial
analytics needed to validate valuation analyses performed by vendors
and clearing banks.
* TALF agent due diligence. In January 2010, FRBNY issued revised
guidance to TALF agents to address concerns that two primary dealers
had not conducted appropriately thorough reviews of certain borrowers.
In addition, FRBNY performed on-site reviews of selected TALF agents
and required TALF agents to provide due diligence files on all
borrowers.
* Oversight of vendor compliance with program requirements. As
discussed earlier, FRBNY did not always conduct timely on-site reviews
of vendor processes and controls. For example, although PIMCO played a
key role in administering CPFF program requirements starting in
October 2008, FRBNY did not conduct an on-site review of PIMCO's
controls until March 2009. As discussed earlier, in May 2010, FRBNY
issued new policy guidance on vendor oversight.
Our review of the implementation of selected program requirements
revealed relatively infrequent instances of incorrect application of
these requirements. Specifically, our review of the detailed
collateral data for PDCF found that the correct haircuts were applied
in the vast majority of cases. Specifically, we found only about 2
percent of cases where the haircut applied was either above or below
that prescribed by the haircut schedules. For PDCF, we identified some
instances of apparent discrepancies between prices that clearing banks
applied to the same types of assets. However, we were unable to
determine the source of these differences. As a result, we were unable
to determine the extent to which these discrepancies may have impacted
the level of undercollateralization. FRBNY staff noted that these
differences may have been due in part to differences in the pricing
sources and pricing algorithms used by the two clearing banks. In the
vast majority of the cases, the haircut setting for the TAF collateral
was consistent with published discount window haircut rates. There
were not pricing discrepancies between the same collateral pledged by
different borrowers, and TAF loans were covered by the value of the
collateral after application of TAF haircut rates.
FRBNY Took Several Steps to Enhance Its Risk Management:
During the crisis, FRBNY took steps to strengthen its financial risk-
management function by expanding and clarifying its risk management
structure and enhancing its risk analytics capabilities and risk
reporting for its emergency programs. However, according to FRBNY
officials, some of the significant organizational changes and staff
additions to enhance risk management did not occur until summer 2009,
when use of many programs was winding down.
When the crisis began, FRBNY's risk management group did not have the
staffing resources and expertise needed to adequately oversee the
risks of FRBNY's new, large-scale emergency programs. FRBNY's Credit
Risk Management group (CRM) was housed within its Financial
Institution Supervision Group and had a small staff of around 10
employees. According to FRBNY, this staff size was commensurate with
the much more limited level of credit risk FRBNY had traditionally
assumed through its vendor relationships, discount window lending, and
open market operations. According to FRBNY's Chief Risk Officer, FRBNY
management moved CRM outside of the Financial Institution Supervision
Group to make it part of an independent group shortly following the
Bear Stearns assistance and creation of PDCF. FRBNY's Chief Risk
Officer said that CRM's responsibilities in 2008 and early 2009
focused on tracking and reporting FRBNY's risk exposures from its
emergency lending and collaborating with FRBNY program staff to assess
specific risks.
Outside of CRM, FRBNY assigned special teams to manage risks related
to certain emergency lending activities. For example, in summer 2008,
FRBNY management created an Investment Support Office to oversee the
day-to-day vendor oversight and portfolio management for the Maiden
Lane portfolio. FRBNY created an Investment Committee, composed of
FRBNY officers from a range of functions, to serve as the oversight
body for the Maiden Lane portfolio. FRBNY also assigned oversight
responsibilities to the Investment Support Office and Investment
Committee for the Maiden Lane II and III portfolios. As discussed
later, FRBNY modified this management structure for the Maiden Lane
portfolios in June 2010. In fall 2008, FRBNY also assembled an AIG
monitoring team to manage the risks of its lending to AIG. For TALF,
FRBNY created a TALF project team to establish and implement the
program.
In January 2009, FRBNY hired an outside consulting firm to conduct an
independent review of its management infrastructure surrounding its
emergency programs. In response to specific recommendations made by
the vendor's March 2009 report and as part of its ongoing efforts to
enhance its risk management function, FRBNY made the following
changes: (1) the creation of a Financial Risk Management Division to
be headed by the Chief Risk Officer, (2) enhancements to its risk
analytics capabilities and risk reporting, (3) reorganization and
clarification of its management structure for making key risk
decisions for the Maiden Lane portfolios, and (4) the creation of a
new policy to establish a process for the early review and monitoring
of new activities that could expose FRBNY to increased or additional
risks.
Creation of the Financial Risk Management Division. In the second
quarter of 2009, following the report of the outside consulting firm,
FRBNY formally established the role of Chief Risk Officer and
appointed the head of the Credit Payments Risk Group, which included
the CRM function, to that role. In summer 2009, FRBNY expanded its
risk management capabilities, adding expertise that would come to be
organized as two new functions, Structured Products and Risk
Analytics. Currently, these two functions and the classic credit risk
management function comprise the Financial Risk Management Division.
Figure 7 illustrates the organizational structure for FRM as of
January 2011. Staff within this division were assigned to be risk
liaisons to the AIG monitoring team and selected members of the TALF
business team. According to FRBNY staff, FRBNY significantly expanded
FRM's resources in summer 2009. FRBNY staff estimated that by October
2009 FRM had about 24 employees.
Figure 7: Organizational Structure of FRBNY's Financial Risk
Management Division, as of January 2011:
[Refer to PDF for image: organizational structure]
Top level:
Board of Directors.
Second level, reporting to Board of Directors:
FRBNY President.
Third level, reporting to FRBNY President and Board of Directors:
Financial Risk Management (FRM) (Chief Risk Officer).
Fourth level, under Financial Risk Management (FRM):
* Credit Risk Management Payment System Risk and Counterparty Credit
Risk:
Implements payment system risk policy with respect to depository
institution (and other) accounts to intraday credit from a Reserve Bank;
conducts condition monitoring of depository institutions and
counterparty credit analysis; and acts as the primary liaison to
Discount Window and Open Market Desk.
* Structured Products and Risk Reporting:
Responsible for monitoring and analysis of structured credit exposures
across bank activities. Conducts ad hoc valuation and price
verification and has product specialists for certain securities
products. Review and advise on risk management practices at the
Discount Window. Coordinate information and report production and
distribution.
* Risk Analytics:
Responsible for development of models to value and assess complex
financial instruments and exposures (e.g., loss forecasting and stress
testing), model validation, price verification, and ad hoc analytic
support.
Source: GAO presentation of FRBNY information.
[End of figure]
Enhanced risk reporting and analytics. In summer 2009, FRBNY made
improvements to its risk reporting and risk analytics for its
emergency programs and assistance to individual institutions. In June
2009, FRM staff made two significant enhancements to the risk reports
provided to senior FRBNY management. First, FRM created a set of risk
indicators that provided summary metrics and information for FRBNY's
emergency lending activities. Second, FRBNY began reporting its
aggregate credit exposures to the institutions that were the largest
borrowers across FRBNY's emergency programs. Previously, FRBNY had
produced management-level reports that showed the largest credit
exposures within each emergency program and aggregate credit exposures
of primary dealers--TSLF, PDCF, and other dealer exposures--and banks--
TAF and regular discount window exposures. According to FRBNY staff,
during the second quarter of 2009, FRBNY began staffing the new Risk
Analytics group within FRM. According to FRBNY officials, this group's
responsibilities include performing modeling and other analytics to
validate work performed by FRBNY vendors.
Risk management for the Maiden Lane portfolios. In June 2010, FRBNY
formally reorganized its management structure for the Maiden Lane
portfolios. Previously, the Investment Committee had been the
oversight and decision-making body for the Maiden Lane portfolios.
FRBNY assigned the newly formed Risk Oversight Committee with
membership of senior officers from across the organization to provide
an additional layer of oversight for higher-risk decisions. As
illustrated in figure 8, FRBNY set forth risk escalation procedures by
which the Investment Support Office would make routine day-to-day
decisions and escalate higher-risk issues to the Investment Committee,
the Risk Oversight Committee, and the FRBNY President, as appropriate.
Figure 8: Risk Escalation Protocols for Oversight of Maiden Lane
Portfolios, as of June 2010:
[Refer to PDF for image: illustration]
Investment Support Office:
Investment Support Office documents decisions and oversees decision
execution.
High risk/significant loss transaction identified by Investment
Support Office: Escalate to and discuss with Investment Committee.
Investment Committee:
Discuss with Risk Oversight Committee Chair to see if a review by the
Risk Oversight Committee is warranted.
Risk Oversight Committee-Chair: Risk Oversight Committee:
FRBNY President:
Final decision made by FRBNY President with input from Investment
Committee and the Risk Oversight Committee.
Source: GAO presentation of FRBNY information.
[End of figure]
Policy for reviewing new initiatives. In December 2009, FRBNY
implemented a new policy that established a process for the early
review and monitoring of new programs or activities that could expose
FRBNY to increased or additional risks. This policy outlines high-
level protocols to better ensure proper review, consultation, and
consideration of risks for significant new initiatives. For example,
for major new lending programs or changes to such programs, the policy
directs FRBNY to assign responsibilities for documenting a high-level
implementation plan and sharing this plan with relevant stakeholders
within FRBNY to help ensure proper consideration of the expected
outcomes, risks, and risk controls for the program.
Opportunities Exist to Improve the Federal Reserve System's Risk
Management for Any Future Emergency Activities:
While FRBNY's policy for reviewing new initiatives provides guidance
that would be useful in the event of future deployment of emergency
programs, opportunities exist for FRBNY and the Federal Reserve System
as a whole to strengthen risk management practices and procedures for
future emergency lending activities. Our review identified two areas
where the Federal Reserve System had less robust practices for
managing the risk of losses from its emergency lending: (1) monitoring
the size of losses that could occur under more adverse economic
conditions within and across emergency programs and (2) documenting
procedures used to guide Reserve Bank efforts to monitor and mitigate
risks posed by eligible borrowers who pose higher risk of loss.
Estimation of Stress Losses for Emergency Programs. First, while for
some of its programs FRBNY estimated stress losses that could occur
under more adverse economic scenarios, neither FRBNY nor the Federal
Reserve Board systematically estimated and tracked stress loss
estimates across all emergency lending programs. FRBNY did not
calculate estimates for stress losses for TAF, TSLF, and PDCF, and
FRBB did not create such estimates for its AMLF lending. As a result,
there was no information on the size of potential total stress losses
for the Federal Reserve Board to consider as it made decisions to
authorize and modify its emergency lending programs. In addition,
FRBNY estimated and monitored the level of undercollateralization that
could occur in stress scenarios for some TAF, TSLF, and PDCF
borrowers, but these estimates did not represent potential stress
losses for these borrowers or for these programs.
The Federal Reserve System has directed the largest institutions it
regulates to perform stress testing to quantify the impact of adverse
macroeconomic and financial market scenarios, both at the level of an
individual counterparty and aggregated across counterparties. Federal
Reserve Board and FRBNY staff we spoke with said calculating stress
losses for some programs was appropriate. Accordingly, stress loss
estimates were periodically calculated for the Maiden Lane portfolios.
In addition, in January 2009, FRBNY began estimating expected and
stressed losses for CPFF and for weekly CPFF reports created for
senior officials, calculated the size of these estimated losses
relative to its capital.[Footnote 116] For that month, an FRBNY
analysis estimated that CPFF losses in a stressed scenario could have
reached approximately $35 billion--nearly three times the size of
FRBNY's capital as of December 31, 2008.[Footnote 117]
However, Federal Reserve Board and FRBNY staff we spoke with said that
they did not believe it would be useful for the Federal Reserve System
to calculate stress losses for all emergency programs. For areas where
FRBNY did not routinely estimate and track stress losses, FRBNY staff
indicated that doing so was unnecessary because the haircuts applied
to the collateral built in a cushion based on an analysis of expected
changes in the price of the collateral. However, while these haircuts
provided some protection against historical price movements for assets
pledged as collateral, they did not reflect potential price movements
during a financial crisis. For example, these haircuts did not provide
protection against price declines in stressed scenarios. Although
FRBNY staff told us that estimating stress losses for TAF, PDCF, and
TSLF was unnecessary, FRBNY did conduct analysis to help monitor its
potential exposure to price declines that exceeded haircuts for its
lending to some institutions through these programs.
In the second quarter of 2008, to better monitor risk for
collateralized exposures to depository institutions and primary
dealers, FRBNY's CRM began including a metric known as "Dollars at
risk in Event of Need to Terminate under Stress" (DENTS) in its daily
risk reports provided to its senior management. For a stress scenario
with severe declines in collateral values, the DENTS metric
represented an estimate of the potential shortfall that could occur
between the collateral value and the FRBNY loan amount. CRM's risk
reports reported the DENTS for depository institutions and primary
dealers with loans outstanding. FRBNY staff explained that DENTS
estimates were used as rough estimates of stress exposures but did not
reflect the likely level of losses in a stress scenario. For example,
in the event of a borrower default, FRBNY would not be forced to
liquidate collateral immediately at stressed prices, as assumed by the
DENTS calculation. While FRBNY's monitoring of DENTS provided useful
information about potential risk exposures from the three programs,
the Federal Reserve System lacked estimates of potential total losses
from these programs under stressed conditions. While the Federal
Reserve System's emergency programs did not suffer losses during the
crisis, a more comprehensive view of the total potential risk
exposures from its emergency programs under adverse economic scenarios
could help the Federal Reserve Board and Reserve Banks to make more
informed risk management decisions in the event of a future crisis.
Procedures for Restricting Program Access. During the crisis, existing
discount window program guidance did not provide details on how
Reserve Banks should exercise certain discretion to deny TAF access to
otherwise eligible depository institutions that posed higher risks. In
addition, FRBNY lacked documented procedures to guide Reserve Bank
decisions to restrict lending to higher-risk primary dealers through
TSLF and PDCF. In 2010, after TAF, PDCF, and TSLF had closed, the
Federal Reserve System enhanced its guidance to Reserve Banks on
monitoring higher-risk borrowers at the discount window and FRBNY
created a new risk management framework for primary dealers. However,
these documents do not include detailed guidance that may be needed to
help ensure that Reserve Bank staff take consistent and appropriate
steps to manage program access by higher-risk borrowers if these
programs are deployed in the future.
For TAF, Reserve Banks relied on existing discount window procedures
for monitoring the financial condition of depository institutions, but
discount window guidance lacked specific protocols to guide discretion
they used to deny TAF access to some institutions. A November 30,
2007, Federal Reserve System staff memo noted that "protocols could be
developed to guide a Reserve Bank's response to a [TAF] bid by a
depository institution about which the Reserve Bank has concerns" to
address the risk that a depository institution's financial condition
could deteriorate during the term of its TAF funding (generally 28 or
84 days). However, according to Federal Reserve Board and FRBNY staff
with whom we spoke, such protocols were not subsequently developed
during the crisis. According to the Federal Reserve Board, Reserve
Banks exercised this discretion to restrict access by at least 30
institutions. The Federal Reserve Board was unable to readily verify
the completeness of the list of TAF restrictions provided to us.
Without specific guidance on how such restrictions should have been
applied for TAF, whether each Reserve Bank considered appropriate
criteria in deciding to reject TAF bidders remains unclear.
In July 2010, the Subcommittee on Credit Risk Management, a committee
of credit risk management leaders from the Reserve Banks, revised its
guidance on standards and practices Reserve Banks should follow to
monitor and manage risks posed by higher-risk institutions borrowing
from the discount window. These revisions provided more granular risk
classifications of depository institutions, including a new
classification ("Group A") that would include institutions at risk of
losing TAF eligibility--specifically, primary-credit-eligible
institutions at high risk of losing their primary-credit eligibility.
While the revised guidance indicates that it may be appropriate to
disallow term borrowing, which would include TAF, for Group A
institutions, it does not specify criteria that could be considered
for applying this discretion. For Group A institutions, the guidance
notes that "if appropriate, [the Reserve Bank should] evaluate
imposing a term limit on discount window credit extensions." According
to FRBNY staff, the Federal Reserve System has not formally analyzed
the consistency and appropriateness of Reserve Banks' decisions to
restrict TAF access. Without such an analysis, the Federal Reserve
System lacks assurance that Reserve Bank staff took consistent and
appropriate steps to manage these risks.
While TSLF and PDCF program terms and conditions allowed all primary
dealers to participate, FRBNY monitored the financial condition of
primary dealers and applied special restrictions to two primary
dealers it determined to pose higher risks. FRBNY staff said they had
an on-site presence at some primary dealer firms subject to Securities
and Exchange Commission regulation starting in March 2008. FRBNY
developed procedures to guide staff efforts to monitor and mitigate
risks posed by higher-risk CPFF issuers, but FRBNY staff said such
procedures were not developed for TSLF and PDCF. In June 2010, FRBNY
documented a risk management framework for primary dealers. While this
framework outlines steps FRBNY's CRM group should take to monitor the
financial condition and level of risk posed by primary dealers, it
lacks details on what steps should be taken to determine whether
special restrictions are warranted in the event that serious risk
concerns emerge. In such situations, the framework advises "more
comprehensive reviews…to assess an appropriate level of risk" but does
not specify what these reviews should include, such as specific
practices followed during the crisis (for example, establishing an on-
site presence). A more specific plan for consistently and
appropriately applying special restrictions to primary dealers could
help to ensure that FRBNY manages risk effectively during a crisis.
The recent crisis illustrated that liquidity can disappear rapidly for
depository institutions and primary dealer firms and some of these
firms failed or nearly failed even as they continued to qualify for
these Federal Reserve System programs. Moreover, the urgent nature of
a crisis limits the time available for crafting these procedures,
which underscores the benefit of having taken preparatory steps
beforehand. Without more specific guidance on information to monitor
and the type and amount of documentation to maintain, Reserve Bank
staff responsible for implementing future emergency loan programs may
not take consistent and appropriate steps to mitigate the risks posed
by higher-risk borrowers. If such protocols are not established in
advance of a future crisis, it may be difficult for Reserve Banks to
develop them in a timely manner under crisis conditions that strain
staff resources.
While Emergency Programs and Assistance Impact Excess Earnings to
Treasury, the Federal Reserve Board Does Not Formally Make Projections
for Several Reasons:
Each year, pursuant to its policy, the Federal Reserve Board remits
the Federal Reserve System's "excess earnings" to Treasury. These
excess earnings consist of Federal Reserve System earnings in excess
of operating expenditures, capital paid out in dividends to member
banks, and an amount reserved by Reserve Banks to equate surplus with
capital paid-in. The Federal Reserve Board's emergency lending
programs and the purchase of $1.25 trillion of agency MBS have
resulted in large increases in the excess earnings remitted to
Treasury in 2009 and 2010 (see figure 9). Most of the emergency
programs have closed, but at the time of this report, the agency MBS
remaining on the Federal Reserve System's balance sheet and income
from the Maiden Lane transactions continue to contribute to elevated
levels of excess earnings.
Figure 9: Federal Reserve Board Excess Earnings Distributed to
Treasury, 2001-2010:
[Refer to PDF for image: vertical bar graph]
Year: 2001;
Excess Earning distributed to Treasury: $27.1 billion.
Year: 2002;
Excess Earning distributed to Treasury: $24.5 billion.
Year: 2003;
Excess Earning distributed to Treasury: $22.0 billion.
Year: 2004;
Excess Earning distributed to Treasury: $18.1 billion.
Year: 2005;
Excess Earning distributed to Treasury: $21.5 billion.
Year: 2006;
Excess Earning distributed to Treasury: $29.1 billion.
Year: 2007;
Excess Earning distributed to Treasury: $34.6 billion.
Year: 2008;
Excess Earning distributed to Treasury: $31.7 billion.
Year: 2009;
Excess Earning distributed to Treasury: $47.4 billion.
Year: 2010;
Excess Earning distributed to Treasury: $79.3 billion.
Source: Federal Reserve Board annual reports for 2009 and 2010.
[End of figure]
According to Federal Reserve Board staff, the Federal Reserve Board
does not formally project the Reserve Banks' expected excess earnings
on a regular basis, primarily because it considers excess earnings to
be a by-product of monetary policy decisions. Federal Reserve Board
staff said they run ad-hoc simulations, at the request of FOMC
members, to analyze the potential impacts of possible future monetary
policy decisions, including their impact on the size and composition
of the Federal Reserve System's balance sheet and the level of excess
earnings. However, they do not believe that creating a single set of
formal projections for excess earnings would have significant benefits
for monetary policy decision making because the conduct of monetary
policy is based on the Federal Reserve's statutory mandate to foster
maximum employment and stable prices, and the path of Federal Reserve
earnings has very limited influence on these fundamental macroeconomic
objectives. Before the recent financial crisis, the most significant
factors contributing to changes in excess earnings were changes in
interest rates and changes in Reserve Bank holdings of U.S. Treasuries
as a result of FOMC monetary policy directives. The Federal Reserve
System's emergency programs and assistance and the FOMC's Agency MBS
program significantly changed the composition of income-earning assets
held on Reserve Bank balance sheets. According to Federal Reserve
Board staff, increased income from the Federal Reserve Board's
financial stability programs did not influence how the Reserve Banks
and the Federal Reserve Board budgeted operating expenses. Although
the Federal Reserve System is not funded by congressional
appropriations, the Federal Reserve Board annually provides Congress
with a budget document that outlines its planned expenditures for the
year. Furthermore, Federal Reserve Board officials noted that the
Federal Reserve Board and the Reserve Banks promote transparency with
respect to their expenditures by publishing audited financial
statements on their Web sites.
For projections made as part of receipts estimation for the
administrations annual Budget of the U.S. Government, Treasury
includes a line item with projections for the amount of Federal
Reserve System excess earnings that could be remitted to Treasury in
the coming year. Treasury staff told us they do not receive or rely
upon Federal Reserve Board forecasts. Although the Federal Reserve
System's recent activities have complicated the projection exercise,
Treasury staff said that the Federal Reserve Board's public
disclosures provide sufficient information for them to develop
projections for the administration's budget. For example, they have
used the consolidated income statement for the Reserve Banks (from the
Reserve Banks' public financial statements) as a starting point to
project future earnings. They have also incorporated information from
Federal Reserve Board press releases about monetary policy decisions.
For example, Treasury adjusted its projections to reflect the November
2010 announcement that FRBNY would implement a new $600 billion
program to purchase Treasury securities. In recent years, the Federal
Reserve System has published detailed information about its holdings
of agency MBS securities and changes in these holdings. According to
Treasury staff with whom we spoke, these additional disclosures have
been sufficient to help Treasury project excess earnings. Treasury
relies on the administration's forecasts for future interest rates as
an input to its excess earnings projections. Treasury staff are able
to make projections for the administration's budget without the
Federal Reserve Board formally projecting excess earnings and sharing
these projections with Treasury or the public.
While the Federal Reserve Board Took Steps to Promote Consistent
Treatment of Participants, It Lacked Guidance and Documentation for
Some Access Decisions:
The Federal Reserve Board and its Reserve Banks took steps to promote
consistent treatment of eligible program participants and generally
offered assistance on the same terms and conditions to eligible
institutions in the broad-based emergency programs. However, in a few
programs, the Reserve Banks placed restrictions on some participants
that presented higher risk. As discussed earlier, Reserve Banks lacked
specific guidance for exercising certain discretion to restrict
program access for higher-risk borrowers for a few programs;
therefore, whether such restrictions were applied consistently is
unclear. Furthermore, the Federal Reserve Board did not fully document
its justification for authorizing credit extensions on terms similar
to those available through PDCF for affiliates of a few primary
dealers and did not provide guidance to Reserve Banks on the types of
program decisions that required consultation with Federal Reserve
Board policymakers. Taken collectively, the lack of guidance and
documentation for certain decisions regarding program access may
lessen the transparency and consistency of such decisions and could
unintentionally lead to inconsistent treatment of participants.
The Federal Reserve Board Designed Program Eligibility Requirements to
Target Assistance to Groups of Institutions Facing Liquidity Strains:
The Federal Reserve Board created each broad-based emergency program
to address liquidity strains in a particular funding market and
designed the program eligibility requirements primarily to target
significant participants in these markets. As discussed earlier in the
report, the programs extended loans both directly to institutions
facing liquidity strains and through intermediary borrowers. For
programs that extended credit directly, the Federal Reserve Board took
steps to limit program eligibility to institutions it considered to be
generally sound. For programs that provided loans to intermediary
borrowers, the Federal Reserve Board based eligibility requirements in
part on the ability of borrowing institutions, as a group, to channel
sufficient liquidity support to eligible sellers.
TAF. TAF loans were auctioned to depository institutions eligible for
primary credit at the discount window and expected by their local
Reserve Bank to remain primary-credit-eligible during the term the TAF
loan would be outstanding. U.S. branches and agencies of foreign banks
that were statutorily permitted to borrow from the discount window
were also permitted to borrow from TAF. The Monetary Control Act of
1980 mandates that the Reserve Banks provide equal access to discount
window credit to U.S. branches and agencies of foreign banks, and the
Federal Reserve Board interpreted this requirement to apply to TAF,
which was authorized under section 10B of the Federal Reserve Act, the
same authority under which Reserve Banks provide traditional discount
window loans.
Dollar swap lines. Under the dollar swap lines, FRBNY's counterparties
were 14 foreign central banks, which each loaned dollars obtained
through the swap lines to eligible institutions in their respective
jurisdictions pursuant to their own lending programs.[Footnote 118]
The FOMC's consideration of a new swap line arrangement generally
followed a request from an interested foreign central bank, but not
all requests were granted. In fall 2008, the Federal Reserve Board
received a number of requests for swap lines arrangements from foreign
central banks in countries with emerging market economies. An October
2008 Federal Reserve Board staff memorandum outlined criteria in
support of a recommendation that the FOMC approve swap lines with four
emerging-market-economy central banks. FOMC approvals of swap line
requests from such banks were generally based on the economic and
financial mass of the country's economy, a record of sound economic
management, and the probability that the swap line would make an
economic difference.[Footnote 119] According to Federal Reserve Board
staff, the swap line arrangements were generally made with foreign
central banks of important U.S. trading partners or global financial
centers, such as Switzerland, Japan, and England, based on global
funding needs.
TSLF and PDCF. The Federal Reserve Board limited program eligibility
for TSLF and PDCF to the primary dealers, who were key participants in
the repurchase agreement markets and traditional FRBNY counterparties.
FRBNY officials explained that FRBNY was able to leverage its existing
relationships with primary dealers and their clearing banks to quickly
deploy TSLF and PDCF. For example, FRBNY already had longstanding
legal agreements with these primary dealers to govern their
participation in FRBNY's securities lending program and certain open
market operations (repurchase agreement transactions).[Footnote 120]
The Federal Reserve Board considered the primary dealers to be
generally sound because primary dealers must meet certain standards
set out by FRBNY in order to maintain their designation as primary
dealers. For example, FRBNY requires that the primary dealer be a bank
or broker-dealer supervised by SEC, the Federal Reserve Board, or one
of the other bank supervisors. Although less regulated institutions,
such as hedge funds, also participated in the repurchase agreement
market, the Federal Reserve Board decided not to extend program
eligibility beyond the primary dealers.
AMLF. The Federal Reserve Board developed program eligibility
requirements for two sets of AMLF participants: (1) MMMFs that could
sell eligible ABCP through the program to obtain cash to satisfy
redemption demands from fund investors and (2) intermediary borrowers
that could use AMLF loan proceeds to purchase ABCP from the MMMFs at
book value. AMLF targeted 2a-7 MMMFs as eligible sellers because of
the key economic role they played as a source of short-term credit for
financial institutions and concerns about their vulnerability to
rapid, large-scale redemption demands. In particular, the 2a-7 MMMFs
were significant investors in highly-rated ABCP, and a policy
objective of AMLF was to support the ABCP market by encouraging these
MMMFs to continue to purchase and hold ABCP.[Footnote 121]
The Federal Reserve Board authorized U.S. depository institutions,
U.S. bank holding companies and their broker-dealer affiliates, and
U.S. branches and agencies of foreign banks to participate as AMLF
borrowers. Federal Reserve Board officials said that they identified
the types of AMLF borrowers based on the entities' operational ability
to purchase ABCP securities directly from MMMFs. MMMFs generally
conducted custodial and funding activities with institutions that were
eligible as AMLF borrowers and FRBB officials said that they
anticipated institutions that provided custodian bank services, which
include holding and administering the accounts with MMMF assets, to
MMMFs to be the likely AMLF borrowers. Moreover, by lending to
discount window-eligible institutions and entities that were
affiliated with discount-window eligible institutions (U.S. bank
holding companies and their broker-dealer affiliates), FRBB could
deploy AMLF quickly. According to FRBB staff, lending through discount-
window eligible institutions was particularly important, because MMMFs
are not permitted to maintain transactional accounts with a Reserve
Bank.
MMIFF. As discussed earlier, MMIFF's design featured a relatively
complex lending structure through which FRBNY could make loans to five
SPVs that would help to finance purchases of eligible short-term debt
obligations from MMMFs and other eligible MMIFF investors.[Footnote
122] Eligible MMIFF investors were initially restricted to 2a-7 MMMFs
to facilitate a rapid launch and to allow time for additional analysis
of the potential legal risks of including a broader set of investors.
When FRBNY analyses indicated that the additional participants would
not affect the ratings of the ABCP issued by the SPVs, the Federal
Reserve Board expanded program eligibility to include securities
lenders and investment funds that operated in a manner similar to
MMMFs. Although MMIFF was never used, FRBNY staff said that the
program likely benefited eligible participants through its presence as
a backstop.
CPFF. Issuers of ABCP and financial and nonfinancial unsecured issuers
whose paper received the top-tier ratings from one or more NRSROs were
eligible to sell commercial paper through CPFF. FRBNY estimated that
top-tier commercial paper eligible for CPFF represented nearly 90
percent of the commercial paper market. As a result, CPFF was expected
to provide a backstop for a large part of the commercial paper market.
Federal Reserve Board officials said that nonfinancial issuers were
granted access to CPFF to address liquidity strains that had spread
from financial markets to these issuers. Nonfinancial issuers that
were significant participants in the commercial paper markets included
large automobile manufacturers and restaurant chains. Eligible CPFF
borrowers included U.S. subsidiaries of foreign companies who were
participants in U.S. commercial paper markets.
TALF. TALF was open to any eligible U.S. company that owned eligible
collateral. Eligible TALF borrowers included a broad range of
institutions ranging from depository institutions to U.S. organized
investment funds. Federal Reserve Board officials told us that broad
participation in TALF would facilitate the program goal of encouraging
the flow of credit to consumers and small businesses. To prevent
participation by borrowers that might pose fraud or reputational risk,
FRBNY required all prospective TALF borrowers to approach the program
through one of the primary dealers or other firms that acted as TALF
agents.[Footnote 123] FRBNY directed TALF agents to conduct due
diligence on prospective TALF borrowing institutions and "material
investors" in these institutions.[Footnote 124] While TALF eligibility
rules allowed participation by U.S.-domiciled institutions with
foreign investors, it prohibited participation by entities controlled
by a foreign government.
While Reserve Banks Generally Offered the Same Terms to Eligible
Participants, Some Programs Lacked Documented Procedures to
Systematically Apply Special Restrictions:
The Federal Reserve Board promoted consistent treatment of eligible
participants in its emergency programs by generally offering
assistance on the same terms and conditions to all eligible
participants. As previously discussed, in a few programs, FRBNY placed
special restrictions on individual borrowing institutions but
procedures for a few programs did not have specific guidance to help
ensure that restrictions were applied consistently to higher-risk
borrowers. Moreover, for TAF, the Federal Reserve Board could not
readily provide documentation of all TAF restrictions placed on
individual institutions. Our review of Federal Reserve System data for
selected programs found that incorrect application of certain program
requirements was generally infrequent and that cases of incorrect
application of criteria did not appear to indicate intentional
preferential treatment of one or more program participants.[Footnote
125]
The Federal Reserve Board Generally Offered Same Terms and Conditions
to Eligible Participants:
The Federal Reserve Board generally set the same program terms and
conditions for all eligible participants within each of its emergency
programs. In designing the programs to promote financial stability,
the Federal Reserve Board generally did not seek to make loan terms
more or less restrictive based on differences in the levels of credit
risk posed by eligible borrowers. As discussed previously, for
emergency programs that involved recourse loans directly to borrowers
facing liquidity strains, the Federal Reserve Board designed
eligibility requirements to restrict access to generally sound
institutions, such as primary-credit eligible depository institutions,
primary dealers, and commercial paper issuers with top-tier credit
ratings. With the exception of a few cases discussed later, all
institutions that met the announced eligibility requirements for a
particular emergency program could borrow at the same interest rate,
against the same types of collateral, and where relevant, with the
same schedule of haircuts applied to their collateral. One Federal
Reserve Board official explained that even if the Federal Reserve
Board had sought to negotiate different terms with each borrower, it
would not have had time for separate negotiations with so many
borrowers.
Relatively Few Cases of Incorrect Application of Program Requirements
Occurred:
Our review of the implementation of selected program requirements
found isolated instances where these requirements were incorrectly
applied. Errors identified by our review do not appear to indicate a
systematic bias towards favoring one or more eligible institutions.
For example, our review of TAF collateral data found that in almost
all cases, TAF loans were less than the amount of the lendable value
of collateral pledged (based on application of TAF haircuts) and the
pricing of the TAF collateral was generally consistent. Similarly, TAF
collateral haircuts were consistent with the published collateral
haircut rates. Our review of detailed collateral data for PDCF found
that both clearing banks applied the contracted-for haircuts in the
vast majority of cases. We found that 50 of the 1,376 PDCF loans did
not post collateral in the amount required by program guidelines and
the total amount of undercollateralization comprised about 0.1 percent
of the total value of all PDCF loans.
Existing Procedures for a Few Programs Lacked Specific Guidance Needed
to Help Ensure Consistent Decisions to Restrict Access by Certain
Borrowers:
As discussed earlier in this report, Reserve Banks exercised
discretion to restrict program access for some borrowers in TAF, PDCF,
and CPFF to limit risk exposure. For TAF and CPFF, restrictions
included directing some borrowing institutions to limit or terminate
their use of the program and PDCF restrictions included specific
limits on a primary dealer's borrowing or higher haircuts applied to
its eligible collateral. FRBNY generally based its decisions about
these restrictions on supervisory and other information it obtained
about the financial condition of program participants or on a
perceived misuse of particular programs.
However, a few programs lacked specific procedures for processes that
the lending Reserve Bank should follow to exercise discretion to
restrict access for higher-risk borrowers. While FRBNY had specific
documented guidance for CPFF to guide its response to higher-risk
commercial paper issuers, other emergency lending programs lacked
similar documented guidance for making decisions about whether to
apply certain restrictions. For TAF, PDCF, TSLF, and CPFF, table 7
summarizes the Reserve Bank guidelines and practices related to
discretionary actions taken.
Table 7: Summary of Reserve Bank Practices for Applying Special
Restrictions to Some Borrowers:
Program: TAF;
Factors Reserve Banks considered in restricting or denying program
access:
* An institution became ineligible for TAF if it was no longer
eligible for primary credit;
* Institutions qualifying for primary credit but posing heightened
credit risk based on judgments made from supervisory input and other
sources could be excluded from TAF at the discretion of the Reserve
Banks;
* Existing discount window policy provided guidance on how Reserve
Banks should monitor and identify higher-risk borrowers, but lacked
specific guidance on how Reserve Banks should exercise discretion to
restrict access to term funding through TAF;
Restrictions applied:
According to Federal Reserve Board staff, Reserve Banks restricted at
least 6 institutions from participating in the 84-day TAF auctions and
at least 25 institutions from participating in any TAF auction. The
Reserve Banks made these restrictions based on the concern that the
institutions would not remain in sound condition through the term of
the loan.
Program: PDCF and TSLF; Factors Reserve Banks considered in
restricting or denying program access:
* All primary dealers were eligible;
* Dealers that posed higher risk could have been subject to additional
restriction on an exception basis;
* Per FOMC directive, TSLF restrictions could have been placed on the
volume of securities loans to individual borrowers;
* No additional written criteria for exclusion of use or restriction;
Restrictions applied:
For two primary dealers in PDCF, FRBNY imposed higher haircuts on
certain collateral types. For one of these dealers, FRBNY placed a
specific borrowing cap.
Program: CPFF;
Factors Reserve Banks considered in restricting or denying program
access:
* Noncompliance with CPFF's credit rating criteria;
* Significant probability of default in the next 3 to 6 months, even
with use of the facility;
* ABCP program had been inactive for an extended period of time due to
difficulties in maintaining acceptance by market of business model
(e.g. certain credit arbitrage vehicles). This condition may often be
accompanied by lapsed. compliance with program documents;
* Material misrepresentation on certification of maximum amount of
commercial paper it would be eligible to issue through CPFF;
Restrictions applied:
Based on credit risk assessments of borrowing institutions, FRBNY took
the following discretionary actions;
accompanied by lapsed. compliance with program documents;
* Required stronger sponsor support or additional collateral in the
case of ABCP issuers;
accompanied by lapsed. compliance with program documents;
* Required collateralization or guarantee from another entity in the
case of unsecured commercial paper issuers;
accompanied by lapsed. compliance with program documents;
* Imposed a limit on issuance that is below the maximum otherwise
allowed;
accompanied by lapsed. compliance with program documents;
* Disallowed or limited new issuance through CPFF to replace maturing
commercial paper held by CPFF LLC;
accompanied by lapsed. compliance with program documents;
* Advised registrant not to participate.
Sources: GAO analysis of program documentation for TAF, PDCF, TSLF,
and CPFF.
[End of table]
For TAF-related decisions, Federal Reserve Board staff told us that
Reserve Banks applied general discount window guidance issued by the
Reserve Banks' Subcommittee on Credit Risk Management, which they
considered to be appropriate as TAF loans were made under the same
broader authority and internal policies as the discount window.
However, while Reserve Banks have traditionally exercised discretion
in adjusting lending terms for individual institutions through the
discount window program, TAF presented Reserve Banks with new risk
management considerations, including how to determine that it was
prudent for the Reserve Bank to extend TAF credit to an otherwise
eligible institution for terms as long as 84 days. Because Reserve
Banks' existing discount window procedures did not contain specific
guidance on exercising discretion and documenting actions to restrict
higher-risk TAF borrowers, the Federal Reserve System lacked assurance
that such restrictions were applied consistently. Moreover, the
Federal Reserve Board provided us with a list of decisions by the
Reserve Banks to direct depository institutions to restrict borrowings
to the 28-day TAF auctions (rather than allowing access to 84-day TAF
credit as well) or to exclude them from TAF auctions altogether by
directing them to borrow under the discount window program. However,
Federal Reserve Board staff noted that this list may be incomplete as
TAF restrictions may not always have been formally recorded by all
Reserve Banks. According to FRBNY staff, the Federal Reserve System
has not formally analyzed the consistency and appropriateness of
Reserve Banks' decisions to restrict TAF access. Complete
documentation of these decisions would be needed for the Federal
Reserve System to fully assess the consistency of Reserve Banks'
decisions to restrict TAF access.
For PDCF and TSLF, FRBNY generally lacked criteria during the life of
the programs for applying restrictions to help ensure that
restrictions were applied consistently across the primary dealers.
FRBNY staff said that decisions to place restrictions on 2 of the 20
primary dealers were made on an ad-hoc basis. As discussed earlier in
this report, in June 2010, after both PDCF and TSLF had closed, FRBNY
created a credit risk management framework for primary dealers that
codified FRBNY's practice of applying borrowing limits or special
haircuts on an exception basis to higher-risk primary dealers. This
documented framework outlines FRBNY's general approach for reviewing
and monitoring risks related to primary dealers' role as
counterparties in open market operations and notes that more
comprehensive reviews of primary dealers may be needed in the event
that concerns are raised from the monitoring process. However, the
framework does not specify the steps that would be included in a more
comprehensive review, such as what communication should take place
with the institution and its regulator.
Without clear, documented guidance to direct Reserve Banks' efforts to
monitor and restrict access by higher-risk borrowers, there is little
assurance that Reserve Bank decisions to restrict certain institutions
under any future deployment of such emergency lending programs will be
consistent within a centralized program or programs operated across
Reserve Banks. FRBNY staff commented that the range of activities that
may trigger restrictions may not be captured even if a guideline was
established. However, by having written procedures to guide decision-
making for restrictions and suggestions for documentation of the
rationale for such decisions, the Federal Reserve Board may more be
able to review such decisions and ensure that future implementation of
emergency lending programs will result in consistent treatment of
higher-risk borrowers.
The Federal Reserve Board Did Not Fully Document the Basis for
Extending Credit to a Few Affiliates of Primary Dealers:
The Federal Reserve Board did not fully document the basis for its
decisions to extend credit on terms similar to those available at PDCF
to certain broker-dealer affiliates of four of the primary dealers. In
September and November of 2008, the Federal Reserve Board invoked
section 13(3) of the Federal Reserve Act to authorize FRBNY to extend
credit to the London-based broker-dealer subsidiaries of Merrill
Lynch, Goldman Sachs, Morgan Stanley, and Citigroup, as well as the
U.S. broker-dealer subsidiaries of Merrill Lynch, Goldman Sachs, and
Morgan Stanley. Federal Reserve Board officials told us that the
Federal Reserve Board did not consider the extension of credit to
these subsidiaries to be a legal extension of PDCF but separate
actions to specifically assist these four primary dealers by using
PDCF as an operational tool.
However, to fulfill its statutory requirement under the Emergency
Economic Stabilization Act of 2008 to publicly report on the
justification of each action taken under section 13(3) of the Federal
Reserve Act, the Federal Reserve Board included short descriptions of
these exceptional credit extensions in its report on the basis for
authorizing PDCF and in its April 2009 report providing an update on
the emergency programs. But the Emergency Economic Stabilization Act
of 2008 reports, other public disclosures and submitted documents we
reviewed did not provide complete explanations of how these
exceptional credit extensions satisfied section 13(3) criteria. In a
September 21, 2008, press release, for example, the Federal Reserve
Board explained only that "transitional credit" for the U.S. broker-
dealer subsidiaries of Goldman Sachs and Morgan Stanley was intended
to increase liquidity support to these firms as they transitioned to
managing their funding within a bank holding company structure and
noted that a similar arrangement would be provided for the broker-
dealer subsidiary of Merrill Lynch. In explaining the basis for these
exceptional credit extensions, Federal Reserve Board officials cited
the continuing strains in financial markets and concerns about the
possible failures of these dealers at the time. However, the Federal
Reserve Board could not provide documentation explaining why these
extensions were provided specifically to affiliates of these four
primary dealers.
Federal Reserve Board officials told us that the Federal Reserve Board
did not draft detailed memoranda to document the rationale for all
uses of section 13(3) authority but that unusual and exigent
circumstances existed in each of these cases as critical funding
markets were in crisis. However, without more complete documentation,
how assistance to these broker-dealer subsidiaries satisfied the
statutory requirements for using this authority remains unclear.
Moreover, without more complete public disclosure of the basis for
these actions, these decisions may not be subject to an appropriate
level of transparency and accountability.
The Dodd-Frank Act includes 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. To address these new reporting requirements, the Federal
Reserve Board will have to take steps to further enhance its reporting
requirements to more consistently and comprehensively document its
analysis and recommendations to carryout its section 13(3) authority
going forward.[Footnote 126] Without improved documentation
requirements, the Federal Reserve Board risks making disclosures that
are not consistent with these new reporting requirements.
The Federal Reserve Board Generally Has Not Provided Documented
Guidance to Reserve Banks on Types of Program Decisions That Require
Consultation with the Federal Reserve Board:
In authorizing the Reserve Banks to operate its emergency programs,
the Federal Reserve Board has not provided documented guidance on the
types of program policy decisions--including allowing atypical uses of
broad-based assistance--that should be reviewed by the Federal Reserve
Board. Standards for internal control for federal government agencies
provide that transactions and other significant events should be
authorized and executed only by persons acting within the scope of
their authority. An FRBNY official said that FRBNY recognized the
importance of distinguishing between "policy-level" decisions that
required consultation with the Federal Reserve Board and "execution"
decisions that did not. A Federal Reserve Board official described
execution decisions as those that fell within the program design
parameters authorized by the Federal Reserve Board. Outside of the
established protocols for the discount window, FRBNY staff said that
the Federal Reserve Board generally did not provide written guidance
on expectations for types of decisions or events requiring formal
Federal Reserve Board review, although program decisions that deviated
from policy set by the Federal Reserve Board were generally understood
to require Board staff consultation.[Footnote 127]
In December 2009, FRBNY's Capital Markets Group revised its risk
escalation protocols to help ensure that risk events were brought to
the attention of the appropriate set of FRBNY decision makers based on
their level of risk, but the Federal Reserve Board was unable to
readily provide a similar set of documented protocols for consultation
that should have taken place related to the emergency programs.
FRBNY's policy defines examples of such risk events, which include
unplanned, nonroutine occurrences that increase the Markets Group's
operational or reputational risk exposure. We identified two atypical
uses of broad-based programs to support an institution determined to
be systemically significant. According to Federal Reserve Board
officials, FRBNY generally consulted Federal Reserve Board officials
on such matters. However, our review found that FRBNY staff were not
directed to do so by documented guidance and, furthermore, Federal
Reserve Board staff could not provide documentation of its
consideration of these atypical uses.
* FRBNY allowed an AIG-sponsored conduit to continue to use the CPFF
following a January 2009 Federal Reserve Board rule change that likely
would have made the conduit ineligible for the program if it had been
a new applicant. Specifically, in January 2009, the Federal Reserve
Board changed CPFF rules to prohibit ABCP conduits that had been
inactive before the CPFF's creation from using the program. According
to FRBNY staff, FRBNY identified three conduits using the CPFF at the
time of the rule change that were likely to have been inactive before
the creation of the program. FRBNY staff said they interpreted the
revised eligibility requirements as applying prospectively to new
applicants but that they nonetheless, and in accordance with their
general understanding with Federal Reserve Board staff, encouraged
existing conduits that would not have met the revised criteria to
decrease their usage. Of the three conduits, two exited the program
within a few months. However, the third conduit, which was sponsored
by AIG, was permitted to continue to borrow from CPFF at similar
levels until a week before CPFF closed. According to FRBNY staff, the
decision to allow continued access by this AIG-sponsored conduit was
part of FRBNY's overall management of its assistance to AIG, which
included scheduled reductions in other more significant AIG-related
CPFF exposures beginning in 2009. While the Federal Reserve Board
documented the basis for the January 2009 change to CPFF terms and
conditions to prohibit access by inactive conduits, neither the
Federal Reserve Board nor FRBNY staff could readily provide
documentation supporting the decision to allow the AIG conduit to
continue its borrowing. However, FRBNY staff said that they kept the
Federal Reserve Board staff apprised of FRBNY's efforts to achieve an
orderly repayment of the AIG-related commercial paper holdings in
CPFF. Whether FRBNY consulted the appropriate set of Federal Reserve
Board policymakers before making this decision is unclear.
* In October 2008, according to Federal Reserve Board staff, the
Federal Reserve Board allowed the Swiss National Bank to use dollars
under its swap line agreement to provide special assistance to UBS, a
large Swiss banking organization. Specifically, on October 16, 2008,
the Swiss National Bank announced that it would use dollars obtained
through its swap line with FRBNY to help fund an SPV it would create
to purchase up to $60 billion of illiquid assets from UBS. According
to FRBNY data, from December 11, 2008, through June 2009, Swiss
National Bank drew dollar amounts generally not exceeding about $13
billion to help fund this SPV that served a function similar to that
of the Maiden Lane SPVs. Federal Reserve Board staff acknowledged that
this was an atypical use of swap line dollars as the swap line
agreements were initially designed to help foreign central banks
provide dollar loans broadly to institutions facing dollar funding
strains. Although the FOMC had delegated approval authority to FRBNY
for each swap line draw by the Swiss National Bank, Federal Reserve
Board staff said that this proposed use by Swiss National Bank was
informally brought to the attention of the FOMC Foreign Currency
Subcommittee members for their consideration before the Swiss National
Bank's announcement. Federal Reserve Board staff said that Foreign
Currency Subcommittee members believed that this use was consistent
with the broader policy objective of stabilizing dollar funding
markets and that the Swiss National Bank was a very reliable
counterparty. Federal Reserve Board staff said that this consultation
was not required by the policies and procedures established for the
swap lines program. According to FRBNY staff, this use of swap line
dollars was permitted under FRBNY's amended agreement with the Swiss
National Bank.
Without documented guidance for Reserve Banks on types of program
decisions that require consultation with the Federal Reserve Board,
Reserve Bank staff and officials may fail to escalate significant
policy decisions to the appropriate set of policymakers at the Federal
Reserve Board. This uncertainty may increase the risk that a Reserve
Bank may permit an exceptional use of emergency assistance that is
inconsistent with the Federal Reserve Board's policy goals or exposes
the Federal Reserve System to increased reputational risk. For
example, although required approvals of swap line draws generally were
routine in nature, going forward additional requirements for special
approval and documentation for exceptional uses could help to ensure
the proper level of transparency and accountability for any such uses
in the future.
The Federal Reserve Board Took Steps to Prevent Use that Would Be
Inconsistent with Its Policy Objectives:
To assess whether program use was consistent with the Federal Reserve
Board's announced policy objectives, we analyzed program transaction
data to identify significant trends in borrowers' use of the programs.
According to Federal Reserve Board staff, they designed program terms
and conditions to discourage use that would have been inconsistent
with program policy objectives. As discussed earlier, program terms--
such as the interest charged and haircuts applied--generally were
designed to be favorable only for institutions facing liquidity
strains. Within and across the programs, certain participants used the
programs more frequently and were slower to exit than others. Reserve
Bank officials noted that market conditions and the speed with which
the participant recovered affected use of the program by individual
institutions. As a result of its monitoring of program usage, the
Federal Reserve Board modified terms and conditions of several
programs to reinforce policy objectives and program goals.
Large Global Institutions Were Among the Largest Users of Several
Programs:
Several of the programs saw greater use by large global institutions
that were significant participants in the funding markets targeted by
the Federal Reserve Board. Tables 8 and 9 rank the largest borrowing
institutions according to aggregate borrowing (irrespective of
differences in term to maturity) and total borrowing after adjusting
for differences in loan terms. For both tables, we show transaction
amounts for AMLF and TALF, but do not factor these amounts into the
rankings as entities participating in these programs served as
intermediary borrowers whose purchases provided liquidity support to
other market participants. We aggregated dollar transaction amounts
for borrowing entities at the parent company level. For each parent
company, total amounts borrowed include amounts borrowed by the parent
company, its subsidiaries, branches or agencies, and in the case of
CPFF, dollar amounts of ABCP issued by entities sponsored by the
holding company or one of its subsidiaries. In cases where we
identified an acquisition that took place during the operation of a
program, we consolidated transaction amounts following the completion
of the acquisition. Table 8 aggregates total dollar transaction
amounts by adding the total dollar amount of all loans but does not
adjust these amounts to reflect differences across programs in the
term over which loans were outstanding. For example, an overnight PDCF
loan of $10 billion that was renewed daily at the same level for 30
business days would result in an aggregate amount borrowed of $300
billion although the institution, in effect, borrowed only $10 billion
over 30 days. In contrast, a TAF loan of $10 billion extended over a 1-
month period would appear as $10 billion. As a result, the total
transaction amounts shown in table 8 for PDCF are not directly
comparable to the total transaction amounts shown for TAF and other
programs that made loans for periods longer than overnight.
Table 8: Institutions with Largest Total Transaction Amounts (Not Term-
Adjusted) across Broad-Based Emergency Programs (Borrowing Aggregated
by Parent Company and Includes Sponsored ABCP Conduits), December 1,
2007 through July 21, 2010:
Dollar in billions.
Borrowing Parent Company: Citigroup Inc.;
TAF: $110;
PDCF: $$2,020;
TSLF: $348;
CPFF: $33;
Subtotal: $2,511;
AMLF: $1;
TALF: [Empty];
Total loans: 2,513.
Borrowing Parent Company: Morgan Stanley;
TAF: [Empty];
PDCF: $1,913;
TSLF: $115;
CPFF: $4;
Subtotal: $2,032;
AMLF: [Empty];
TALF: $9;
Total loans: 2,041.
Borrowing Parent Company: Merrill Lynch & Co.;
TAF: $0;
PDCF: $1,775;
TSLF: $166;
CPFF: $8;
Subtotal: $1,949;
AMLF: [Empty];
TALF: [Empty];
Total loans: 1,949.
Borrowing Parent Company: Bank of America Corporation;
TAF: $280;
PDCF: $947;
TSLF: $101;
CPFF: $15;
Subtotal: $1,342;
AMLF: $2;
TALF: [Empty];
Total loans: 1,344.
Borrowing Parent Company: Barclays PLC (United Kingdom);
TAF: $232;
PDCF: $410;
TSLF: $187;
CPFF: $39;
Subtotal: $868;
AMLF: [Empty];
TALF: [Empty];
Total loans: 868.
Borrowing Parent Company: Bear Stearns Companies, Inc.;
TAF: [Empty];
PDCF: $851;
TSLF: $2;
CPFF: [Empty];
Subtotal: $853;
AMLF: [Empty];
TALF: [Empty];
Total loans: 853.
Borrowing Parent Company: Goldman Sachs Group Inc.;
TAF: [Empty];
PDCF: $589;
TSLF: $225;
CPFF: $0;
Subtotal: $814;
AMLF: [Empty];
TALF: [Empty];
Total loans: 814.
Borrowing Parent Company: Royal Bank of Scotland Group PLC (United
Kingdom);
TAF: $212;
PDCF: [Empty];
TSLF: $291;
CPFF: $39;
Subtotal: $541;
AMLF: [Empty];
TALF: [Empty];
Total loans: 541.
Borrowing Parent Company: Deutsche Bank AG (Germany);
TAF: $77;
PDCF: $1;
TSLF: $277;
CPFF: [Empty];
Subtotal: $354;
AMLF: [Empty];
TALF: [Empty];
Total loans: 354.
Borrowing Parent Company: UBS AG (Switzerland);
TAF: $56;
PDCF: $35;
TSLF: $122;
CPFF: $75;
Subtotal: $287;
AMLF: [Empty];
TALF: [Empty];
Total loans: 287.
Borrowing Parent Company: JP Morgan Chase & Co.;
TAF: $99;
PDCF: $112;
TSLF: $68;
CPFF: [Empty];
Subtotal: $279;
AMLF: $111;
TALF: [Empty];
Total loans: 391.
Borrowing Parent Company: Credit Suisse Group AG (Switzerland);
TAF: $0;
PDCF: $2;
TSLF: $261;
CPFF: [Empty];
Subtotal: $262;
AMLF: $0;
TALF: [Empty];
Total loans: 262.
Borrowing Parent Company: Lehman Brothers Holdings Inc.;
TAF: [Empty];
PDCF: $83;
TSLF: $99;
CPFF: [Empty];
Subtotal: $183;
AMLF: [Empty];
TALF: [Empty];
Total loans: 183.
Borrowing Parent Company: Bank of Scotland PLC (United Kingdom);
TAF: $181;
PDCF: [Empty];
TSLF: [Empty];
CPFF: [Empty];
Subtotal: $181;
AMLF: [Empty];
TALF: [Empty];
Total loans: 181.
Borrowing Parent Company: BNP Paribas SA (France);
TAF: $64;
PDCF: $66;
TSLF: $41;
CPFF: $3;
Subtotal: $175;
AMLF: [Empty];
TALF: [Empty];
Total loans: 175.
Borrowing Parent Company: Wells Fargo & Co.;
TAF: $159;
PDCF: [Empty];
TSLF: [Empty];
CPFF: [Empty];
Subtotal: $159;
AMLF: [Empty];
TALF: [Empty];
Total loans: 159.
Borrowing Parent Company: Dexia SA (Belgium);
TAF: $105;
PDCF: [Empty];
TSLF: [Empty];
CPFF: $53;
Subtotal: $159;
AMLF: [Empty];
TALF: [Empty];
Total loans: 159.
Borrowing Parent Company: Wachovia Corporation;
TAF: $142;
PDCF: [Empty];
TSLF: [Empty];
CPFF: [Empty];
Subtotal: $142;
AMLF: [Empty];
TALF: [Empty];
Total loans: 142.
Borrowing Parent Company: Dresdner Bank AG (Germany);
TAF: $123;
PDCF: $0;
TSLF: $1;
CPFF: $10;
Subtotal: $135;
AMLF: [Empty];
TALF: [Empty];
Total loans: 135.
Borrowing Parent Company: Societe Generale SA (France);
TAF: $124;
PDCF: [Empty];
TSLF: [Empty];
CPFF: [Empty];
Subtotal: $124;
AMLF: [Empty];
TALF: [Empty];
Total loans: 124.
Borrowing Parent Company: All other borrowers;
TAF: $1,854;
PDCF: $146;
TSLF: $14;
CPFF: $460;
Subtotal: $2,475;
AMLF: $103;
TALF: $62;
Total loans: 2,639.
Borrowing Parent Company: Total:
TAF: $3,818;
PDCF: $8,951;
TSLF: $2,319;
CPFF: $738;
Subtotal: $15,826;
AMLF: $217;
TALF: $71;
Total loans: 16,115.
Source: GAO analysis of Federal Reserve System data.
Note: The total dollar amounts borrowed represent the sum of all loans
and have not been adjusted to reflect differences in terms to maturity
for the loans. Total borrowing is aggregated at the parent company
level and generally includes borrowing by branches, agencies,
subsidiaries, and sponsored ABCP conduits that we could identify.
Total borrowing for each parent company consolidates amounts borrowed
by acquired institutions following the completion of acquisitions.
PDCF totals include credit extensions to affiliates of some primary
dealers and TSLF totals include loans under the TSLF Options Program
(TOP).
[End of table]
To account for differences in the terms for loans that were
outstanding, we multiplied each loan amount by the number of days the
loan was outstanding and divided this amount by the number of days in
a year (365). Table 9 shows the top 20 borrowing institutions in terms
of term-adjusted total transaction amount for emergency programs and
other assistance provided directly to institutions facing liquidity
strains.
Table 9: Institutions with Largest Total Term-Adjusted Borrowing
across Broad-Based Emergency Programs, December 1, 2007 through July
21, 2010:
Dollars in billions.
Borrowing Parent Company: Bank of America Corporation;
TAF: $48;
PDCF: $6;
TSLF: $8;
CPFF: $6;
Subtotal: $67;
AMLF: $0;
TALF: [Empty];
Total loans: $67;
Percent of total: 6%.
Borrowing Parent Company: Citigroup Inc.;
TAF: $15;
PDCF: $8;
TSLF: $27;
CPFF: $8;
Subtotal: $58;
AMLF: $0;
TALF: [Empty];
Total loans: $58;
Percent of total: 5.
Borrowing Parent Company: Royal Bank of Scotland Group PLC (United
Kingdom);
TAF: $25;
PDCF: [Empty];
TSLF: $23;
CPFF: $10;
Subtotal: $58;
AMLF: [Empty];
TALF: [Empty];
Total loans: $58;
Percent of total: 5.
Borrowing Parent Company: Barclays Group PLC (United Kingdom);
TAF: $24;
PDCF: $2;
TSLF: $15;
CPFF: $10;
Subtotal: $50;
AMLF: [Empty];
TALF: [Empty];
Total loans: $50;
Percent of total: 4.
Borrowing Parent Company: UBS AG (Switzerland);
TAF: $7;
PDCF: $0;
TSLF: $9;
CPFF: $18;
Subtotal: $35;
AMLF: [Empty];
TALF: [Empty];
Total loans: $35;
Percent of total: 3.
Borrowing Parent Company: Deutsche Bank AG (Germany);
TAF: $9;
PDCF: $0;
TSLF: $22;
CPFF: [Empty];
Subtotal: $30;
AMLF: [Empty];
TALF: [Empty];
Total loans: $30;
Percent of total: 3.
Borrowing Parent Company: Wells Fargo & Co.;
TAF: $25;
PDCF: [Empty];
TSLF: [Empty];
CPFF: [Empty];
Subtotal: $25;
AMLF: [Empty];
TALF: [Empty];
Total loans: $25;
Percent of total: 2.
Borrowing Parent Company: Dexia SA (Belgium);
TAF: $10;
PDCF: [Empty];
TSLF: [Empty];
CPFF: $13;
Subtotal: $23;
AMLF: [Empty];
TALF: [Empty];
Total loans: $23;
Percent of total: 2.
Borrowing Parent Company: Credit Suisse Group AG (Switzerland);
TAF: $0;
PDCF: $0;
TSLF: $21;
CPFF: [Empty];
Subtotal: $21;
AMLF: $0;
TALF: [Empty];
Total loans: $21;
Percent of total: 2.
Borrowing Parent Company: Bank of Scotland PLC (United Kingdom);
TAF: $20;
PDCF: [Empty];
TSLF: [Empty];
CPFF: [Empty];
Subtotal: $20;
AMLF: [Empty];
TALF: [Empty];
Total loans: $20;
Percent of total: 2.
Borrowing Parent Company: Commerzbank AG (Germany);
TAF: $16;
PDCF: [Empty];
TSLF: [Empty];
CPFF: $4;
Subtotal: $20;
AMLF: [Empty];
TALF: [Empty];
Total loans: $20;
Percent of total: 2.
Borrowing Parent Company: Goldman Sachs Group Inc.;
TAF: [Empty];
PDCF: $2;
TSLF: $17;
CPFF: $0;
Subtotal: $20;
AMLF: [Empty];
TALF: [Empty];
Total loans: $20;
Percent of total: 2.
Borrowing Parent Company: Merrill Lynch & Co.;
TAF: $0;
PDCF: $5;
TSLF: $14;
CPFF: [Empty];
Subtotal: $19;
AMLF: [Empty];
TALF: [Empty];
Total loans: $19;
Percent of total: 2.
Borrowing Parent Company: BNP Paribas SA (France);
TAF: $11;
PDCF: $0;
TSLF: $3;
CPFF: $4;
Subtotal: $19;
AMLF: [Empty];
TALF: [Empty];
Total loans: $19;
Percent of total: 2.
Borrowing Parent Company: Societe Generale SA (France);
TAF: $17;
PDCF: [Empty];
TSLF: [Empty];
CPFF: [Empty];
Subtotal: $17;
AMLF: [Empty];
TALF: [Empty];
Total loans: $17;
Percent of total: 1.
Borrowing Parent Company: Morgan Stanley;
TAF: [Empty];
PDCF: $8;
TSLF: $8;
CPFF: $1;
Subtotal: $17;
AMLF: [Empty];
TALF: $28;
Total loans: $45;
Percent of total: 4.
Borrowing Parent Company: Wachovia Corporation;
TAF: $16;
PDCF: [Empty];
TSLF: [Empty];
CPFF: [Empty];
Subtotal: $16;
AMLF: [Empty];
TALF: [Empty];
Total loans: $16;
Percent of total: 1.
Borrowing Parent Company: JP Morgan Chase & Co.;
TAF: $13;
PDCF: $0;
TSLF: $3;
CPFF: [Empty];
Subtotal: $16;
AMLF: $15;
TALF: [Empty];
Total loans: $31;
Percent of total: 3.
Borrowing Parent Company: AIG;
TAF: [Empty];
PDCF: [Empty];
TSLF: [Empty];
CPFF: $15;
Subtotal: $15;
AMLF: [Empty];
TALF: [Empty];
Total loans: $15;
Percent of total: 1.
Borrowing Parent Company: Norinchukin Bank (Japan);
TAF: $15;
PDCF: [Empty];
TSLF: [Empty];
CPFF: [Empty];
Subtotal: $15;
AMLF: [Empty];
TALF: [Empty];
Total loans: $15;
Percent of total: 1.
Borrowing Parent Company: All other borrowers;
TAF: $204;
PDCF: $4;
TSLF: $11;
CPFF: $94;
Subtotal: $313;
AMLF: $13;
TALF: $211;
Total loans: $537;
Percent of total: 47.
Borrowing Parent Company: Total;
TAF: $474;
PDCF: $35;
TSLF: $179;
CPFF: $183;
Subtotal: $870;
AMLF: $29;
TALF: $240;
Total loans: $1,139;
Percent of total: 100%.
Source: GAO analysis of Federal Reserve System data.
Note: The dollar amounts borrowed for each loan were term-adjusted by
multiplying the loan amount by the term to maturity for the loan and
dividing by 365 days. Term to maturity is calculated as the difference
between the original loan maturity date and the trade date and does
not reflect repayments of loans that occurred before the original loan
maturity date. Total borrowing is aggregated at the parent company
level and generally includes borrowing by branches, agencies,
subsidiaries, and sponsored ABCP conduits that we could identify.
Total borrowing for each parent company consolidates amounts borrowed
by acquired institutions following the completion of acquisitions.
PDCF totals include credit extensions to affiliates of some primary
dealers and TSLF totals include loans under the TSLF Options Program
(TOP).
[End of table]
U.S. branches and agencies of foreign banks and U.S. subsidiaries of
foreign institutions received over half of the total dollar amount of
TAF and CPFF loans made (see figure 10). As noted previously, such
institutions were permitted to borrow under the terms and conditions
of the lending programs. For both programs, FRBNY staff explained that
as long as participating institutions were eligible to use the
program, monitoring whether certain types of institutions accessed a
program more than others was not relevant to the programs' objectives.
Federal Reserve Board officials told us the programs sought to support
funding markets that were global, and agencies and branches of foreign
firms were significant participants in lending to U.S. households and
businesses.
Figure 10: Total Transaction Amount by Parent Company Country of
Domicile for TAF and CPFF:
[Refer to PDF for image: 2 pie-charts]
TAF:
United States: 35%;
United Kingdom: 17%;
Germany: 16%;
Japan: 8%;
France: 7%;
Other countries: 16%.
CPFF:
United States: 41%;
United Kingdom: 18%;
Belgium: 10%;
Switzerland: 9%;
Germany: 9%;
France: 6%;
Other countries: 7%.
Source: GAO
Note: For TAF, the total dollar amount of TAF loans are aggregated at
the level of the parent company for participating depository
institutions. For CPFF, the total dollar amount of issuance through
CPFF is aggregated at the parent company level and includes ABCP
issuance by entities sponsored by the parent company or one of its
subsidiaries. The country of domicile for parent companies is based on
SNL Financial data.
[End of figure]
Under TAF, approximately 65 percent of the loans were made to U.S.
branches, agencies, and subsidiaries of foreign institutions. Federal
Reserve Board officials told us that the use of the program by U.S.
branches and agencies of foreign banks was expected because these
institutions were facing liquidity strains in dollar funding markets.
FRBNY staff identified a few possible reasons for high use by U.S.
branches and agencies of foreign banks. First, many of them faced
liquidity strains arising from the need to bring certain illiquid U.S.
dollar assets back onto their balance sheets and could not finance
these assets elsewhere.[Footnote 128] In addition, many of these
institutions held U.S.-dollar dominated collateral that could be
pledged to TAF but not in their home country. A FRBNY memorandum noted
that U.S. banks generally bid for smaller loan amounts and could not
bid as aggressively as their foreign counterparts, because they did
not have enough collateral pledged at the discount window.
Under CPFF, approximately 60 percent of the commercial paper was
issued by U.S. subsidiaries of foreign institutions over the life of
the program. At the time CPFF was created, U.S. companies owned by
foreign institutions were among the most significant participants in
the U.S. commercial paper market.
The Federal Reserve Board's analysis of TALF showed that under TALF,
while the majority of the U.S. companies that received loans had U.S.
domiciled material investors, 36 percent had one or more non-U.S.
domiciled "material investors."[Footnote 129] Federal Reserve Board
officials noted that the loans were made to TALF borrowers, not to the
material investors in the companies that borrowed from TALF. While
only U.S. companies with eligible collateral could participate in
TALF, "material investors" that invested in TALF borrowers could be
foreign entities. According to the Federal Reserve Board, 26 percent
of "material investors" were domiciled abroad with a majority of non-
U.S. domiciled material investors located in Cayman Islands, followed
by Korea and Bermuda. As with TALF borrowers, primary dealers and
other firms acting as TALF agents also conducted due diligence on
"material investors" to help ensure that they did not present credit,
fraud, or reputational risk to FRBNY. FRBNY officials commented that
by requiring all TALF-eligible securities to be entirely or almost
entirely backed by loans to U.S. residents or U.S. businesses, TALF
benefited the intended beneficiaries, such as small businesses.
Additionally, FRBNY officials commented that like many firms, some
TALF borrowers were partly owned by foreign entities or had investors
that were based abroad.
Use of the Programs Peaked at the Height of the Financial Crisis and
Fell as Market Conditions Recovered:
Use of the programs generally peaked during the height of the
financial crisis and fell as market conditions recovered. Figure 11
shows how the use of broad-based programs changed over time. Federal
Reserve Board officials told us that even as the market recovered,
funding conditions improved for certain borrowers but not others. As a
result, in PDCF, TSLF, and CPFF, several participants remained in the
programs even as others exited. However, all activities wound down
before the programs were terminated, and in the case of TSLF and PDCF,
several months before program termination. Federal Reserve Board
officials told us as market conditions improved and use of CPPF
declined, they were in active discussions with firms that remained in
CPFF to confirm they were going to be able to leave CPFF in an orderly
manner.
Figure 11: Total Loans Outstanding for Broad-Based Programs, December
1, 2007-June 29, 2011:
[Refer to PDF for image: multiple line graph]
[Values shown are first values given for the indicated month]
Dollars in billions:
December 2007;
TAF: $0;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $0;
TALF: $0.
January 2008;
TAF: $40;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $0;
TALF: $0.
February 2008;
TAF: $60;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $0;
TALF: $0.
March 2008;
TAF: $60;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $0;
TALF: $0.
April 2008;
TAF: $100;
PDCF: $34;
TSLF: $75;
AMLF: $0;
CPFF: $0;
TALF: $0.
May 2008;
TAF: $100;
PDCF: $16;
TSLF: $143;
AMLF: $0;
CPFF: $0;
TALF: $0.
June 2008;
TAF: $150;
PDCF: $8;
TSLF: $99;
AMLF: $0;
CPFF: $0;
TALF: $0.
July 2008;
TAF: $150;
PDCF: $0;
TSLF: $104;
AMLF: $0;
CPFF: $0;
TALF: $0.
August 2008;
TAF: $150;
PDCF: $0;
TSLF: $125;
AMLF: $0;
CPFF: $0;
TALF: $0.
September 2008;
TAF: $150;
PDCF: $0;
TSLF: $116;
AMLF: $0;
CPFF: $0;
TALF: $0.
October 2008;
TAF: $149;
PDCF: $147;
TSLF: $236;
AMLF: $152;
CPFF: $0;
TALF: $0.
December 2008;
TAF: $407;
PDCF: $56;
TSLF: $185;
AMLF: $49;
CPFF: $303;
TALF: $0.
January 2009;
TAF: $384;
PDCF: $34;
TSLF: $156;
AMLF: $21;
CPFF: $332;
TALF: $0.
February 2009;
TAF: $413;
PDCF: $27;
TSLF: $121;
AMLF: $17;
CPFF: $257;
TALF: $0.
March 2009;
TAF: $493;
PDCF: $24;
TSLF: $112;
AMLF: $8;
CPFF: $239;
TALF: $0.
April 2009;
TAF: $467;
PDCF: $18;
TSLF: $86;
AMLF: $6;
CPFF: $247;
TALF: $5.
May 2009;
TAF: $404;
PDCF: $1;
TSLF: $33;
AMLF: $29;
CPFF: $165;
TALF: $6.
June 2009;
TAF: $373;
PDCF: $0;
TSLF: $27;
AMLF: $24;
CPFF: $139;
TALF: $15.
July 2009;
TAF: $283;
PDCF: $0;
TSLF: $7;
AMLF: $15;
CPFF: $110;
TALF: $25.
August 2009;
TAF: $234;
PDCF: $0;
TSLF: $3;
AMLF: $0;
CPFF: $57;
TALF: $30.
September 2009;
TAF: $212;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $43;
TALF: $37.
October 2009;
TAF: $178;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $37;
TALF: $42.
November 2009;
TAF: $139;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $10;
TALF: $43.
December 2009;
TAF: $101;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $10;
TALF: $44.
January 2010;
TAF: $76;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $9;
TALF: $47.
February 2010;
TAF: $39;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $4;
TALF: $47.
March 2010;
TAF: $15;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $3;
TALF: $46.
April 2010;
TAF: $3;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $3;
TALF: $47.
May 2010;
TAF: $0;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $0;
TALF: $45.
June 2010;
TAF: $0;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $0;
TALF: $44.
July 2010;
TAF: $0;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $0;
TALF: $42.
August 2010;
TAF: $0;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $0;
TALF: $40.
September 2010;
TAF: $0;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $0;
TALF: $34.
October 2010;
TAF: $0;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $0;
TALF: $29.
November 2010;
TAF: $0;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $0;
TALF: $28.
December 2010;
TAF: $0;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $0;
TALF: $25.
January 2011;
TAF: $0;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $0;
TALF: $25.
February 2011;
TAF: $0;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $0;
TALF: $23.
March 2011;
TAF: $0;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $0;
TALF: $20.
April 2011;
TAF: $0;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $0;
TALF: $18.
May 2011;
TAF: $0;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $0;
TALF: $16.
June 2011;
TAF: $0;
PDCF: $0;
TSLF: $0;
AMLF: $0;
CPFF: $0;
TALF: $14.
Source: GAO analysis of Federal Reserve System data.
Note: PDCF loans outstanding includes loans to affiliates of primary
dealers. TSLF loans outstanding includes TOP loans.
[End of figure]
For some programs, the Federal Reserve Board actively managed program
terms to help ensure that usage decreased as markets returned to
normal. In TAF and TSLF, the Federal Reserve Board made active
decisions to wind down the programs through actions such as lowering
the amount offered through each auction or ceasing the auctions. For
AMLF, FRBB staff continually weighed the pros and cons of potential
changes to terms and conditions in the context of market conditions.
For example, in May 2009, FRBB staff considered whether to increase
the interest rate above primary credit rates to discourage ABCP
issuers from using the program. However, they determined that such a
change would have made the program unattractive to the borrowers and
discouraged them from participating as intermediaries, which would
have reduced the program's efficacy should MMMFs experience heightened
redemption pressures. For CPFF, FRBNY staff held conversations with
issuers about reducing their use of the program, including the firms'
plans for repayment.
The Federal Reserve Board Modified Terms and Conditions of Several
Programs to Reinforce Policy Objectives and Program Goals:
For several programs, the Federal Reserve Board modified the terms and
conditions to reinforce its policy objectives. To reinforce the
principle that the programs should only act as temporary liquidity
backstops and not as substitute for normal market funding, the Federal
Reserve Board revised the eligibility criteria for CPFF and AMLF. As
discussed earlier in this section, for CPFF, the Federal Reserve Board
made ABCP issuers that were inactive prior to CPFF's creation
generally ineligible. In June 2009, AMLF terms were revised such that
MMMFs had to experience and demonstrate a minimum level of investor
redemptions before they could sell ABCP to eligible borrowers. The
Federal Reserve Board's decision to establish a redemption filter was
influenced by a spike in AMLF activity in May 2009. According to FRBB
staff, the May 2009 activity reflected market participant and MMMF
concerns that there could be credit rating downgrades of some ABCP
issuers and their sponsors, which could in turn make certain ABCP
ineligible as AMLF collateral. MMMFs, fearing the potential
ineligibility of such ABCP, sold the ABCP through AMLF before the
downgrades would become effective. For TALF, to meet the objective of
attracting a broad range of participants, the Federal Reserve Board
added four additional TALF agents, comprised of three minority-owned
firms and one midsized firm. Federal Reserve Board officials told us
the change was made to address the concern that established customers
of primary dealer-agents had an advantage in gaining access to the
program. Similarly, for TAF, the Federal Reserve Board lowered the
minimum bid rate from $10 million to $5 million to make the program
more broadly available.
AMLF Borrowing Was Concentrated Among Large Custodian Banks:
AMLF borrowing was concentrated among a few large custodian banks (and
their affiliates) that held pre-existing relationships with MMMFs. Two
of these banks and affiliates of these banks accounted for 85 percent
of the total borrowing over the life of the program. FRBB's review of
AMLF found that at the fund level, six individual funds from three
groups of mutual funds commonly referred to as "fund complexes"
accounted for 25 percent of the loans extended under AMLF, and
seventeen individual funds of six fund complexes accounted for half of
the loans. FRBB officials commented that the two largest borrowers
were among the three largest providers of fund administration and
account services for MMMFs and that it was not unexpected that the
largest borrowers were entities that had pre-existing custodial
relationships with MMMFs.
Conclusions:
During the financial crisis that began in the summer of 2007, the
Federal Reserve System took unprecedented steps to stabilize financial
markets and support the liquidity needs of failing institutions that
it considered to be systemically significant. Federal Reserve System
staff often designed and implemented the emergency programs over the
course of only days or weeks as they sought to address rapidly
deteriorating market conditions. To varying degrees, these emergency
actions involved the Reserve Banks in activities that went beyond
their traditional responsibilities. In particular, FRBNY, which
implemented most of the assistance, faced a number of operational
challenges related to implementing and overseeing several broad-based
emergency programs, the three Maiden Lane portfolios, and other
assistance to AIG and Citigroup. FRBNY hired vendors to help manage
the complexities associated with its assistance to individual
institutions and its interventions in new markets, such as the markets
for commercial paper and asset-backed securities. In addition, FRBNY
had to create new policies, procedures, and controls to manage key
risks within and across the programs.
Over time, FRBNY and the other Reserve Banks took steps to improve
program management and oversight, in many cases in response to
recommendations made by their external auditor, Reserve Bank internal
audit functions, or the Federal Reserve Board's RBOPS. For example,
FRBNY greatly expanded its risk management function in 2009, by, among
other things, establishing a new risk management division and creating
a Risk Analytics group within this division to validate the valuation
work performed by vendors on the Maiden Lane portfolios. Expanded
staff expertise in this and other areas has allowed FRBNY to be a more
knowledgeable customer of vendor services. In addition, in May 2010,
FRBNY issued a new vendor management policy to outline guidelines and
requirements for assessing and overseeing the risks posed by vendor
firms. However, the Reserve Banks have not yet fully incorporated some
lessons learned from the crisis into their policies for managing use
of vendors, risk of losses from emergency lending, and conflicts of
interest. Such enhanced policies could offer additional insights to
guide future Federal Reserve System action, should it ever be
warranted.
Vendors have been a critical component of helping create and operate
the emergency programs, with most of the fees concentrated among a few
contracts that were awarded without competition. While the Reserve
Banks followed their acquisition policies regarding vendor selection,
the largest contracts were awarded under an exigency exception to the
competition requirement in those policies. The acquisition policies
did not provide additional guidance on awarding contracts under
exigency exceptions such as seeking as many proposals as practical or
limiting the duration of contracts to the period of the exigency.
Given the nature of the events leading to the emergency programs, it
is reasonable to expect that future emergencies could follow a similar
pattern of sudden financial shocks that leave the Reserve Banks little
time to develop and implement responses, including hiring vendors.
Because exigent circumstances may limit the Reserve Banks' ability to
follow their normal acquisition procedures, taking steps to ensure
that they seek as much competition as is practicable is critical to
the vendor selection process.
The emergency programs brought FRBNY into new relationships with
institutions that fell outside of its traditional lending activities,
and these changes created the possibility for conflicts of interest
for both FRBNY employees and vendors. FRBNY recognized the importance
of identifying and managing conflicts related to employees' access to
sensitive information and to employees' financial interests that were
not specifically prohibited in its Code of Conduct but could be
affected by their participation in matters concerning these emergency
programs. However, while FRBNY staff told us that they believe their
existing policies and guidance are sufficient for managing employee
conflicts during a crisis situation, these policies may still allow
for situations to arise in which the appearance of a conflict of
interest for an FRBNY official could raise questions about the
integrity of FRBNY's programs and operations. This possibility is of
particular concern given the extraordinary sensitivity and potential
importance of emergency lending activities. While FRBNY's current
standards are consistent with 18 U.S.C. § 208 and its regulations, the
lack of more specific procedures for managing conflicts during
emergency lending activities exposes FRBNY to the risk of the
appearance of conflicts which can compromise FRBNY's effectiveness by
causing observers to question its integrity. The Federal Reserve
System plans to update the Reserve Banks' codes of conduct to reflect
its broader role in regulating systemically important institutions.
These planned efforts present an opportunity to consider how recent
experiences with managing employee conflicts might inform changes to
these policies. With respect to vendors, FRBNY has not yet finalized a
policy for managing risks related to conflicts of interest in
connection with its emergency programs. In contrast, Treasury
articulated a detailed policy for managing TARP vendor conflicts of
interest in January 2009. FRBNY created a new vendor-management policy
in 2010, but this policy is not sufficiently detailed or comprehensive
in its guidance on steps FRBNY staff should take to help ensure vendor
conflicts are mitigated. FRBNY staff have said they plan to develop a
documented policy that codifies practices FRBNY put in place during
the crisis. The lack of a comprehensive policy for managing vendor
conflicts could expose FRBNY to greater risk that it would not fully
identify and appropriately manage vendor conflicts of interest in the
event of future crisis situations.
While the Federal Reserve Board's emergency lending programs included
multiple loss-protection features and have not incurred losses to
date, opportunities exist for the Federal Reserve System to improve
its risk management practices related to crisis lending. First, for
TAF and the programs for the primary dealers, Reserve Banks' existing
policies lacked specific guidance on how staff should exercise
discretion and document their actions to restrict or deny program
access for otherwise eligible institutions that posed higher risk of
losses. FRBNY staff recognized the importance of monitoring and
restricting higher-risk institutions for these programs because
institutions could pose unacceptable risks even though they continued
to meet eligibility requirements. Since these programs closed, Reserve
Banks have enhanced their guidance for monitoring exposures to
depository institutions and primary dealers, but revised guidance
continues to lack details applicable to a crisis-driven lending
situation. In addition, FRBNY staff indicated that the Federal Reserve
System has not assessed the consistency of TAF restrictions across the
12 Reserve Banks. Without more detailed procedures, Reserve Bank staff
responsible for implementing future emergency programs may not take
consistent and appropriate steps to mitigate the risks posed by higher-
risk borrowers. Furthermore, without documentation and analysis of
decisions to apply restrictions to particular borrowers and the
processes that led to those restrictions, the Reserve Banks lack
assurance that they are applied consistently across borrowers. Second,
neither the Federal Reserve Board nor FRBNY quantified stress losses
across all of the emergency programs and assistance. While FRBNY
tracked potential losses under stressed scenarios for some programs,
including CPFF and the Maiden Lane portfolios, FRBNY staff said they
did not quantify stressed losses for TAF, TSLF, or PDCF. In a future
crisis, without a more comprehensive view of risk exposures within and
across Reserve Banks, the Federal Reserve Board may lack critical
information needed to make decisions about authorizing and modifying
its emergency lending activities.
Although the Reserve Banks generally offered the same terms to program
participants, the Federal Reserve Board lacked documentation and
guidance to manage some atypical uses of the emergency programs. The
Emergency Economic Stabilization Act of 2008 required the Federal
Reserve Board to publicly report on the justification and terms for
its exercises of emergency assistance pursuant to section 13(3) of the
Federal Reserve Act, and the Dodd-Frank Act includes new reporting
requirements for the Federal Reserve Board to expand its disclosures
concerning the basis for such assistance. However, we found that the
Federal Reserve Board had not fully documented the reasons for
extending credit on terms similar to those of PDCF to U.S. and London-
based affiliates of a few primary dealers--Goldman Sachs, Morgan
Stanley, and Merrill Lynch. Without a more complete documentation
process for public disclosure, the reporting on these decisions will
not help ensure the appropriate level of transparency and
accountability consistent with the new requirements. In addition, the
Federal Reserve Board has not always provided clear guidance on the
types of program decisions for which Reserve Banks should seek
approval by the Federal Reserve Board. While the Federal Reserve Board
approved significant program changes and Reserve Bank staff
periodically consulted with Federal Reserve Board staff, the scope of
authority for Reserve Banks to allow atypical uses of a broad-based
program remains unclear. Without documented guidance, Reserve Banks
operating future emergency programs may not escalate significant
policy decisions to the appropriate officials at the Federal Reserve
Board, increasing the risk that a Reserve Bank may permit an
exceptional use of emergency assistance that is inconsistent with the
Federal Reserve Board's policy goals or that exposes the Federal
Reserve Board to increased financial or reputational risk. Moreover,
more complete documentation could help the Federal Reserve Board
comply with the Dodd-Frank Act's reporting requirements on its use of
its section 13(3) emergency authority.
Recommendations for Executive Action:
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, we recommend that the Chairman of the Federal Reserve Board
direct Federal Reserve Board and Reserve Bank staff to take the
following seven actions:
* 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.
* 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, 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.
* 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
higher-risk vendor firms to provide a written conflict remediation
plan and certify compliance with this plan.
* 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.
* 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.
* In drafting regulations to establish the policies and procedures
governing emergency lending under section 13(3) of the Federal Reserve
Act, 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.
* 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.
Agency Comments and Our Evaluation:
We provided copies of this draft report to the Federal Reserve Board,
FRBNY, and FRBB for their review and comment. We also shared segments
of this draft report with Treasury for technical comments. In written
comments, which are reprinted in appendix XV, the Federal Reserve
Board agreed to give our recommendations serious attention and to
strongly consider how best to respond to them. The Federal Reserve
Board stated that it and the Reserve Banks have already taken the
initiative to address a number of issues raised in the report and
associated recommendations. As our report notes, FRBNY staff said that
they plan to document a more comprehensive policy for managing vendor
conflict issues and Federal Reserve System staff said that the Federal
Reserve System plans to consider updates to the Reserve Banks' codes
of conduct to address potential conflicts of interest related to their
broader role in regulating systemically important institutions.
Implementation of our recommendations would help to enhance the
effectiveness of the initial steps taken by the Federal Reserve System
to strengthen its policies for managing emergency assistance. The
Federal Reserve Board agreed that our recommendations would further
enhance the Federal Reserve System's capability to respond effectively
in future crises. Finally, we received technical comments from the
Federal Reserve Board, FRBNY, and Treasury that we have incorporated
into the report, as appropriate.
We are sending copies of this report to the majority and minority
leaders of the Senate and the House of Representatives, appropriate
congressional committees, the Board of Governors of the Federal
Reserve System, and other interested parties. In addition, the report
is available at no charge on the GAO Web site at [hyperlink,
http://www.gao.gov].
If you or your staffs have any questions about this report, please
contact Orice Williams Brown at williamso@gao.gov or (202) 512-8678.
Contact points for our Offices of Congressional Relations and Public
Affairs may be found on the last page of this report. GAO staff who
made major contributions to this report are listed in appendix XVI.
Signed by:
Orice Williams Brown:
Managing Director, Financial Markets and Community Investment:
List of Congressional Addressees:
The Honorable Harry Reid:
Majority Leader:
United States Senate:
The Honorable Mitch McConnell:
Minority Leader:
United States Senate:
The Honorable Tim Johnson:
Chairman:
The Honorable Richard C. Shelby:
Ranking Member:
Committee on Banking, Housing, and Urban Affairs:
United States Senate:
The Honorable Bernie Sanders:
United States Senate:
The Honorable John Boehner:
Speaker of the House of Representatives:
The Honorable Eric Cantor:
Majority Leader:
House of Representatives:
The Honorable Nancy Pelosi:
Minority Leader:
House of Representatives:
The Honorable Kevin McCarthy:
House Majority Whip:
House of Representatives:
The Honorable Steny Hoyer:
House Minority Whip:
House of Representatives:
The Honorable Spencer Bachus:
Chairman:
The Honorable Barney Frank:
Ranking Member:
Committee on Financial Services:
House of Representatives:
[End of section]
Appendix I: Agency Mortgage-Backed Securities Purchase Program:
Figure 12: Overview of Agency MBS Program:
[Refer to PDF for image: line graph and associated data]
Key observations:
* Authorized under section 14 of the Federal Reserve Act of 1913.
* In November 2008, the Federal Open Market Committee authorized the
Agency Mortgage-Backed Securities Purchase Program (Agency MBS
program) to provide support to the housing market and the broader
economy.
* The announcement of the Agency MBS program was followed by a large
drop in interest rates on mortgages.
* Through the program, the Federal Reserve Bank of New York purchased
$1.25 trillion in agency mortgage-backed securities (agency MBS) in
2009 and 2010.
Date announced: November 25, 2008.
Dates of program purchase phase: January 5, 2009-March 31, 2010.
Total dollar amount purchased (net of sales): $1.25 trillion.
Net purchases of agency MBS, January 5, 2009-March 31, 2010:
[Values shown are for the first day of each indicated month]
January 2009;
Net purchases: $3 billion.
February 2009;
Net purchases: $3 billion.
March 2009;
Net purchases: $5 billion.
April 2009;
Net purchases: $7 billion.
May 2009;
Net purchases: $5 billion.
June 2009;
Net purchases: $7 billion.
July 2009;
Net purchases: $4 billion.
August 2009;
Net purchases: $4 billion.
September 2009;
Net purchases: $5 billion.
October 2009;
Net purchases: $3 billion.
November 2009;
Net purchases: $3 billion.
December 2009;
Net purchases: $6 billion.
January 2010;
Net purchases: $4 billion.
February 2010;
Net purchases: $2 billion.
March 2010;
Net purchases: $2 billion.
Source: GAO analysis of Board of Governors of the Federal Reserve
System documents and data.
Note: The purchase phase completed on March 31, 2010, and on June 28,
2010, FRBNY announced it would purchase coupon swaps to facilitate
settlement which were completed in August 2010.
[End of figure]
Background:
On November 25, 2008, the Federal Open Market Committee (FOMC)
announced that the Federal Reserve Bank of New York (FRBNY) would
purchase up to $500 billion of agency mortgage-backed securities
(agency MBS) to support the housing market and the broader economy.
Agency MBS include mortgage-backed securities (MBS) issued by the
housing government-sponsored enterprises (enterprises), which are
Fannie Mae and Freddie Mac, or guaranteed by Ginnie Mae.[Footnote 130]
The FOMC authorized the Agency Mortgage-Backed Securities Purchase
Program (Agency MBS program) under its authority to direct open market
operations under section 14 of the Federal Reserve Act of 1913. By
purchasing agency MBS with longer maturities (generally 30 years), the
Agency MBS program was intended to lower long-term interest rates for
mortgages and thereby support the housing market and other financial
markets more generally. The Agency MBS program commenced purchases on
January 5, 2009, about 6 weeks after the initial announcement. In
March 2009, the FOMC increased the total amount of planned purchases
from $500 billion up to $1.25 trillion. The program executed its final
purchases in March 2010 and settlement was completed in August 2010.
Agency MBS play a significant role in the U.S. mortgage finance
system. As part of their mission to assist the U.S. secondary mortgage
market and facilitate the flow of mortgage credit, the enterprises
purchase mortgages, package most of them into MBS, and issue and
guarantee these MBS in the secondary market. The enterprises purchase
conventional mortgages that meet their underwriting standards, known
as conforming mortgages, from primary mortgage lenders such as banks
or thrifts. In turn, banks and thrifts use the proceeds to originate
additional mortgages. The enterprises hold some of the mortgages that
they purchase in their portfolios. However, most of the mortgages are
packaged into MBS, which are sold to investors in the secondary
mortgage market. In exchange for a fee (the guarantee fee) the
enterprises guarantee the timely payment of interest and principal on
MBS that they issue. Ginnie Mae, a wholly-owned government
corporation, guarantees the timely payment of principal and interest
on MBS issued by private institutions. Securities guaranteed by Ginnie
Mae finance the vast majority of loans backed by the Federal Housing
Administration and the Department of Veterans Affairs, as well as
loans backed by the Rural Housing Service and the Office of Public and
Indian Housing within the Department of Housing and Urban Development.
Every month, cash flows from the mortgages underlying agency MBS are
distributed to the investors who hold the agency MBS.
Large scale purchases of agency MBS through the Agency MBS program
were intended to lower yields on agency MBS and lower long-term
interest rates on mortgages. For the months preceding the announcement
of the Agency MBS program and for the period of the program's
operation, figure 13 illustrates changes in yields for 30-year MBS
guaranteed by Fannie Mae, 30-year interest rates on mortgages, and the
spread between the yields that investors required to purchase 30-year
Fannie Mae securities and the yields investors required for 10-year
Treasury securities (a frequently-cited benchmark for interest rates).
The coupon rate on MBS issued by Fannie Mae is used as an input by
mortgage lenders to calculate interest rate levels that they offer to
homeowners. On the day the FOMC announced the Agency MBS program, the
rate required by investors to invest in 30-year Fannie Mae MBS fell by
63 basis points, which exceeded the 55-basis point decline following
the announcement that the Federal Housing Finance Agency placed Fannie
Mae and Freddie Mac in conservatorship.[Footnote 131] Mortgage rates
available to homeowners and homebuyers also dropped significantly in
the week after the Agency MBS program announcement. Freddie Mac
publishes a weekly average from a survey of mortgage originators it
conducts. The average interest rates on 30-year fixed-rate mortgages
offered by its survey respondents dropped 44 basis points to 5.53
percent in the week following the Agency MBS program announcement. For
the remainder of FRBNY's purchases, mortgage rates remained at levels
at least 37 basis points below their levels before the Agency MBS
program announcement (see figure 13).
Figure 13: Changes in Agency MBS Spreads (Fannie Mae) and 30-Year
Mortgage Rates, September 2008-September 2010:
[Refer to PDF for image: multiple line graph]
September 2008;
Fannie Mae 30-year yield: 5.748%;
30-year mortgage rate: 6.36429%;
Fannie Mae spread to 10-year Treasury yields: 2.00319%.
October 2008;
Fannie Mae 30-year yield: 5.517%;
30-year mortgage rate: 6.09857%;
Fannie Mae spread to 10-year Treasury yields: 1.74861%.
November 2008;
Fannie Mae 30-year yield: 5.946%;
30-year mortgage rate: 6.31143%;
Fannie Mae spread to 10-year Treasury yields: 2.04249%.
The November 2008 announcement of the Agency MBS purchase program was
followed by an instantaneous drop in the yield investors required on
Fannie Mae Mortgage Backed Securities, which led to lower rates being
available to homeowners and home buyers.
December 2008;
Fannie Mae 30-year yield: 4.59%;
30-year mortgage rate: 5.695%;
Fannie Mae spread to 10-year Treasury yields: 1.87283%.
January 2009;
Fannie Mae 30-year yield: 4.193%;
30-year mortgage rate: 5.0775%;
Fannie Mae spread to 10-year Treasury yields: 1.77722%.
February 2009;
Fannie Mae 30-year yield: 4.162%;
30-year mortgage rate: 5.18571%;
Fannie Mae spread to 10-year Treasury yields: 1.44376%.
March 2009;
Fannie Mae 30-year yield: 4.392%;
30-year mortgage rate: 5.11571%;
Fannie Mae spread to 10-year Treasury yields: 1.47468%.
The March 2009 announcement of an increase in the size of the agency MBS
purchases up to $1.25 trillion was followed by another drop in Fannie
Mae MBS yields.
April 2009;
Fannie Mae 30-year yield: 3.911%;
30-year mortgage rate: 4.79%;
Fannie Mae spread to 10-year Treasury yields: 1.2544%.
May 2009;
Fannie Mae 30-year yield: 4.076%;
30-year mortgage rate: 4.78857%;
Fannie Mae spread to 10-year Treasury yields: 0.90463%.
June 2009;
Fannie Mae 30-year yield: 4.65%;
30-year mortgage rate: 5.12714%;
Fannie Mae spread to 10-year Treasury yields: 0.93562%.
July 2009;
Fannie Mae 30-year yield: 4.55%;
30-year mortgage rate: 5.33429%;
Fannie Mae spread to 10-year Treasury yields: 1.00381%.
August 2009;
Fannie Mae 30-year yield: 4.516%;
30-year mortgage rate: 5.23286%;
Fannie Mae spread to 10-year Treasury yields: 0.87777%.
September 2009;
Fannie Mae 30-year yield: 4.397%;
30-year mortgage rate: 5.09714%;
Fannie Mae spread to 10-year Treasury yields: 1.02071%.
October 2009;
Fannie Mae 30-year yield: 4.094%;
30-year mortgage rate: 4.94%;
Fannie Mae spread to 10-year Treasury yields: 0.90044%.
November 2009;
Fannie Mae 30-year yield: 4.341%;
30-year mortgage rate: 5.00143%;
Fannie Mae spread to 10-year Treasury yields: 0.91994%.
December 2009;
Fannie Mae 30-year yield: 4.039%;
30-year mortgage rate: 4.7275%;
Fannie Mae spread to 10-year Treasury yields: 0.76601%.
January 2010;
Fannie Mae 30-year yield: 4.53%;
30-year mortgage rate: 5.11143%;
Fannie Mae spread to 10-year Treasury yields: 0.69012%.
February 2010;
Fannie Mae 30-year yield: 4.384%;
30-year mortgage rate: 4.99714%;
Fannie Mae spread to 10-year Treasury yields: 0.73096%.
March 2010;
Fannie Mae 30-year yield: 4.325%;
30-year mortgage rate: 5.00429%;
Fannie Mae spread to 10-year Treasury yields: 0.7199%.
April 2010;
Fannie Mae 30-year yield: 4.553%;
30-year mortgage rate: 5.08%;
Fannie Mae spread to 10-year Treasury yields: 0.69438%.
May 2010;
Fannie Mae 30-year yield: 4.431%;
30-year mortgage rate: 5.02571%;
Fannie Mae spread to 10-year Treasury yields: 0.72689%.
June 2010;
Fannie Mae 30-year yield: 4.148%;
30-year mortgage rate: 4.78714%;
Fannie Mae spread to 10-year Treasury yields: 0.85306%.
July 2010;
Fannie Mae 30-year yield: 3.699%;
30-year mortgage rate: 4.58%;
Fannie Mae spread to 10-year Treasury yields: 0.77517%.
August 2010;
Fannie Mae 30-year yield: 3.569%;
30-year mortgage rate: 4.51143%;
Fannie Mae spread to 10-year Treasury yields: 0.60723%.
September 2010;
Fannie Mae 30-year yield: 3.373%;
30-year mortgage rate: 4.32571%;
Fannie Mae spread to 10-year Treasury yields: 0.79195%.
Source: GAO analysis of Freddie Mac and broker-dealer data.
[End of figure]
FRBNY staff noted that a key operational challenge for the program was
its size. FRBNY hired investment managers to provide execution support
and advisory services needed to help execute large-scale purchases.
FRBNY did not have the systems or staff resources to operate a program
of this size. FRBNY had not been active in the MBS market and needed
partners with the infrastructure and the expertise needed to navigate
this complex, system-intensive market. Initially, FRBNY relied on four
external investment managers to conduct the purchases to minimize
operational and financial risk. The initial need for four external
investment managers reflected the short time frame for launching the
program and the complexity of the agency MBS market. FRBNY wanted the
program to be operational within 6 weeks of the November 2008
announcement. On August 17, 2009, FRBNY moved to using only one
investment manager for purchases. On March 2, 2010, FRBNY began using
an in-house team to execute purchases on some days. Table 10 shows the
total agency MBS purchases executed by the four investment managers
and FRBNY.
Table 10: Total Agency MBS Purchases by Investment Manager, January
2009-July 2010:
Dollars in billions.
Investment manager: BlackRock;
Purchases: $275,122;
Sales: $85,815;
Net: $189,307.
Investment manager: FRBNY;
Purchases: $57,243;
Sales: $41,169;
Net: $16,074.
Investment manager: Goldman Sachs Asset Management;
Purchases: $281,667;
Sales: $87,694;
Net: $193,973.
Investment manager: Pacific Investment Management Company LLC;
Purchases: $273,198;
Sales: $96,661;
Net: $176,537.
Investment manager: Wellington Management Company;
Purchases: $962,914;
Sales: $288,806;
Net: $674,108.
Investment manager: Total;
Purchases: $1,850,145;
Sales: $600,145;
Net: $1,249,999.
Source: GAO analysis of Board of Governors of the Federal Reserve
System data.
[End of table]
Because of guarantees provided by Fannie Mae, Freddie Mac, and Ginnie
Mae, FRBNY and other purchasers of agency MBS are not exposed to
credit risk associated with mortgage borrowers. While there has been
some credit risk associated with Fannie Mae and Freddie Mac's ability
to guarantee the principal and interest payments on agency MBS, the
federal government has taken actions to greatly lessen such concerns
by providing financial assistance to the enterprises after they were
placed in conservatorship.[Footnote 132] Because Ginnie Mae is wholly-
owned by the federal government, MBS guaranteed by Ginnie Mae have
long been viewed as similar to Treasury securities from a credit risk
perspective. Agency MBS are subject to interest rate risk--the risk of
possible losses and changes in value from increases or decreases in
market interest rates. For example, increases in interest rates reduce
the market value of agency MBS. While decreases in interest rates
increase the market value of agency MBS, some of this increase can be
offset by borrower prepayments on mortgages underlying the agency MBS.
Prepayments can lower returns to holders of agency MBS if borrowers
prepay the loans when interest rates decline.[Footnote 133]
Key Vendors for the Agency MBS Program:
FRBNY used a number of vendors to manage this program. As table 11
shows, while most were investment managers, it also had key contracts
with others.
Table 11: Vendors for Agency MBS Program that Earned Fees Greater than
$1 Million, 2008-2010:
Vendor: Wellington Management Company;
Services provided: Investment manager;
Contract date: 12/30/2008;
Awarded competitively? Yes;
Total fees paid (2008-2010): $26,557,427.
Vendor: JP Morgan Chase & Co.;
Services provided: Administrator, custodian;
Contract date: 12/31/2008;
Awarded competitively? Yes;
Total fees paid (2008-2010): $16,248,051.
Vendor: BlackRock;
Services provided: Investment manager;
Contract date: 12/30/2008;
Awarded competitively? Yes;
Total fees paid (2008-2010): $11,157,427.
Vendor: Goldman Sachs;
Services provided: Investment manager;
Contract date: 12/30/2008;
Awarded competitively? Yes;
Total fees paid (2008-2010): $11,157,426.
Vendor: Pacific Investment Management Company LLC;
Services provided: Investment manager;
Contract date: 12/30/2008;
Awarded competitively? Yes;
Total fees paid (2008-2010): $11,157,426.
Vendor: BlackRock;
Contract date: Services provided: Risk reporting;
Contract date: 8/17/2009;
Awarded competitively? Yes;
Total fees paid (2008-2010): $5,126,000.
Source: GAO presentation of FRBNY information.
[End of table]
[End of section]
Appendix II: Asset-Backed Commercial Paper Money Market Mutual Fund
Liquidity Facility:
Figure 14: Overview of AMLF:
[Refer to PDF for image: line graph and associated data]
Key observations:
* Authorized under section 13(3) of the Federal Reserve Act of 1913.
* The Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity
Facility (AMLF) was created to help money market mutual funds to meet
redemption requests from investors and to foster liquidity in the
asset-backed commercial paper (ABCP) market.
* AMLF made loans to intermediary borrowers, who used the loan funds
to purchase highly rated ABCP from money market mutual funds (MMMF).
* AMLF use peaked within the first 2 weeks of operation at
approximately $152 billion.
* Three large custodian banks—Bank of New York Mellon, JP Morgan Chase
& Co., and State Street Corporation—and their affiliates accounted for
about 98 percent of the total dollar amount of AMLF loans.
Date announced: September 19, 2008;
Dates of operation: September 22, 2008-February 1, 2010;
Total unique borrowers: 11 (from 7 different holding companies);
Total loans: 1,133.
Figure: Loans outstanding under AMLF, September 17, 2008-February 1,
2010:
[Line graph]
September 2008;
Loans outstanding under AMLF: $73 billion.
October 2008;
Loans outstanding under AMLF: $152 billion.
Peak loans outstanding: October 1, 2008.
November 2008;
Loans outstanding under AMLF: $85 billion.
December 2008;
Loans outstanding under AMLF: $49 billion.
January 2009;
Loans outstanding under AMLF: $21 billion.
February 2009;
Loans outstanding under AMLF: $17 billion.
March 2009;
Loans outstanding under AMLF: $8 billion.
April 2009;
Loans outstanding under AMLF: $6 billion.
May 2009;
Loans outstanding under AMLF: $29 billion.
June 2009;
Loans outstanding under AMLF: $24 billion.
July 2009;
Loans outstanding under AMLF: $15 billion.
August 2009;
Loans outstanding under AMLF: $0 billion.
September 2009;
Loans outstanding under AMLF: $0 billion.
October 2009;
Loans outstanding under AMLF: $0 billion.
November 2009;
Loans outstanding under AMLF: $0 billion.
December 2009;
Loans outstanding under AMLF: $0 billion.
January 2009;
Loans outstanding under AMLF: $0 billion.
February 2009;
Loans outstanding under AMLF: $0 billion.
Source: GAO analysis of Board of Governors of the Federal Reserve
System documents and data.
[End of figure]
Background:
On September 19, 2008, the Board of Governors of the Federal Reserve
System (Federal Reserve Board) authorized the creation of the Asset-
Backed Commercial Paper Money Market Mutual Fund Liquidity Facility
(AMLF) under section 13(3) of the Federal Reserve Act of 1913 to
provide liquidity support to money market mutual funds (MMMF) facing
redemption pressures and to promote liquidity in the asset-backed
commercial paper (ABCP) markets.[Footnote 134] AMLF became operational
on September 22, 2008, and was operated by the Federal Reserve Bank of
Boston (FRBB). AMLF was initially set to expire on January 30, 2009.
The Federal Reserve Board authorized three separate extensions of the
program to address continuing strains in financial markets. AMLF
expired on February 1, 2010.
MMMFs are mutual funds that are registered under the Investment
Company Act of 1940, and regulated under rule 2a-7 under that act.
[Footnote 135] MMMFs invest in high-quality, short-term debt
instruments such as commercial paper, treasury bills and repurchase
agreements. Generally, these funds, unlike other investment companies,
seek to maintain a stable net asset value per share (market value of
assets minus liabilities divided by number of shares outstanding),
typically $1 per share. While investments in MMMFs are not covered by
federal deposit insurance, given restrictions on the types of
investments MMMFs may hold, many investors have viewed MMMFs as a safe
alternative to bank savings accounts.
In September 2008, following the failure of Lehman Brothers Inc.
(Lehman Brothers), many MMMFs faced severe liquidity pressures as
redemption requests from their investors increased significantly. Many
MMMF investors became concerned about potential losses on their
investments when they learned that the Reserve Primary Money Fund, a
large MMMF that suffered losses on holdings of Lehman Brothers
commercial paper, "broke the buck"--that is, the net asset value of
the fund dropped below its target value of $1 per share. Under normal
circumstances, MMMFs would have been able to meet redemption demands
by drawing on their cash reserves or selling assets, including ABCP,
into liquid markets. However, these markets were strained; interest
rates on ABCP spiked in September 2008. The Federal Reserve Board grew
concerned that stress in the ABCP market would be exacerbated should
MMMFs choose to sell assets at a discount or reduce their purchases of
ABCP to meet extraordinary demands on their liquidity. Such actions
could have further depressed the price of these assets and potentially
resulted in further losses to MMMFs and increased redemption requests
as investor confidence in MMMFs weakened.
To quickly support the MMMF market, the Federal Reserve Board
authorized loans to discount window eligible depository institutions
and their primary dealer affiliates to purchase ABCP from MMMFs. By
providing MMMFs the option to sell ABCP at amortized cost--the
carrying value of the investment in the MMMF's accounting records--
rather than at deeply discounted prices, AMLF was intended to help
MMMFs raise cash in a way that did not exacerbate market stresses.
AMLF's design reflected the need to overcome practical constraints in
lending to MMMFs directly. According to Federal Reserve Board
officials, MMMFs were concerned that they would have limited ability
to borrow directly from the Federal Reserve System because of
statutory and fund-specific limitations on fund borrowing. Because the
interest rate on the AMLF loan was lower than the returns on eligible
ABCP, eligible intermediary borrowers had an incentive to participate.
By fostering liquidity in the ABCP market and money markets more
generally, the AMLF may have encouraged MMMFs to continue to purchase
ABCP as they would have the option to later pledge the ABCP to AMLF.
If an AMLF borrower defaulted, FRBB would have attempted to recover
losses through its claim on the assets collateralizing the ABCP. AMLF
did not apply haircuts and accepted only highly rated ABCP as
collateral. Federal Reserve System staff said that requiring
overcollateralization for AMLF loans would have been inconsistent with
policy objectives to quickly and effectively provide liquidity support
to MMMFs. If MMMFs sold assets to the intermediary borrowers through
AMLF at less than book value to fund redemption requests from MMMF
shareholders, they would have incurred losses to the detriment of
remaining MMMF shareholders, creating further incentives for MMMF
shareholders to redeem shares. Accordingly, the Federal Reserve Board
sought to help fund purchases of MMMF assets at book value. Therefore,
it authorized loans to intermediary borrowers that were equal to the
book value of the ABCP. Upon providing an AMLF loan, FRBB accepted the
risk of credit loss on the ABCP securing the loan. Applying haircuts
to AMLF loans would have reduced the economic incentives for eligible
borrowers to participate as they would have had to fund part of the
ABCP purchases on their own. Furthermore, the Federal Reserve Board
authorized nonrecourse lending to increase incentives for intermediary
borrowers to participate. In the event of losses on the ABCP
collateral, the borrower could surrender the ABCP to FRBB and choose
not to repay its loan. Under the terms of the AMLF program lending
agreement, the nonrecourse provisions of the loan could be voided,
giving FRBB full recourse to recover any losses from a borrower's
assets, if the borrower was found to have misrepresented compliance
with AMLF requirements. Figure 15 illustrates the structure of the
AMLF.
Figure 15: Structure of the AMLF:
[Refer to PDF for image: illustration]
MMMF: ABCP to Eligible borrower.
Eligible borrower: ABCP pledged as collateral to FRBB.
FRBB: Nonrecourse loan to Eligible borrower.
Eligible borrower: AMLF proceeds to MMMF.
MMMF: Redemptions to Investors.
Source: GAO presentation of FRBB information.
[End of figure]
Terms and Conditions for AMLF:
Borrower Eligibility Requirements:
Initially all U.S. depository institutions, U.S. bank holding
companies (parent companies or their U.S. broker-dealer subsidiaries),
or U.S. branches and agencies of foreign banks with eligible ABCP were
eligible to participate in AMLF. All borrowers were required to
execute legal borrowing agreements with FRBB representing, among other
things, that the borrower met the stated requirements and would pledge
only eligible collateral.
Table 12 ranks the largest AMLF borrowers at the holding company
level. JP Morgan Chase & Co. and State Street Corporation, which have
large bank subsidiaries that are major providers of custodial services
for MMMFs, accounted for more than 92 percent of total AMLF loans.
Table 12: Largest AMLF Borrowers by Total Dollar Amount of Loans:
Parent company of AMLF borrowing institution(s): 1. JP Morgan Chase &
Co.;
Total AMLF loans: $111.4 billion;
Percent of total: 51.3%.
Parent company of AMLF borrowing institution(s): 2. State Street
Corporation;
Total AMLF loans: $89.2 billion;
Percent of total: 41.1%.
Parent company of AMLF borrowing institution(s): 3. Bank of New York
Mellon;
Total AMLF loans: $12.9 billion;
Percent of total: 5.9%.
Parent company of AMLF borrowing institution(s): 4. Bank of America
Corporation;
Total AMLF loans: $1.6 billion;
Percent of total: 0.7%.
Parent company of AMLF borrowing institution(s): 5. Citigroup Inc.;
Total AMLF loans: $1.4 billion;
Percent of total: 0.7%.
Parent company of AMLF borrowing institution(s): 6. SunTrust;
Total AMLF loans: $0.5 billion;
Percent of total: 0.2%.
Parent company of AMLF borrowing institution(s): 7. Credit Suisse;
Total AMLF loans: $0.2 billion;
Percent of total: 0.1%.
Parent company of AMLF borrowing institution(s): Total;
Total AMLF loans: $217.3 billion;
Percent of total: 100.0%.
Source: GAO analysis of Federal Reserve Board data.
[End of table]
Seller Eligibility Requirements:
MMMFs registered under Securities and Exchange Commission Rule 2a-7
pursuant to the Investment Company Act of 1940 were eligible to
participate in AMLF. In May 2009, prior to the release of results from
the U.S. government's examination of whether the largest banking
organizations had sufficient capital to withstand adverse economic
scenarios, AMLF experienced a moderate increase in
utilization.[Footnote 136] This activity coincided with the potential
for these results to have resulted in credit rating downgrades of some
highly rated ABCP that would have made this ABCP ineligible for sale
through AMLF. On June 25, 2009, the Federal Reserve Board responded by
implementing a redemption requirement so that an MMMF would have to
experience a minimum level of redemptions--defined as 5 percent of net
assets in a single day or at least 10 percent of net assets within the
prior 5 business days--before it could sell eligible ABCP through
AMLF. This change was intended to ensure that AMLF provided liquidity
support, not credit risk support, to MMMFs.
Table 13 ranks the largest sellers of ABCP through AMLF at the level
of the fund family. Twenty fund managers accounted for approximately
88 percent of ABCP sold through AMLF.
Table 13: Largest MMMF (Aggregated by Fund Family) Sellers of Asset-
Backed Commercial Paper through AMLF:
Rank: 1.
Fund family seller: Reserve Funds;
Total dollar amount of ABCP sold through AMLF: $19 billion;
Percent of total AMLF loans: 8.9%.
Rank: 2.
Fund family seller: JP Morgan Chase & Co.;
Total dollar amount of ABCP sold through AMLF: $18 billion;
Percent of total AMLF loans: 8.1%.
Rank: 3.
Fund family seller: Dreyfus;
Total dollar amount of ABCP sold through AMLF: $17 billion;
Percent of total AMLF loans: 7.6%.
Rank: 4.
Fund family seller: Columbia Funds;
Total dollar amount of ABCP sold through AMLF: $15 billion;
Percent of total AMLF loans: 6.9%.
Rank: 5.
Fund family seller: Barclays;
Total dollar amount of ABCP sold through AMLF: $13 billion;
Percent of total AMLF loans: 5.9%.
Rank: 6.
Fund family seller: Wells Fargo;
Total dollar amount of ABCP sold through AMLF: $12 billion;
Percent of total AMLF loans: 5.6%.
Rank: 7.
Fund family seller: BlackRock;
Total dollar amount of ABCP sold through AMLF: $12 billion;
Percent of total AMLF loans: 5.5%.
Rank: 8.
Fund family seller: Federated;
Total dollar amount of ABCP sold through AMLF: $10 billion;
Percent of total AMLF loans: 4.7%.
Rank: 9.
Fund family seller: Morgan Stanley;
Total dollar amount of ABCP sold through AMLF: $10 billion;
Percent of total AMLF loans: 4.4%.
Rank: 10.
Fund family seller: Short Term Investments Trust;
Total dollar amount of ABCP sold through AMLF: $9 billion;
Percent of total AMLF loans: 4.4%.
Rank: 11.
Fund family seller: Goldman Sachs;
Total dollar amount of ABCP sold through AMLF: $9 billion;
Percent of total AMLF loans: 4.0%.
Rank: 12.
Fund family seller: Evergreen;
Total dollar amount of ABCP sold through AMLF: $9 billion;
Percent of total AMLF loans: 3.9%.
Rank: 13.
Fund family seller: Merrill Lynch;
Total dollar amount of ABCP sold through AMLF: $7 billion;
Percent of total AMLF loans: 3.2%.
Rank: 14.
Fund family seller: T. Rowe Price;
Total dollar amount of ABCP sold through AMLF: $6 billion;
Percent of total AMLF loans: 2.8%.
Rank: 15.
Fund family seller: Fidelity;
Total dollar amount of ABCP sold through AMLF: $5 billion;
Percent of total AMLF loans: 2.5%.
Rank: 16.
Fund family seller: DWS Investments;
Total dollar amount of ABCP sold through AMLF: $5 billion;
Percent of total AMLF loans: 2.4%.
Rank: 17.
Fund family seller: UBS;
Total dollar amount of ABCP sold through AMLF: $5 billion;
Percent of total AMLF loans: 2.3%.
Rank: 18.
Fund family seller: Master Money LLC;
Total dollar amount of ABCP sold through AMLF: $4 billion;
Percent of total AMLF loans: 1.8%.
Rank: 19.
Fund family seller: General Money Market Fund;
Total dollar amount of ABCP sold through AMLF: $3 billion;
Percent of total AMLF loans: 1.5%.
Rank: 20.
Fund family seller: Charles Schwab;
Total dollar amount of ABCP sold through AMLF: $3 billion;
Percent of total AMLF loans: 1.2%.
Fund family seller: All other sellers;
Total dollar amount of ABCP sold through AMLF: $27 billion;
Percent of total AMLF loans: 12.3%.
Total:
Total dollar amount of ABCP sold through AMLF: $217 billion;
Percent of total AMLF loans: 100.0%.
Source: GAO analysis of Federal Reserve Board data.
[End of table]
Collateral Eligibility Requirements:
To be eligible for purchase through AMLF, ABCP was required to be U.S.-
dollar denominated and to be rated not lower than A-1/P-1/F-1 by a
major Nationally Recognized Statistical Rating Organization (NRSRO).
If rated by multiple NRSROs, the ABCP was required to have this
highest rating from at least two or more major NRSROs. On April 22,
2009, the Federal Reserve changed the asset eligibility requirements
to exclude ABCP that was rated A-1/P-1/F-1 and on "negative watch."
This change was intended to provide a greater level of credit risk
protection for FRBB.
Term to Maturity for Loans:
AMLF loan maturities matched the remaining maturity of the pledged
ABCP collateral and could not exceed 120 days for borrowers that were
depository institutions and 270 days for all other eligible borrowers.
[Footnote 137]
Interest Rates:
The interest rate on AMLF loans was equal to the primary credit rate
in effect at the time the loan was extended. The AMLF program did not
include any fees or surcharges.
Recourse Status:
AMLF loans were made without recourse to the intermediary borrower.
However, under the AMLF lending agreement, FRBB would have had
recourse to a borrower's assets in the event that the borrower had
misrepresented the eligibility of the collateral pledged to the AMLF.
[End of section]
Appendix III: Assistance to American International Group, Inc.
Table: Key observations:
* Authorized under section 13(3) of the Federal Reserve Act of 1913; *
* American International Group, Inc. (AIG) was one of the largest
recipients of federal government assistance during the recent
financial crisis;
* AIG has repaid its borrowings under the revolving credit facility
and the securities borrowing facility;
* The Federal Reserve Bank of New York (FRBNY) does not project losses
on its loans to Maiden Lane II LLC and Maiden Lane III LLC.
Source: GAO summary of Board of Governors of the Federal Reserve
System documents.
[End of table]
Overview:
In late 2008 and early 2009, the Board of Governors of the Federal
Reserve System (Federal Reserve Board) invoked section 13(3) of the
Federal Reserve Act of 1913 to authorize the Federal Reserve Bank of
New York (FRBNY) to take the following actions to assist American
International Group, Inc. (AIG):
* providing a revolving credit facility (RCF) to lend up to $85
billion to help AIG and its subsidiaries address strains on their
liquidity;
* creating a securities borrowing facility (SBF) to provide up to
$37.8 billion of direct funding support to a securities lending
program operated by certain regulated U.S. life insurance subsidiaries
of AIG;
* creating a special purpose vehicle (SPV), Maiden Lane II LLC, and
providing a $19.5 billion loan to this SPV to help finance the
purchase of assets that had contributed to liquidity strains for its
securities lending program;
* creating another SPV, Maiden Lane III LLC, to help resolve liquidity
strains associated with certain credit default swaps (CDS) to which
AIG Financial Products Corp. (AIGFP) was a party by providing a $24.3
billion loan to this SPV to finance the purchase of collateralized
debt obligations (CDO) from AIG counterparties in connection with
terminating CDS contracts on those CDOs; and:
* purchasing a contemplated securitization of income (AIG life
insurance securitization) from certain AIG life insurance companies.
[Footnote 138]
The AIG RCF and SBF have closed and were fully repaid and FRBNY
expects full repayment on amounts outstanding on its loans to Maiden
Lane II LLC and Maiden Lane III LLC. The Federal Reserve Board
authorized changes to the borrowing limit and other terms for the AIG
RCF over time, and AIG fully repaid amounts outstanding from the AIG
RCF in January 2011. AIG's borrowing under the AIG SBF peaked at $20.6
billion before the AIG SBF was fully repaid in connection with the
creation of Maiden Lane II LLC in December 2008. As of June 29, 2011,
$8.6 billion and $12.3 billion in principal and accrued interest
remained outstanding on FRBNY's senior loans to Maiden Lane II LLC and
Maiden Lane III LLC, respectively. As discussed below, FRBNY recently
began to hold auctions to sell parts of the Maiden Lane II LLC
portfolio. According to FRBNY staff, the AIG life insurance
securitization option was abandoned for a number of reasons, including
that it would have required FRBNY to manage a long-term exposure to
life insurance businesses with which it had little experience.
Background:
From July 2008 through early September 2008, AIG faced increasing
pressure on its liquidity following a downgrade in its credit ratings
in May 2008 due in part to losses from its securities lending program.
This deterioration followed liquidity strains earlier in the year,
although AIG was able to raise capital in May 2008 to address its
needs at that time. Two key sources of AIG's difficulties were AIGFP
and a securities lending program operated by certain AIG insurance
subsidiaries.[Footnote 139] AIGFP faced growing collateral calls on
CDS it had written on CDOs.[Footnote 140] Meanwhile, AIG faced demands
on its liquidity from securities lending counterparties who were
returning borrowed securities and demanding that AIG return their cash
collateral. Declines in its securities lending reinvestment portfolio
of residential mortgage-backed securities (RMBS) and declining values
of CDOs against which AIGFP had written CDS protection forced AIG to
use an estimated $9.3 billion of its cash reserves in July and August
2008 to repay securities lending counterparties that terminated
existing agreements and to post additional collateral required by the
trading counterparties of AIGFP. AIG attempted to raise additional
capital in the private market in September 2008 but was unsuccessful.
On September 15, 2008, the rating agencies downgraded AIG's debt
rating, which resulted in the need for an additional $20 billion to
fund its added collateral demands and transaction termination
payments. In addition, AIG's share price fell from $22.76 on September
8, 2008, to $4.76 per share on September 15, 2008. Following the
credit rating downgrade, an increasing number of counterparties
refused to transact with AIG for fear that it would fail. Also around
this time, the insurance regulators decided they would no longer allow
AIG's insurance subsidiaries to lend funds to the parent company under
a revolving credit facility that AIG maintained. Furthermore, the
insurance regulators demanded that any outstanding loans be repaid and
that the facility be terminated.
The Federal Reserve Board and the Department of the Treasury
(Treasury) determined through analysis of information provided by AIG
and insurance regulators, as well as publicly available information,
that market events in September 2008 could have caused AIG to fail,
which would have posed systemic risk to financial markets given market
conditions. Consequently, the Federal Reserve Board and Treasury took
steps to ensure that AIG obtained sufficient liquidity and could
complete an orderly sale of its operating assets, continue to meet its
obligations and close its investment positions in its securities
lending program and AIGFP. The Federal Reserve Board explained that a
major concern was public confidence in the financial system and the
economy. The Federal Reserve Board and Treasury said that financial
markets and financial institutions were experiencing unprecedented
strains resulting from the placement of Fannie Mae and Freddie Mac
under conservatorship; the failure of financial institutions,
including Lehman Brothers Holdings Inc. (Lehman Brothers); and the
collapse of the housing markets. The Federal Reserve Board said that
in light of these events, a disorderly failure of AIG could have
contributed to higher borrowing costs, diminished availability of
credit, and additional failures. They concluded that the effects of
the collapse of AIG would have been much more severe than that of
Lehman Brothers because of its global operations, large and varied
retail and institutional customer base, and different types of
financial service offerings. The Federal Reserve Board and Treasury
said that a default by AIG would have placed considerable pressure on
numerous counterparties and triggered serious disruptions in the
commercial paper market. Moreover, counterparties of AIGFP would no
longer have protection or insurance against losses if AIGFP, a major
seller of CDS contracts, defaulted on its obligations and CDO values
continued to decline.
The Federal Reserve Board intended the initial September 2008
assistance to enable AIG to meet these obligations to its
counterparties and begin the process of selling noncore business units
in order to raise cash to repay the credit facility and other
liabilities. However, AIG's continuing financial deterioration and
instability in the financial markets resulted in subsequent assistance
by FRBNY and Treasury.
While AIG has repaid its direct assistance provided by FRBNY, FRBNY's
loans to Maiden Lane II LLC and Maiden Lane III LLC remain outstanding
and Treasury continues to have significant equity exposure. We have
issued several reports that provide additional background on the
federal government's assistance to AIG.[Footnote 141]
AIG Revolving Credit Facility (AIG RCF):
Date announced: September 16, 2008.
Dates of operation: September 16, 2008-January 14, 2011.
Table: Key observations:
* The Federal Reserve Bank of New York (FRBNY) initially was
authorized to loan AIG up to $85 billion;
* Two key sources of AIG's liquidity problems were a securities
lending program operated by its subsidiaries and credit default swaps;
* AIG's use of the AIG RCF peaked at $72 billion in October 2008;
* AIG paid down its RCF balance in January 2011.
Source: GAO summary of Board of Governors of the Federal Reserve
System documents and data.
[End of table]
Background:
On September 16, 2008, one day after the Lehman Brothers Holdings Inc.
bankruptcy announcement, the Federal Reserve Board invoked section
13(3) of the Federal Reserve Act to authorize FRBNY to provide loans
of up to $85 billion through the AIG RCF to help AIG and its
subsidiaries to address strains on their liquidity. The announcement
of this assistance followed a downgrade of the firm's credit rating,
which had prompted collateral calls by its counterparties and raised
concerns that a rapid failure of the company would further destabilize
financial markets.
Under FRBNY's credit agreement with AIG (and related security
agreement), amounts borrowed by AIG under the AIG RCF were secured by
a substantial portion of the assets of AIG and its primary
nonregulated subsidiaries, including AIG's ownership interest in its
regulated U.S. and foreign subsidiaries. This credit agreement
included provisions intended to help ensure that the proceeds AIG
received from planned AIG assets sales would be used to permanently
repay outstanding balances under the AIG RCF. In addition, the
security agreement provided for AIG's borrowings under this facility
to be guaranteed by each of AIG's domestic, nonregulated subsidiaries
that had more than $50 million in assets. As a condition of providing
this loan, FRBNY also created a trust to receive AIG preferred stock
for the benefit of the Department of the Treasury. On January 14,
2011, the trust exchanged these preferred shares for about 562.9
million shares of AIG common stock, which was then transferred to
Treasury as part of the broader recapitalization of AIG.
Due to restructuring and mandatory repayments from the sale of assets,
the borrowing limit on the amount of direct assistance available to
AIG through the AIG RCF was lowered several times over the life of the
facility, and the amount AIG owed the facility also declined. Figure
16 illustrates the AIG RCF balance owed and the total amount available
from October 2008 through December 1, 2010. The AIG RCF was fully
repaid by AIG and closed on January 14, 2011.
Figure 16: FRBNY Revolving Credit Facility Balance Owed and Total
Amount Available, October 2008-December 1, 2010:
[Refer to PDF for image: multiple line graph]
[Values shown represent the first business day of each month]
October 2008;
Amount owed: $62.000 billion;
(Amount owed: 10/22/08: $72.332 billion);
Borrowing limit (until 11/26/08): $85.000 billion.
November 2008;
Amount owed: $61.365 billion;
Borrowing limit (until 11/26/08): $85.000 billion.
December 2008;
Amount owed: $35.437 billion;
Revolving credit ceiling: $60.000 billion.
January 2009;
Amount owed: $39.003 billion;
Revolving credit ceiling: $60.000 billion.
February 2009;
Amount owed: $39.013 billion;
Revolving credit ceiling: $60.000 billion.
March 2009;
Amount owed: $41.652 billion;
Revolving credit ceiling: $60.000 billion.
April 2009;
Amount owed: $44.712 billion;
Revolving credit ceiling: $60.000 billion.
May 2009;
Amount owed: $45.496 billion;
Revolving credit ceiling: $60.000 billion.
June 2009;
Amount owed: $43.578 billion;
Revolving credit ceiling: $60.000 billion.
July 2009;
Amount owed: $42.834 billion;
Revolving credit ceiling: $60.000 billion.
August 2009;
Amount owed: $41.335 billion;
Revolving credit ceiling: $60.000 billion.
September 2009;
Amount owed: $38.792 billion;
Revolving credit ceiling: $60.000 billion.
October 2009;
Amount owed: $39.882 billion;
Revolving credit ceiling: $60.000 billion.
November 2009;
Amount owed: $44.539 billion;
Revolving credit ceiling: $60.000 billion.
December 2009;
Amount owed: $20.660 billion;
Revolving credit ceiling: $35.000 billion.
January 2010;
Amount owed: $22.215 billion;
Revolving credit ceiling: $35.000 billion.
February 2010;
Amount owed: $25.662 billion;
Revolving credit ceiling: $35.000 billion.
March 2010;
Amount owed: $25.109 billion;
Revolving credit ceiling: $35.000 billion.
April 2010;
Amount owed: $25.388 billion;
Revolving credit ceiling: $34.156 billion.
May 2010;
Amount owed: $27.097 billion;
Revolving credit ceiling: $34.156 billion.
June 2010;
Amount owed: $26.624 billion;
Revolving credit ceiling: $34.156 billion.
July 2010;
Amount owed: $24.560 billion;
Revolving credit ceiling: $33.728 billion.
August 2010;
Amount owed: $23.661 billion;
Revolving credit ceiling: $33.728 billion.
September 2010;
Amount owed: $20.057 billion;
Revolving credit ceiling: $29.672 billion.
October 2010;
Amount owed: $20.001 billion;
Revolving credit ceiling: $29.175 billion.
November 2010;
Amount owed: $19.530 billion;
Revolving credit ceiling: $29.175 billion.
December 2010;
Amount owed: $21.326 billion;
Revolving credit ceiling: $28.786 billion.
Sources: GAO analysis of Federal Reserve Statistical Release H.4.1 and
Federal Reserve data.
[End of figure]
AIG RCF Terms and Conditions:
Total amount available. The borrowing limit for the AIG RCF was
initially $85 billion and was lowered to $60 billion in November 2008,
and lowered further to $35 billion in December 2009.
Interest rate. Initially, the interest rate on funds drawn on the AIG
RCF was the London Interbank Offer Rate (LIBOR) plus 8.5 percent (with
a minimum floor on LIBOR set at 3.5 percent). Under the initial terms,
AIG was also required to pay a one-time commitment fee of 2 percent on
the aggregate amount available under the facility, or $1.7 billion,
and an ongoing commitment fee each quarter equal to 8.5 percent of the
average undrawn funds available during the previous quarter. In
November 2008, the interest rate was lowered to LIBOR plus 3 percent
and the fee on undrawn funds was reduced to 0.75 percent. On April 17,
2009, the minimum floor on LIBOR was removed.
Duration. The Federal Reserve Board initially authorized the AIG RCF
for up to 2 years and in November 2008 extended the term over which it
could be available to 5 years.
Key Vendors for AIG RCF:
FRBNY used a number of vendors to help manage and administer the AIG
RCF. Table 14 lists AIG RCF vendors that have been paid more than $1
million.
Table 14: Vendors for AIG RCF that Earned Fees Greater than $1
Million, 2008-2010:
Vendor: Morgan Stanley;
Services provided: Investment banking advisory services;
Contract date:10/16/2008;
Awarded competitively? No;
Total fees paid (2008-2010): $108,400,327.
Vendor: Ernst & Young;
Services provided: Due diligence;
Contract date:9/19/2008;
Awarded competitively? No;
Total fees paid (2008-2010): $66,887,780.
Vendor: Davis Polk & Wardwell;
Services provided: Legal services;
Contract date:9/16/2008;
Awarded competitively? No;
Total fees paid (2008-2010): $32,595,896.
Vendor: Houlihan Lokey;
Services provided: Valuation services;
Contract date:4/9/2009;
Awarded competitively? Yes;
Total fees paid (2008-2010): $1,390,881.
Vendor: Sidley Austin;
Services provided: Legal services;
Contract date:4/13/2009;
Awarded competitively? No;
Total fees paid (2008-2010): $1,312,494.
Source: GAO presentation of FRBNY information.
[End of table]
AIG Securities Borrowing Facility (SBF):
Figure 17: Overview of AIG SBF:
[Refer to PDF for image: line graph and associated data]
Key observations:
* The Federal Reserve Bank of New York (FRBNY) was authorized to lend
up to $37.8 billion through the AIG SBF at any one time.
* AIG’s borrowing under the AIG SBF peaked at $20.6 billion.
* Maiden Lane II LLC was established to purchase assets in AIG’s
securities lending portfolio and terminate the SBF program.
Date announced: October 8, 2008;
Dates of operation: October 8, 2008-December 12, 2008;
Total loans: 44.
Figure: AIG SBF loan amount outstanding, October 6, 2008-December 11,
2008:
Dollars in billions:
[Values depicted for dates within each month]
October 6, 2008;
AIG SBF loan amount outstanding: $6.1;
AIG SBF loan amount outstanding: $10.6;
AIG SBF loan amount outstanding: $11.9;
AIG SBF loan amount outstanding: $13;
AIG SBF loan amount outstanding: $15.3;
AIG SBF loan amount outstanding: $17.1;
AIG SBF loan amount outstanding: $17.7;
AIG SBF loan amount outstanding: $17.7;
AIG SBF loan amount outstanding: $18;
AIG SBF loan amount outstanding: $18.3;
AIG SBF loan amount outstanding: $18.3;
AIG SBF loan amount outstanding: $18.3;
AIG SBF loan amount outstanding: $17.8;
AIG SBF loan amount outstanding: $17.7;
AIG SBF loan amount outstanding: $17.6;
AIG SBF loan amount outstanding: $17.6.
November 2008;
AIG SBF loan amount outstanding: $19.2;
AIG SBF loan amount outstanding: $19.9;
AIG SBF loan amount outstanding: $19.9;
AIG SBF loan amount outstanding: $19.8;
AIG SBF loan amount outstanding: $19.8;
AIG SBF loan amount outstanding: $20.6;
AIG SBF loan amount outstanding: $20.2;
AIG SBF loan amount outstanding: $20.5;
AIG SBF loan amount outstanding: $20.5;
AIG SBF loan amount outstanding: $20.5;
AIG SBF loan amount outstanding: $20.5;
AIG SBF loan amount outstanding: $20.5;
AIG SBF loan amount outstanding: $20.5;
AIG SBF loan amount outstanding: $20.5;
AIG SBF loan amount outstanding: $20.5;
AIG SBF loan amount outstanding: $20.5;
AIG SBF loan amount outstanding: $20.5;
AIG SBF loan amount outstanding: $20.5.
December 2008;
AIG SBF loan amount outstanding: $20.5;
AIG SBF loan amount outstanding: $20.5;
AIG SBF loan amount outstanding: $20.5;
AIG SBF loan amount outstanding: $20.5;
AIG SBF loan amount outstanding: $20.5;
AIG SBF loan amount outstanding: $20.5;
AIG SBF loan amount outstanding: $20.5;
AIG SBF loan amount outstanding: $20.5;
AIG SBF loan amount outstanding: $20.5.
Source: GAO analysis of Board of Governors of the Federal Reserve
System documents and data.
[End of figure]
Background:
On October 6, 2008, the Federal Reserve Board authorized the creation
of the AIG SBF to provide up to $37.8 billion of direct funding
support to a securities lending program operated by certain domestic
insurance subsidiaries of AIG. The securities lending program allowed
AIG's insurance subsidiaries, primarily AIG's life insurance
companies, to lend securities in return for cash collateral that these
AIG insurance subsidiaries then invested in investments such as RMBS.
From October 8, 2008, through December 11, 2008, FRBNY provided cash
loans to certain AIG domestic life insurance companies, collateralized
by investment grade debt obligations.
As of October 1, 2008, AIG had drawn down approximately $62 billion on
the AIG RCF. AIG used those funds, in part, to settle transactions
with counterparties that were returning securities they had borrowed
under AIG's securities lending program. The withdrawal of AIG's
securities lending counterparties placed strains on AIG's liquidity as
closing out these transactions required AIG to return cash collateral
that had been pledged by these counterparties. By providing overnight
loans against investment grade debt obligations, the AIG SBF was
intended to reduce pressure on AIG's subsidiaries to meet demands for
returning cash collateral by liquidating the portfolio of RMBS in
strained markets. The size of the AIG SBF was intended to be large
enough to allow AIG to replace all of its securities lending program
counterparties.
Terms and Conditions for AIG SBF:
Collateral. Through the AIG SBF, FRBNY provided loans to AIG that were
collateralized by investment grade debt obligations. These loans were
made with recourse to AIG's assets beyond the assets pledged as
collateral and FRBNY generally applied higher haircuts than it
required for these collateral types in the Primary Dealer Credit
Facility (PDCF).
Term of loans. Overnight, although loans could be rolled over.
Interest rate. The interest rate on AIG SBF loans was 100 basis points
plus the average overnight repurchase agreement rate offered by
dealers for the relevant collateral type.
Program duration. The AIG SBF was authorized to provide loans until
September 16, 2010, but was terminated in December 2008.
AIG's borrowing under the AIG SBF peaked at $20.6 billion before the
AIG SBF was fully repaid in connection with the creation of Maiden
Lane II LLC in December 2008.
Maiden Lane II LLC:
Date announced: November 10, 2008.
Dates of operation: December 12, 2008-present.
Table: Key observations:
* The Federal Reserve Bank of New York (FRBNY) established Maiden Lane
II LLC to fund the purchase of RMBS from the securities lending
portfolio operated by certain insurance subsidiaries of AIG;
* FRBNY provided a senior loan of $19.5 billion and AIG's first loss
position was $1 billion;
* As of June 29, 2011, total principal and accrued interest owed to
FRBNY was $8.6 billion, and as of that date, the portfolio had a fair
value of $12.5 billion based on valuations as of March 31, 2011;
* As of June 9, 2011, FRBNY had sold assets with a current face amount
of approximately $10 billion through competitive auctions.
Source: GAO summary of Board of Governors of the Federal Reserve
System documents and data.
[End of table]
Background:
FRBNY created Maiden Lane II LLC to alleviate capital and liquidity
pressures on AIG associated with the securities lending program
operated by certain domestic insurance subsidiaries of AIG. On
November 10, 2008, FRBNY announced plans to create an RMBS facility--
Maiden Lane II LLC--to purchase RMBS assets from AIG's securities
lending portfolio. The Federal Reserve Board authorized FRBNY to lend
up to $22.5 billion to Maiden Lane II LLC; AIG also acquired a
subordinated, $1 billion interest in the facility, which would absorb
the first $1 billion of any losses. On December 12, 2008, FRBNY
extended a $19.5 billion loan to Maiden Lane II LLC to fund its
portion of the purchase price of the securities (see figure 18). The
proceeds AIG's insurance subsidiaries received from the purchase of
the securities by Maiden Lane II LLC were used to repay in full
obligations under the AIG SBF and terminate that program. As of June
29, 2011, Maiden Lane II LLC owed $8.6 billion in principal and
interest to FRBNY.
Figure 18: Maiden Lane II LLC Transaction:
[Refer to PDF for image: illustration]
Private institution: selling assets to the LLC:
Private institutions selling assets to the LLC: AIG subsidiaries
($20.5 billion assets to Maiden Lane II LLC);
Assets and liabilities: Maiden Lane II LLC ($19.5 billion cash to AIG
subsidiaries);
Assets:
Residential mortgage-backed securities;
Liabilities:
FRBNY senior loan;
$1.0 billion deferred purchase price by AIG subsidiaries;
Sources of funding for LLC’s purchase of assets:
FRBNY: $19.5 billion.
Source: GAO analysis of FRBNY information.
[End of figure]
Terms and Conditions for Maiden Lane II:
Assets in the Maiden Lane II LLC portfolio. The Maiden Lane II LLC
portfolio included RMBS assets purchased from 11 domestic AIG
insurance company subsidiaries with an estimated fair market value of
$20.8 billion as of October 31, 2008. Maiden Lane II LLC purchased
only U.S.-dollar-denominated RMBS held in AIG's securities lending
portfolio. Foreign-currency-denominated RMBS were excluded to avoid
the complexity of managing currency exposures.
Terms to maturity of FRBNY loan. FRBNY extended its senior loan for a
term of up to 6 years with the option to extend at its discretion.
Interest rates. The interest rate on FRBNY's senior loan is one-month
LIBOR plus 100 basis points. After FRBNY's senior loan has been repaid
in full plus interest, to the extent that there are remaining cash
proceeds from the Maiden Lane II LLC portfolio, AIG's domestic
insurance company subsidiaries would be entitled to receive from the
LLC additional deferred consideration in the amount of up to $1
billion, plus interest at a rate of one-month LIBOR plus 300 basis
points.
Cash flow waterfall. Repayment of FRBNY's loan was to begin
immediately upon the receipt of proceeds from Maiden Lane II LLC's
RMBS portfolio. Payments from the maturity or liquidation of the
assets in the LLC were to occur on a monthly basis, and were to be
made in the following order (each category must be fully paid before
proceeding to the next lower category):
1. necessary costs and expenses of the LLC, including those incurred
in managing and holding or liquidating assets, plus the funding of a
cash reserve for future expenses;
2. entire $19.5 billion principal due to FRBNY;
3. all interest due to FRBNY on its senior secured loan;
4. up to $1 billion of deferred consideration to AIG's domestic
insurance company subsidiaries; and:
5. interest due in respect of such deferred consideration.
After payment of all of the foregoing, 1/6th of any remaining cash
flows from the RMBS assets will be paid as deferred consideration to
participating domestic AIG insurance company subsidiaries, and 5/6th
will be paid to FRBNY as contingent interest on the senior loan.
Financial Performance:
As of June 29, 2011, approximately $8.6 billion remained outstanding
on FRBNY's loan to Maiden Lane II LLC. FRBNY projects full repayment
of this loan. In the months following the Maiden Lane II LLC
transaction, the portfolio experienced declines that brought the
portfolio value below the amount owed to FRBNY. However, as market
conditions improved in late 2009 and 2010, the value of the portfolio
increased and as of June 29, 2011, the fair value of the portfolio
(approximately $12.5 billion based on valuations as of March 31, 2011)
exceeds the amount owed to FRBNY.
On March 30, 2011, FRBNY announced that it would begin a process to
sell the assets in the Maiden Lane II LLC portfolio through BlackRock
both individually and in segments over time as market conditions
warrant through a competitive sales process. As of June 9, 2011, FRBNY
had sold assets with a current face amount of approximately $10
billion through competitive auctions.
Key Vendors for Maiden Lane II:
FRBNY used vendors to help manage this program. The key vendors are
listed in table 15.
Table 15: Vendors for Maiden Lane II LLC that Earned Fees Greater than
$1 Million, 2008-2010:
Vendor: BlackRock;
Services provided: Investment manager;
Contract date: 12/12/2008;
Awarded competitively? No;
Total fees paid (2008-2010): $24,102,579.
Vendor: Ernst & Young;
Services provided: Due diligence;
Contract date: 9/19/2008;
Awarded competitively? No;
Total fees paid (2008-2010): $1,192,888.
Source: GAO presentation of FRBNY information.
[End of table]
Maiden Lane III LLC:
Date announced: November 10, 2008.
Dates of operation: November 25, 2008-present.
Table: Key observations;
* The Federal Reserve Bank of New York (FRBNY) created a special
purpose vehicle called Maiden Lane III LLC to restructure the
financial support for AIG by purchasing collateralized debt
obligations (CDO) from certain AIG Financial Products Corp. (AIGFP)
counterparties;
* To finance Maiden Lane III LLC's purchase of the CDOs, FRBNY
provided a senior loan of $24.3 billion and AIG provided a $5 billion
equity investment;
* As of June 29, 2011, total principal and interest owed to FRBNY was
$12.3 billion. As of that date, the portfolio had a fair value of
$24.2 billion based on valuations as of March 31, 2011.
Source: GAO summary of Board of Governors of the Federal Reserve
System documents and data.
[End of table]
Background:
On November 10, 2008, FRBNY announced plans to create a separate
facility--Maiden Lane III LLC--to purchase CDOs on which AIGFP had
written CDS contracts. This facility was aimed at facilitating the
restructuring of AIG by addressing the greatest threat to AIG's
liquidity. In connection with the purchase of the CDOs, AIG's CDS
counterparties agreed to terminate the CDS contracts. The Federal
Reserve Board authorized FRBNY to lend up to $30 billion to Maiden
Lane III LLC. On November 25, 2008, and December 18, 2008, FRBNY
extended a total of $24.3 billion in loans to Maiden Lane III LLC; AIG
also contributed $5 billion of equity to Maiden Lane III LLC, which
would absorb the first $5 billion of any losses (see figure 19).
Figure 19: Maiden Lane III LLC Transaction:
[Refer to PDF for image: illustration]
Private institutions selling assets to the LLC: AIGFP; AIGFP
counterparties ($29.3 billion (CDOs underlying CDS contracts to Maiden
Lane III LLC);
Assets and liabilities: Maiden Lane III LLC ($29.3 billion cash to
AIGFP ($2.5 billion) and AIGFP counterparties($26.8 billion));
Assets:
Collateralized debt obligations;
Liabilities:
FRBNY senior loan;
AIG equity interest;
Sources of funding for LLC’s purchase of assets:
FRBNY: $24.3 billion;
AIG: $5.0 billion.
Source: GAO analysis of FRBNY information.
[End of figure]
FRBNY's loan to Maiden Lane III LLC is expected to be repaid with the
proceeds from the maturity or liquidation of the assets in the
facility. As with Maiden Lane II LLC, the repayment will occur through
cash flows from the underlying securities as they are paid off. Maiden
Lane III LLC may hold the assets to maturity. Until this time, the
government's investment remains exposed to risk of loss. In connection
with the purchases of CDOs by Maiden Lane III LLC and the termination
of the related credit derivative contracts, Maiden Lane III LLC paid
AIGFP's counterparties $26.8 billion and AIGFP $2.5 billion.
Terms and Conditions for Maiden Lane III LLC:
Assets in the Maiden Lane III portfolio. The Maiden Lane III LLC
portfolio consists of U.S. dollar denominated CDOs with an estimated
fair value of approximately $29.3 billion and a par value of
approximately $62.1 billion as of October 31, 2008. Maiden Lane III
LLC did not acquire bonds for which AIGFP could not produce certain
documentation. In addition, Maiden Lane III LLC did not purchase cash
CDO positions that AIG and its affiliates owned outright or synthetic
CDO exposures that were derivative instruments rather than cash
securities.[Footnote 142]
Term to maturity of FRBNY loan. FRBNY extended its senior loan for up
to 6 years with option to extend at FRBNY's discretion.
Interest rates. The interest rate on the loan from FRBNY is one-month
LIBOR plus 100 basis points. AIG's equity contribution will accrue
distributions at a rate of one-month LIBOR plus 300 basis points.
Cash flow waterfall. Repayment of FRBNY's senior loan was to begin
immediately upon the receipt of proceeds from the Maiden Lane III LLC
portfolio. Payments from the portfolio holdings of Maiden Lane III LLC
are to be made in the following order and each category must be fully
paid before proceeding to the next category:
1. necessary costs and operating expenses of Maiden Lane III LLC, and
amounts to fund a reserve account for expenses payable and other
payments that may be incurred with the management of CDO defaults;
2. all principal due on FRBNY's loan;
3. all interest due on FRBNY's loan;
4. repayment of AIG's $5 billion equity contribution;
5. distributions accruing to AIG on its equity contribution; and:
6. amounts due under certain currency hedging transactions to the
extent the counterparty to the hedge is in default.
Any remaining funds resulting from holding or selling the assets in
Maiden Lane III LLC are to be distributed between FRBNY and AIG's
subsidiaries. FRBNY will receive 67 percent of the remaining proceeds,
while the AIG subsidiaries will receive 33 percent of any remaining
proceeds.
Financial Performance:
As of June 29, 2011, approximately $12.3 billion remained outstanding
on FRBNY's loan to Maiden Lane III LLC. FRBNY projects full repayment
of this loan. In the months following the Maiden Lane LLC transaction,
the portfolio experienced declines that brought the portfolio value
below the amount owed to FRBNY. However, as market conditions improved
in late 2009 and 2010, the value of the portfolio has increased and as
of June 29, 2011, the fair value of the portfolio (approximately $24.2
billion based on valuations as of March 31, 2011) exceeds the amount
owed to FRBNY.
Key Vendors for Maiden Lane III:
FRBNY uses a number of vendors associated with Maiden Lane III. Table
16 lists the key vendors associated with this program.
Table 16: Vendors for Maiden Lane III LLC that Earned Fees Greater
than $1 Million, 2008-2010:
Vendor: BlackRock;
Services provided: Investment manager;
Contract date: 11/25/2008;
Awarded competitively? No;
Total fees paid (2008-2010): $50,031,879.
Vendor: Ernst & Young;
Services provided: Due diligence;
Contract date: 9/19/2008;
Awarded competitively? No;
Total fees paid (2008-2010): $2,820,172.
Vendor: Bank of New York Mellon;
Services provided: Administrator, custodian;
Contract date: 11/25/2008;
Awarded competitively? Yes;
Total fees paid (2008-2010): $1,390,452.
Vendor: Davis Polk & Wardwell;
Services provided: Legal services;
Contract date: 9/16/2008;
Awarded competitively? No;
Total fees paid (2008-2010): $1,018,815.
Source: GAO presentation of FRBNY information.
[End of table]
[End of section]
Appendix IV: Assistance to Facilitate Private Sector Acquisition of
Bear Stearns Companies, Inc.
Table: Key observations:
* Authorized under section 13(3) of the Federal Reserve Act of 1913;
* On March 14, 2008, the Federal Reserve Bank of New York (FRBNY)
extended credit to Bear Stearns Companies, Inc. (Bear Stearns) to
provide additional time for a private sector solution that would avoid
a disorderly failure of the firm;
* On March 16, 2008, FRBNY agreed to lend up to $30 billion against
Bear Stearns's assets to facilitate JP Morgan Chase & Co.'s
acquisition of the firm;
* Pursuant to a renegotiation of this lending agreement, FRBNY and JP
Morgan Chase & Co. made loans to a special purpose vehicle, Maiden
Lane LLC, which used the proceeds from these loans to purchase and
hold Bear Stearns's assets;
* As of June 29, 2011, approximately $22 billion in principal and
accrued interest remained outstanding on FRBNY's loan to Maiden Lane
LLC. FRBNY projects full repayment of this loan.
Source: GAO summary of Board of Governors of the Federal Reserve
System documents and data.
[End of table]
Background:
In March 2008, the Board of Governors of the Federal Reserve System
(Federal Reserve Board) invoked its emergency authority under section
13(3) of the Federal Reserve Act of 1913 to authorize the Federal
Reserve Bank of New York (FRBNY) to take two actions to avert a
disorderly failure of Bear Stearns Companies, Inc. (Bear Stearns): (1)
a loan to help fund the firm through the weekend of March 15-16, 2008,
to allow more time for a private sector solution and (2) an agreement
to lend up to $30 billion against Bear Stearns's assets to facilitate
an acquisition of the firm.
Bridge Loan to Bear Stearns:
Shortly following the announcement of the Term Securities Lending
Facility (TSLF), the Federal Reserve Board invoked its emergency
authority under section 13(3) of the Federal Reserve Act to authorize
an emergency loan to avert a disorderly failure of Bear Stearns. TSLF
was announced on March 11, 2008, and the first TSLF auction was held
on March 27, 2008. Federal Reserve Board officials noted that although
TSLF was announced to address market tensions impacting many firms,
some market participants concluded that its establishment was driven
by specific concerns about Bear Stearns. Over a few days, Bear Stearns
experienced liquidity problems as many of its lenders grew concerned
that the firm would suffer greater losses in the future and stopped
providing funding to the firm, even on a fully-secured basis with high-
quality assets provided as collateral.[Footnote 143] Late on Thursday,
March 13, 2008, the senior management of Bear Stearns notified FRBNY
that it would likely have to file for bankruptcy protection the
following day unless the Federal Reserve Board authorized an emergency
loan to the firm. The Federal Reserve Board feared that the sudden
failure of Bear Stearns could have serious adverse impacts on markets
in which Bear Stearns was a significant participant, including the
repurchase agreements market. In particular, a Bear Stearns failure
may have threatened the liquidity and solvency of other large
institutions that relied heavily on short-term secured funding
markets. On Friday, March 14, 2008, the Federal Reserve Board voted to
authorize FRBNY to provide a $12.9 billion loan to Bear Stearns
through JP Morgan Chase Bank, National Association, the largest bank
subsidiary of JP Morgan Chase & Co. (JPMC), and accept $13.8 billion
of Bear Stearns's assets as collateral.[Footnote 144]
Figure 20 illustrates the back-to-back loan transaction, which was
repaid on Monday, March 17, 2008, with almost $4 million of interest.
Figure 20: FRBNY Bridge Loan to Bear Stearns:
[Refer to PDF for image: illustration]
FRBNY: $12.9 billion loan to JPMC bank subsidiary.
JPMC bank subsidiary: $12.9 billion loan to Bear Stearns.
Bear Stearns: $13.8 billion collateral to JPMC bank subsidiary.
JPMC bank subsidiary: $13.8 billion collateral to FRBNY.
Source: GAO presentation of Federal Reserve Board information.
[End of figure]
This emergency loan enabled Bear Stearns to avoid bankruptcy and
continue to operate through the weekend. This provided time for
potential acquirers, including JPMC, to assess Bear Stearns's
financial condition and for FRBNY to prepare a new liquidity program,
the Primary Dealer Credit Facility (PDCF), to address strains that
could emerge from a possible Bear Stearns bankruptcy announcement the
following Monday. Federal Reserve Board and FRBNY officials hoped that
a bankruptcy could be averted by the announcement that a private
sector firm would acquire Bear Stearns and stand behind its
liabilities when the markets reopened on Monday.
Maiden Lane LLC:
On Sunday, March 16, 2008, the Federal Reserve Board announced that
FRBNY would lend up to $30 billion against certain Bear Stearns's
assets to facilitate JPMC's acquisition of Bear Stearns. Over the
weekend, JPMC had emerged as the only viable acquirer of Bear Stearns.
In congressional testimony, Timothy Geithner, who was FRBNY's
President in March 2008, provided the following account:
Bear approached several major financial institutions, beginning on
March 13. Those discussions intensified on Friday and Saturday. Bear's
management provided us with periodic progress reports about a possible
merger. Although several different institutions expressed interest in
acquiring all or part of Bear, it was clear that the size of Bear, the
apparent risk in its balance sheet, and the limited amount of time
available for a possible acquirer to conduct due diligence compounded
the difficulty. Ultimately, only JP Morgan Chase was willing to
consider an offer of a binding commitment to acquire the firm and to
stand behind Bear's substantial short-term obligations.[Footnote 145]
According to FRBNY officials, on the morning of Sunday, March 16,
2008, JPMC's Chief Executive Officer told FRBNY that the merger would
only be possible if certain mortgage-related assets were removed from
Bear Stearns's balance sheet. Negotiations between JPMC and FRBNY
senior management resulted in a preliminary agreement under which
FRBNY would make a $30 billion nonrecourse loan to JPMC collateralized
by these Bear Stearns assets. A March 16, 2008, letter from then-FRBNY
President Geithner to JPMC's Chief Executive Officer documented the
terms of the preliminary agreement.[Footnote 146]
During the following week, however, the terms of this agreement were
renegotiated, resulting in the creation of a new lending structure in
the form of Maiden Lane LLC. Significant issues that threatened to
unravel the merger agreement emerged soon after the announcement. Bear
Stearns's board members and shareholders thought JPMC's offer to
purchase the firm at $2 per share was too low and threatened to vote
against the merger. Perceived ambiguity in the terms of the merger
agreement raised further concerns that JPMC could be forced to stand
behind Bear Stearns's obligations even in the event that the merger
was rejected. Moreover, some Bear Stearns's counterparties stopped
trading with Bear Stearns because of uncertainty about whether certain
Bear Stearns obligations would be covered by JPMC. FRBNY also had
concerns with the level of protection provided under the preliminary
lending agreement, under which FRBNY had agreed to lend on a
nonrecourse basis against risky collateral. The risks of an unraveled
merger agreement included a possible Bear Stearns bankruptcy and
losses for JPMC, which might have been legally required to stand
behind the obligations of a failed institution. Recognizing the risk
that an unraveled merger posed to JPMC and the broader financial
markets, FRBNY officials sought to renegotiate the lending agreement.
From March 17-March 24, 2008, FRBNY, JPMC, and Bear Stearns engaged in
dual track negotiations to address each party's concerns with the
preliminary merger and lending agreements. On March 24, 2008, FRBNY
and JPMC agreed to a new lending structure that incorporated greater
loss protections for FRBNY.
This new lending structure took the form of FRBNY and JPMC loans to a
newly-created special purpose vehicle (SPV), Maiden Lane LLC, which
used the proceeds from these loans to purchase and hold Bear Stearns's
assets. FRBNY extended a senior loan to the SPV and this loan was
collateralized by the portfolio of assets held by the SPV. Key loss
protection features for Maiden Lane LLC included:
* First loss position for JPMC. JPMC agreed to take a first loss
position by making a $1.15 billion subordinated loan to help finance
the SPV's $30 billion purchase of the Bear Stearns asset portfolio
(see figure 21). JPMC would begin to receive payments on this
subordinated loan only after FRBNY received the full principal and
interest on its $28.8 billion senior loan to the SPV. This lending
structure protects FRBNY from up to $1.15 billion in losses on the
portfolio.
* Asset selection and filters. The broad categories of assets selected
for inclusion in the Maiden Lane portfolio were based on the policy
objectives of the transaction, but FRBNY specified certain asset
filters, or criteria, that were intended to exclude certain higher
risk assets. For example, FRBNY accepted only U.S. dollar denominated
assets to avoid the complexities of managing currency exposures from
foreign currency assets. In addition, FRBNY agreed to accept only
commercial and residential loans that were "performing," or no more
than 30 days past due, as of March 14, 2008, the date of the bridge
loan to Bear Stearns.
* Valuation and due diligence. FRBNY hired vendors to help value the
assets in the portfolio and to conduct due diligence to exclude assets
that were proposed for inclusion but did not meet the specified asset
filters or lacked documentation. The purchase price for the Maiden
Lane assets was based on Bear Stearns's recorded values for these
assets as of March 14, 2008. FRBNY hired an external audit firm, Ernst
& Young, to conduct due diligence for the portfolio.
* Portfolio management. For the Maiden Lane portfolio, FRBNY retained
sole discretion over the decisions about how to manage the assets to
maximize the value recovered on FRBNY's senior loan. FRBNY hired
BlackRock to manage the portfolio and to advise on a strategy for
investing and disposing of the assets. For Maiden Lane, FRBNY agreed
to a 2-year reinvestment period during which all cash income from the
portfolio would be reinvested in relatively low-risk investments; and
FRBNY would not be permitted, without penalty, to receive repayment on
its loan prior to the end of the reinvestment period unless the JPMC
loan was repaid in full. According to FRBNY staff, JPMC requested this
reinvestment period out of concern that FRBNY could sell portfolio
assets at prices that would recover value for FRBNY but incur losses
for JPMC. FRBNY staff said they agreed to this reinvestment strategy
because it would not increase the risk of loss on its senior loan.
FRBNY hired other vendors to help oversee and manage the risks of
specific asset classes included in the Maiden Lane portfolio. For
example, FRBNY hired vendors to advise on the risks posed by
commercial real estate loans.
Figure 21: Maiden Lane LLC Transaction:
[Refer to PDF for image: illustration]
Private institutions selling assets to the LLC: Bear Stearns
Companies, Inc. ($30 billion in Bear Stearns assets to Maiden Lane
LLC);
Assets and liabilities: Maiden Lane LLC ($30 billion cash to Bear
Stearns):
Assets:
Agency MBS ($10.1 billion);
Commercial whole loans ($8.2 billion);
Nonagency RMBS ($5.1 billion);
Derivatives ($3.7 billion);
Residential whole loans ($1.6 billion);
Other ($1.3 billion);
Liabilities:
FRBNY senior loan;
JPMC subordinated loan;
Sources of funding for LLC’s purchase of assets:
FRBNY: $28.8 billion;
JP Morgan Chase: $1.2 billion.
Source: GAO analysis of FRBNY information.
[End of figure]
Key Vendors for Maiden Lane LLC:
FRBNY used a number of vendors to help manage and administer Maiden
Lane LLC. Table 17 lists Maiden Lane LLC vendors that have received
more than $1 million in fees.
Table 17: Vendors for Maiden Lane LLC that Earned Fees Greater than $1
Million, 2008-2010:
Vendor: BlackRock;
Services provided: Investment manager;
Contract date: 9/9/2008;
Awarded competitively? No;
Total fees paid (2008-2010): $107,648,136.
Vendor: Ernst & Young;
Services provided: Due diligence;
Contract date: 4/15/2008;
Awarded competitively? No;
Total fees paid (2008-2010): $11,657,764.
Vendor: State Street Corporation;
Services provided: Administrator, custodian;
Contract date: 6/26/2008;
Awarded competitively? Yes;
Total fees paid (2008-2010): $9,182,946.
Vendor: EMC;
Services provided: Primary servicer;
Contract date: 6/1/2008;
Awarded competitively? No;
Total fees paid (2008-2010): $8,455,193.
Vendor: NationStar;
Services provided: Special servicer;
Contract date: 2/5/2010;
Awarded competitively? Yes;
Total fees paid (2008-2010): $3,456,150.
Vendor: Clayton;
Services provided: Servicer surveillance, advisory services;
Contract date: 7/8/2009;
Awarded competitively? Yes;
Total fees paid (2008-2010): $2,739,711.
Vendor: Cleary Gottlieb Stein & Hamilton;
Services provided: Legal services;
Contract date: 9/13/2008;
Awarded competitively? No;
Total fees paid (2008-2010): $2,422,169.
Vendor: Deloitte & Touche;
Services provided: Audit services;
Contract date: 9/1/2008;
Awarded competitively? N/A;
Total fees paid (2008-2010): $1,725,586.
Vendor: Axiom;
Services provided: Legal services;
Contract date: 11/19/2008;
Awarded competitively? No;
Total fees paid (2008-2010): $1,413,821.
Vendor: Wells Fargo;
Services provided: Primary servicer;
Contract date: 6/1/2008;
Awarded competitively? No;
Total fees paid (2008-2010): $1,300,949.
Vendor: Simpson Thacher & Bartlett;
Services provided: Legal services;
Contract date: 3/24/2008;
Awarded competitively? No;
Total fees paid (2008-2010): $1,147,617.
Vendor: Kelley Drye & Warren;
Services provided: Legal services;
Contract date: 9/22/2009;
Awarded competitively? No;
Total fees paid (2008-2010): $1,001,123.
Sources: GAO presentation of FRBNY information.
[End of table]
[End of section]
Appendix V: Bank of America Corporation Lending Commitment:
Table: Key observations:
* Authorized under section 13(3) of the Federal Reserve Act of 1913;
* The Federal Reserve Bank of Richmond (FRBR) agreed to provide a
lending commitment as part of a larger package of assistance intended
to avert a disorderly failure of Bank of America Corporation (Bank of
America);
* FRBR did not finalize an agreement with Bank of America Corporation
to provide this lending commitment. As part of the agreement to
terminate the agreement-in-principle, Bank of America paid a $57
million fee to FRBR in compensation for out-of-pocket expenses and
commitment fees.
Source: GAO summary of Board of Governors of the Federal Reserve
System documents and data.
[End of table]
Background:
On January 15, 2009, the Board of Governors of the Federal Reserve
System (Federal Reserve Board) authorized, under section 13(3) of the
Federal Reserve Act of 1913, the Federal Reserve Bank of Richmond
(FRBR) to provide a lending commitment to Bank of America Corporation
(Bank of America). As in the Citigroup Inc. (Citigroup) case, the
Federal Reserve Board authorized this assistance as part of a
coordinated effort with the Department of the Treasury (Treasury) and
the Federal Deposit Insurance Corporation (FDIC) to assist an
institution determined to be systemically important. The circumstances
surrounding the agencies' decision to provide this arrangement for
Bank of America, however, were somewhat different and were the subject
of congressional hearings.[Footnote 147] While the Citigroup loss
sharing agreement emerged during a weekend over which the agencies
attempted to avert an impending failure of the firm, the agencies'
discussions with Bank of America about a possible similar arrangement
occurred over several weeks during which Bank of America was not
facing imminent failure. According to Federal Reserve Board officials,
possible assistance for Bank of America was first discussed in late
December 2008 when Bank of America management raised concerns about
the financial impact of completing the merger with Merrill Lynch & Co.
(Merrill Lynch). Following the January 1, 2009, completion of Bank of
America's acquisition of Merrill Lynch, the Federal Reserve Board and
the other agencies agreed to provide a loss sharing agreement on
selected Merrill Lynch assets to assure markets that unusually large
losses on these assets would not destabilize Bank of America. In
September 2009, the agencies and FRBR agreed to terminate the loss
sharing agreement with Bank of America. As part of the agreement to
terminate the agreement-in-principle, Bank of America paid a $57
million fee to FRBR in compensation for out-of-pocket expenses
incurred by FRBR and an amount equal to the commitment fees required
by the agreement.
Under the agreement-in-principle announced on January 16, 2009,
Treasury and FDIC agreed to share in losses on a pool of up to $118
billion pool of assets if they exceeded $10 billion and FRBR agreed to
lend against the residual value of this asset pool if losses on these
assets exceeded $18 billion. Bank of America agreed to absorb the
first $10 billion in cash losses plus 10 percent of any remaining
losses incurred. Ninety percent of covered asset losses exceeding $10
billion would be borne by Treasury and FDIC, with maximum guarantee
payments capped at $10 billion.[Footnote 148] Based on analyses by an
outside vendor, FRBR determined that it would be unlikely that losses
on the Bank of America "ring-fence" assets would exceed the level
above which FRBR would be obligated to provide a loan.
Federal Reserve Board staff we spoke with cited two factors that
influenced the termination of the agreement-in-principle with Bank of
America. First, according to Federal Reserve Board staff, while the
Citigroup loss sharing agreement covered only cash losses (such as
losses arising from the sale of an asset at a loss), Bank of America
requested that its agreement cover mark-to-market losses, which would
include accounting losses arising from changes in the market value of
the assets. Federal Reserve Board staff said the U.S. government
agencies were unwilling to provide protection against such losses and
thought making payments to Bank of America based on temporary
accounting losses that could reverse if asset prices recovered would
be inappropriate. According to Federal Reserve Board staff, the lack
of protection on mark-to-market losses made the loss-sharing agreement
less appealing to Bank of America. Second, according to Federal
Reserve Board staff, because both Federal Reserve System staff and
Bank of America Corporation were involved in the Supervisory Capital
Assessment Program (SCAP), they agreed to delay negotiations to
finalize the loss-sharing agreement. As discussed in detail in a
September 2010 report, the purpose of SCAP, as implemented by the
Federal Reserve Board and other federal banking regulators, was to
determine through a stress test whether the largest 19 U.S. bank
holding companies, including Bank of America, had enough capital for
the next 2 years (2009-2010) to support their lending activities and
survive a second similar economic shock.[Footnote 149] According to
Federal Reserve Board staff, based on the results of the SCAP
exercise, Bank of America determined that the loss sharing agreement
would not provide enough value to move forward with finalizing an
agreement. The Federal Reserve Board agreed with this assessment and
began negotiations to terminate the agreement-in-principle.
Key Vendors for Bank of America Lending Commitment:
The key vendors for the Bank of America lending commitment are listed
in table 18.
Table 18: Vendors for Bank of America Lending Commitment that Earned
Fees Greater than $1 Million, 2008-2010:
Vendor: Pacific Investment Management Company LLC;
Services provided: Valuation services;
Contract date: 1/9/2009;
Awarded competitively? No;
Total fees paid (2008-2010):$12,025,000.
Vendor: Ernst & Young;
Services provided: Due Diligence;
Contract date: 1/16/2009;
Awarded competitively? No;
Total fees paid (2008-2010):$10,593,795.
Source: GAO presentation of FRBR information.
[End of table]
[End of section]
Appendix VI: Citigroup Inc. Lending Commitment:
Table: Key observations:
* Authorized under section 13(3) of the Federal Reserve Act of 1913;
* The Federal Reserve Bank of New York (FRBNY) provided a lending
commitment as part of a larger package of assistance intended to avert
a disorderly failure of Citigroup Inc. (Citigroup);
* FRBNY did not lend to Citigroup under this agreement and received a
$50 million fee from Citigroup following termination of the agreement
in December 2009.
Source: GAO summary of Board of Governors of the Federal Reserve
System documents and data.
[End of table]
Background:
On November 23, 2008, the Board of Governors of the Federal Reserve
System (Federal Reserve Board) authorized the Federal Reserve Bank of
New York (FRBNY) to lend to Citigroup Inc. (Citigroup), if necessary,
under section 13(3) of the Federal Reserve Act of 1913. This lending
commitment was approved as part of a package of coordinated actions by
the Department of the Treasury (Treasury), the Federal Deposit
Insurance Corporation (FDIC), and the Federal Reserve Board to avert a
disorderly failure of Citigroup. This package of assistance to
Citigroup included an additional $20 billion of capital from
Treasury's Troubled Asset Relief Program and a loss sharing agreement
intended to assure market participants that Citigroup would not fail
in the event of larger-than-expected losses on certain of its assets.
On December 23, 2009, Citigroup announced that it had entered into an
agreement with FDIC, FRBNY, and Treasury to terminate the loss sharing
agreement. As part of the termination agreement, Citigroup agreed to
pay a $50 million termination fee to FRBNY. FRBNY did not make any
loans to Citigroup under the loss-sharing agreement.
As discussed in our April 2010 report on Treasury's use of the
systemic risk determination, Treasury, FDIC, and the Federal Reserve
Board said they provided emergency assistance to Citigroup because
they were concerned that a failure of a firm of Citigroup's size and
interconnectedness would have systemic implications.[Footnote 150] As
of September 30, 2008, Citigroup was the second largest banking
organization in the United States, with total consolidated assets of
approximately $2 trillion. At the time, Citigroup was a major supplier
of credit in the U.S. and one of the largest holders of bank deposits
in the world.
Figure 22 illustrates the structure of the loss sharing agreement with
Citigroup. Under the final agreement executed on January 15, 2009,
Treasury and FDIC agreed to share in losses on a $301 billion pool of
Citigroup assets if they exceeded pre-set thresholds and FRBNY agreed
to lend against the residual value of this asset pool if losses on
these assets exceeded the limits on loss sharing by Treasury and FDIC.
Specifically, Citigroup agreed to absorb the first $39.5 billion in
cash losses plus 10 percent of any remaining losses incurred. Ninety
percent of covered asset losses exceeding $39.5 billion would be borne
by Treasury and FDIC, with maximum guarantee payments capped at $5
billion and $10 billion, respectively.[Footnote 151] Based on stress
analyses by an outside vendor, FRBNY determined that it would be
unlikely that losses on the Citigroup "ring-fenced" assets would
exceed $56.17 billion--the level above which FRBNY would be obligated
to provide a loan. FRBNY's loan would have been a one-time, all-or-
nothing loan secured by a first priority perfected security interest
in all of the remaining assets at the time that the loan was
triggered. In addition, interest on the loan would have been with
recourse to Citigroup and Citigroup would have had an on-going
obligation to pay 10 percent of the losses (with recourse to
Citigroup).
Figure 22: Structure of Loss Sharing Agreement with Citigroup:
[Refer to PDF for image: illustration]
Total value of Ring Fence assets as of Jan. 15, 2009: $300.8 billion.
FRBNY lending commitment (FRBNY agreed to lend to Citigroup against
the remaining value of the ring fence assets on losses exceeding $56.2
billion).
Citigroup: (100%; $39.5 billion);
First loss position: $39.5 billion;
Treasury: (90%; $5 billion);
Second loss position: $45.1 billion;
FDIC: (90%; $10 billion);
$56.2 billion.
Source: GAO analysis of terms of ring-fence agreement.
[End of figure]
Key Vendors for Citigroup Lending:
FRBY used vendors to analyze the assets that were identified as part
of the ring-fencing effort. The two key vendors were BlackRock and
PricewaterhouseCoopers (see table 19).
Table 19: Vendors for Citigroup Inc. Lending Commitment that Earned
Fees Greater than $1 Million, 2008-2010:
Vendor: BlackRock;
Services provided: Valuation services;
Contract date: 12/14/2008;
Awarded competitively? No;
Total fees paid (2008-2010): $12,700,000.
Vendor: PricewaterhouseCoopers;
Services provided: Valuation services;
Contract date: 12/1/2008;
Awarded competitively? No;
Total fees paid (2008-2010): $7,833,199.
Source: GAO presentation of FRBNY information.
[End of table]
[End of section]
Appendix VII: Commercial Paper Funding Facility:
Figure 14: Overview of CPFF:
[Refer to PDF for image: line graph and associated data]
Key observations:
* Authorized under section 13(3) of the Federal Reserve Act of 1913.
* The Commercial Paper Funding Facility (CPFF) served as a backstop
for commercial paper markets that came under increased strain in fall
2008.
* CPFF was the second largest lending program in terms of peak
lending, with peak use of $348 billion in January 2009.
* CPFF loans to fund purchases of unsecured commercial paper were
secured in part by borrower surcharges that served as an insurance
fund to absorb any losses.
* CPFF earned about $5 billion in net income, representing a large
share of the total income generated by the lending programs.
Date announced: October 7, 2008.
Dates of operation: October 27, 2008-February 1, 2010.
Total unique borrowers: 120.
Total loans: 1,157.
Figure: Loans outstanding to CPFF LLC, October 1, 2008-July 21, 2010:
[Line graph]
Initial values for each month are depicted.
October 2008;
Loans outstanding: $145 billion.
November 2008;
Loans outstanding: $243 billion.
December 2008;
Loans outstanding: $303 billion.
January 2009;
Loans outstanding: $332 billion.
[Peak loans outstanding to CPFF LLC: $348 billion: January 21, 2009]
February 2009;
Loans outstanding: $257 billion.
March 2009;
Loans outstanding: $239 billion.
April 2009;
Loans outstanding: $247 billion.
May 2009;
Loans outstanding: $165 billion.
June 2009;
Loans outstanding: $139 billion.
July 2009;
Loans outstanding: $110 billion.
August 2009;
Loans outstanding: $57 billion.
September 2009;
Loans outstanding: $43 billion.
October 2009;
Loans outstanding: $37 billion.
November 2009;
Loans outstanding: $10 billion.
December 2009;
Loans outstanding: $10 billion.
January 2010;
Loans outstanding: $9 billion.
February 2010;
Loans outstanding: $4 billion.
March 2010;
Loans outstanding: $3 billion.
April 2010;
Loans outstanding: $3 billion.
May 2010;
Loans outstanding: $0.
June 2010;
Loans outstanding: $0.
July 2010;
Loans outstanding: $0.
Source: GAO analysis of Board of Governors of the Federal Reserve
System documents and data.
[End of figure]
Background:
On October 7, 2008, the Board of Governors of the Federal Reserve
System (Federal Reserve Board) authorized the creation of the
Commercial Paper Funding Facility (CPFF) under section 13(3) of the
Federal Reserve Act of 1913 to provide a liquidity backstop to U.S.
issuers of commercial paper. CPFF became operational on October 27,
2008, and was operated by the Federal Reserve Bank of New York
(FRBNY). CPFF was initially set to expire on April 30, 2009. The
Federal Reserve Board authorized extensions of the CPFF to October 30,
2009, and subsequently to February 1, 2010.
Commercial paper is an important source of short-term funding for U.S.
financial and nonfinancial businesses. There are two main types of
commercial paper: unsecured and asset-backed. Unsecured paper is not
backed by collateral, and the credit rating of the issuing institution
is a key variable in determining the cost of its issuance. In
contrast, asset-backed commercial paper (ABCP) is collateralized by
assets and therefore is a secured form of borrowing.
Following the failure of Lehman Brothers Holdings Inc. (Lehman
Brothers) in September 2008, commercial paper markets generally ceased
to function properly. In the weeks leading up to the announcement of
CPFF, the commercial paper markets showed clear signs of strain: the
volume of commercial paper outstanding declined, interest rates on
longer-term commercial paper increased significantly, and increasing
amounts of commercial paper were issued on an overnight basis as money
market mutual funds (MMMF) and other investors became reluctant to
purchase commercial paper at longer-dated maturities. As discussed in
appendix II, which provides an overview of the Asset-Backed Commercial
Paper Money Market Mutual Fund Liquidity Facility, during this time,
MMMFs faced a surge of redemption demands from investors concerned
about losses on presumably safe instruments. The Federal Reserve Board
concluded that disruptions in the commercial paper markets, combined
with strains in other credit markets, threatened the broader economy,
because many large commercial paper issuers provided credit for
households and businesses.
By standing ready to purchase eligible commercial paper, CPFF was
intended to eliminate much of the risk that commercial paper issuers
would be unable to "roll over" their maturing commercial paper
obligations--that is, they would be unable to repay maturing
commercial paper with a new issue of commercial paper. By reducing
this roll-over risk, CPFF was expected to encourage investors to
continue or resume their purchases of commercial paper at longer
maturities.
Figure 24 illustrates the structure of CPFF. The relatively complex
structure reflected the added complication of engaging in market
transactions outside FRBNY's traditional operating framework. In
contrast to other emergency programs that made direct discount window
loans to depository institutions or primary dealers that had been
traditional FRBNY counterparties, FRBNY created a special purpose
vehicle (CPFF LLC) to facilitate discount window lending to the
commercial paper market. FRBNY hired State Street Corporation to
perform custodial, accounting, and administrative services. In
addition, to execute CPFF transactions, FRBNY relied on primary
dealers as transaction agents to coordinate issuance requests brought
to the facility. The use of primary dealers as transaction agents
leveraged the existing role these dealers played in underwriting,
placing, and making markets in the commercial paper market.
Figure 24: Structure of CPFF:
[Refer to PDF for image: illustration]
Issuer: Issuance request to Primary dealer.
Primary dealer: Trade details to PIMCO (FRBNY transaction agent).
PIMCO (FRBNY transaction agent): approval back to primary dealer; loan
request to FRBNY discount window.
FRBNY discount window: sends funds to State Street (custodian bank):
CRFFLLC (special-purpose vehicle).
FRBNY CPFF program team: interacts with PIMCO and CRFFLLC:
* Program management;
* Eligibility approval;
* Vendor oversight;
* Financial reporting.
State Street (custodian bank): sends funds to Depository trust
company; receives commercial paper back.
Depository trust company: sends funds to Issuer's issuing and paying
agent; receives commercial paper back.
Issuer's issuing and paying agent: sends funds to Issuer.
Source: GAO presentation of FRBNY information.
[End of figure]
A typical CPFF transaction included the following steps:
1. An issuer brought a CPFF issuance request to a primary dealer, who
then brought this request to FRBNY's transaction agent, Pacific
Investment Management Company LLC (PIMCO).
2. PIMCO would review the request and if the issuer met FRBNY's
predetermined eligibility requirements, the transaction would be
approved.
3. CPFF LLC was authorized to purchase the issuer's commercial paper.
Each day, CPFF purchases were matched by a loan from FRBNY's discount
window to the custodian, and the custodian bank would transfer the
loan amount to CPFF LLC to fund the purchases. CPFF LLC purchased
commercial paper through the Depository Trust Company, the market's
standard clearing institution.
4. At maturity, the issuer paid the CPFF LLC the loan principal and
interest, and the special purpose vehicle (SPV) paid FRBNY the
interest on the discount window loan. CPFF LLC retained interest,
surcharges, and fees paid in excess of the interest paid on the
discount window loan. This excess income was intended to stand ready
to absorb potential losses on unsecured paper held by CPFF LLC. As
investment manager, PIMCO invested this excess income in permitted
investments as directed by FRBNY.
Terms and Conditions for CPFF:
Assets Eligible for Purchase:
CPFF purchased 3-month U.S. dollar-denominated commercial paper from
eligible issuers. Commercial paper (including ABCP) purchased by CPFF
was required to be rated not lower than A-1/P-1/F-1 by a major
Nationally Recognized Statistical Rating Organization (NRSRO) and if
rated by multiple NRSROs was required to have this highest rating from
at least two or more major NRSROs.
Issuer Eligibility Requirements:
All U.S. issuers (including U.S. issuers with a foreign parent) with
eligible unsecured commercial paper or ABCP were eligible for CPFF.
The maximum amount a single issuer could have outstanding at CPFF was
limited to the greatest amount of U.S. dollar-denominated commercial
paper the issuer had had outstanding on any day between January 1 and
August 31, 2008. This limit was intended to prevent excessive use of
the facility that would be inconsistent with its role as a backstop.
On January 23, 2009, the Federal Reserve Board changed the eligibility
requirements to prohibit access by ABCP conduits that had been
inactive prior to the time CPFF was announced. This change was
intended to avoid reviving ABCP conduits that had closed as a result
of market discipline.
Table 20 lists the top 25 largest borrowers, which accounted for
approximately 88 percent of the commercial paper purchased through
CPFF. Total dollar amounts issued through CPFF are aggregated at the
level of the parent company for the entities that issued unsecured
commercial paper or sponsored ABCP conduits that issued ABCP to CPFF.
Table 20: Top 25 Largest CPFF Borrowers:
Dollars in billions.
Rank: 1;
Issuer of unsecured commercial paper or sponsor of ABCP issuer: UBS AG
(Switzerland);
ABCP: $0.0;
Unsecured commercial paper: $74.5;
Issuer total: $74.5;
Percent of total CPFF issuance: 10.1%.
Rank: 2;
Issuer of unsecured commercial paper or sponsor of ABCP issuer:
American International Group;
ABCP: $36.3;
Unsecured commercial paper: $24.0;
Issuer total: $60.2;
Percent of total CPFF issuance: 8.2%.
Rank: 3;
Issuer of unsecured commercial paper or sponsor of ABCP issuer: Dexia
SA (Belgium);
ABCP: $0.0;
Unsecured commercial paper: $53.5;
Issuer total: $53.5;
Percent of total CPFF issuance: 7.2%.
Rank: 4;
Issuer of unsecured commercial paper or sponsor of ABCP issuer: Hudson
Castle;
ABCP: $53.3;
Unsecured commercial paper: $0.0;
Issuer total: $53.3;
Percent of total CPFF issuance: 7.2%.
Rank: 5;
Issuer of unsecured commercial paper or sponsor of ABCP issuer: BSN
Holdings (United Kingdom);
ABCP: $42.8;
Unsecured commercial paper: $0.0;
Issuer total: $42.8;
Percent of total CPFF issuance: 5.8%.
Rank: 6;
Issuer of unsecured commercial paper or sponsor of ABCP issuer: The
Liberty Hampshire Company;
ABCP: $41.4;
Unsecured commercial paper: $0.0;
Issuer total: $41.4;
Percent of total CPFF issuance: 5.6%.
Rank: 7;
Issuer of unsecured commercial paper or sponsor of ABCP issuer:
Barclays PLC (United Kingdom);
ABCP: $0.0;
Unsecured commercial paper: $38.8;
Issuer total: $38.8;
Percent of total CPFF issuance: 5.3%.
Rank: 8;
Issuer of unsecured commercial paper or sponsor of ABCP issuer: Royal
Bank of Scotland Group PLC (United Kingdom);
ABCP: $24.8;
Unsecured commercial paper: $13.7;
Issuer total: $38.5;
Percent of total CPFF issuance: 5.2%.
Rank: 9;
Issuer of unsecured commercial paper or sponsor of ABCP issuer: Fortis
Bank SA/NV (Belgium);
ABCP: $26.9;
Unsecured commercial paper: $11.6;
Issuer total: $38.5;
Percent of total CPFF issuance: 5.2%.
Rank: 10;
Issuer of unsecured commercial paper or sponsor of ABCP issuer:
Citigroup Inc.;
ABCP: $12.8;
Unsecured commercial paper: $19.9;
Issuer total: $32.7;
Percent of total CPFF issuance: 4.4%.
Rank: 11;
Issuer of unsecured commercial paper or sponsor of ABCP issuer:
Natixis (France);
ABCP: $4.7;
Unsecured commercial paper: $22.3;
Issuer total: $27.0;
Percent of total CPFF issuance: 3.7%.
Rank: 12;
Issuer of unsecured commercial paper or sponsor of ABCP issuer:
General Electric Co;
ABCP: $0.0;
Unsecured commercial paper: $16.1;
Issuer total: $16.1;
Percent of total CPFF issuance: 2.2%.
Rank: 13;
Issuer of unsecured commercial paper or sponsor of ABCP issuer: Ford
Credit;
ABCP: $15.9;
Unsecured commercial paper: $0.0;
Issuer total: $15.9;
Percent of total CPFF issuance: 2.1%.
Rank: 14;
Issuer of unsecured commercial paper or sponsor of ABCP issuer: Bank
of America Corporation;
ABCP: $0.0;
Unsecured commercial paper: $14.9;
Issuer total: $14.9;
Percent of total CPFF issuance: 2.0%.
Rank: 15;
Issuer of unsecured commercial paper or sponsor of ABCP issuer: State
Street Corporation;
ABCP: $14.1;
Unsecured commercial paper: $0.0;
Issuer total: $14.1;
Percent of total CPFF issuance: 1.9%.
Rank: 16;
Issuer of unsecured commercial paper or sponsor of ABCP issuer: GMAC
LLC;
ABCP: $13.5;
Unsecured commercial paper: $0.0;
Issuer total: $13.5;
Percent of total CPFF issuance: 1.8%.
Rank: 17;
Issuer of unsecured commercial paper or sponsor of ABCP issuer: KBC
BANK NV (Belgium);
ABCP: $9.0;
Unsecured commercial paper: $2.3;
Issuer total: $11.3;
Percent of total CPFF issuance: 1.5%.
Rank: 18;
Issuer of unsecured commercial paper or sponsor of ABCP issuer: ING
Groep NV (Netherlands);
ABCP: $0.0;
Unsecured commercial paper: $10.9;
Issuer total: $10.9;
Percent of total CPFF issuance: 1.5%.
Rank: 19;
Issuer of unsecured commercial paper or sponsor of ABCP issuer:
Dresdner Bank AG (Germany);
ABCP: $5.1;
Unsecured commercial paper: $4.9;
Issuer total: $10.0;
Percent of total CPFF issuance: 1.4%.
Rank: 20;
Issuer of unsecured commercial paper or sponsor of ABCP issuer:
Northcross (United Kingdom);
ABCP: $8.6;
Unsecured commercial paper: $0.0;
Issuer total: $8.6;
Percent of total CPFF issuance: 1.2%.
Rank: 21;
Issuer of unsecured commercial paper or sponsor of ABCP issuer: WestLB
(Germany);
ABCP: $8.2;
Unsecured commercial paper: $0.0;
Issuer total: $8.2;
Percent of total CPFF issuance: 1.1%.
Rank: 22;
Issuer of unsecured commercial paper or sponsor of ABCP issuer:
Merrill Lynch & Co;
ABCP: $0.0;
Unsecured commercial paper: $8.0;
Issuer total: $8.0;
Percent of total CPFF issuance: 1.1%.
Rank: 23;
Issuer of unsecured commercial paper or sponsor of ABCP issuer: Allied
Irish Bank (Ireland);
ABCP: $0.0;
Unsecured commercial paper: $6.6;
Issuer total: $6.6;
Percent of total CPFF issuance: 0.9%.
Rank: 24;
Issuer of unsecured commercial paper or sponsor of ABCP issuer:
Bayerische Motoren Werke AG (Germany);
ABCP: $0.0;
Unsecured commercial paper: $6.2;
Issuer total: $6.2;
Percent of total CPFF issuance: 0.8%.
Rank: 25;
Issuer of unsecured commercial paper or sponsor of ABCP issuer:
Handelsbanken (Sweden);
ABCP: $0.0;
Unsecured commercial paper: $6.0;
Issuer total: $6.0;
Percent of total CPFF issuance: 0.8%.
Rank: All Others;
ABCP: $24.9;
Unsecured commercial paper: $61.8;
Issuer total: $86.7;
Percent of total CPFF issuance: 11.8%.
Total:
ABCP: $342.3;
Unsecured commercial paper: $395.9;
Issuer total: $738.3;
Percent of total CPFF issuance: 100.0%.
Source: GAO analysis of Federal Reserve Board data.
Note: In the above figure, total amounts borrowed represent the sum of
all loans. Total borrowing is aggregated at the parent company level
and generally includes borrowing by branches, agencies, subsidiaries,
and sponsored ABCP conduits that we could identify. Total borrowing
for each parent company consolidates amounts borrowed by acquired
institutions as of the date the acquisition was completed. The country
of domicile is shown in parentheses for companies based outside the
United States.
[End of table]
Interest Rates and Credit Surcharges:
CPFF controlled for changes in short-term interest rates by setting
the price of commercial paper issuance to CPFF at a fixed spread above
the daily 3-month overnight indexed swap (OIS) rate, a rate that
tracks investor expectations about the future federal funds rate.
Consistent with market practice, commercial paper issued to CPFF was
sold at a discount from face value based on the interest rate. Table
21 summarizes the pricing structure for CPFF. The higher funding costs
for ABCP relative to unsecured paper backed by the full faith and
credit of the issuer reflected the riskiness and illiquidity of the
underlying collateral in ABCP conduits.[Footnote 152] To secure loans
against purchases of unsecured paper, CPFF required issuers of
unsecured paper to pay a credit surcharge. FRBNY intended for these
surcharges to absorb potential losses and based the level of the
surcharge on historical loss rates for highly rated commercial paper.
Issuers of unsecured paper did not have to pay a surcharge to CPFF if
their paper was guaranteed by the Federal Deposit Insurance
Corporation through its Temporary Liquidity Guarantee Program
(TLGP).[Footnote 153]
Table 21: Interest rates for CPFF:
Rates and fees: Interest rate;
Unsecured commercial paper: 3-month OIS + 100 basis points;
ABCP: 3-month OIS + 300 basis points.
Rates and fees: Credit surcharge;
Unsecured commercial paper: 100 basis points;
ABCP: None.
Rates and fees: All-in-cost;
Unsecured commercial paper: 3-month OIS + 200 basis points;
ABCP: 3-month OIS + 300 basis points.
Source: CPFF program terms and conditions.
[End of table]
Registration Fees:
To sell commercial paper to CPFF, an issuer was first required to
register in advance of the initial issuance. Issuers were required to
pay a registration fee of 10 basis points charged on the maximum
amount an issuer could sell to CPFF. This fee also served as an
insurance premium that could absorb potential losses. The registration
process allowed FRBNY to verify eligibility criteria, review the
issuer's credit quality, and process the registration fee.
Key Vendors for CPFF:
Table 22 lists the key vendors FRBNY used to help administer the CPFF.
Table 22: Vendors for Commercial Paper Funding Facility That Earned
Fees Greater than $1 Million:
Vendor: PIMCO;
Services provided: Investment manager, transaction agent;
Contract date: 10/20/2008;
Awarded competitively? No;
Total fees paid (2008-2010): $33,608,841.
Vendor: State Street Corporation;
Services provided: Administrator, custodian;
Contract date: 10/20/2008;
Awarded competitively? No;
Total fees paid (2008-2010): $8,809,904.
Source: GAO presentation of FRBNY data.
[End of table]
[End of section]
Appendix VIII: Direct Money Market Mutual Fund Lending Facility:
Table: Key observations;
* Authorized under section 13(3) of the Federal Reserve Act of 1913.;
* The Direct Money Market Mutual Fund Liquidity Facility (DMLF) was
authorized to help money market mutual funds to provide additional
liquidity support following the failure of Lehman Brothers Holdings
Inc.;
* The program's authorization was rescinded on October 10, 2008 and
never became operational;
Date announced: n/a;
Dates of operation: Never became operational;
Total unique borrowers: n/a;
Total loans: n/a;
Loans outstanding under DMLF: n/a.
Source: GAO summary of Board of Governors of the Federal Reserve
System documents.
[End of table]
Background:
On October 3, 2008, the Board of Governors of the Federal Reserve
System (Federal Reserve Board) authorized the creation of the Direct
Money Market Mutual Fund Lending Facility (DMLF) under section 13(3)
of the Federal Reserve Act of 1913 to provide loans to money market
mutual funds (MMMF) to help them address liquidity challenges that
emerged following the failure of Lehman Brothers Holdings Inc. in
September 2008. Following the launch of the Asset-Backed Commercial
Paper Money Market Mutual Fund Liquidity Facility (AMLF) on September
22, 2008, DMLF was approved to provide additional liquidity support to
MMMFs facing redemption pressures from their investors and to help
prevent forced sales of high-credit quality assets by MMMFs.
However, after consultation with market participants about the
program's feasibility, the Federal Reserve Board decided against
implementing it. An October 9, 2008, Federal Reserve Board staff memo
noted that market participants expressed the view that DMLF could be
counterproductive as increased leverage among MMMFs through DMLF
borrowing could undermine confidence in the MMMF industry. On October
10, 2008, the Federal Reserve Board rescinded its approval of DMLF and
the program never became operational.
If DMLF had been implemented and used, the Federal Reserve Banks of
Atlanta and Chicago would have extended DMLF loans to eligible MMMFs
against eligible collateral and applied a standard schedule of
haircuts. The Federal Reserve Board anticipated that DMLF eligibility
would have been limited to 2a-7 MMMFs participating in the Department
of Treasury's (Treasury) Temporary Guarantee Program for Money Market
Funds.[Footnote 154] The initial program authorization limited
eligible collateral to all U.S. dollar-denominated securities,
excluding Treasury or agency securities, rated A-1/P-1 or the
equivalent with maturities from 1 to 28 days. DMLF loans would have
been extended with recourse to the MMMFs' assets.
[End of section]
Appendix IX: Dollar Swap Lines with Foreign Central Banks:
Figure 16: Overview of Dollar Swap Lines with Foreign Central Banks:
[Refer to PDF for image: line graph and associated data]
Key observations:
* Authorized under section 14 of the Federal Reserve Act of 1913.
* Announced concurrently with the Term Auction Facility.
* The Federal Open Market Committee approved swap lines with 14
foreign central banks to address stresses in U.S. dollar funding in
overseas markets.
* The foreign central banks used dollars obtained through the swap
lines to make dollar loans to institutions in their jurisdictions and
assumed the risk of losses from this lending.
* Dollars outstanding to foreign central banks peaked at $586 billion
in December 2008, with the European Central Bank accounting for about
80 percent of total dollars drawn.
Date announced: December 12, 2007.
Dates of operation: December 17, 2007-February 1, 2010[A].
Unique borrowers: n/a.
Total number of transactions: 569.
Weekly foreign exchange swap line amounts outstanding by foreign central
bank, December 1, 2010-July 21, 2010:
[Multiple line graph]
Dollars in billions.
Initial value depicted for each month.
December 2007;
European Central Bank: $0;
Bank of England: $0;
Swiss National Bank: $0;
Bank of Japan: $0;
Others: $0.
January 2008;
European Central Bank: $20;
Bank of England: $0;
Swiss National Bank: $4;
Bank of Japan: $0;
Others: $0.
February 2008;
European Central Bank: $20;
Bank of England: $0;
Swiss National Bank: $4;
Bank of Japan: $0;
Others: $0.
March 2008;
European Central Bank: $0;
Bank of England: $0;
Swiss National Bank: $0;
Bank of Japan: $0;
Others: $0.
April 2008;
European Central Bank: $15;
Bank of England: $0;
Swiss National Bank: $6;
Bank of Japan: $0;
Others: $0.
May 2008;
European Central Bank: $30;
Bank of England: $0;
Swiss National Bank: $6;
Bank of Japan: $0;
Others: $0.
June 2008;
European Central Bank: $50;
Bank of England: $0;
Swiss National Bank: $12;
Bank of Japan: $0;
Others: $0.
July 2008;
European Central Bank: $50;
Bank of England: $0;
Swiss National Bank: $12;
Bank of Japan: $0;
Others: $0.
August 2008;
European Central Bank: $50;
Bank of England: $0;
Swiss National Bank: $12;
Bank of Japan: $0;
Others: $0.
September 2008;
European Central Bank: $50;
Bank of England: $0;
Swiss National Bank: $12;
Bank of Japan: $0;
Others: $0.
October 2008;
European Central Bank: $162;
Bank of England: $50.91;
Swiss National Bank: $28.9;
Bank of Japan: $29.622;
Others: $15.
November 2008;
European Central Bank: $293.681;
Bank of England: $71.915;
Swiss National Bank: $28.421;
Bank of Japan: $70.168;
Others: $64.17.
December 2008;
European Central Bank: $264.113;
Bank of England: $54.295;
Swiss National Bank: $20.851;
Bank of Japan: $96.99;
Others: $70.57.
January 2009;
European Central Bank: $281.718;
Bank of England: $33.46;
Swiss National Bank: $23.185;
Bank of Japan: $118.394;
Others: $81.405.
February 2009;
European Central Bank: $206.373;
Bank of England: $23.453;
Swiss National Bank: $20.38;
Bank of Japan: $84.582;
Others: $52.66.
March 2009;
European Central Bank: $155.466;
Bank of England: $15.993;
Swiss National Bank: $6.8679;
Bank of Japan: $70.994;
Others: $65.89.
April 2009;
European Central Bank: $165.717;
Bank of England: $14.963;
Swiss National Bank: $6.1923;
Bank of Japan: $61.025;
Others: $60.895.
May 2009;
European Central Bank: $130.102;
Bank of England: $13.488;
Swiss National Bank: $11.6507;
Bank of Japan: $39.81;
Others: $54.251.
June 2009;
European Central Bank: $99.7276;
Bank of England: $2.488;
Swiss National Bank: $8.7844;
Bank of Japan: $25.006;
Others: $39.736.
July 2009;
European Central Bank: $59.8988;
Bank of England: $2.503;
Swiss National Bank: $0.3688;
Bank of Japan: $17.923;
Others: $33.891.
August 2009;
European Central Bank: $48.2522;
Bank of England: $0.013;
Swiss National Bank: $0.019;
Bank of Japan: $8.113;
Others: $19.874.
September 2009;
European Central Bank: $46.112;
Bank of England: $0.013;
Swiss National Bank: $0.01;
Bank of Japan: $2.121;
Others: $15.031.
October 2009;
European Central Bank: $37.7368;
Bank of England: $0.013;
Swiss National Bank: $0;
Bank of Japan: $1.53;
Others: $10.551.
November 2009;
European Central Bank: $24.6654;
Bank of England: $0.013;
Swiss National Bank: $0;
Bank of Japan: $0.935;
Others: $6.271.
December 2009;
European Central Bank: $18.939;
Bank of England: $0.013;
Swiss National Bank: $0;
Bank of Japan: $0.415;
Others: $3.671.
January 2010;
European Central Bank: $6.506;
Bank of England: $0;
Swiss National Bank: $0;
Bank of Japan: $0.545;
Others: $3.221.
February 2010;
European Central Bank: $0;
Bank of England: $0;
Swiss National Bank: $0;
Bank of Japan: $0.1;
Others: $0.
March 2010;
European Central Bank: $0;
Bank of England: $0;
Swiss National Bank: $0;
Bank of Japan: $0;
Others: $0.
April 2010;
European Central Bank: $0;
Bank of England: $0;
Swiss National Bank: $0;
Bank of Japan: $0;
Others: $0.
May 2010;
European Central Bank: $0;
Bank of England: $0;
Swiss National Bank: $0;
Bank of Japan: $0;
Others: $0.
June 2010;
European Central Bank: $6.432;
Bank of England: $0;
Swiss National Bank: $0;
Bank of Japan: $0.21;
Others: $0.
July 2010;
European Central Bank: $1.032;
Bank of England: $0;
Swiss National Bank: $0;
Bank of Japan: $0.213;
Others: $0.
Source: GAO analysis of Board of Governors of the Federal Reserve
System documents and data.
[A] As noted in the following section, in May 2010, swap lines were
reopened with some foreign central banks.
[End of figure]
Background:
In 2007 and 2008, the Federal Open Market Committee (FOMC) authorized
the Federal Reserve Bank of New York (FRBNY) to open temporary dollar
swap lines with 14 foreign central banks to enhance the ability of
these foreign central banks to provide U.S. dollar funding to
financial institutions in their jurisdictions. Table 23 lists the
dates the FOMC announced swap lines with these central banks. The swap
lines expired on February 1, 2010. In May 2010, in response to the re-
emergence of strains in short-term dollar funding markets abroad, the
FOMC reauthorized dollar liquidity swap lines with five foreign
central banks through January 2011.[Footnote 155] On December 21,
2010, the FOMC announced an extension of these lines through August 1,
2011. On June 29, 2011, the FOMC announced an extension of these lines
through August 1, 2012.
Table 23: Announcement Dates for FRBNY's Dollar Swap Lines with
Foreign Central Banks:
Date: December 12, 2007;
Foreign central bank: European Central Bank and Swiss National Bank.
Date: September 18, 2008;
Foreign central bank: Bank of Japan, Bank of England, and Bank of
Canada.
Date: September 24, 2008;
Foreign central bank: Reserve Bank of Australia, Sveriges Riksbank
(Sweden), Norges Bank (Norway), Danmarks Nationalbank (Denmark).
Date: October 28, 2008;
Foreign central bank: Reserve Bank of New Zealand.
Date: October 29, 2008;
Foreign central bank: Banco Central do Brasil (Brazil), Banco de
Mexico, Bank of Korea (South Korea), and Monetary Authority of
Singapore.
Source: Federal Reserve Board press releases.
[End of table]
Figure 26 illustrates a typical swap line transaction, in which FRBNY
exchanged dollars for the foreign central bank's currency at the
prevailing exchange rate and the foreign central bank agreed to buy
back its currency (to "unwind" the exchange) at this same exchange
rate at an agreed upon future date. The foreign central bank would
then lend the dollars to banks in its jurisdiction. Foreign central
banks assumed the risk of losses on these dollar loans and paid FRBNY
the interest collected on these loans. FRBNY did not pay interest on
the foreign currency it received under the swap lines. To avoid
difficulties that could arise for foreign central banks in managing
the level of their currency reserves, FRBNY agreed not to lend or
invest the foreign currency.
Figure 26: Dollar Swap Line Transaction:
[Refer to PDF for image: illustration]
1) FRBNY sends dollars to European Central Bank.
2) Distribution of dollar loans to financial institutions under its
jurisdiction.
3) European Central Bank sends dollars and interest to FRBNY.
Source: GAO presentation of FRBNY information.
[End of figure]
The FOMC approved these swap line arrangements to help address
challenges in the global market for interbank lending in U.S. dollars.
Many foreign banks held U.S. dollar-denominated assets and faced
challenges borrowing in dollars to fund these assets. In contrast to
U.S. commercial banks, foreign banks did not hold significant U.S.
dollar deposits, and as a result, dollar funding strains were
particularly acute for many foreign banks. The Board of Governors of
the Federal Reserve System (Federal Reserve Board) staff memos
recommending that the FOMC approve swap lines noted that continuing
strains in dollar funding markets abroad could further exacerbate
strains in U.S. funding markets. For example, foreign banks facing
difficulties borrowing against U.S. dollar assets may have faced
increased pressure to sell these assets at a time of stress,
potentially putting downward pressure on prices for these assets. The
dollar swap lines allowed foreign central banks to make dollar loans
to banks in their jurisdictions without being forced to draw down
dollar holdings of foreign exchange reserves or to acquire dollars
directly in the foreign exchange market. An FRBNY staff paper noted
that the dollar reserves of many foreign central banks at the start of
the crisis were smaller than the amounts they borrowed under the swap
lines and that efforts by foreign central banks to buy dollars in the
market could have crowded out private transactions, making it more
difficult for foreign banks to obtain dollars.[Footnote 156] This
paper further noted that the Federal Reserve System (the Federal
Reserve Board and Reserve Banks collectively) was in a unique position
to provide dollars needed by foreign central banks to provide lender-
of-last-resort liquidity to banks in their jurisdictions. The increase
in reserves was offset through sales of Treasury securities and
increasing incentives for depository institutions to hold excess
reserves at FRBNY.
The Federal Reserve Board authorized these swap lines under section 14
of the Federal Reserve Act of 1913. The Federal Reserve Board has
interpreted section 14 of the Federal Reserve Act to permit the
Federal Reserve Banks to conduct open market operations in foreign
exchange markets and to open and maintain accounts in foreign currency
with foreign central banks. Section 14 states that "any Federal
reserve bank may…purchase and sell in the open market, at home or
abroad, either from or to domestic or foreign banks, firms,
corporations, or individuals, cable transfers…" The Federal Reserve
Board has interpreted "cable transfers" to mean foreign exchange.
Section 14(e) authorizes Reserve Banks to "open and maintain accounts
in foreign countries, appoint correspondents, and establish agencies
in such countries" and "to open and maintain banking accounts for…
foreign banks or bankers." Federal Reserve Board officials noted that
the establishment of dollar swap lines with foreign central banks was
not unprecedented. In the days following the September 11, 2001,
terrorist attacks, the FOMC authorized a similar system of swap lines
to help ensure the continued functioning of global financial markets.
Use of Dollar Swap Lines by Foreign Central Banks:
Table 24 lists the foreign central banks in order of the aggregate
amount of dollars drawn under the swap line arrangements with FRBNY.
The European Central Bank received the largest amount of dollars under
the swap line arrangements. Banco do Brasil, Bank of Canada, Monetary
Authority of Singapore, and the Reserve Bank of New Zealand did not
draw on their swap lines. The European Central Bank accounted for
about 80 percent of total dollars drawn under the swap lines.
Table 24: Foreign Central Banks' Use of Dollar Swap Lines by Aggregate
Dollar Transactions:
Dollars in billions.
Rank: 1;
Central bank: European Central Bank;
Number of transactions: 271;
Aggregate dollar transactions: $8,011;
Percent of total: 79.7%.
Rank: 2;
Central bank: Bank of England;
Number of transactions: 114;
Aggregate dollar transactions: $919;
Percent of total: 9.1%.
Rank: 3;
Central bank: Swiss National Bank;
Number of transactions: 81;
Aggregate dollar transactions: $466;
Percent of total: 4.6%.
Rank: 4;
Central bank: Bank of Japan;
Number of transactions: 35;
Aggregate dollar transactions: $387;
Percent of total: 3.9%.
Rank: 5;
Central bank: Danmarks Nationalbank (Denmark);
Number of transactions: 19;
Aggregate dollar transactions: $73;
Percent of total: 0.7%.
Rank: 6;
Central bank: Sveriges Riksbank (Sweden);
Number of transactions: 18;
Aggregate dollar transactions: $67;
Percent of total: 0.7%.
Rank: 7;
Central bank: Reserve Bank of Australia;
Number of transactions: 10;
Aggregate dollar transactions: $53;
Percent of total: 0.5%.
Rank: 8;
Central bank: Bank of Korea (South Korea);
Number of transactions: 10;
Aggregate dollar transactions: $41;
Percent of total: 0.4%.
Rank: 9;
Central bank: Norges Bank (Norway);
Number of transactions: 8;
Aggregate dollar transactions: $30;
Percent of total: 0.3%.
Rank: 10;
Central bank: Banco de Mexico;
Number of transactions: 3;
Aggregate dollar transactions: $10;
Percent of total: 0.1%.
Total:
Number of transactions: 569;
Aggregate dollar transactions: $10,057;
Percent of total: 100.0%.
[End of table]
Note: Foreign central banks not included in this table did not draw
dollars under their swap line agreement with FRBNY. Aggregate dollar
transactions represent the sum of all dollars drawn under the swap
line arrangements and have not been adjusted to reflect differences in
the terms over which the dollar draws were outstanding.
Source: GAO analysis of Federal Reserve Board data.
[End of section]
Appendix X: Money Market Investor Funding Facility:
Table: Key observations:
* Authorized under section 13(3) of the Federal Reserve Act of 1913;
* The Money Market Investor Funding Facility (MMIFF) was created to
provide additional liquidity support to money market mutual funds
(MMMF), but was never used;
* Through MMIFF, the Federal Reserve Bank of New York (FRBNY) would
have extended loans to special purpose vehicles (SPV) created in
collaboration with the private sector to purchase eligible financial
instruments held by MMMFs;
* MMMFs selling assets to an MMIFF SPV would have had to fund 10
percent of the purchase price in the form of a subordinated note
issued by the SPV; any initial losses on an SPV's assets would have
been absorbed by MMMFs holding the subordinated note;
* Feedback FRBNY received from MMMFs indicated that they would have
accessed MMIFF only under a significant deterioration of market
conditions that did not occur during the life of the MMIFF program;
Date announced: October 21, 2008;
Dates of operation: November 24, 2008-October 30, 2009;
Total unique borrowers: 0;
Total loans: 0;
MMIFF loans: n/a.
Source: GAO summary of Board of Governors of the Federal Reserve
System documents.
[End of table]
Background:
On October 21, 2008, the Board of Governors of the Federal Reserve
System (Federal Reserve Board) authorized the Federal Reserve Bank of
New York (FRBNY) to work with the private sector to create the Money
Market Investor Funding Facility (MMIFF) under section 13(3) of the
Federal Reserve Act of 1913 to provide additional liquidity support to
money market mutual funds (MMMF). MMIFF became operational on November
24, 2008. Of the Federal Reserve Board's broad-based emergency
programs that became operational, MMIFF was the only program that was
never used. MMIFF was initially set to expire on April 30, 2009, but
did not close until October 30, 2009.
As discussed in appendix II, which provides an overview of the Asset-
Backed Commercial Paper Money Market Mutual Fund Liquidity Facility
(AMLF), beginning in mid-September 2008, MMMFs faced considerable
liquidity pressure from increased redemption demands from investors.
To meet these redemption demands, MMMFs faced pressure to sell assets
into stressed markets, and the Federal Reserve Board observed that
MMMFs became increasingly reluctant to purchase new debt obligations
of financial institutions, particularly at longer-dated maturities.
The Federal Reserve Board became concerned that liquidity pressures on
MMMFs were exacerbating difficulties for financial institutions in
borrowing in short-term debt markets, further impairing these
institutions' capacity to meet the credit needs of households and
businesses.
MMIFF was intended to complement AMLF by standing ready to purchase a
broader range of short-term debt instruments held by MMMFs. AMLF,
which began operation in September 2008, financed the purchase of
MMMFs' highly rated asset-backed commercial paper (ABCP). In addition
to ABCP, MMMFs were significant investors in other short-term debt
instruments of financial institutions, such as certificates of
deposit, bank notes, and commercial paper. Federal Reserve Board and
FRBNY staff noted that the ability of AMLF to address MMMFs' liquidity
problems was limited by the amount of eligible ABCP held by MMMFs and
that not all MMMFs had significant holdings of eligible ABCP. By
allowing MMMFs to sell a broader range of debt instruments at
amortized cost--rather than at losses into the markets--MMIFF was
intended to reduce the liquidity risks faced by MMMFs and to encourage
them to continue or renew purchases of these instruments. FRBNY staff
with whom we spoke observed that even if an MMMF did not sell assets
through MMIFF, knowing that these assets could be sold to MMIFF if
needed provided a form of insurance to MMMFs choosing to continue to
hold them.
MMIFF's design featured a relatively complex lending structure
intended to facilitate additional liquidity support for MMMFs while
building in additional loss protection through a subordinated note
feature. Unlike AMLF, which made loans to intermediary borrowers to
finance purchases of ABCP, MMIFF created five special purpose vehicles
(SPV) that could use FRBNY loans to help finance purchases of eligible
assets from MMMFs. MMIFF-eligible assets included short-term debt
obligations of 50 financial institutions that FRBNY determined were
broadly held by many MMMFs. FRBNY planned to fund 90 percent of each
SPV's purchases of eligible MMIFF assets with a senior loan. The
remaining 10 percent of MMIFF purchases would have been funded by a
subordinated note issued by the MMIFF SPV to the selling MMMF. The
first 10 percent of any losses on assets held by a MMIFF SPV would
have been absorbed by the subordinated note holders. This would have
mitigated some of FRBNY's risk on loans to the SPV. The Federal
Reserve Board authorized FRBNY to lend up to $540 billion to the MMIFF
SPVs, which could have facilitated the purchase of up to $600 billion
of assets from eligible funds.
In contrast to SPVs created by other Federal Reserve Board programs,
the MMIFF SPVs were set up and managed by the private sector in
collaboration with FRBNY. According to FRBNY staff, JP Morgan Chase &
Co. (JPMC), in collaboration with other firms that sponsored large
MMMFs, brought the idea for an MMIFF-like facility to FRBNY in early
October 2008. FRBNY worked with JPMC to set up the MMIFF SPVs but did
not contract directly with JPMC or the firm that managed the MMIFF
SPVs. The deployment of multiple SPVs was intended, in part, to better
ensure that MMIFF could continue to provide funding support in the
event that one of its SPVs was required to cease purchases.[Footnote
157]
Because 2a-7 funds could only purchase and hold highly rated debt
instruments, the Federal Reserve Board and FRBNY designed MMIFF terms
and conditions to help ensure that the subordinated notes issued by
each SPV would receive the highest rating from two or more major
Nationally Recognized Statistical Rating Organizations (NRSRO). MMIFF
SPVs were required to hold any assets purchased until the assets
matured, and proceeds from these assets were to be used to repay
FRBNY's senior loan and the subordinated note. Minimum yield
requirements for assets eligible for purchase and terms for the
interest rate to be paid to FRBNY were set to help ensure that SPVs
would accumulate sufficient excess income (the positive difference
between the yield on purchased assets and interest owed) to absorb
potential losses.
MMIFF was never used. Feedback FRBNY received from MMMFs indicated
that they viewed MMIFF as a backstop that they would access only in
dire circumstances. According to FRBNY, JPMC, as structuring advisor,
bore the expenses associated with operating the MMIFF, including
payments to the vendors hired by the MMIFF SPVs.
Terms and Conditions for MMIFF:
Assets Eligible for Sale through MMIFF:
MMIFF SPVs were prepared to purchase U.S. dollar-denominated
certificates of deposit, bank notes, and commercial paper issued by
selected financial institutions and having a remaining maturity of 7
to 90 days. The selected financial institutions initially included 50
institutions chosen by representatives of the U.S. MMMF industry,
according to the Federal Reserve Board and FRBNY. MMIFF program terms
required each of the 50 financial institutions to maintain the highest
short-term debt rating (A-1/P-1/F-1) from two or more major NRSROs. As
illustrated in figure 27, each of the five SPVs was authorized to
purchase obligations of 10 of the 50 designated institutions. FRBNY
staff said that the 50 institutions selected were determined to be
among the largest issuers of MMIFF-eligible assets held by MMMFs. In
addition, FRBNY staff said that the selected group reflected the need
to achieve geographical diversification in each of the five SPVs that
could help reduce the risk of the pool of assets held by any given
SPV. In addition, to be eligible for MMIFF purchase, assets had to
meet minimum yield requirements set by the Federal Reserve Board to
help ensure that SPVs would earn a sufficient spread between assets
purchased and the interest rate on the senior loan to FRBNY.
Figure 27: Five MMIFF SPVs and Approved Financial Institutions for
Each:
[Refer to PDF for image: illustrated table]
Country of domicile: United States;
MMIFF SPVs:
Hadrian ($220 billion): Bank of America; Citigroup;
Trajan ($150 billion): J.P. Morgan Chase & Co.; Natixis[A];
Aurelius ($140 billion): General Electric; Wells Fargo;
Antonious ($70 billion): Bank of New York Mellon; State Street;
Nerva ($20 billion): PNC; U.S. Bank.
Country of domicile: United Kingdom;
MMIFF SPVs:
Hadrian ($220 billion): Royal Bank of Scotland
Trajan ($150 billion): Barclays;
Aurelius ($140 billion): Bank of Scotland;
Antonious ($70 billion): Lloyds TSB;
Nerva ($20 billion): HSBC.
Country of domicile: France/Belgium/Spain;
MMIFF SPVs:
Hadrian ($220 billion): BNP Paribas;
Trajan ($150 billion): Societe Generale;
Aurelius ($140 billion): Dexia;
Antonious ($70 billion): Santander;
Nerva ($20 billion): CIC.
Country of domicile: Scandinavian countries/other;
MMIFF SPVs:
Hadrian ($220 billion): Nordea;
Trajan ($150 billion): Svenska Handelsbanken;
Aurelius ($140 billion): Danske Bank;
Antonious ($70 billion): Abbey National;
Nerva ($20 billion): DnB Nor.
Country of domicile: Canada;
MMIFF SPVs:
Hadrian ($220 billion): Royal Bank of Canada;
Trajan ($150 billion): Bank of Montreal;
Aurelius ($140 billion): Toronto Dominion;
Antonious ($70 billion): Bank of Nova Scotia;
Nerva ($20 billion): CIBC.
Country of domicile: Australia/New Zealand;
MMIFF SPVs:
Hadrian ($220 billion): Westpac Banking Corporation;
Trajan ($150 billion): ANZ;
Aurelius ($140 billion): Comm. Bank of Australia;
Antonious ($70 billion): National Australia Bank;
Nerva ($20 billion): Westpac NZ.
Country of domicile: Other foreign;
MMIFF SPVs:
Hadrian ($220 billion): Calyon/Credit Agricole; Intesa San Paolo;
Trajan ($150 billion): BBVA; Rabobank;
Aurelius ($140 billion): Credit Suisse; ING;
Antonious ($70 billion): Allied Irish Bank; Deutsche Bank;
Nerva ($20 billion): ABN Amro; KBC.
Country of domicile: United States or other;
MMIFF SPVs:
Hadrian ($220 billion): UBS;
Trajan ($150 billion): Unicredito;
Aurelius ($140 billion): Bank of Ireland;
Antonious ($70 billion): Toyota Motor Credit;
Nerva ($20 billion): Wachovia.
Source: GAO presentation of FRBNY program documentation for MMIFF.
Note: According to FRBNY staff, a few of the 50 institutions initially
selected experienced ratings downgrades that made their short-term
debt obligations ineligible for MMIFF purchase. In January 2009,
following a ratings downgrade of Dexia, FRBNY approved the suggestion
by JPMC, the MMIFF referral agent, to replace Dexia with Bank of Tokyo
Mitsubishi. According to FRBNY staff, the other downgraded
institutions were not replaced because it appeared unnecessary given
the projection for limited use of the MMIFF.
[A] Natixis is based in France.
[End of figure]
Seller Eligibility:
Initially, all U.S. 2a-7 MMMFs were eligible to sell assets through
MMIFF.[Footnote 158] On January 7, 2009, the Federal Reserve Board
expanded MMIFF eligibility to include other funds that were managed or
owned by a U.S. bank, insurance company, pension fund, trust company,
Securities and Exchange Commission-registered investment advisor, or a
U.S. state-or local-government entity.[Footnote 159]
Concentration Limits:
At the time of an MMIFF SPV's purchase from an eligible investor of a
debt instrument issued by 1 of the 50 financial institutions, debt
instruments issued by that financial institution could not exceed 15
percent of the assets of the SPV (except during the initial ramp-up
period, when the limit was 20 percent).
Interest Rates:
FRBNY committed to lend to the MMIFF SPVs at the primary credit rate
in effect at the time of the loan. To protect subordinated note
holders from increases in the primary credit rate to be paid to FRBNY,
which could reduce SPV income available to pay the subordinated note
holders, FRBNY agreed to subordinate its right to receive certain
amounts of potential interest payments if the primary credit rate rose
above specified levels. The interest rate earned by subordinated note
holders was expected to be at least 25 basis points below the interest
rate on the assets they sold to the MMIFF SPV.
Accumulated Interest Income:
Accumulated interest income remaining after full repayment of the
senior loan and subordinated note would be distributed to subordinated
note holders and FRBNY. According to MMIFF terms and conditions, a
small fixed amount of any accumulated income remaining in a MMIFF SPV
after completion of a wind-down process would have been allocated
proportionally among funds that sold assets to the SPVs. FRBNY would
have received any remaining income.
Program Structure:
Figure 28 illustrates the structure of MMIFF. Five SPVs were created
as limited liability companies incorporated in Delaware to purchase
eligible money market instruments from eligible investors using
financing from FRBNY and from the issuance of ABCP. JPMC, the referral
agent, stood ready to solicit sales of eligible assets from eligible
sellers. These assets would then have been purchased at amortized cost
using a loan from FRBNY for 90 percent of the purchase price. For the
other 10 percent, the SPV would have issued to the seller of the
eligible asset subordinated ABCP equal to 10 percent of the asset's
purchase price.
Figure 28: Structure of the MMIFF:
[Refer to PDF for image: illustration]
Custodian bank (MMIFF SPV): secured loan from FRBNY.
Send ABCP; 10% and 90% cash to 2a-7 MMMF and others.
2a-7 MMMF and others: Eligible assets (bank notes, certificates of
deposit, commercial paper) to Custodian Bank (MMIFF SPV).
Source: GAO presentation of FRBNY information.
[End of figure]
Key Vendors for MMIFF:
All of the MMIFF service providers were hired directly by the SPVs.
FRBNY engaged a single law firm to act as deal counsel, but otherwise
did not participate in any direct hiring of vendors for this program.
However, FRBNY reviewed all relevant contracts to ensure their
interests as the senior lender were protected.
[End of section]
Appendix XI: Primary Dealer Credit Facility and Credit Extensions for
Affiliates of Primary Dealers:
Figure 29: Overview of PDCF and Credit Extensions for Affiliates of
Primary Dealers:
[Refer to PDF for image: multiple line graph and associated data]
Key observations:
* Created under section 13(3) of the Federal Reserve Act of 1913.
* The Primary Dealer Credit Facility (PDCF) provided collateralized,
overnight cash loans to primary dealers to help address challenges in
secured funding markets.
* The Board of Governors of the Federal Reserve System (Federal
Reserve Board) expanded the types of collateral accepted for PDCF
loans in September 2008.
* PDCF use peaked on September 26, 2008, at $130 billion.
* In 2008, the Federal Reserve Board authorized lending to U.S. and
London affiliates of four primary dealers on terms similar to those
available through the PDCF. These primary dealers were Goldman Sachs
Group Inc., Morgan Stanley, Merrill Lynch, and Citigroup Inc.
Dates of operation: March 17, 2008-February 1, 2010;
Total unique borrowers: 18 (for PDCF);
Total loans: 1,021 for PDCF and 355 loans to London affiliates of four
primary dealers;
Figure: Loans outstanding under PDCF and credit extensions to London
affiliates of some firms, March 17, 2008-February 1, 2010:
[Multiple line graph]
Dollars in billions:
Initial values for each month are depicted:
March 2008;
PDCF: $34.5;
Credit extensions to London affiliates of some firms: $0.
April 2008;
PDCF: $35.5;
Credit extensions to London affiliates of some firms: $0.
May 2008;
PDCF: $17.7;
Credit extensions to London affiliates of some firms: $0.
June 2008;
PDCF: $8.5;
Credit extensions to London affiliates of some firms: $0.
July 2008;
PDCF: $4.7;
Credit extensions to London affiliates of some firms: $0.
September 2008;
PDCF: $2.4;
Credit extensions to London affiliates of some firms: $0.
[Peak loans outstanding (PDCF only): $130 billion (September 26, 2008)]
[Peak loans outstanding (including London affiliates): $156 billion
(September 29, 2008)]
October 2008;
PDCF: $105.6;
Credit extensions to London affiliates of some firms: $41.
November 2008;
PDCF: $64.9;
Credit extensions to London affiliates of some firms: $14.6.
December 2008;
PDCF: $46.2;
Credit extensions to London affiliates of some firms: $14.
January 2009;
PDCF: $23.3;
Credit extensions to London affiliates of some firms: $13.3.
February 2009;
PDCF: $24.7;
Credit extensions to London affiliates of some firms: $6.
March 2009;
PDCF: $19.8;
Credit extensions to London affiliates of some firms: $3.8.
April 2009;
PDCF: $15.8;
Credit extensions to London affiliates of some firms: $2.5.
May 2009;
PDCF: $0.6;
Credit extensions to London affiliates of some firms: $0.
June 2009;
PDCF: $0;
Credit extensions to London affiliates of some firms: $0.
July 2009;
PDCF: $0;
Credit extensions to London affiliates of some firms: $0.
August 2009;
PDCF: $;
Credit extensions to London affiliates of some firms: $0.
September 2009;
PDCF: $0;
Credit extensions to London affiliates of some firms: $0.
October 2009;
PDCF: $0;
Credit extensions to London affiliates of some firms: $0.
November 2009;
PDCF: $0;
Credit extensions to London affiliates of some firms: $0.
December 2009;
PDCF: $0;
Credit extensions to London affiliates of some firms: $0.
January 2010;
PDCF: $0;
Credit extensions to London affiliates of some firms: $0.
February 2010;
PDCF: $0;
Credit extensions to London affiliates of some firms: $0.
Source: GAO analysis of Board of Governors of the Federal Reserve
System documents and data.
[End of figure]
Background:
On March 16, 2008, the Board of Governors of the Federal Reserve
System (Federal Reserve Board) authorized the creation of the Primary
Dealer Credit Facility (PDCF) under section 13(3) of the Federal
Reserve Act of 1913 to provide overnight secured loans to primary
dealers facing strains in the repurchase agreement markets. PDCF was
initially set to expire on January 30, 2009. The Federal Reserve Board
authorized three extensions of the PDCF in response to market
conditions. PDCF was administered by the Federal Reserve Bank of New
York (FRBNY) with operational assistance provided by the Federal
Reserve Banks of Atlanta and Chicago. PDCF expired on February 1, 2010.
On March 11, 2008, the Federal Reserve Board had announced the
creation of the Term Securities Lending Facility (TSLF) to ease these
strains, but the first TSLF auction would not be held until March 27,
2008. Challenges obtaining overnight secured funding had contributed
to the near failure of Bear Stearns in the preceding days, and Federal
Reserve Board officials were concerned that other primary dealers
could face runs on their liquidity. Federal Reserve Board and FRBNY
staff worked over the weekend of March 15-16, 2008, to prepare PDCF
for its launch on Monday, March 17, 2008.
Although PDCF and TSLF were both created to help address funding
challenges faced by the primary dealers, the programs had key
differences, including the following:
* PDCF provided cash loans rather than loans of Treasury securities,
and it provided them against a broader range of collateral than those
eligible for TSLF. By providing funding support for a broader range of
collateral, PDCF was intended to further reduce the potential that
primary dealers might be forced to sell assets into stressed markets
to meet their funding needs.
* While TSLF held scheduled weekly auctions, PDCF was a standing
facility that primary dealers could access as needed.
* While TSLF loaned Treasury securities for terms of about 1 month,
PDCF made overnight loans. Because primary dealers relied on overnight
secured funding through the repurchase agreements markets, they were
vulnerable to potential runs on their liquidity if they were unable to
borrow in those markets, as illustrated by the rapid deterioration in
Bear Stearns' liquidity position. The Federal Reserve Board intended
for PDCF to provide assurance to market participants that primary
dealers would be able to obtain overnight funding against PDCF-
eligible collateral.
As with TSLF, FRBNY used the tri-party repurchase agreement system in
relying on the two major clearing banks--JP Morgan Chase & Co. and
Bank of New York Mellon--to perform collateral custody and valuation
services for PDCF loans.
Figure 30 illustrates the clearing bank's role in a PDCF transaction.
To request a PDCF loan, a primary dealer typically communicated its
loan request to its clearing bank before 5 p.m. on business days. The
clearing bank was responsible for pricing the collateral pledged by
the primary dealer and verifying that a sufficient amount of eligible
collateral had been pledged to secure the requested loan. Once FRBNY
received notice that a sufficient amount of eligible collateral was
assigned to its account, it transferred the loan amount to the
clearing bank for credit to the primary dealer. The clearing banks
priced pledged collateral using a range of pricing services, and
applied haircuts to the collateral based on a schedule set by FRBNY.
Figure 30: Structure of the PDCF:
[Refer to PDF for image: illustration]
Primary dealer: sends collateral to Clearing Bank.
Clearing Bank send collateral to FRBNY.
FRBNY sends loan proceeds to Clearing Bank.
Clearing Bank sends loan proceeds to Primary dealer.
Source: GAO presentation of Federal Reserve Board information.
[End of figure]
In September 2008, strains in credit markets intensified following the
bankruptcy of Lehman Brothers Inc., the parent company of one of the
primary dealers. On September 14, 2008, to help alleviate these
strains, the Federal Reserve Board expanded the types of collateral
eligible for PDCF beyond investment grade securities to include all
collateral eligible for tri-party repurchase agreements through one of
the two major clearing banks. New types of collateral that became
eligible for PDCF included noninvestment grade bonds and equities.
On September 21, 2008, the Federal Reserve Board announced that it
would extend credit on terms similar to those of PDCF to the U.S. and
London broker-dealer subsidiaries of Merrill Lynch & Co. (Merrill
Lynch), Goldman Sachs Group Inc., and Morgan Stanley to provide
support to these subsidiaries as they became part of bank holding
companies that would be regulated by the Federal Reserve System. In
November 2008, as part of a package of federal government assistance
to stabilize Citigroup Inc. (Citigroup), the Federal Reserve Board
authorized an extension of PDCF assistance to the London affiliate of
Citigroup's primary dealer. While the Federal Reserve Board considered
these credit extensions to be separate from the PDCF program, the
interest rates and collateral requirements for these loans were based
on PDCF program requirements. A key difference was that FRBNY accepted
collateral denominated in foreign currencies from the London-based
affiliates, and it applied higher haircuts to this foreign-currency
denominated collateral.
Terms and Conditions for PDCF:
Borrower Eligibility:
PDCF was available only to the primary dealers.
Table 25 ranks the primary dealers by the total dollar amount of their
borrowing through PDCF. The largest five borrowers accounted for
approximately 82.5 percent of the total dollar amount of PDCF loans.
Table 25: Largest PDCF Borrowers by Total Dollar Amount of Loans:
Dollars in billions.
Rank: 1;
Primary dealer: Citigroup Global Markets Inc.;
Total PDCF loans: $1,756.8;
Percent of total: 23.8%.
Rank: 2;
Primary dealer: Morgan Stanley & Co. Inc.;
Total PDCF loans: $1,364.4;
Percent of total: 18.5%.
Rank: 3;
Primary dealer: Merrill Lynch Government Securities Inc.;
Total PDCF loans: $1,281.8;
Percent of total: 17.3%.
Rank: 4;
Primary dealer: Bear Stearns & Co., Inc.;
Total PDCF loans: $850.8;
Percent of total: 11.5%.
Rank: 5;
Primary dealer: Banc of America Securities LLC;
Total PDCF loans: $845.6;
Percent of total: 11.4%.
Rank: 6;
Primary dealer: Goldman Sachs & Co.;
Total PDCF loans: $433.6;
Percent of total: 5.9%.
Rank: 7;
Primary dealer: Barclays Capital Inc.;
Total PDCF loans: $410.4;
Percent of total: 5.6%.
Rank: 8;
Primary dealer: J. P. Morgan Securities Inc.;
Total PDCF loans: $112.3;
Percent of total: 1.5%.
Rank: 9;
Primary dealer: Lehman Brothers Inc.;
Total PDCF loans: $83.3;
Percent of total: 1.1%.
Rank: 10;
Primary dealer: Countrywide Financial Corporation;
Total PDCF loans: $75.6;
Percent of total: 1.0%.
Rank: 11;
Primary dealer: BNP Paribas Securities Corp.;
Total PDCF loans: $66.4;
Percent of total: 0.9%.
Rank: 12;
Primary dealer: Mizuho Securities USA Inc.;
Total PDCF loans: $42.3;
Percent of total: 0.6%.
Rank: 13;
Primary dealer: UBS Securities LLC.;
Total PDCF loans: $35.4;
Percent of total: 0.5%.
Rank: 14;
Primary dealer: Cantor Fitzgerald & Co.;
Total PDCF loans: $28.1;
Percent of total: 0.4%.
Rank: 15;
Primary dealer: Credit Suisse Securities (USA) LLC;
Total PDCF loans: $1.5;
Percent of total: 0.0%.
Rank: 16;
Primary dealer: Deutsche Bank Securities Inc.;
Total PDCF loans: $0.5;
Percent of total: 0.0%.
Rank: 17;
Primary dealer: Daiwa Securities America Inc.;
Total PDCF loans: $0.4;
Percent of total: 0.0%.
Rank: 18;
Primary dealer: Dresdner Kleinwort Securities LLC;
Total PDCF loans: $0.1;
Percent of total: 0.0%.
Total:
Total PDCF loans: $7,389.4;
Percent of total: 100.0%.
Source: GAO analysis of Federal Reserve Board data.
Note: Total borrowing for JP Morgan Securities reflects consolidation
of total borrowing by Bear, Stearns & Co., Inc. after the acquisition
was completed. Amount shown for Bank of America Corporation reflects
consolidation of total borrowing by Merrill Lynch and Countrywide
following the completion of those acquisitions.
[End of table]
As discussed above, the Federal Reserve Board authorized FRBNY to
extend credit to the London broker-dealer affiliates of four primary
dealers. Table 26 lists the total borrowings by these affiliates.
Table 26: Total Amounts Borrowed by London-based Affiliates of Primary
Dealers:
Dollars in billions.
Primary dealer: 1. Morgan Stanley & Co. Inc.;
Loans to London affiliates: $548.2;
Percent of total: 35.1%.
Primary dealer: 2. Merrill Lynch & Co.;
Loans to London affiliates: $493.1;
Percent of total: 31.6%.
Primary dealer: 3. Citigroup Global Markets Inc.;
Loans to London affiliates: $263.5;
Percent of total: 16.9%.
Primary dealer: 4. Goldman Sachs & Co.;
Loans to London affiliates: $155.7;
Percent of total: 10.0%.
Primary dealer: 5. Banc of America Securities LLC;
Loans to London affiliates: $101.2;
Percent of total: 6.5%.
Total:
Loans to London affiliates: $1,561.6;
Percent of total: 100.0%.
Source: GAO analysis of Federal Reserve Board data.
Note: Amount shown for Banc of America Securities reflects borrowings
by the London affiliate of Merrill Lynch Government Securities
subsequent to completion of Bank of America Corporation's acquisition
of Merrill Lynch.
[End of table]
Term to Maturity for Loans:
PDCF made overnight cash loans. FRBNY disbursed PDCF loan proceeds to
the clearing banks on the evening of the loan request and the
transactions were unwound the following morning when the clearing bank
would return the cash to FRBNY's account and the collateral to the
borrowing primary dealers' accounts.
Collateral Eligibility:
Initially, the Federal Reserve Board restricted eligible collateral
for PDCF to collateral eligible for open-market operations as well as
investment-grade corporate securities, municipal securities, and asset-
backed securities, including mortgage-backed securities. In September
2008, the Federal Reserve Board expanded the set of eligible
collateral to match closely all of the types of instruments that could
be pledged in the tri-party repurchase agreement system, including
noninvestment grade securities and equities.
Loan Size:
The Federal Reserve Board did not impose a borrowing limit that
applied to each individual primary dealer. The total amount a primary
dealer could borrow from PDCF was limited by the amount of haircut-
adjusted eligible collateral it had pledged to its clearing bank.
Interest Rate:
The interest rate on PDCF loans was equal to the primary credit rate,
the interest rate the Reserve Banks charged on discount window loans
to depository institutions through its primary credit program.
Frequency-Based Fee:
FRBNY charged a frequency-based fee to dealers who accessed the
facility on more than 45 business days out of 180 business days. The
frequency fee increased according to the following schedule:
* No fee, loans granted on 45 days or less during the first 180 days
of the program.
* 10 basis points, annualized rate, 46-90 days.
* 20 basis points, annualized rate, 91-135 days.
* 40 basis points, annualized rate, 136-180 days.
Recourse:
PDCF loans were made with recourse beyond the pledged collateral to
the primary dealer's other assets.
[End of section]
Appendix XII: Term Asset-Backed Securities Loan Facility:
Figure 19: Overview of TALF:
[Refer to PDF for image: line graph and associated data]
Key observations:
* Authorized under section 13(3) of the Federal Reserve Act of 1913.
* The Term Asset-Backed Securities Loan Facility (TALF) was intended
to increase credit availability by supporting the issuance of asset-
backed securities.
* Though authorized to lend up to $200 billion, the Federal Reserve
Bank of New York (FRBNY) made approximately $71 billion of TALF loans.
TALF loans outstanding peaked at $48 billion in March 2010.
* TALF featured multiple layers of loss protection, including haircuts
to help minimize the credit risk to FRBNY.
* The Department of the Treasury initially provided a $20 billion
backstop to protect against any potential losses but reduced this
amount to $4.3 billion in July 2010.
* In 2009 and 2010, FRBNY earned about $400 million in interest income
from TALF.
* As of June 29, 2011, $12.8 billion in TALF loans remain outstanding.
Date announced: November 25, 2008;
Dates of operation: March 17, 2009-June 30, 2010;
Total unique borrowers: 177;
Total loans: 2,310.
Figure: TALF loans outstanding, March 18, 2009-June 29, 2011:
[Line graph]
Dollars in billions:
March 2009;
Loans outstanding: $0.
April 2009;
Loans outstanding: $5.
May 2009;
Loans outstanding: $6.
June 2009;
Loans outstanding: $15.
July 2009;
Loans outstanding: $25.
August 2009;
Loans outstanding: $30.
September 2009;
Loans outstanding: $37.
October 2009;
Loans outstanding: $42.
November 2009;
Loans outstanding: $43.
December 2009;
Loans outstanding: $44.
January 2010;
Loans outstanding: $48.
February 2010;
Loans outstanding: $47.
March 2010;
Loans outstanding: $46.
[Peak loans outstanding: $48 billion (March 17, 2010)]
April 2010;
Loans outstanding: $47.
May 2010;
Loans outstanding: $45.
June 2010;
Loans outstanding: $44.
July 2010;
Loans outstanding: $42.
August 2010;
Loans outstanding: $40.
September 2010;
Loans outstanding: $34.
October 2010;
Loans outstanding: $29.
November 2010;
Loans outstanding: $28.
December 2010;
Loans outstanding: $25.
January 2011;
Loans outstanding: $25.
February 2011;
Loans outstanding: $23.
March 2011;
Loans outstanding: $20.
April 2011;
Loans outstanding: $18.
May 2011;
Loans outstanding: $16.
June 2011;
Loans outstanding: $14.
Source: GAO analysis of Board of Governors of the Federal Reserve
System documents and data.
[End of figure]
Background:
On November 24, 2008, the Board of Governors of the Federal Reserve
System (Federal Reserve Board) authorized the creation of the Term
Asset-Backed Securities Loan Facility (TALF) under section 13(3) of
the Federal Reserve Act of 1913 to increase credit availability and
support economic activity by facilitating renewed issuance in
securitization markets. TALF became operational on March 17, 2009, and
was operated by the Federal Reserve Bank of New York (FRBNY). TALF was
initially set to expire on December 31, 2009. The Federal Reserve
Board authorized one extension of TALF to allow lending against newly
issued asset-backed securities (ABS) and legacy commercial mortgage-
backed securities (CMBS) through March 31, 2010, and lending against
newly issued CMBS through June 30, 2010.
Securitization is a process by which similar debt instruments--such as
loans, leases, or receivables--are aggregated into pools, and interest-
bearing securities backed by such pools are then sold to investors.
These ABS provide a source of liquidity for consumers and small
businesses because financial institutions can take assets that they
would otherwise hold on their balance sheets, sell them as securities,
and use the proceeds to originate new loans, among other purposes.
During the recent financial crisis, the value of many ABS dropped
precipitously, bringing originations in the securitization markets to
a virtual halt. Problems in the securitization markets threatened to
make accessing the credit households and small businesses needed to,
among other things, buy cars and homes and expand inventories and
operations more difficult. The Federal Reserve Board determined that
the continued disruption of the ABS markets, when combined with other
ongoing stresses in the credit markets, presented a significant risk
to financial stability.
Through TALF, FRBNY provided nonrecourse 3-or 5-year loans to any
eligible borrower owning eligible collateral. TALF borrowers served as
intermediaries that used TALF loans from FRBNY to purchase ABS, which
served as collateral for TALF loans. Borrowers requested TALF loans
through primary dealers and a few other firms that served as TALF
agents. To increase the support that TALF borrowers could provide to
the securitization markets, the Federal Reserve Board set borrower
eligibility requirements to permit broad participation by U.S.
entities. TALF loans were made without recourse to borrowers' assets
beyond the ABS collateral.[Footnote 160] TALF contained multiple
layers of loss protection:
* First, the Federal Reserve Board required TALF collateral to be
rated AAA or its equivalent by two of the rating agencies that it
deemed eligible to provide credit ratings for TALF.[Footnote 161] The
rating requirement helped to ensure that the securities TALF accepted
as collateral presented minimal credit risks. Due diligence performed
on securities to be purchased served as another pillar of loss
protection. FRBNY, with the support of vendors, reviewed the credit
risks related to individual ABS FRBNY might consider accepting as TALF
collateral.[Footnote 162]
* Second, the Federal Reserve Board required TALF loans to be
overcollateralized through haircut requirements. These haircut
requirements determined the amount of a TALF borrower's equity in the
ABS collateral. This equity represented the amount of money that a
TALF borrower would lose by surrendering the collateral and not
repaying the loan.
* Third, a special purpose vehicle created by FRBNY--TALF LLC--
received a portion of the interest income earned by FRBNY on TALF
loans and if a TALF borrower chose to not repay its loan, this
accumulated excess interest income could be used to purchase
collateral surrendered by the borrower.
* Finally, if the excess interest income accumulated in TALF LLC was
insufficient to purchase the surrendered collateral, the Department of
the Treasury (Treasury) initially committed to lend up to $20 billion
of Troubled Asset Relief Program funds to TALF LLC for any such
purchases. The Federal Reserve Board authorized FRBNY to lend up to
$180 billion for any purchases exceeding this maximum TARP
commitment.[Footnote 163] Both loans would be secured by the assets of
TALF LLC, and FRBNY's loan, if made, would be senior to Treasury's
loan.[Footnote 164]
Terms and Conditions for TALF:
Borrower Eligibility Requirements:
TALF was open to any eligible U.S. company that owned eligible
collateral. Eligible TALF borrowers included a broad range of
institutions ranging from depository institutions to U.S.-based
investment funds. Federal Reserve Board officials told us that broad
participation in TALF would facilitate the program goal of encouraging
the flow of credit to consumers and small businesses. To prevent
participation by borrowers that might pose fraud or reputational risk,
FRBNY required all prospective TALF borrowers to approach the program
through one of the primary dealers or other firms that acted as TALF
agents.[Footnote 165] FRBNY directed TALF agents to conduct due
diligence on prospective TALF borrowing institutions and "material
investors" in these institutions.[Footnote 166] While TALF eligibility
rules allowed participation by U.S.-domiciled institutions with
foreign investors, it prohibited participation by entities controlled
by a foreign government.
Table 27 lists the top 20 largest TALF borrowers (aggregated at the
level of the fund family), which accounted for more than 75 percent of
TALF loans.
Table 27: Top 20 Largest TALF Borrowers:
Rank: 1;
Asset management parent or borrowing entity: Morgan Stanley;
Total TALF loans: $9.3;
Percent of total: 13.0%.
Rank: 2;
Asset management parent or borrowing entity: PIMCO;
Total TALF loans: $7.3;
Percent of total: 10.2%.
Rank: 3;
Asset management parent or borrowing entity: California Public
Employees' Retirement System;
Total TALF loans: $5.4;
Percent of total: 7.6%.
Rank: 4;
Asset management parent or borrowing entity: Arrowpoint Capital;
Total TALF loans: $4.0;
Percent of total: 5.7%.
Rank: 5;
Asset management parent or borrowing entity: Angelo Gordon & Co.;
Total TALF loans: $3.7;
Percent of total: 5.2%.
Rank: 6;
Asset management parent or borrowing entity: Metropolitan West Asset
Management, LLC;
Total TALF loans: $3.1;
Percent of total: 4.4%.
Rank: 7;
Asset management parent or borrowing entity: Belstar Group;
Total TALF loans: $2.8;
Percent of total: 4.0%.
Rank: 8;
Asset management parent or borrowing entity: Wexford Capital;
Total TALF loans: $2.8;
Percent of total: 4.0%.
Rank: 9;
Asset management parent or borrowing entity: BlackRock, Inc.;
Total TALF loans: $2.8;
Percent of total: 3.9%.
Rank: 10;
Asset management parent or borrowing entity: AllianceBernstein;
Total TALF loans: $1.7;
Percent of total: 2.5%.
Rank: 11;
Asset management parent or borrowing entity: One William Street
Capital;
Total TALF loans: $1.7;
Percent of total: 2.4%.
Rank: 12;
Asset management parent or borrowing entity: Seer Capital;
Total TALF loans: $1.3;
Percent of total: 1.9%.
Rank: 13;
Asset management parent or borrowing entity: Prudential Financial Inc.;
Total TALF loans: $1.2;
Percent of total: 1.6%.
Rank: 14;
Asset management parent or borrowing entity: Ladder Capital;
Total TALF loans: $1.1;
Percent of total: 1.6%.
Rank: 15;
Asset management parent or borrowing entity: Apollo Global Management,
LLC;
Total TALF loans: $1.1;
Percent of total: 1.6%.
Rank: 16;
Asset management parent or borrowing entity: Teachers Insurance and
Annuity Association of America;
Total TALF loans: $1.1;
Percent of total: 1.6%.
Rank: 17;
Asset management parent or borrowing entity: OppenheimerFunds, Inc.;
Total TALF loans: $1.1;
Percent of total: 1.5%.
Rank: 18;
Asset management parent or borrowing entity: Magnetar Capital LLC;
Total TALF loans: $1.1;
Percent of total: 1.5%.
Rank: 19;
Asset management parent or borrowing entity: Atlantic Asset
Management, LLC;
Total TALF loans: $1.0;
Percent of total: 1.4%.
Rank: 20;
Asset management parent or borrowing entity: Treesdale Partners, LLC;
Total TALF loans: $0.9;
Percent of total: 1.3%.
Asset management parent or borrowing entity: All Others;
Total TALF loans: $16.5;
Percent of total: 23.2%.
Total:
Total TALF loans: $71.1;
Percent of total: 100.0%.
Source: GAO analysis of Federal Reserve Board data.
Note: In this table, TALF loans are aggregated across multiple
entities for the following companies: Pacific Investment Management
Company LLC (PIMCO), Arrowpoint Capital, Belstar Group, BlackRock
Inc., AllianceBernstein, Seer Capital, and Ladder Capital. This table
aggregates loans only for borrowing entities bearing the name of the
same investment fund manager. Morgan Stanley funds include TALF
borrowing by funds managed by FrontPoint LLC, which was owned by
Morgan Stanley at the time TALF operated.
[End of table]
Eligible Collateral Assets Classes:
To be eligible for TALF, ABS had to have a long-term credit rating in
the highest investment-grade rating category (for example, AAA) from
two or more nationally recognized statistical rating organizations.
All or substantially all of the credit exposure underlying eligible
ABS must have been exposure to U.S.-domiciled obligors. TALF-eligible
collateral included U.S. dollar-denominated ABS with one of the
following underlying credit exposures:
* auto loans,
* student loans,
* credit card loans,
* equipment loans,
* "floorplan" loans,
* insurance premium finance loans,
* small business loans fully guaranteed as to principal and interest
by the U.S. Small Business Administration,
* receivables related to residential mortgage servicing advances
(servicing advance receivables), or:
* commercial mortgage loans.
Interest Rates:
Interest rates for TALF loans were either fixed or floating and varied
according to the collateral securing the loan, as determined by FRBNY.
For example, the interest rate on loans secured by certain fixed-rate
ABS, other than SBA and student loan-related ABS, was 100 basis points
over the one-year LIBOR swap rate for securities with a weighted
average life less than one year. As another example, TALF loans
secured by ABS backed by federally guaranteed student loans had an
interest rate of 50 basis points over one-month LIBOR.
Haircuts:
FRBNY officials said that TALF haircuts were designed to approximate
multiples of stressed historical impairment rates for ABS. Table 28
summarizes the haircuts for TALF loans.
Table 28: TALF Haircuts by Asset Class:
Sector: Auto;
Subsector: Prime retail lease;
Weighted average life in years for ABSs:
0 to less than 1: 10%;
1 to less than 2: 11%;
2 to less than 3: 12%;
3 to less than 4: 13%;
4 to less than 5: 14%;
5 to less than 6: [Empty];
6 to less than 7: [Empty].
Sector: Auto;
Subsector: Prime retail loan;
Weighted average life in years for ABSs:
0 to less than 1: 6;
1 to less than 2: 7;
2 to less than 3: 8;
3 to less than 4: 9;
4 to less than 5: 10;
5 to less than 6: [Empty];
6 to less than 7: [Empty].
Sector: Auto;
Subsector: Subprime retail loan;
Weighted average life in years for ABSs:
0 to less than 1: 9;
1 to less than 2: 10;
2 to less than 3: 11;
3 to less than 4: 12;
4 to less than 5: 13;
5 to less than 6: [Empty];
6 to less than 7: [Empty].
Sector: Auto;
Subsector: Motorcycle or other recreational vehicles;
Weighted average life in years for ABSs:
0 to less than 1: 7;
1 to less than 2: 8;
2 to less than 3: 9;
3 to less than 4: 10;
4 to less than 5: 11;
5 to less than 6: [Empty];
6 to less than 7: [Empty].
Sector: Auto;
Subsector: Commercial and government fleets;
Weighted average life in years for ABSs:
0 to less than 1: 9;
1 to less than 2: 10;
2 to less than 3: 11;
3 to less than 4: 12;
4 to less than 5: 13;
5 to less than 6: [Empty];
6 to less than 7: [Empty].
Sector: Auto;
Subsector: Rental fleets;
Weighted average life in years for ABSs:
0 to less than 1: 12;
1 to less than 2: 13;
2 to less than 3: 14;
3 to less than 4: 15;
4 to less than 5: 16;
5 to less than 6: [Empty];
6 to less than 7: [Empty].
Sector: Credit Card;
Subsector: Prime;
Weighted average life in years for ABSs:
0 to less than 1: 5;
1 to less than 2: 5;
2 to less than 3: 6;
3 to less than 4: 7;
4 to less than 5: 8;
5 to less than 6: [Empty];
6 to less than 7: [Empty].
Sector: Credit Card;
Subsector: Subprime;
Weighted average life in years for ABSs:
0 to less than 1: 6;
1 to less than 2: 7;
2 to less than 3: 8;
3 to less than 4: 9;
4 to less than 5: 10;
5 to less than 6: [Empty];
6 to less than 7: [Empty].
Sector: Equipment;
Subsector: Loans and leases;
Weighted average life in years for ABSs:
0 to less than 1: 5;
1 to less than 2: 6;
2 to less than 3: 7;
3 to less than 4: 8;
4 to less than 5: 9;
5 to less than 6: [Empty];
6 to less than 7: [Empty].
Sector: Floor plan;
Subsector: Auto;
Weighted average life in years for ABSs:
0 to less than 1: 12;
1 to less than 2: 13;
2 to less than 3: 14;
3 to less than 4: 15;
4 to less than 5: 16;
5 to less than 6: [Empty];
6 to less than 7: [Empty].
Sector: Floor plan;
Subsector: Nonauto;
Weighted average life in years for ABSs:
0 to less than 1: 11;
1 to less than 2: 12;
2 to less than 3: 13;
3 to less than 4: 14;
4 to less than 5: 15;
5 to less than 6: [Empty];
6 to less than 7: [Empty].
Sector: Premium finance;
Subsector: Property and casualty;
Weighted average life in years for ABSs:
0 to less than 1: 5;
1 to less than 2: 6;
2 to less than 3: 7;
3 to less than 4: 8;
4 to less than 5: 9;
5 to less than 6: [Empty];
6 to less than 7: [Empty].
Sector: Servicing advances;
Subsector: Residential mortgages;
Weighted average life in years for ABSs:
0 to less than 1: 12;
1 to less than 2: 13;
2 to less than 3: 14;
3 to less than 4: 15;
4 to less than 5: 16;
5 to less than 6: [Empty];
6 to less than 7: [Empty].
Sector: Small business;
Subsector: SBA loans;
Weighted average life in years for ABSs:
0 to less than 1: 5;
1 to less than 2: 5;
2 to less than 3: 5;
3 to less than 4: 5;
4 to less than 5: 5;
5 to less than 6: 6;
6 to less than 7: 6.
Sector: Student loan;
Subsector: Private;
Weighted average life in years for ABSs:
0 to less than 1: 8;
1 to less than 2: 9;
2 to less than 3: 10;
3 to less than 4: 11;
4 to less than 5: 12;
5 to less than 6: 13;
6 to less than 7: 14.
Sector: Student loan;
Subsector: Government guaranteed;
Weighted average life in years for ABSs:
0 to less than 1: 5;
1 to less than 2: 5;
2 to less than 3: 5;
3 to less than 4: 5;
4 to less than 5: 5;
5 to less than 6: 6;
6 to less than 7: 6.
Sector: New-issue CMBSs;
Weighted average life in years for ABSs:
0 to less than 1: 15;
1 to less than 2: 15;
2 to less than 3: 15;
3 to less than 4: 15;
4 to less than 5: 15;
5 to less than 6: [Empty][A];
6 to less than 7: [Empty][A].
Sector: Legacy CMBSs;
Weighted average life in years for ABSs:
0 to less than 1: 15;
1 to less than 2: 15;
2 to less than 3: 15;
3 to less than 4: 15;
4 to less than 5: 15;
5 to less than 6: [Empty][B];
6 to less than 7: [Empty][B].
Source: GAO presentation of information gathered from FRBNY's web site.
Note: For ABSs benefiting from a government guarantee with average
lives of 5 years and beyond, haircuts were to increase by 1 percentage
point for every 2 additional years (or portion thereof) of average
life at or beyond 5 years. For all other ABSs with average lives of 5
years and beyond, haircuts were to increase by 1 percentage point for
each additional year (or portion thereof) of average life at or beyond
5 years.
[A] For newly issued CMBSs with average lives beyond 5 years,
collateral haircuts were to increase by 1 percentage point of par for
each additional year of average life. No newly issued CMBS could have
an average life of more than 10 years.
[B] For legacy CMBSs with average lives beyond 5 years, haircuts were
to increase by 1 percentage point of par for each additional year of
average life. No legacy CMBS could have an average life of more than
10 years.
[End of table]
Administrative Fees:
FRBNY did not charge a registration fee to use TALF although it did
charge an administrative fee equal to 10 basis points of the loan
amount for nonmortgaged-backed ABS collateral and 20 basis points for
CMBS collateral.
Key Vendors for TALF:
FRBNY used a number of entities to help administer the TALF program:
* TALF agents, which were primary dealers or designated broker-dealers
whose responsibilities included conducting due diligence on TALF
borrowers and making representations to FRBNY regarding eligibility of
TALF borrowers and their collateral, submitting TALF loan requests and
supporting documentation to FRBNY and the TALF custodian on behalf of
borrowers, delivering administrative fees and collateral from TALF
borrowers to FRBNY, and distributing the TALF borrower's share of
principal and interest payments paid on the collateral backing the
TALF loan.
* The Bank of New York Mellon, which has served as custodian of the
program and has been responsible for administering TALF loans, holding
and reviewing collateral, collecting payments and administrative fees,
disbursing cash flows, maintaining the program's books and records,
and assisting other TALF entities with the pricing of collateral.
* Collateral monitors--Trepp LLC and Pacific Investment Management
Company LLC (PIMCO)--which checked the pricing and ratings of
securities; provided valuation, modeling, reporting, and analytical
support; and advised on related matters.
* CW Capital, which provided underwriting advisory services related to
certain commercial mortgage loans backing newly issued CMBSs.
Table 29 lists all TALF vendors that received more than $1 million in
fees.
Table 29: Vendors for TALF That Earned Fees Greater than $1 Million:
Vendor: PIMCO;
Services provided: Collateral monitor;
Contract date: 7/23/2009;
Awarded competitively? Yes;
Total fees paid (2008-2010): $12,567,458.
Vendor: Bank of New York Mellon;
Services provided: Administrator, custodian;
Contract date: 3/16/2009;
Awarded competitively? Yes;
Total fees paid (2008-2010): $3,983,816.
Vendor: Trepp LLC;
Services provided: Collateral Monitor;
Contract date: 6/12/2009;
Awarded competitively? Yes;
Total fees paid (2008-2010): $3,217,941.
Vendor: Sidley Austin;
Services provided: Legal services;
Contract date: 4/13/2009;
Awarded competitively? No;
Total fees paid (2008-2010): $2,696,831.
Vendor: Davis Polk & Wardwell;
Services provided: Legal services;
Contract date: 9/16/2008;
Awarded competitively? No;
Total fees paid (2008-2010): $1,353,911.
Vendor: BlackRock;
Services provided: Collateral monitor;
Contract date: 2/16/2010;
Awarded competitively? Yes;
Total fees paid (2008-2010): $1,250,000.
Source: GAO presentation of FRBNY information.
[End of table]
[End of section]
Appendix XIII: Term Auction Facility:
Figure 20: Overview of TAF:
[Refer to PDF for image: line graph and associated data]
Key observations:
* Authorized under section 10B of the Federal Reserve Act of 1913.
* The Term Auction Facility (TAF) auctioned 28-day and 84-day discount
window loans to eligible depository institutions.
* TAF was the largest Federal Reserve System emergency lending program
in terms of peak loans outstanding, with loans outstanding peaking at
$493 billion on March 4, 2009.
* Sixty-five percent of TAF loans were awarded to U.S. branches and
agencies of foreign institutions, which have historically had access
to discount window loans on the same terms as depository institutions
with U.S. holding companies.
Date announced: December 12, 2007;
Dates of operation: December 17, 2007-March 8, 2010;
Total unique borrowers: 416;
Total loans: 4,214.
Figure: TAF loans outstanding, December 1, 2007-July 21, 2010:
[Line graph]
Dollars in billions:
December 2007;
Loans outstanding: $20.
January 2008;
Loans outstanding: $40.
February 2008;
Loans outstanding: $60.
March 2008;
Loans outstanding: $60.
April 2008;
Loans outstanding: $100.
May 2008;
Loans outstanding: $100.
June 2008;
Loans outstanding: $150.
July 2008;
Loans outstanding: $150.
August 2008;
Loans outstanding: $150.
September 2008;
Loans outstanding: $150.
October 2008;
Loans outstanding: $149.
November 2008;
Loans outstanding: $301.
December 2008;
Loans outstanding: $407.
January 2009;
Loans outstanding: $384.
February 2009;
Loans outstanding: $413.
March 2009;
Loans outstanding: $493.
[Peak loans outstanding: $493 billion (March 4, 2009)]
April 2009;
Loans outstanding: $467.
May 2009;
Loans outstanding: $404.
June 2009;
Loans outstanding: $373.
July 2009;
Loans outstanding: $283.
August 2009;
Loans outstanding: $234.
September 2009;
Loans outstanding: $212.
October 2009;
Loans outstanding: $178.
November 2009;
Loans outstanding: $139.
December 2009;
Loans outstanding: $101.
January 2010;
Loans outstanding: $76.
February 2010;
Loans outstanding: $39.
March 2010;
Loans outstanding: $15.
April 2010;
Loans outstanding: $3.
May 2010;
Loans outstanding: $0.
June 2010;
Loans outstanding: $0.
July 2010;
Loans outstanding: $0.
Source: GAO analysis of Board of Governors of the Federal Reserve
System documents and data.
[End of figure]
Background:
On December 12, 2007, the Board of Governors of the Federal Reserve
System (Federal Reserve Board) authorized the creation of the Term
Auction Facility (TAF) to address continuing strains in U.S. term
interbank lending markets--markets in which banks lend to one another
for terms of 1 month or longer. Section 10B of the Federal Reserve Act
of 1913 authorizes Reserve Banks to make discount window loans to
depository institutions. The Federal Reserve Board revised regulations
governing Reserve Bank discount window lending to allow the Reserve
Banks to auction TAF loans to depository institutions that were
eligible to borrow from the discount window.[Footnote 167] The first
TAF auction was held on December 17, 2007, with subsequent auctions
occurring approximately every 2 weeks. The final TAF auction was held
on March 8, 2010. The auction amount was determined by the Chairman of
the Board of Governors of the Federal Reserve Board and announced
before the date of the auction. All Reserve Banks participated in the
operation of TAF as lenders to banks in their respective districts.
In late summer 2007, sudden strains in term interbank lending markets
emerged primarily due to intensifying investor concerns about
commercial banks' actual exposure to various mortgage-related
activities. The cost of term interbank funding spiked, and commercial
banks increasingly had to resort to borrowing overnight to meet their
funding needs. To address these funding pressures, the Federal Reserve
Board first lowered the discount rate at the discount window and
extended the term at the discount window from overnight to up to 30
days. These funding pressures subsided in October 2007 but worsened in
late November 2007, possibly driven in part by a seasonal contraction
in the supply of year-end funding.
The Federal Reserve Board authorized TAF as an alternative to the
discount window to provide term funding support to depository
institutions. In contrast to the traditional discount window program,
TAF was designed to auction loans to many eligible institutions at
once at an auction-determined interest rate. The interest rate on
loans for each TAF auction was determined using a single-price auction
format. For each auction, winning bidders would be awarded loans at
the same interest rate. To determine the interest rate, or "stop-out
rate" for each auction, the Federal Reserve Bank of New York (FRBNY)
staff ordered bids from all Reserve Bank districts from the highest to
the lowest interest rate. Bids were accepted starting with the highest
interest rate submitted, down to successively lower rates, until the
total auction amount was allocated or the minimum bid rate for the
auction was reached, whichever occurred first.[Footnote 168] When the
total bid amount exceeded the auction amount, institutions that placed
bids at or above this stop-out rate received loans at this rate. When
the total bid amount was less than the auction amount, all bidding
institutions would receive loans at the minimum bid rate.
Federal Reserve Board officials noted that one important advantage of
this auction approach was that it could address concerns among
eligible borrowers about the perceived stigma of discount window
borrowing. Federal Reserve Board officials and other market observers
have noted that an institution might be reluctant to borrow from the
discount window out of concern that its creditors and other
counterparties might become aware of its discount window use and
perceive it as a sign of distress. The auction format allowed banks to
approach the Reserve Banks collectively rather than individually and
obtain funds at an interest rate set by auction rather than at a
premium set by the Federal Reserve Board.[Footnote 169] Additionally,
whereas discount window loan funds could be obtained immediately by an
institution facing severe funding pressures, TAF borrowers did not
receive loan funds until 3 days after the auction.
Another important advantage of TAF relative to encouraging greater use
of the discount window was that the Federal Reserve Board could more
easily control the impact of auctioned funds on monetary policy. While
the Federal Reserve Board could not predict with certainty the demand
for discount window loans, it could control the amount of TAF loans
provided at each auction. As a result, the Federal Open Market
Committee (FOMC) and FRBNY could more easily coordinate monetary
policy operations to offset the impact of TAF auctions. For example,
to offset the injection of $75 billion of reserves into the financial
system in the form of TAF loans, FRBNY could sell $75 billion of
Treasury securities through its open market operations. All else
equal, the net effect of these two actions would be to have no impact
on total reserves.
Terms and Conditions for TAF:
Borrower Eligibility:
Depository institutions that were eligible for the primary credit
discount window program and that were expected to remain so over the
TAF loan term were eligible to participate in TAF auctions. Primary
credit is a discount window lending program available to depository
institutions judged to be in generally sound financial condition.
Institutions with a CAMELS or equivalent supervisory rating of 1, 2,
or 3 generally are considered eligible for the primary credit program.
[Footnote 170] U.S. branches and agencies of foreign institutions that
met TAF eligibility requirements were eligible to participate.
Table 30 lists the 25 largest borrowers (at the parent company level),
which accounted for more than 70 percent of the loans made under this
program.
Table 30: Top 25 Largest TAF Borrowers at the Parent Company Level:
Dollars in billions:
Rank: 1;
Parent company of TAF borrowing institution(s): Bank of America
Corporation;
Total TAF loans: $280;
Percent of total: 7.3%.
Rank: 2;
Parent company of TAF borrowing institution(s): Barclays PLC (United
Kingdom);
Total TAF loans: $232;
Percent of total: 6.1%.
Rank: 3;
Parent company of TAF borrowing institution(s): Royal Bank of Scotland
Group PLC (United Kingdom);
Total TAF loans: $212;
Percent of total: 5.5%.
Rank: 4;
Parent company of TAF borrowing institution(s): Bank of Scotland PLC
(United Kingdom);
Total TAF loans: $181;
Percent of total: 4.7%.
Rank: 5;
Parent company of TAF borrowing institution(s): Wells Fargo & Co.;
Total TAF loans: $159;
Percent of total: 4.2%.
Rank: 6;
Parent company of TAF borrowing institution(s): Wachovia Corporation;
Total TAF loans: $142;
Percent of total: 3.7%.
Rank: 7;
Parent company of TAF borrowing institution(s): Societe Generale SA
(France);
Total TAF loans: $124;
Percent of total: 3.3%.
Rank: 8;
Parent company of TAF borrowing institution(s): Dresdner Bank AG
(Germany);
Total TAF loans: $123;
Percent of total: 3.2%.
Rank: 9;
Parent company of TAF borrowing institution(s): Citigroup Inc.;
Total TAF loans: $110;
Percent of total: 2.9%.
Rank: 10;
Parent company of TAF borrowing institution(s): Bayerische Landesbank
(Germany);
Total TAF loans: $108;
Percent of total: 2.8%.
Rank: 11;
Parent company of TAF borrowing institution(s): Dexia AG (Belgium);
Total TAF loans: $105;
Percent of total: 2.8%.
Rank: 12;
Parent company of TAF borrowing institution(s): Norinchukin Bank
(Japan);
Total TAF loans: $105;
Percent of total: 2.8%.
Rank: 13;
Parent company of TAF borrowing institution(s): JP Morgan Chase & Co.;
Total TAF loans: $99;
Percent of total: 2.6%.
Rank: 14;
Parent company of TAF borrowing institution(s): UniCredit SpA (Italy);
Total TAF loans: $97;
Percent of total: 2.5%.
Rank: 15;
Parent company of TAF borrowing institution(s): Mitsubishi UFJ
Financial Group, Inc. (Japan);
Total TAF loans: $84;
Percent of total: 2.2%.
Rank: 16;
Parent company of TAF borrowing institution(s): WestLB AG (Germany);
Total TAF loans: $78;
Percent of total: 2.1%.
Rank: 17;
Parent company of TAF borrowing institution(s): Deutsche Bank AG
(Germany);
Total TAF loans: $77;
Percent of total: 2.0%.
Rank: 18;
Parent company of TAF borrowing institution(s): Regions Financial
Corporation;
Total TAF loans: $72;
Percent of total: 1.9%.
Rank: 19;
Parent company of TAF borrowing institution(s): BNP Paribas SA
(France);
Total TAF loans: $64;
Percent of total: 1.7%.
Rank: 20;
Parent company of TAF borrowing institution(s): Sumitomo Mitsui
Banking Corporation (Japan);
Total TAF loans: $56;
Percent of total: 1.5%.
Rank: 21;
Parent company of TAF borrowing institution(s): UBS AG (Switzerland);
Total TAF loans: $56;
Percent of total: 1.5%.
Rank: 22;
Parent company of TAF borrowing institution(s): HSH Nordbank AG
(Germany);
Total TAF loans: $53;
Percent of total: 1.4%.
Rank: 23;
Parent company of TAF borrowing institution(s): Mizhuo Financial
Group, Inc. (Japan);
Total TAF loans: $51;
Percent of total: 1.3%.
Rank: 24;
Parent company of TAF borrowing institution(s): Commerzbank AG;
Total TAF loans: $51;
Percent of total: 1.3%.
Rank: 25;
Parent company of TAF borrowing institution(s): Hypo Real Estate
Holding AG (Germany);
Total TAF loans: $47;
Percent of total: 1.2%.
Parent company of TAF borrowing institution(s): All others;
Total TAF loans: $1,051;
Percent of total: 27.5%.
Total:
Total TAF loans: $3,818;
Percent of total: 100.0%.
Source: GAO analysis of Federal Reserve Board data.
Note: In the above figure, total amounts borrowed represent the sum of
all loans and have not been adjusted to reflect differences in terms
to maturity for the loans. Total borrowing is aggregated at the parent
company level and generally includes borrowing by branches, agencies,
and subsidiaries that we could identify. Total borrowing for each
parent company consolidates amounts borrowed by acquired institutions
as of the date the acquisition was completed. The country of domicile
is shown in parentheses for companies based outside the United States.
[End of table]
Term to Maturity for Loans:
TAF initially auctioned 28-day loans. The Federal Reserve Board
authorized TAF auctions of 84-day loans beginning in August 2008 to
provide additional funding support at longer maturities.
Maximum and Minimum Bid Amounts:
Eligible depository institutions could submit up to two bids in each
TAF auction, and the combined dollar amount of these bids could not
exceed 10 percent of the total auction amount. U.S. branches and
agencies of the same foreign institution could place separate TAF
bids, but their combined bid amount for an auction could not exceed 10
percent of the auction amount. The minimum bid amount for TAF
initially was $10 million. In February 2008, the minimum bid amount
was decreased from $10 million to $5 million to encourage
participation by smaller banks.
Minimum Bid Rate:
The Federal Reserve Board initially determined the minimum bid rate
based on a measure of the average expected overnight federal funds
rate over the term of the loans being auctioned. On December 16, 2008,
the FOMC lowered its target federal funds rate from 1 percent to a
range of between 0 and 0.25 percent. On January 12, 2009, the Federal
Reserve Board announced that the minimum bid rate for TAF auctions
would be set equal to the interest rate banks earned on excess reserve
balances at the Reserve Banks.[Footnote 171]
Collateral Eligibility:
TAF loans were collateralized based on haircut requirements for the
discount window program. For TAF loans, Reserve Banks accepted as
collateral any assets that were eligible to secure discount window
loans. In addition, a depository institution's TAF loans outstanding
with terms greater than 28 days could not exceed 75 percent of the
value of collateral it had pledged to the discount window. This
requirement was intended to help ensure that depository institutions
would retain additional capacity to borrow at the discount window in
the event of unexpected funding strains.
Recourse:
As with traditional discount window loans, TAF loans were made with
recourse to the assets of the borrower beyond the assets pledged as
collateral. In the event of a default on a recourse loan, the Reserve
Bank would have a claim on the borrower's assets that could allow it
to recover all or part of any shortfall arising from the liquidation
of the borrower's collateral.
Vendors and Third Parties:
The Reserve Banks did not use vendors or third parties for TAF.
TAF Auction Trends:
Figure 33 illustrates the bid coverage ratio for all TAF auctions. Bid
coverage ratio refers to the ratio of the aggregate bid amount to the
auction amount and indicates the level of demand for TAF loans
relative to the amount of TAF loans offered at each auction. From
December 2007 through September 2008, the bid coverage ratio was more
than 100 percent for all TAF auctions, indicating that demand for TAF
loans exceeded the amounts auctioned. The Federal Reserve Board
increased the TAF auction amount to $150 billion for the October 6,
2008 auction and kept the auction amount at this level until July 13,
2009, when it reduced it to $125 billion. As shown by the blue line in
the figure, the level of demand for TAF loans fluctuated from October
2008 through the end of the program and all TAF auctions during this
period were not well subscribed, with total bid amounts below the
auction amount. For auctions during this period, all bidders received
loans at the minimum bid rate rather than at a competitively
determined rate.
Figure 33: Bid Coverage Ratio for TAF Auctions, December 2007-March
2010:
[Refer to PDF for image: combined vertical bar and line graph]
Dollars in billions:
December 2007;
Auction size: $20;
Bid coverage ratio (bids over auction size): 308.
January 2008;
Auction size: $30;
Bid coverage ratio (bids over auction size): 185.
February 2008;
Auction size: $30;
Bid coverage ratio (bids over auction size): 195.
March 2008;
Auction size: $50;
Bid coverage ratio (bids over auction size): 185.
April 2008;
Auction size: $50;
Bid coverage ratio (bids over auction size): 183,
May 2008;
Auction size: $75;
Bid coverage ratio (bids over auction size): 129.
June 2008;
Auction size: $75;
Bid coverage ratio (bids over auction size): 128.
July 2008;
Auction size: $75;
Bid coverage ratio (bids over auction size): 124.
August 2008;
Auction size: $25;
Bid coverage ratio (bids over auction size): 219.
September 2008;
Auction size: $25;
Bid coverage ratio (bids over auction size): 127.
November 2008;
Auction size: $150;
Bid coverage ratio (bids over auction size): 93.
December 2008;
Auction size: $150;
Bid coverage ratio (bids over auction size): 44.
January 2009;
Auction size: $150;
Bid coverage ratio (bids over auction size): 72.
February 2009;
Auction size: $150;
Bid coverage ratio (bids over auction size): 95.
March 2009;
Auction size: $150;
Bid coverage ratio (bids over auction size): 78.
April 2009;
Auction size: $150;
Bid coverage ratio (bids over auction size): 71.
May 2009;
Auction size: $150;
Bid coverage ratio (bids over auction size): 88.
June 2009;
Auction size: $150;
Bid coverage ratio (bids over auction size): 64.
July 2009;
Auction size: $125;
Bid coverage ratio (bids over auction size): 38.
August 2009;
Auction size: $100;
Bid coverage ratio (bids over auction size): 43.
September 2009;
Auction size: $75;
Bid coverage ratio (bids over auction size): 43.
October 2009;
Auction size: $50;
Bid coverage ratio (bids over auction size): 50.
November 2009;
Auction size: $25;
Bid coverage ratio (bids over auction size): 53.
December 2009;
Auction size: $75;
Bid coverage ratio (bids over auction size): 61.
January 2010;
Auction size: $75;
Bid coverage ratio (bids over auction size): 51.
February 2010;
Auction size: $50;
Bid coverage ratio (bids over auction size): 31.
March 2010;
Auction size: $25;
Bid coverage ratio (bids over auction size): 14.
Source: GAO analysis of Federal Reserve System data.
[End of figure]
Use by Foreign Institutions:
Approximately sixty-five percent of the TAF loans were allocated to
U.S. branches, agencies, or subsidiaries of foreign institutions in
accordance with the auction terms. FRBNY staff identified a few
possible reasons for high use by U.S. branches and agencies foreign
banks. First, many of them faced liquidity strains arising from the
need to bring certain illiquid U.S. dollar assets back on to their
balance sheets and could not finance these assets elsewhere. In
addition, many of these institutions held U.S.-dollar denominated
collateral that could be pledged to TAF but not in their home country.
[End of section]
Appendix XIV: Term Securities Lending Facility:
Figure 34: Overview of TSLF:
[Refer to PDF for image: multiple line graph and associated data]
Key observations:
* On March 11, 2008, the Board of Governors of the Federal Reserve
System (Federal Reserve Board) invoked section 13(3) of the Federal
Reserve Act of 1913 for the first time during the recent crisis to
authorize the Term Securities Lending Facility (TSLF).
* TSLF was a security-for-security lending program that allowed
primary dealers to pledge less liquid securities as collateral to
obtain U.S. Treasury securities that were easier to borrow cash
against in secured funding markets.
* TSLF loans outstanding, including TSLF Options Program (TOP) loans,
peaked at $236 billion in October 2008.
Date announced: March 11, 2008;
Dates of operation: March 27, 2008-February 1, 2010;
Total unique borrowers: 18 (of which 11 used TOP);
Total loans: 542 TSLF loans and 17 TOP loans.
Figure: TSLF loans outstanding (including TOP loans), March 1, 2008-
February 1, 2010:
[Multiple line graph]
Dollars in billions:
March 2008;
Schedule 1: $0;
Schedule 2: $0;
TOP: $0.
April 2008;
Schedule 1: $0;
Schedule 2: $75;
TOP: $0.
May 2008;
Schedule 1: $49.1;
Schedule 2: $93.4;
TOP: $0.
June 2008;
Schedule 1: $23.7;
Schedule 2: $74.9;
TOP: $0.
July 2008;
Schedule 1: $40.4;
Schedule 2: $63.7;
TOP: $0.
August 2008;
Schedule 1: $46.3;
Schedule 2: $78.9;
TOP: $0.
September 2008;
Schedule 1: $50;
Schedule 2: $65.9;
TOP: $0.
October 2008;
Schedule 1: $46.5;
Schedule 2: $141.8;
TOP: $47.2.
[Peak loans outstanding: $236 billion (October 1, 2008)]
November 2008;
Schedule 1: $50;
Schedule 2: $150;
TOP: $0.
December 2008;
Schedule 1: $42.6;
Schedule 2: $142.5;
TOP: $0.
January 2009;
Schedule 1: $45;
Schedule 2: $110.9;
TOP: $0.
February 2009;
Schedule 1: $26.5;
Schedule 2: $94.1;
TOP: $0.
March 2009;
Schedule 1: $21.8;
Schedule 2: $90.4;
TOP: $0.
April 2009;
Schedule 1: $8.5;
Schedule 2: $77.2;
TOP: $0.
May 2009;
Schedule 1: $0;
Schedule 2: $32.6;
TOP: $0.
June 2009;
Schedule 1: $0;
Schedule 2: $27.4;
TOP: $0.
July 2009;
Schedule 1: $0;
Schedule 2: $6.8;
TOP: $0.
August 2009;
Schedule 1: $0;
Schedule 2: $2.7;
TOP: $0.
September 2009;
Schedule 1: $0;
Schedule 2: $0;
TOP: $0.
October 2009;
Schedule 1: $0;
Schedule 2: $0;
TOP: $0.
November 2009;
Schedule 1: $0;
Schedule 2: $0;
TOP: $0.
December 2009;
Schedule 1: $0;
Schedule 2: $0;
TOP: $0.
January 2010;
Schedule 1: $0;
Schedule 2: $0;
TOP: $0.
February 2010;
Schedule 1: $0;
Schedule 2: $0;
TOP: $0.
Source: GAO analysis of Board of Governors of the Federal Reserve
System documents and data.
[End of figure]
Background:
On March 11, 2008, the Board of Governors of the Federal Reserve
System (Federal Reserve Board) announced the creation of the Term
Securities Lending Facility (TSLF) to help address growing strains in
the repurchase agreement markets, which are large, short-term
collateralized funding markets that many financial institutions rely
on to finance securities. The Federal Reserve Board authorized the
Federal Reserve Bank of New York (FRBNY) to operate TSLF under
sections 13(3) and 14 of the Federal Reserve Act of 1913. The Federal
Reserve Board authorized three extensions of the TSLF in response to
market conditions. The program expired on February 1, 2010.
In the repurchase agreement markets, a borrowing institution generally
acquires funds by selling securities to a lending institution and
agreeing to repurchase the securities after a specified time at a
given price. The securities, in effect, are collateral provided by the
borrower to the lender. In the event of a borrower's default on the
repurchase transaction, the lender would be able to take (and sell)
the collateral provided by the borrower. Lenders typically will not
provide a loan for the full market value of the posted securities, and
the difference between the values of the securities and the loan is
called a margin or haircut. This deduction is intended to protect the
lenders against a decline in the price of the securities provided as
collateral. In early March 2008, the Federal Reserve Board found that
repurchase agreement lenders were requiring higher haircuts for loans
against a range of less liquid securities and were becoming reluctant
to lend against mortgage-related securities. As a result, many
financial institutions increasingly had to rely on higher quality
collateral, such as Department of the Treasury (Treasury) securities,
to obtain cash in these markets, and a shortage of such high-quality
collateral emerged.
Through TSLF, primary dealers--a group of securities firms that are
traditional counterparties of FRBNY and that were significant
participants in the repurchase agreement markets--were able to
temporarily exchange illiquid assets for more liquid Treasury
securities. The Federal Reserve Board authorized FRBNY to auction up
to $200 billion of Treasury securities to primary dealers through
competitive auctions that allowed dealers to bid a fee to exchange
harder-to-finance collateral for easier-to-finance Treasury
securities. These securities then served as high-quality collateral
for these dealers to borrow cash against in the repurchase agreement
markets. TSLF was intended to promote confidence among lenders and to
reduce the need for dealers to sell illiquid assets into the markets,
which could have further depressed the prices of these assets and
contributed to a downward price spiral.[Footnote 172]
The Federal Reserve Board and FRBNY structured TSLF as an extension of
FRBNY's securities lending program, through which it auctioned
overnight loans of Treasury securities to primary dealers. In
comparison to the securities lending program, TSLF loaned Treasury
securities over a longer term (usually 28 days) and accepted a broader
range of collateral. TSLF held separate auctions of Treasury
securities against two different schedules of collateral to apply a
higher minimum interest rate to riskier assets. Schedule 1 collateral
included Treasury securities, agency debt, and agency mortgage-backed
securities (MBS) collateral that FRBNY accepted in repurchase
agreements as part of its execution of open market operations.
Schedule 2 collateral included schedule 1 collateral as well as a
broader range of asset types, including highly rated private MBS,
against which FRBNY had not traditionally loaned Treasury securities.
The Federal Reserve Board determined that providing funding support
for private mortgage-backed securities through the schedule 2 auctions
fell outside the scope of FRBNY's authority to conduct its securities
lending program under section 14 of the Federal Reserve Act.
Accordingly, for the first time during this crisis, the Federal
Reserve Board invoked section 13(3) of the Federal Reserve Act to
authorize the extension of credit to nondepository institutions--in
this case, the primary dealers.
For TSLF transactions with participating dealers, FRBNY used a tri-
party repurchase agreement system in which both parties to the
repurchase agreement must have cash and collateral accounts at the
same tri-party agent, which is by definition also a clearing bank. The
tri-party agent is responsible for ensuring that collateral pledged is
sufficient and meets eligibility requirements, and all parties agree
to use collateral prices supplied by the tri-party agent. FRBNY relied
on the two clearing banks--JP Morgan Chase & Co. and Bank of New York
Mellon--to perform collateral custody and valuation services for TSLF
loans. According to FRBNY, using the tri-party system had several
advantages. First, the Treasury securities loaned through TSLF
remained within the closed tri-party system, helping ensure the safe
return of the securities to FRBNY upon maturity of the loan. In
addition, the tri-party banks could facilitate the daily repricing and
application of haircuts for of a wide range of collateral types.
Further, clearing banks were able to facilitate this form of tri-party
lending within the tight time constraints.
Figure 35 illustrates the role of the clearing banks in TSLF loan
transactions. The clearing banks, which served as the intermediaries
between FRBNY and the primary dealers in open market operations,
facilitated the clearing, settlement and application of haircuts for
TSLF loans. A primary dealer seeking to borrow Treasury securities
through TSLF would pledge eligible collateral to its account at its
clearing bank. The clearing bank would exchange the Treasury
securities and pledged collateral between FRBNY and the primary
dealers, transferring collateral to FRBNY's account in amounts needed
to collateralize the loan in accordance with TSLF haircut
requirements. The loaned Treasury securities remained in the primary
dealer's account at the clearing bank, and the eligible collateral
remained in an FRBNY account at the clearing bank.
Figure 35: Structure of the TSLF:
[Refer to PDF for image: illustration]
Primary dealer: sends eligible collateral to Clearing Bank; sends
auction bid for Treasury securities to FRBNY.
Clearing Bank: sends eligible collateral to FRBNY.
FRBNY: Lending of Treasury securities to Clearing Bank.
Clearing Bank: Lending of Treasury securities to Primary dealer.
Source: GAO presentation of Federal Reserve Board information.
[End of figure]
On July 30, 2008, the Federal Reserve Board announced the TSLF Options
Program (TOP), in which options to draw shorter-term TSLF loans at
future dates were auctioned to the primary dealers. The program was
limited to $50 billion and was intended to offer additional liquidity
during periods of heightened funding pressures. The Federal Reserve
Board approved the establishment of TOP pursuant to its authorization
for the TSLF program. The creation of TOP required administrative
changes to some TSLF terms, and the Federal Reserve Board did not make
a separate authorization for TOP under section 13(3) of the Federal
Reserve Act. TOP was suspended effective July 1, 2009.
Terms and Conditions for TSLF:
Borrower Eligibility:
Only primary dealers were eligible to borrow from TSLF.
Table 31 ranks the primary dealers by the total market value (at the
time of the loan) of Treasury securities they borrowed through TSLF.
Table 31: Largest TSLF Borrowers by Total Dollar Amount of Loans
(Includes TOP Loans):
Dollars in billions.
Rank: 1;
Primary dealer: Citigroup Global Markets Inc.;
Total TSLF loans (market value): $348;
Percent of total: 15.0%.
Rank: 2;
Primary dealer: RBS Securities Inc.;
Total TSLF loans (market value): $291;
Percent of total: 12.6%.
Rank: 3;
Primary dealer: Deutsche Bank Securities Inc.;
Total TSLF loans (market value): $277;
Percent of total: 11.9%.
Rank: 4;
Primary dealer: Credit Suisse Securities (USA) LLC;
Total TSLF loans (market value): $261;
Percent of total: 11.2%.
Rank: 5;
Primary dealer: Goldman Sachs & Co.;
Total TSLF loans (market value): $225;
Percent of total: 9.7%.
Rank: 6;
Primary dealer: Barclays Capital Inc.;
Total TSLF loans (market value): $187;
Percent of total: 8.0%.
Rank: 7;
Primary dealer: Merrill Lynch Government Securities Inc.;
Total TSLF loans (market value): $166;
Percent of total: 7.2%.
Rank: 8;
Primary dealer: UBS Securities LLC.;
Total TSLF loans (market value): $122;
Percent of total: 5.3%.
Rank: 9;
Primary dealer: Morgan Stanley & Co. Incorporated;
Total TSLF loans (market value): $115;
Percent of total: 4.9%.
Rank: 10;
Primary dealer: Banc of America Securities LLC;
Total TSLF loans (market value): $101;
Percent of total: 4.3%.
Rank: 11;
Primary dealer: Lehman Brothers Inc.;
Total TSLF loans (market value): $99;
Percent of total: 4.3%.
Rank: 12;
Primary dealer: J.P. Morgan Securities LLC;
Total TSLF loans (market value): $68;
Percent of total: 2.9%.
Rank: 13;
Primary dealer: BNP Paribas Securities Corp.;
Total TSLF loans (market value): $41;
Percent of total: 1.8%.
Rank: 14;
Primary dealer: Countrywide Securities Corporation;
Total TSLF loans (market value): $8;
Percent of total: 0.3%.
Rank: 15;
Primary dealer: HSBC Securities (USA) Inc.;
Total TSLF loans (market value): $4;
Percent of total: 0.2%.
Rank: 16;
Primary dealer: Cantor Fitzgerald & Co.;
Total TSLF loans (market value): $3;
Percent of total: 0.1%.
Rank: 17;
Primary dealer: Bear Stearns & Co., Inc.;
Total TSLF loans (market value): $2;
Percent of total: 0.1%.
Rank: 18;
Primary dealer: Dresdner Kleinwort Securities LLC;
Total TSLF loans (market value): $1;
Percent of total: 0.1%.
Total:
Total TSLF loans (market value): $2,319;
Percent of total: 100.0%.
Source: GAO analysis of Federal Reserve Board data.
Note: Amount shown for Banc of America Securities LLC reflects
consolidation of total borrowing by Merrill Lynch after the January 1,
2009, acquisition closing date.
[End of table]
Auction Amount:
The amount of Treasury collateral available at each auction was
determined by FRBNY and announced one day before the auction date.
Term to Maturity for Loans:
The term of securities loans under TSLF was 28 days, unless otherwise
stated in the auction announcement.
Maximum and Minimum Bid Amounts:
Primary dealers could submit up to two bids in each TSLF auction, and
the maximum auction award for each dealer was limited to 20 percent of
the offering amount for the auction. The minimum bid size was $10
million.
Interest Rate:
The interest rate on TSLF loans of Treasury securities was determined
using a single-price auction format. For each auction, winning bidders
were awarded loans at the same interest rate. The interest rate bid by
a primary dealer represented the interest rate it was willing to pay
to borrow a basket of Treasury securities against other pledged
collateral. A dealer's bid rate could be considered to be roughly
equivalent to the difference that dealer expected between the higher
interest rate repurchase agreement lenders could be expected to charge
on loans secured by collateral pledged to TSLF and the lower interest
rate these lenders could be expected to charge on loans secured by the
Treasury securities obtained through TSLF. To determine the interest
rate or "stop-out rate" for each auction, FRBNY staff ordered bids
from the highest to the lowest interest rate. Bids were accepted in
order starting with the highest interest rate submitted until the
total auction amount was allocated or the minimum bid rate for the
auction was reached, whichever occurred first. The interest rate of
the lowest successful bid was the rate applied to all other successful
bids for that auction. The minimum bid rates for the TSLF Schedule 1
and Schedule 2 auctions were 10 basis points and 25 basis points,
respectively. FRBNY held separate auctions for schedule 1 and schedule
2 collateral to better calibrate the appropriate minimum bid rate.
Collateral Eligibility:
TSLF auctioned loans of Treasury securities against two schedules of
collateral. Schedule 1 included all collateral eligible for open
market operations, including Treasury securities, agency debt
securities, and agency MBS. Schedule 2 initially included schedule 1
collateral as well as highly rated MBS. In September 2008, eligible
schedule 2 collateral was expanded to include investment grade
corporate securities, municipal securities, MBS and asset-backed
securities. To mitigate credit risk, FRBNY imposed haircuts on the
collateral pledged by dealers. If the pledged collateral fell in value
or became ineligible, the dealer would be required to make a
collateral substitution over the term of the loan. The initial haircut
schedule for TSLF was generally based on FRBNY's existing open market
operations practices. According to FRBNY staff, haircuts for assets
that were not eligible for open market operations were calculated
based in part on discount window margins.
Recourse:
TSLF loans were made with recourse beyond the pledged collateral to
the primary dealer's other assets. In the event of a default on a
recourse loan, the Reserve Bank would have a claim on the borrower's
assets that could allow it to recover all or part of any shortfall
arising from the liquidation of the borrower's collateral.
Key Vendors and Third Parties:
FRBNY did not hire vendors for the program. As mentioned previously,
however, clearing banks facilitated the clearing, settlement and
margining of the TSLF program.
[End of section]
Appendix XV: Comments from the Board of Governors of the Federal
Reserve System:
Board Of Governors Of The Federal Reserve System:
Scott G. Alvarez:
General Counsel:
Washington, D.C. 20551:
July 8, 2011:
Ms. Orice Williams Brown:
Managing Director:
Financial Markets and Community Investment:
Government Accountability Office:
441 G Street, NW:
Washington, DC 20548:
Dear Ms. Brown:
On behalf of the Federal Reserve System, thank you for the opportunity
to comment on the GAO's draft report (GA0-11-696) regarding the
Federal Reserve's policies and processes for managing emergency
assistance. As you know, we have worked closely with the GAO
throughout the fact-gathering portion of its review and have provided
extensive technical comments separately. We appreciate the GAO's
substantial efforts to review these complex programs and the
understanding of these programs that your report demonstrates.
As the report notes, the actions reviewed here took place in times of
great economic stress. The Federal Reserve responded with carefully
crafted programs, developed rapidly under great pressure. The report
shows that the emergency lending programs created during those
difficult times were effectively designed and effectively operated. We
also appreciate the GAO's recognition that the emergency lending
programs have, to date, recouped all funds lent and are expected to
recoup all remaining outstanding balances.
The GAO has made seven recommendations regarding procedural changes
that would benefit Federal Reserve officials facing times of crises in
the future. These recommendations are designed to improve procurement
policies in times of crisis, policies for promptly addressing
perceived employee conflicts, management of risks related to vendor
conflicts of interest, guidance to Reserve Banks about lending to
higher-risk borrowers, stress testing across multiple emergency
programs, and the level of documentation of Reserve Bank discretion in
operating emergency facilities.
These issues are very important to the Federal Reserve and, as the
report notes, the Board and Reserve Banks have already identified and
taken the initiative to address a number of the report's issues and
associated recommendations. To the extent not already addressed, the
Board and the Reserve Banks will give each recommendation serious
attention, and will strongly consider how best to respond to each. We
are confident that this process will further enhance the Federal
Reserve's capability to respond effectively in future crises.
Sincerely,
Signed by:
Scott Alvarez:
[End of section]
Appendix XVI: GAO Contact and Staff Acknowledgments:
GAO Contact:
Orice Williams Brown, (202) 512-8678 or williamso@gao.gov:
GAO Acknowledgments:
In addition to the contact named above, Paula Rascona and William T.
Woods (lead Directors); Cheryl Clark, Karen Tremba, and Katherine
Trimble (lead Assistant Directors); Serena Agoro-Menyang, Brandon
Booth, Bill Boutboul, Mariana Calderon, Tania Calhoun, Marcia Carlsen,
Francine DelVecchio, Rachel DeMarcus, Lynda Downing, Abe Dymond, John
Fisher, Chuck Fox, Jason Kelly, Michael Kendix, Caroline Kirby, Jeff
Knott, Rob Lee, Aaron Livernois, Gail Luna, Robert Mabasa, Tom McCool,
Sarah M. McGrath, Marc Molino, Tim Mooney, Lauren Nunnally, Joseph O
Neill, Jennifer Schwartz, Sophie Simonard, Andrew Stavisky, Eva Su,
Cynthia S. Taylor, Greg Wilshusen, and Weifei Zheng made significant
contributions to this report.
[End of section]
Glossary of Terms:
Agency Mortgage-Backed Securities:
Mortgage-backed securities issued by the housing government-sponsored
enterprises, which are Fannie Mae and Freddie Mac, or guaranteed by
Ginnie Mae.
Asset:
An item owned by an individual, corporation, or government that
provides a benefit, has economic value, and could be converted into
cash. For businesses, an asset generates cash flow and may include,
for example, accounts receivable and inventory. Assets are listed on a
company's balance sheet.
Asset-Backed Commercial Paper:
Short-term debt instruments (maturities ranging from overnight to 270
days) issued by corporations and financial institutions to meet short-
term financing needs. The instruments are backed by assets, such as
credit card receivables.
Asset-Backed Securities:
Tradable securities backed by pools of assets, such as loans, leases,
or other cash-flow producing assets. The holders of asset-backed
securities are entitled to payments that are distributed by the
underlying assets.
Bank Holding Company:
A company controlling one or more banks. Bank holding companies are
supervised by the Board of Governors of the Federal Reserve System
(Federal Reserve Board).
Clearing Bank:
A financial services company that provides settlement services for
financial transactions between two counterparties.
Collateral:
Properties or other assets pledged by a borrower to secure credit from
a lender. If the borrower does not pay back or defaults on the loan,
the lender may seize the collateral.
Collateralized Debt Obligation:
Securities backed by a pool of bonds, loans, or other assets. In a
basic collateralized debt obligation, a pool of bonds, loans, or other
assets are pooled and securities then are issued in different tranches
that vary in risk and return.
Commercial Paper:
An unsecured obligation with maturities ranging from 2 to 270 days
issued by banks, corporations, and other borrowers with high credit
ratings to finance short-term credit needs, such as operating expenses
and account receivables. Commercial paper is a low-cost alternative to
bank loans. Issuing commercial paper allows a company to raise large
amounts of funds quickly without the need to register with the
Securities and Exchange Commission, either by selling them directly to
an investor or to a dealer who then sells them to a large and varied
pool of institutional buyers.
Credit Default Swap:
Bilateral contract that is sold over the counter and transfers credit
risks from one party to another. In return for a periodic fee, the
seller (who is offering credit protection) agrees to compensate the
buyer (who is buying credit protection) if a specified credit event,
such as default, occurs.
Credit Rating:
An external assessment of the creditworthiness of corporations and
securities. A credit rating is a financial risk indicator used by
potential investors. The ratings are assigned by credit rating
agencies, such as Standard & Poor's, Moody's, or Fitch Ratings.
Depository Institution:
A bank or other entity responsible for holding assets in safekeeping.
Discount Window:
A Federal Reserve Board lending program that allows eligible
institutions to borrow money, usually on a short-term basis, from the
Federal Reserve Board at an above market rate to meet temporary
liquidity shortages.
Equity:
Ownership interest in a business in the form of common stock or
preferred stock.
Fair Value:
An estimated value of an asset or liability that is reasonable to all
willing parties involved in a transaction taking into account market
conditions other than liquidation. For example, the fair value of
derivative liability represents the fair market valuation of the
liabilities in a portfolio of derivatives. In this example, the fair
value provides an indicator of the dollar amount the market thinks the
trader of the portfolio would need to pay to eliminate its liabilities.
Haircut:
The amount by which a maximum authorized loan amount is below the
value of the assets used as collateral for the loan. When a borrower
pledges assets as collateral, the lender making the loan treats the
assets as being worth less than they actually are, so as to provide
the lender a cushion in case the assets' market price decreases.
Liability:
A business's financial obligation that must be made to satisfy the
contractual terms of such an obligation. Current liabilities, such as
accounts payable or wages, are debts payable within 1 year, while long-
term liabilities, such as leases and bond repayments, are payable over
a longer period.
Liquidity:
Measure of the extent to which a business has cash to meet its
immediate and short-term obligations. Liquidity also is measured in
terms of a company's ability to borrow money to meet short-term
demands for funds:
London Interbank Offered Rate:
The interest rate at which banks borrow unsecured funds in the London
wholesale money market.
Margin:
A percentage applied to the observed market price or estimated fair
market value of an asset to mitigate the risk that the observed market
price or estimated market value of an asset will decline over time.
The Federal Reserve Board's margins are based on risk characteristics
of the pledged asset as well as the anticipated volatility of the fair
market value of the pledged asset over an estimated liquidation time
frame.
Money Market Mutual Fund:
A fund that invests solely in money market instruments, such as
government securities, certificates of deposit, commercial paper, and
other short-term and low-risk securities. Unlike a money market
deposit account at a bank, money market mutual funds are not federally
insured. The Securities and Exchange Commission regulates money market
mutual funds under the Investment Company Act of 1940.
Mortgage-Backed Securities:
Securities or debt obligations that represent claims to the cash flows
from pools of mortgage loans, such as mortgages on residential
property. These securities are issued by Ginnie Mae, Fannie Mae, and
Freddie Mac, as well as private institutions, such as brokerage firms
and banks.
Nationally Recognized Statistical Rating Organizations:
Credit rating agencies that provide their opinions on a business
entity's or security's creditworthiness. They are registered with the
Securities and Exchange Commission. These ratings demarcate investment-
grade (quality) and noninvestment grade (lower quality) securities and
provide additional risk-based information for investors to make
investment decisions.
Open Market Operations:
The primary tool used to implement monetary policy. This tool consists
of Federal Reserve Board sales, purchases, or repurchase agreements
regarding financial instruments, usually securities issued by the
Department of the Treasury, federal agencies, and government-sponsored
enterprises. Open market operations are carried out by FRBNY's Trading
Desk under direction from the Federal Open Market Committee. The
transactions are undertaken with primary dealers.
Overnight Indexed Swap Rate:
The overnight indexed swap rate is a type of interest rate swap that
is based on daily federal funds rates. The rates indicate investor
expectations of future interest rates set by central banks, such as
the federal funds rate.
Primary Dealers:
Firms that are authorized to buy and sell U.S. government securities
with FRBNY's Open Market Desk, which operates on behalf of the Federal
Open Market Committee, in order to implement monetary policy.
Repurchase Agreement:
A financial transaction in which the holder of a security obtains
funds by selling that security to another financial market participant
under an agreement to repurchase the security at a fixed price on a
predetermined future date.
Securitization:
The process of pooling debt obligations and dividing that pool into
portions (called tranches) that can be sold as securities in the
secondary market--a market in which investors purchase securities or
assets from other investors. Financial institutions use securitization
to transfer the credit risk of the assets they originate from their
balance sheets to those of the investors who purchased the securities.
Special Purpose Vehicle:
A legal entity, such as a limited partnership that a company creates
to carry out some specific financial purpose or activity. Special
purpose vehicles can be used for purposes such as securitizing loans
to help spread the credit and interest rate risk of their portfolios
over a number of investors.
Tri-party Repurchase Agreement:
Tri-party repurchase agreements include three parties: the borrower,
the lender, and a tri-party agent that facilitates the repurchase
agreement transaction by providing custody of the securities posted as
collateral and valuing the collateral, among other services.
[End of section]
Related GAO Products:
Troubled Asset Relief Program: The Government's Exposure to AIG
Following the Company's Recapitalization. [hyperlink,
http://www.gao.gov/products/GAO-11-716]. Washington, D.C.: July 18,
2011.
Federal Reserve Banks: Areas for Improvement in Information Systems
Controls. [hyperlink, http://www.gao.gov/products/GAO-11-447R].
Washington, D.C.: March 31, 2011.
Troubled Asset Relief Program: Third Quarter 2010 Update of Government
Assistance Provided to AIG and Description of Recent Execution of
Recapitalization Plan. [hyperlink,
http://www.gao.gov/products/GAO-11-46]. Washington, D.C.: January 20,
2011.
Troubled Asset Relief Program: Status of Programs and Implementation
of GAO Recommendations. [hyperlink,
http://www.gao.gov/products/GAO-11-74]. Washington, D.C.: January 12,
2011.
Troubled Asset Relief Program: Opportunities Exist to Apply Lessons
Learned from the Capital Purchase Program to Similarly Designed
Programs and to Improve the Repayment Process. [hyperlink,
http://www.gao.gov/products/GAO-11-47]. Washington, D.C.: October 4,
2010.
Troubled Asset Relief Program: Bank Stress Test Offers Lessons as
Regulators Take Further Actions to Strengthen Supervisory Oversight.
[hyperlink, http://www.gao.gov/products/GAO-10-861]. Washington, D.C.:
September 29, 2010.
Financial Assistance: Ongoing Challenges and Guiding Principles
Related to Government Assistance for Private Sector Companies.
[hyperlink, http://www.gao.gov/products/GAO-10-719]. Washington, D.C.:
August 3, 2010.
Troubled Asset Relief Program: Treasury's Framework for Deciding to
Extend TARP Was Sufficient, but Could be Strengthened for Future
Decisions. [hyperlink, http://www.gao.gov/products/GAO-10-531].
Washington, D.C.: June 30, 2010.
Financial Markets Regulation: Financial Crisis Highlights Need to
Improve Oversight of Leverage at Financial Institutions and across
System. [hyperlink, http://www.gao.gov/products/GAO-10-555T].
Washington, D.C.: May 6, 2010.
Troubled Asset Relief Program: Update of Government Assistance
Provided to AIG. [hyperlink, http://www.gao.gov/products/GAO-10-475].
Washington, D.C.: April 27, 2010.
Federal Deposit Insurance Act: Regulators' Use of Systemic Risk
Exception Raises Moral Hazard Concerns and Opportunities Exist to
Clarify the Provision. [hyperlink,
http://www.gao.gov/products/GAO-10-100]. Washington, D.C.: April 15,
2010.
Troubled Asset Relief Program: Treasury Needs to Strengthen Its
Decision-Making Process on the Term Asset-Backed Securities Loan
Facility. [hyperlink, http://www.gao.gov/products/GAO-10-25].
Washington, D.C.: February 5, 2010.
Troubled Asset Relief Program: One Year Later, Actions Are Needed to
Address Remaining Transparency and Accountability Challenges.
[hyperlink, http://www.gao.gov/products/GAO-10-16]. Washington, D.C.:
October 8, 2009.
Troubled Asset Relief Program: Status of Government Assistance
Provided to AIG. [hyperlink, http://www.gao.gov/products/GAO-09-975].
Washington, D.C.: September 21, 2009.
Troubled Asset Relief Program: Status of Efforts to Address
Transparency and Accountability Issues. [hyperlink,
http://www.gao.gov/products/GAO-09-920T]. Washington, D.C.: July 22,
2009.
Troubled Asset Relief Program: June 2009 Status of Efforts to Address
Transparency and Accountability Issues. [hyperlink,
http://www.gao.gov/products/GAO-09-658]. Washington, D.C.: June 17,
2009.
Troubled Asset Relief Program: March 2009 Status of Efforts to Address
Transparency and Accountability Issues. [hyperlink,
http://www.gao.gov/products/GAO-09-504]. Washington, D.C.: March 31,
2009.
Financial Regulation: Review of Regulators' Oversight of Risk
Management Systems at a Limited Number of Large, Complex Financial
Institutions. [hyperlink, http://www.gao.gov/products/GAO-09-499T].
Washington, D.C.: March 18, 2009.
Federal Financial Assistance: Preliminary Observations on Assistance
Provided to AIG. [hyperlink, http://www.gao.gov/products/GAO-09-490T].
Washington, D.C.: March 18, 2009.
Systemic Risk: Regulatory Oversight and Recent Initiatives to Address
Risk Posed by Credit Default Swaps. [hyperlink,
http://www.gao.gov/products/GAO-09-397T]. Washington, D.C.: March 5,
2009.
Troubled Asset Relief Program: Status of Efforts to Address
Transparency and Accountability Issues. [hyperlink,
http://www.gao.gov/products/GAO-09-296]. Washington, D.C.: January 30,
2009.
Financial Regulation: A Framework for Crafting and Assessing Proposals
to Modernize the Outdated U.S. Financial Regulatory System.
[hyperlink, http://www.gao.gov/products/GAO-09-216]. Washington, D.C.:
January 8, 2009.
Troubled Asset Relief Program: Additional Actions Needed to Better
Ensure Integrity, Accountability, and Transparency. [hyperlink,
http://www.gao.gov/products/GAO-09-161]. Washington, D.C.: December 2,
2008.
Federal Reserve System: Current and Future Challenges Require
Systemwide Attention. [hyperlink,
http://www.gao.gov/products/GAO/GGD-96-128]. Washington, D.C.: June
17, 1996.
[End of section]
Footnotes:
[1] For this report, we use Federal Reserve Board to refer to the
federal agency and Federal Reserve System to refer collectively to the
federal agency and the Reserve Banks. The background section of this
report contains more information about the roles and responsibilities
of the Federal Reserve Board and the Reserve Banks.
[2] Lehman Brothers was an investment banking institution that offered
equity, fixed-income, trading, investment banking, asset management,
and other financial services. According to the bankruptcy examiner
appointed by the bankruptcy court, Lehman Brothers originated
mortgages, securitized them, and then sold the securitized assets.
Although headquartered in New York, Lehman Brothers operated globally.
Lehman Brothers had $639 billion in total assets and $613 billion in
total debts as of May 31, 2008, the date of its last audited financial
statements.
[3] On December 1, 2010, the Federal Reserve Board disclosed detailed
information about entities that received loans or other financial
assistance from its emergency programs. This information included, but
was not limited to, the identity of the entities that received the
assistance, the type of financial assistance provided, the value or
amount of the assistance, the date on which the assistance was
provided, and terms of loan repayment.
[4] Pub. L. No. 111-203, Title XI, 121 Stat. 1376, 2113 (2010).
[5] In addition, this report does not cover the single-tranche term
repurchase agreements conducted by FRBNY in 2008. FRBNY conducted
these repurchase agreements with primary dealers through an auction
process under its statutory authority for conducting temporary open
market operations.
[6] The Dodd-Frank Act includes provisions that expand the roles and
responsibilities of the Federal Reserve System. First, the act
authorizes the Federal Reserve Board to regulate nonbank financial
companies designated as systemically significant by a newly created
Financial Stability Oversight Council (FSOC). The FSOC is chaired by
the Secretary of the Treasury and its membership includes the Chairman
of the Federal Reserve Board and the heads of the other federal
financial regulators. In addition, the act consolidated many federal
consumer protection responsibilities into a new independent Bureau of
Consumer Financial Protection within the Federal Reserve Board.
[7] The Dodd-Frank Act also requires us to report on issues related to
Reserve Bank governance by October 2011. Among other issues, that
report will examine the extent to which the current system of
appointing Reserve Bank directors effectively represents ''the public,
without discrimination on the basis of race, creed, color, sex, or
national origin, and with due but not exclusive consideration to the
interests of agriculture, commerce, industry, services, labor, and
consumers'' in the selection of Reserve Bank directors, as such
requirement is set forth under section 4 of the Federal Reserve Act.
[8] These excess earnings remitted to Treasury consist of Reserve Bank
earnings after providing for operating expenditures, capital paid out
in dividends to banks that are members of the Federal Reserve System,
and an amount reserved by Reserve Banks to equate surplus with capital
paid in.
[9] Capital generally is defined as a firm's long-term source of
funding, contributed largely by a firm's equity stockholders and its
own returns in the form of retained earnings. One important function
of capital is to absorb losses. Each of the 12 Reserve Banks maintains
two capital accounts--a paid-in-capital account and a surplus account.
The paid-in capital account represents the contributions by member
banks of the Federal Reserve System. Under the Federal Reserve Act,
members of the Federal Reserve System, which include state-chartered
banks that apply for and have been granted membership and all national
banks, must subscribe to the stock of their respective Reserve Bank.
Dividends paid by the Reserve Banks to the member banks are set by law
at the rate of 6 percent on paid-in capital stock. The Reserve Banks'
second capital account is the capital surplus account. According to
Federal Reserve Board policy, this account is to be maintained at a
level equal to the paid-in capital. The capital surplus account is
funded from the Reserve Banks' earnings after operating expenses and
dividends are paid.
[10] For purposes of the Capital Purchase Program, qualifying
financial institutions generally include stand-alone U.S.-controlled
banks and savings associations, as well as bank holding companies and
savings and loan holding companies.
[11] On October 14, 2008, the Secretary of the Treasury invoked the
systemic risk provision in the Federal Deposit Insurance Act to allow
FDIC to provide certain assistance to insured depository institutions,
their holding companies, and qualified affiliates under TLGP. For more
information about Treasury's use of the systemic risk provision, see
GAO, Federal Deposit Insurance Act: Regulators' Use of Systemic Risk
Exception Raises Moral Hazard Concerns and Opportunities Exist to
Clarify the Provision, GAO-10-100 (Washington, D.C.: Apr. 15, 2010).
[12] At the time of these authorizations, section 13(3) allowed the
Federal Reserve Board, in "unusual and exigent circumstances," to
authorize any Reserve Bank to extend credit in the form of a discount
to individuals, partnerships, or corporations when the credit was
endorsed or otherwise secured to the satisfaction of the Reserve Bank,
after obtaining evidence that the individual, partnership, or
corporation was unable to secure adequate credit accommodations from
other banking institutions. As a result of amendments to section 13(3)
made by the Dodd-Frank Act, the Federal Reserve Board can now
authorize 13(3) lending only through programs or facilities with broad-
based eligibility.
[13] Mortgage-backed securities are securities that represent claims
to the cash flows from pools of mortgage loans, such as mortgages on
residential property.
[14] The sudden spike in the cost of term funding followed the August
9, 2007, announcement by BNP Paribas, a large banking organization
based in France, that it could not value certain mortgage-related
assets in three of its investment funds because of a lack of liquidity
in U.S. securitization markets. Greater reliance on overnight
borrowing increased the volatility of banks' funding costs and
increased "roll-over" risk, or the risk that banks would not be able
to renew their funding as loans matured.
[15] One basis point is equivalent to 0.01 percent or 1/100th of a
percent.
[16] Federal Reserve Board, Monetary Policy Report to the Congress
(February 27, 2008). This paper observed that the average interest
rate in interbank lending markets was almost equal, on average, to the
lower discount rate. In addition, because of the perceived stigma
associated with borrowing from the discount window, depository
institutions may have been reluctant to turn to the discount window
for funding support.
[17] Section 10B of the Federal Reserve Act provides the Reserve Banks
broad authority to extend credit to depository institutions.
[18] Another important advantage of TAF relative to encouraging
greater use of the discount window was that the Federal Reserve Board
could more easily control the impact of auctioned funds on monetary
policy. While the Federal Reserve Board could not predict with
certainty the demand for discount window loans, it could control the
amount of TAF loans provided at each auction. As a result, the FOMC
and FRBNY could more easily coordinate monetary policy operations to
offset the impact of TAF auctions. For example, to offset the
injection of $75 billion of reserves into the financial system in the
form of TAF loans, FRBNY could sell $75 billion of Treasury securities
through its open market operations. All else equal, the net effect of
these two actions would be to have no impact on total reserves.
[19] As discussed in appendix XIII, when TAF auction demand was less
than the total amount offered for the TAF auction, the interest rate
resulting from the auction was the minimum bid rate set by the Federal
Reserve Board--not a competitively-determined rate.
[20] In April 2009, the FOMC announced foreign-currency swap lines
with the Bank of England, the European Central Bank, the Bank of
Japan, and the Swiss National Bank. The foreign currency swap lines
were designed to provide the Federal Reserve System with capacity to
offer liquidity to U.S. institutions in foreign currency. According to
the Federal Reserve Board, the foreign currency swap lines were not
used.
[21] For example, an FRBNY staff paper observed that by facilitating
access to dollar funding the swap lines could reduce the need for
foreign banks to sell dollar assets into stressed markets, which could
have further reduced prices for these dollar assets.
[22] The Federal Reserve Board has interpreted section 14 of the
Federal Reserve Act to permit the Federal Reserve Banks to conduct
open market operations in foreign exchange markets and to open and
maintain accounts in foreign currency with foreign central banks.
Section 14 states that "any Federal reserve bank may… purchase and
sell in the open market, at home or abroad, either from or to domestic
or foreign banks, firms, corporations, or individuals, cable transfers…
" The Federal Reserve Board has interpreted "cable transfers" to mean
foreign exchange. Section 14(e) authorizes Reserve Banks to "open and
maintain accounts in foreign countries, appoint correspondents, and
establish agencies in such countries…" and "to open and maintain
banking accounts for…foreign banks or bankers…." The use of swap lines
under section 14 of the Federal Reserve Act is not new. For example,
FRBNY instituted temporary swap arrangements following September 11,
2001, with the European Central Bank and the Bank of England.
[23] These foreign central banks were the Reserve Bank of Australia,
the Banco Central do Brasil, the Bank of Canada, Danmarks Nationalbank
(Denmark), the Bank of England (United Kingdom), the Bank of Japan,
the Bank of Korea (South Korea), the Banco de Mexico, the Reserve Bank
of New Zealand, Norges Bank (Norway), the Monetary Authority of
Singapore, and Sveriges Riksbank (Sweden).
[24] When the market value of assets used to secure or collateralize
repurchase transactions declines, borrowers are usually required to
post additional collateral.
[25] Unusually high demand for certain U.S. Treasury securities
resulted in negative yields on these securities at times during the
crisis, indicating that investors were willing to accept a small loss
in return for the relative safety of these securities.
[26] For more information about the potential causes and impacts of
downward price spirals, see GAO, Financial Markets Regulation:
Financial Crisis Highlights Need to Improve Oversight of Leverage at
Financial Institutions and across System, GAO-09-739 (Washington,
D.C.: Jul. 22, 2009).
[27] Before the crisis, FRBNY ran an overnight securities lending
facility, the terms of which involved the lending of certain Treasury
securities by FRBNY to primary dealers against other Treasury
securities as collateral. Certain of the legal infrastructure for the
traditional securities lending program was used for TSLF. Other legal
and operational infrastructure had to be created specifically for TSLF.
[28] TSLF held separate auctions of Treasury securities against two
different schedules of collateral to better calibrate the interest
rate on TSLF loans to the level of risk associated with the
collateral. The Federal Reserve Board set a higher minimum interest
rate for schedule 2 TSLF auctions, which accepted riskier collateral
types than schedule 1 auctions. For more information about how
interest rates were determined for TSLF auctions, see appendix XIV.
[29] Bear Stearns was one of the largest primary dealers and engaged
in a broad range of activities, including investment banking,
securities and derivatives trading, brokerage services, and
origination and securitization of mortgage loans.
[30] In our prior work on the financial crisis, Securities and
Exchange Commission officials told us that neither they nor the
broader regulatory community anticipated this development and that
Securities and Exchange Commission had not directed large broker-
dealer holding companies to plan for the unavailability of secured
funding in their contingent funding plans. Securities and Exchange
Commission officials stated that no financial institution could
survive without secured funding. Rumors about clients moving cash and
security balances elsewhere and, more importantly, counterparties not
transacting with Bear Stearns also placed strains on the firm's
ability to obtain secured financing. See [hyperlink,
http://www.gao.gov/products/GAO-09-739].
[31] The loan was made through JP Morgan Chase Bank, National
Association pursuant to FRBNY's discount window authority under
section 10B of the Federal Reserve Act. Recognizing that the ultimate
borrower was Bear Stearns, a nondepository institution, the Board of
Governors voted on the afternoon of March 14, 2008, to authorize the
loan under section 13(3) authority. Federal Reserve Board officials
explained that the use of JP Morgan Chase Bank, National Association
as an intermediary was not strictly required as section 13(3)
permitted a direct loan to Bear Stearns. However, they used the back-
to-back loan structure because this was the structure FRBNY lawyers
had prepared for in developing required legal documentation late on
Thursday, March 13, 2008.
[32] Timothy F. Geithner, testimony before the U.S. Senate Committee
on Banking, Housing and Urban Affairs (Washington, D.C., Apr. 3, 2008).
[33] Under the terms outlined in this letter and approved by the
Federal Reserve Board, FRBNY agreed to lend up to $30 billion to JPMC
against eligible Bear Stearns collateral listed in an attachment to
the letter. The types and amounts of eligible collateral under this
agreement were broadly similar to the assets ultimately included under
the final lending structure, Maiden Lane LLC. The agreed price of the
collateral was to be based on Bear Stearns's valuation of the
collateral as of March 14, 2008, regardless of the date of any lending
to JPMC under this agreement. JPMC would not have been required to
post margin in any amount to secure any borrowing under this
agreement. The letter also included certain regulatory exemptions for
JPMC in connection with its agreement to acquire Bear Stearns. For
example, the Federal Reserve Board granted an 18-month exemption to
JPMC from the Federal Reserve Board's risk-based and leverage capital
requirements for bank holding companies. The exemption would allow
JPMC to exclude the assets and exposures of Bear Stearns from its risk-
weighted assets for purposes of applying the risk-based capital
requirements at the parent bank holding company.
[34] Before the crisis, FRBNY regularly undertook traditional
temporary open market operations--repurchase agreement transactions--
with primary dealers. The repurchase transactions, in normal times,
are used by FRBNY to attempt to meet the target federal funds rate, as
directed by the FOMC, by temporarily increasing the amount of
reserves. The repurchase transactions undertaken pursuant to PDCF were
not for the purpose of increasing reserves (although they did do
that), but rather for extending credit as authorized by the Federal
Reserve Board.
[35] For TSLF, previously, only Treasury securities, agency
securities, and AAA-rated mortgage-backed and asset-backed securities
could be pledged. For PDCF, previously, eligible collateral had to
have at least an investment-grade rating. Tri-party repurchase
agreements include three parties: the borrower, the lender, and a tri-
party agent that facilitates the repurchase agreement transaction by
providing custody of the securities posted as collateral and valuing
the collateral, among other services.
[36] Concurrently, the Federal Reserve Board announced that it had
approved applications by Goldman Sachs and Morgan Stanley to become
bank holding companies. In addition, Bank of America agreed to acquire
Merrill Lynch, which would become part of a bank holding company
pending completion of its merger with Bank of America, a bank holding
company supervised by the Federal Reserve System upon completion of
the acquisition. On November 23, 2008, in connection with other
actions taken by Treasury, FDIC, and the Federal Reserve Board to
assist Citigroup Inc., the Federal Reserve Board authorized FRBNY to
extend credit to the London-based broker-dealer of Citigroup on terms
similar to those applicable to PDCF loans. The other actions taken to
assist Citigroup Inc. are discussed later in this section.
[37] A mutual fund is a company that pools money from many investors
and invests the money in stocks, bonds, short-term money market
instruments, other securities or assets, or some combination of these
investments. These investments comprise the fund's portfolio. Mutual
funds are registered and regulated under the Investment Company Act of
1940, and are supervised by the Securities and Exchange Commission.
Mutual funds sell shares to public investors. Each share represents an
investor's proportionate ownership in the fund's holdings and the
income those holdings generate. Mutual fund shares are "redeemable,"
which means that when mutual fund investors want to sell their shares,
the investors sell them back to the fund, or to a broker acting for
the fund, at their current net asset value per share, minus any fees
the fund may charge. MMMFs are mutual funds that are registered under
the Investment Company Act of 1940, and regulated under Securities and
Exchange Commission rule 2a-7 under that act. MMMFs invest in high-
quality, short-term debt instruments such as commercial paper,
treasury bills and repurchase agreements. Generally, these funds,
unlike other investment companies, seek to maintain a stable net asset
value per share (market value of assets minus liabilities divided by
number of shares outstanding), typically $1 per share.
[38] Many financial institutions created ABCP conduits that would
purchase various assets, including mortgage-related securities,
financial institution debt, and receivables from industrial
businesses. To obtain funds to purchase these assets, these conduits
borrowed using shorter-term debt instruments, such as ABCP and medium-
term notes. The difference between the interest paid to the ABCP or
note holders and the income earned on the entity's assets produced fee
and other income for the sponsoring institution. However, these
structures carried the risk that the entity would find it difficult or
costly to renew its debt financing under less-favorable market
conditions.
[39] A branch or agency of a foreign bank is a legal extension of the
foreign bank and is not a freestanding entity in the United States.
Foreign bank branches and agencies operating in the United States are
subject to Federal Reserve regulations, and the Federal Reserve
examines most foreign bank branches and agencies annually.
[40] There are two main types of commercial paper: unsecured and asset-
backed. Unsecured paper is not backed by collateral and the credit
rating of the issuing institution is a key variable in determining the
cost of its issuance. In contrast, ABCP is collateralized by assets
and therefore is a secured form of borrowing.
[41] As discussed in appendix VII, the CPFF SPV was needed to allow
FRBNY to engage in market transactions (purchases of commercial paper)
outside its traditional operating framework for discount window
lending.
[42] Commercial paper generally has fixed maturities of 1 to 270 days.
[43] Securitization is a process by which similar debt instruments--
such as loans, leases, or receivables--are aggregated into pools, and
interest-bearing securities backed by such pools are then sold to
investors. These asset-backed securities provide a source of liquidity
for consumers and small businesses because financial institutions can
take assets that they would otherwise hold on their balance sheets,
sell them as securities, and use the proceeds to originate new loans,
among other purposes.
[44] Initially, securities backed by automobile, credit card, and
student loans, as well as loans guaranteed by the Small Business
Administration were deemed eligible for TALF because of the need to
make credit in these sectors more widely available. The Federal
Reserve Board later expanded TALF eligibility to other ABS classes,
including commercial mortgage-backed securities.
[45] TALF loans were made without recourse to the intermediary
borrower. However, under the TALF lending agreement, if FRBNY found
that the collateral provided for a TALF loan or a borrower who had
participated in the program was found to be ineligible, the
nonrecourse feature of the loan would have become inapplicable.
[46] Through AIGFP--a financial products subsidiary that engaged in a
variety of financial transactions, including standard and customized
financial products--AIG was a participant in the derivatives market.
The securities lending program allowed certain insurance companies,
primarily the life insurance companies, to lend securities in return
for cash collateral that was invested in residential mortgage-backed
securities.
[47] Credit default swaps are bilateral contracts that are sold over
the counter and transfer credit risks from one party to another. The
seller, who is offering credit protection, agrees, in return for a
periodic fee, to compensate the buyer if a specified credit event,
such as default, occurs. Collateralized debt obligations are
securities backed by a pool of bonds, loans, or other assets.
[48] All three Maiden Lane SPVs incorporated a first-loss position for
the private sector that was equal to the difference between the total
purchase price of the assets and the amount of the FRBNY loan. As
discussed later in this report, this first loss position took
different forms in the three SPVs.
[49] On January 14, 2011, using proceeds from the initial public
offering of AIA Group Limited and the sale of American Life Insurance
Company to another insurance company, AIG repaid its outstanding
balance on the AIG RCF.
[50] See also GAO, Troubled Asset Relief Program: Status of Government
Assistance Provided to AIG, [hyperlink,
http://www.gao.gov/products/GAO-09-975] (Washington, D.C.: Sept. 21,
2009).
[51] As of September 30, 2008, Citigroup was the second largest
banking organization in the United States, with total consolidated
assets of approximately $2 trillion. Citigroup was and remains a major
supplier of credit and one of the largest deposit holders in the
United States and the world.
[52] For more information about the basis for the federal government's
assistance to Citigroup, see [hyperlink,
http://www.gao.gov/products/GAO-10-100].
[53] The amount of this "attachment point" for FRBNY was approximately
$56.17 billion. Even in stress scenarios, FRBNY did not expect losses
to reach this level.
[54] Although FRBNY did not lend to Citigroup under this lending
commitment, FRBNY staff confirmed that Citigroup subsidiaries were
permitted under the agreement to pledge ring-fence assets as
collateral to the Federal Reserve Board's emergency loan programs,
such as PDCF, TSLF, and TAF, subject to the terms and conditions for
these programs. The Citigroup loss-sharing agreement was clear,
however, that if FRBNY ever were to lend to Citigroup under the
agreement, all such pledges would need to be removed.
[55] In June and November 2009, the U.S. House of Representatives
Subcommittee on Domestic Policy, Committee on Government Oversight and
Reform held hearings on the events that led to federal government
assistance to protect Bank of America against losses from Merrill
Lynch assets. Committee members expressed concerns about the reasons
for this intervention when Bank of America had already agreed to
acquire Merrill Lynch without government assistance.
[56] Agency MBS include MBS issued by the housing government-sponsored
enterprises, which are Fannie Mae and Freddie Mac, or guaranteed by
Ginnie Mae.
[57] Section 11B of the Federal Reserve Act, codified at 12 U.S.C. §
248b.
[58] FRBNY consolidated the accounts and results of operations of LLCs
into its financial statements, thereby presenting an aggregate look at
its overall financial position. FRBNY presents consolidated financial
statements because of its controlling financial interest in the LLCs.
Specifically, FRBNY has the power to direct the significant economic
activities of the LLCs and is obligated to absorb losses and has the
right to receive benefits of the LLCs that could potentially be
significant to the LLC. While FRBNY's financial statements include the
accounts and operations of the LLCs, each LLC also issues its own set
of annual financial statements.
[59] As noted previously, on September 21, 2009, the Bank of America
program was terminated. As part of the termination agreement, Bank of
America paid $57 million in compensation for out-of-pocket expenses
incurred by FRBR and an amount equal to the commitment fees required
by the agreement.
[60] Pub. L. No. 107-204, §404, 116 Stat. 745, 789 (July 30, 2002)
requires management assessment of the effectiveness of their internal
control over financial reporting. The Reserve Banks and LLCs are not
registered with the Securities and Exchange Commission and therefore
are not required to follow this law.
[61] Each of the Reserve Banks is supervised by a board of nine
directors who are familiar with economic and credit conditions in the
district. Three of the directors represent member commercial banks and
six of the directors represent the public. The six directors are
elected by member banks in the district, and the three directors are
appointed by the Federal Reserve Board.
[62] COSO is a voluntary initiative of private sector organizations.
COSO is dedicated to guiding executive management and governance
entities toward the establishment of more effective, efficient, and
ethical business operations on a global basis. It sponsors and
disseminates frameworks and guidance based on in-depth research,
analysis, and best practices.
[63] The CPFF LLC issued its final financial statements in August
2010. Deloitte audited these financial statements but did not issue an
opinion on internal control over financial reporting because the LLC
was dissolved during the year.
[64] The audit committee of each Reserve Bank's board of directors is
responsible for assessing the effectiveness and independence of the
Reserve Bank's internal audit function. The Federal Reserve Board
expects the Reserve Bank's board of directors to appoint at least
three independent directors to the audit committee.
[65] OIG, The Federal Reserve's Section 13(3) Lending Facilities to
Support Overall Market Liquidity: Function, Status, and Risk
Management (Washington, D.C., November 2010).
[66] As disclosed in the notes to the Reserve Banks' financial
statements, the Reserve Banks possess a unique set of governmental,
corporate, and central bank characteristics, and accounting principles
for entities with such unique responsibilities have not been
formulated by accounting standard-setting bodies. Therefore, the
Federal Reserve Board develops and issues specialized accounting
principles and practices that it considers appropriate for the nature
and function of a central bank. The Federal Reserve Board requires all
Reserve Banks to adopt and apply accounting policies and practices and
prepare its financial statements in accordance with accounting
principles the Federal Reserve Board establishes. The financial
statements of each of the LLCs are prepared in accordance with GAAP.
Limited differences exist between the accounting principles and
practices of the Federal Reserve Board and GAAP. The primary
differences are the presentation of securities holdings (Treasury
securities, government-sponsored enterprise debt securities, and
foreign government debt instruments) at amortized cost and the
recording of such securities on a settlement-date basis. The cost
basis of the securities is adjusted for amortization of premiums or
accretion of discounts on a straight-line basis, rather than using the
interest method required by GAAP. The effects on the financial
statements of the differences between the accounting principles
established by the Federal Reserve Board and GAAP are also described
in the notes to the financial statements.
[67] The Public Company Accounting Oversight Board is a nonprofit
audit and professional practice standard-setting corporation
established by Congress to oversee the audits of public companies in
order to protect investors and the public interest by promoting
informative, accurate, and independent audit reports.
[68] A material weakness is a deficiency, or a combination of
deficiencies, in internal control such that there is a reasonable
possibility that a material misstatement of the entity's financial
statements will not be prevented or detected and corrected on a timely
basis.
[69] A deficiency in internal control exists when the design or
operation of a control does not allow management or employees, in the
normal course of performing their assigned functions, to prevent or
detect misstatements on a timely basis. A significant deficiency is a
deficiency, or a combination of deficiencies, in internal control that
is less severe than a material weakness yet important enough to merit
attention by those charged with governance.
[70] Service auditors' reports refer to reports typically prepared by
an independent auditor based on a review of the internal controls over
an entity's servicing operations as discussed in the American
Institute of Certified Public Accountants' Statement on Auditing
Standards No. 70, Service Organizations.
[71] FRBNY also paid 36 subvendors more than $3.3 million for services
related to the emergency programs.
[72] The two contracts were with Morgan Stanley and Ernst & Young to
provide AIG RCF-related services, for which FRBNY paid $108.4 million
and $66.9 million, respectively, from 2008 through 2010. AIG
reimbursed FRBNY for these amounts.
[73] FRBB entered into a single $25,000 contract for AMLF and FRBR
entered into three contracts totaling $22.8 million for the Bank of
America ring-fencing agreement.
[74] Any loans made under the Bank of America or Citigroup ringfencing
agreements were to be secured by specified pools of assets belonging
to each institution. However, no loans were extended under the
programs.
[75] As noted earlier, FRBNY has undertaken repurchase agreement
transactions with primary dealers in regular open market operations
for some time. These transactions have been executed through a
triparty arrangement, with the clearing banks providing execution and
collateral-management services. The clearing banks provide this
service to dealers that maintain accounts on their books. The
resulting system is frequently referred to as "triparty." FRBNY
implemented PDCF using the existing triparty legal and operational
infrastructure. For TSLF, FRBNY entered into a new triparty agreement
with each primary dealer and its clearing bank.
[76] FRBNY officials said the structure of the MMIFF program required
that the LLCs be independent of FRBNY. A key to the MMIFF program was
the issuance of highly rated commercial paper to program participants.
However, the rating agencies required that the LLCs be operated
independently of FRBNY so that if losses were sustained, FRBNY could
not potentially place its own interests ahead of the interests of
program participants.
[77] The Reserve Banks jointly developed acquisition guidance, called
the Model Acquisition Guidelines (MAG), based on the American Bar
Association's Model Procurement Code for State and Local Governments.
Individual Reserve Banks use the MAG framework for their acquisition
policies, and FRBNY's Operating Bulleting 10 is an enhanced version of
the MAG. Operating Bulletin 10 has been in place since 1986.
[78] Of the noncompetitive contracts we reviewed, FRBNY awarded only
three under the sole-source exception, when a service was available
from only one vendor.
[79] FAR § 6.301(d).
[80] The American Bar Association's Model Procurement Code for State
and Local Governments, on which Operating Bulletin 10 is based, also
requires as much competition as is practicable under the circumstances.
[81] FAR § 6.302-2(d)(1). Operating Bulletin 10 describes exigency as
follows: "the Bank's need for the property or services is of such
unusual and compelling urgency that it would be demonstrably and
significantly injured unless it can limit the number of suppliers from
which it solicits responses or take other steps to shorten the time
needed to acquire the property or services." Exigency as described in
Operating Bulletin 10 is called "unusual and compelling urgency" in
the FAR. See FAR § 6.302-2.
[82] FRBNY officials noted that multiyear contracts contained
termination rights.
[83] PIMCO's 0.25 basis point variable fee only applied to the first
$400 billion in outstanding commercial paper so it was capped at $10
million per quarter.
[84] The Reserve Banks do not receive appropriated funds and therefore
did not use appropriated funds to pay vendors.
[85] In some cases, vendors were paid directly by the program
recipient so the Reserve Banks did not need to be reimbursed. In one
case, FRBNY paid a Maiden Lane vendor and was later reimbursed.
[86] For TALF, vendors were paid both directly and through a waterfall.
[87] Under 18 U.S.C. § 208(b)(2), the Director of the Office of
Government Ethics, an executive branch agency that provides guidance
to federal government agencies on how to prevent and resolve conflicts
of interest on the part of government employees, may, by regulation,
exempt from the general prohibition financial interests which are too
remote or too inconsequential to affect the integrity of the services
of the employee to which the prohibition applies. See 5 C.F.R. Part
2635, subpart D, and Part 2640.
[88] FRBNY's Code of Conduct incorporated Office of Government Ethics
regulations concerning divestiture, disqualification (recusal), and
waivers of or exemptions from disqualification. See 5 C.F.R. §
2635.402(c)-(e). According to FRBNY staff, some employees recused
themselves out of an abundance of caution even though a conflict of
interest did not exist. In some cases, FRBNY granted a temporary
waiver that allowed an employee to continue to perform duties in
connection with a financial interest while taking steps to divest the
related financial interests.
[89] 5 C.F.R. §2640.301.
[90] While AIG received individual assistance through emergency
actions authorized by the Federal Reserve Board, GE received
assistance through a broad-based program authorized by the Federal
Reserve Board.
[91] As explained in an earlier footnote, COSO is a voluntary
initiative of private-sector organizations. COSO is dedicated to
guiding executive management and governance entities toward the
establishment of more effective, efficient, and ethical business
operations on a global basis. It sponsors and disseminates frameworks
and guidance based on in-depth research, analysis, and best practices.
[92] However, Office of Government Ethics regulations provide that
when an employee acts in accordance with a statutory waiver, the
waiver will constitute a determination that the interest of the
government in the employee's participation outweighs the concern that
a reasonable person may question the integrity of agency programs and
operations. 5 C.F.R. §2635.501.
[93] Office of Government Ethics regulations specifically provide that
Reserve Bank directors may participate in specified matters, even
though they may be particular matters in which they have a
disqualifying financial interest. 5 C.F.R. § 2640.203(h). These
matters concern the establishment of rates to be charged to member
banks for all advances and discounts; consideration of monetary policy
matters and other matters of broad applicability; and approval or
ratification of extensions of credit, advances or discounts to healthy
depository institutions or, in certain conditions, to depository
institutions in hazardous condition.
[94] FRBNY's Audit and Operational Risk Committee is appointed by its
Board of Directors to assist the board in monitoring, (1) the
integrity of the financial statements of the Reserve Bank, (2) the
Reserve Bank's external auditor's qualifications and independence, (3)
the performance of the Reserve Bank's internal audit function and
external auditors, (4) internal controls and the measurement of
operational risk, and (5) the compliance by the Reserve Bank with
legal and regulatory requirements. The Audit and Operational Risk
Committee also assesses the effectiveness of (2), (3), (4), and (5).
[95] Section 1109(b) of the Dodd-Frank Act required us to examine
Reserve Bank governance. This report will be issued in October 2011.
[96] Section 1107 of the Dodd-Frank Act amended the Federal Reserve
Act to require that the president of a Reserve Bank be appointed not
by its board of directors, but only by its Class B and C directors,
with the Federal Reserve Board's approval.
[97] Other changes included prohibiting Class A directors from having
a role in the appointment of FRBNY's president and first vice
president, consistent with the Dodd-Frank amendment, voting for or
playing a role in the selection of individuals managing the Financial
Institution Supervision Group, and approving the budget for the
Financial Institution Supervision Group. In addition, at most, two out
of five Class A directors can serve as members on the Reserve Bank's
Nominating and Corporate Governance Committee, on which at least five
directors must sit.
[98] Security policies refer broadly to policies put in place to
secure repayment of loans. Although the Federal Reserve System is not
funded by appropriations from Congress, any losses on the Reserve
Banks' emergency loans would have reduced the amount of excess
earnings that the Federal Reserve System remitted to Treasury.
[99] For the purposes of this report, we use the term
"overcollateralized" to refer to Reserve Bank lending for which
borrowers were required to pledge collateral in excess of the loan
amount. By using this term, we do not intend to suggest that the
amount of excess collateral required was inappropriately excessive
given the Federal Reserve Board's policy objectives.
[100] The Reserve Banks extend discount window credit to U.S.
depository institutions (including U.S. branches and agencies of
foreign banks) under three programs, one of which is the primary
credit program. Primary credit is available to generally sound
depository institutions, typically on an overnight basis. To assess
whether a depository institution is in sound financial condition, its
Reserve Bank can regularly review the institution's condition, using
supervisory ratings and data on adequacy of the institution's capital.
[101] According to TAF terms and conditions, the aggregate sum of all
TAF loans outstanding with a term to maturity of more than 28 days
could not exceed 75 percent of the value of the collateral available
to secure the loan.
[101] At each examination of a depository institution performed by
federal financial regulators, examiners assign a supervisory CAMELS
rating, which assesses six components of an institution's financial
health: capital, asset quality, management, earnings, liquidity, and
sensitivity to market risk. An institution's CAMELS rating is known
directly only by the institution's senior management and appropriate
regulatory staff. Institutions with a CAMELS or equivalent supervisory
rating of 1, 2, or 3 generally are considered eligible for the primary
credit program, unless supplementary information indicates that the
institution is generally not sound.
[102] In the FRBNY's open market operations repurchase agreement
transactions, the collateral pledged by dealers was subject to a
haircut schedule. Similar to the discount window and TAF margin
tables, these margins were derived using value-at-risk methodology,
but the margins were not identical to discount window margin tables.
Value-at-risk is a statistical measure of the potential loss in the
fair value of a portfolio due to adverse movements in underlying risk
factors. The measure is an estimate of the expected loss that an
institution is unlikely to exceed in a given period with a particular
degree of confidence.
[103] The selected ABCP collateral was highly rated, short-term,
secured by an interest in a diversified pool of assets, and was held
in significant quantity by MMMFs. In addition, as market conditions
improved, the collateral eligibility requirements for AMLF tightened
from its initial design to exclude collateral that had an A1/P1/F1
rating but were on negative watch.
[104] Economic incentives for intermediary borrowers to participate
were based on the ability to earn returns on eligible ABCP in excess
of the interest rate on the AMLF loan.
[105] The use of an SPV allowed FRBNY to leverage existing market
infrastructure for the issuance of commercial paper. Using loans from
FRBNY's discount window infrastructure, the CPFF LLC would purchase
eligible paper in the same way that investors would purchase this
paper in the marketplace.
[106] At the time of its registration to use the CPFF, each issuer
also had to pay a facility fee equal to 10 basis points of the maximum
amount of its commercial paper the SPV could own.
[107] This limit was equal to the sum of the commercial paper an
issuer had issued through CPFF and other outstanding commercial paper
the issuer had issued in the market. According to FRBNY staff, FRBNY
monitored compliance with issuance limits on an ex-post basis due to
limitations with the availability of commercial paper issuance data.
By reviewing the prior day's data rather than reviewing aggregate
amounts in advance of issuance, FRBNY identified a few instances of
CPFF issuers exceeding the program's issuance limits. In these cases,
FRBNY took steps to either unwind the transaction or encourage the
borrower to reduce its exposure to below the limit.
[108] Some MMMFs indicated that the subordinated note feature
presented an obstacle to their participating in MMIFF. In particular,
MMIFF notes were to be collateralized by all assets held by the SPV
and some funds would have had to obtain special approval from their
boards of directors to invest in one or more of the 50 institutions
whose obligations were to be held by the MMIFF SPVs.
[109] TALF collateral was required to have a AAA rating from a minimum
of two rating agencies and was further required to have a AAA rating
from all eligible rating agencies that rated the security.
[110] In addition, for legacy CMBS, FRBNY reserved the right to reject
a legacy CMBS if the legacy CMBS did not meet the explicit
requirements stated in the TALF Terms and Conditions. In addition,
FRBNY conducted due diligence on major participants in CMBS
transactions, including issuers, loan sellers, and sponsors of
mortgage borrowers and reserved the right to reject any legacy or
newly issued CMBS based on its assessment of fraud exposure or other
risks. FRBNY did not disclose its selection criteria to reduce the
likelihood that only the poorest-performing collateral would be put
forward for TALF loans.
[111] Treasury and the Federal Reserve Board later reduced these
lending commitments to up to $4.3 billion from TARP and up to $38.7
billion from FRBNY, respectively.
[112] In contrast to a cash CDO, which invests in fixed income
securities, a synthetic CDO is a form of CDO that invests in credit
default swaps or other noncash assets to gain exposure to fixed income
securities and then issues synthetic CDO securities to match the
underlying exposure.
[113] With a first priority perfected security interest, no other
parties would have a claim to the collateral that would supersede
FRBNY's claim.
[114] According to FRBNY attorneys with whom we spoke, FRBNY's
contracts with some vendors included provisions that would have held
the vendor liable for any losses arising from misapplication of
program requirements.
[115] For its analysis of stress losses for CPFF, FRBNY defined stress
losses as a 1-in-100 years event.
[116] FRBNY staff noted that the Reserve Banks maintain low levels of
capital, remitting excess earnings to Treasury, because capital levels
do not reflect a central bank's ability to bear losses.
[117] As discussed earlier in this report, the foreign institutions
receiving dollar loans through the foreign central banks were not
counterparties to FRBNY.
[118] A Federal Reserve Board staff memorandum indicated that not all
inquiries from foreign central banks were escalated to the FOMC for a
formal FOMC approval or rejection. Staff said they informed some
foreign central banks that the FOMC would be unlikely to approve a
swap line arrangement.
[119] FRBNY leveraged these existing bilateral legal agreements with
the primary dealers by amending them to provide for PDCF and TSLF and
also leveraged existing triparty agreements among FRBNY, each primary
dealer and its clearing bank to implement tri-party aspects of PDCF.
FRBNY negotiated new securities loan agreements to cover the triparty
aspects of TSLF.
[120] 2a-7 MMMFs are required to adhere to the restrictions of the
maturity, quality, and diversification of their assets defined under
the Securities and Exchange Commission rule 2a-7 and held the highly
rated ABCP that could serve as collateral for FRBB loans.
[121] According to FRBNY, MMMF industry representatives selected the
50 financial institutions whose short-term debt obligations would be
eligible for purchase by the five MMIFF SPVs. Each of the five MMIFF
SPVs was authorized to purchase obligations of 10 of these
institutions. According to FRBNY staff, achieving geographic diversity
for each SPV was one criterion considered in allocating these
institutions across the SPVs. More broadly, JPMC and FRBNY considered
the obligations of the selected institutions to be broadly held across
many MMMFs.
[122] TALF agents were primary dealers or designated broker-dealers
whose responsibilities included conducting due diligence on TALF
borrowers and making representations to FRBNY regarding eligibility of
TALF borrowers and their collateral, submitting TALF loan requests and
supporting documentation to FRBNY and the TALF custodian on behalf of
borrowers, delivering administrative fees and collateral from TALF
borrowers to FRBNY, and distributing the TALF borrowers' share of
principal and interest payments paid on the collateral backing the
TALF loan.
[123] FRBNY defined material investors as investors with at least a 10
percent ownership stake in the entity borrowing from TALF.
[124] Our scope was limited to review of detailed collateral data for
TAF and PDCF.
[124] Section 1101 of the Dodd-Frank Act amended the Federal Reserve
Board's section 13(3) authority; such lending can now be made only
through programs or facilities with broad-based eligibility. The
amendments also require the Federal Reserve Board to establish
regulations on the policies and procedures governing its emergency
lending under section 13(3).
[125] The TALF program, which was developed last among the broad-based
emergency programs, included specific rules for changing any of its
extensive documentation that included sign-off from staff at the
Federal Reserve Board, FRBNY, and Treasury. In addition, according to
Federal Reserve Board staff, there were regular daily calls between
the lead staff from the Federal Reserve Board, FRBNY, and Treasury
where all issues related to the program were discussed, including any
issues that fell outside the program documentation. Federal Reserve
Board staff regularly briefed members of the Board of Governors about
the program, and material changes to the program were formally
authorized by the Federal Reserve Board.
[126] When the turmoil in the markets began in 2007, some banks had to
finance the assets held by off-balance-sheet entities when those
entities were unable to refinance their expiring debt due to market
concerns over the quality of the assets. In some cases, these off-
balance-sheet entities relied on financing commitments that banks had
extended to them. In other cases, financial institutions supported
troubled off-balance sheet entities to protect their reputations with
clients even when no legal requirement to do so existed. For more
information about liquidity problems that emerged in connection with
off-balance-sheet entities, see [hyperlink,
http://www.gao.gov/products/GAO-09-739].
[127] A "material investor" is an investor who owns, directly or
indirectly, an interest in any class of securities of a borrower that
is greater than or equal to a 10 percent interest in such outstanding
class of securities.
[129] On September 6, 2008, the Federal Housing Finance Agency (FHFA)
placed Fannie Mae and Freddie Mac into conservatorship out of concern
that the deteriorating financial condition of the two enterprises
threatened the stability of financial markets. According to FHFA's
former Director, James B. Lockhart III, at the time the
conservatorships were established, Fannie Mae and Freddie Mac had
worldwide debt and other financial obligations totaling $5.4 trillion,
and their default on those obligations would have significantly
disrupted the U.S. financial system. For more information about the
enterprises, see GAO, Fannie Mae and Freddie Mac: Analysis of Options
for Revising the Housing Enterprises' Long-Term Structure, [hyperlink,
http://www.gao.gov/products/GAO-09-782] (Washington, D.C.: Sept. 10,
2009).
[130] Prices of fixed income securities such as agency MBS move in the
opposite direction of the yield. When the yield on the Fannie Mae
securities dropped, the price that investors were willing to pay for
agency MBS securities increased. One basis point is equivalent to 0.01
percent or 1/100th of a percent.
[131] The Department of the Treasury (Treasury) agreed to provide
substantial financial support to the enterprises so that they could
continue to support mortgage finance during the financial crisis. On
September 7, 2008, Treasury agreed to provide up to $100 billion in
financial support to each enterprise through the purchase of their
preferred stock so that the enterprises maintain a positive net worth.
In February 2009, Treasury agreed to increase this commitment to $200
billion per enterprise. Treasury also agreed to purchase the
enterprises' mortgage-backed securities and establish a lending
facility to meet their borrowing requirements if needed.
[132] When mortgage interest rates fall, homeowners that had borrowed
at a higher rate may be able to refinance to lower rates. Proceeds
from the new loan are used to pay off the existing loan in the process.
[133] ABCP refers to commercial paper issued by a special purpose
vehicle, or conduit, created to purchase asset-backed securities, such
as mortgage-backed securities or securities backed by other types of
receivables. Many financial institutions created ABCP conduits that
would purchase various assets, including mortgage-related securities,
financial institution debt, and receivables from industrial
businesses. To obtain funds to purchase these assets, these conduits
borrowed using shorter-term debt instruments, such as ABCP and medium-
term notes. The difference between the interest paid to the ABCP or
note holders and the income earned on the entity's assets produced fee
and other income for the sponsoring institution. However, these
structures carried the risk that the entity would find it difficult or
costly to renew its debt financing under less-favorable market
conditions.
[134] A mutual fund is a company that pools money from many investors
and invests the money in stocks, bonds, short-term money market
instruments, other securities or assets, or some combination of these
investments. These investments comprise the fund's portfolio. Mutual
funds are registered and regulated under the Investment Company Act of
1940, and are supervised by the Securities and Exchange Commission.
Mutual funds sell shares to public investors. Each share represents an
investor's proportionate ownership in the fund's holdings and the
income those holdings generate. Mutual fund shares are "redeemable,"
which means that when mutual fund investors want to sell their shares,
the investors sell them back to the fund, or to a broker acting for
the fund, at their current net asset value per share, minus any fees
the fund may charge.
[135] For more about this stress test exercise, see GAO, Troubled
Asset Relief Program: Bank Stress Test Offers Lessons as Regulators
Take Further Actions to Strengthen Supervisory Oversight, [hyperlink,
http://www.gao.gov/products/GAO-10-861] (Washington, D.C.: Sept. 29,
2010).
[136] According to Federal Reserve Board officials, the maximum term
allowed for commercial paper was 270 days, and depository institutions
were restricted to a loan of 120 days because of limitations that
section 10B of the Federal Reserve Act places on the term of loans
Reserve Banks can make to depository institutions.
[137] AIG is an international insurance organization serving customers
in more than 130 countries. As of March 31, 2011, AIG had assets of
$611.2 billion and revenues of $17.4 billion for the 3 preceding
months. AIG companies serve commercial, industrial, and individual
customers through worldwide property-casualty networks. In addition,
AIG companies provide life insurance and retirement services in the
United States.
[138] Through AIGFP--a financial products subsidiary that engaged in a
variety of financial transactions, including standard and customized
financial products--AIG was a participant in the derivatives market.
The securities lending program allowed certain insurance companies,
primarily AIG's life insurance companies, to lend securities in return
for cash collateral that was invested in investments such as
residential mortgage-backed securities.
[139] Credit default swaps are bilateral contracts that are sold over
the counter and transfer credit risks from one party to another. The
seller, who is offering credit protection, agrees, in return for a
periodic fee, to compensate the buyer if a specified credit event,
such as default, occurs. Collateralized debt obligations are
securities backed by a pool of bonds, loans, or other assets.
[140] GAO, Troubled Asset Relief Program: The Government's Exposure to
AIG Following the Company's Recapitalization, [hyperlink,
http://www.gao.gov/products/GAO-11-716] (Washington, D.C.: Jul. 18,
2011); Troubled Asset Relief Program: Third Quarter 2010 Update of
Government Assistance Provided to AIG and Description of Recent
Execution of Recapitalization Plan, [hyperlink,
http://www.gao.gov/products/GAO-11-46] (Washington, D.C.: Jan. 20,
2011); Troubled Asset Relief Program: Update of Government Assistance
Provided to AIG, [hyperlink, http://www.gao.gov/products/GAO-10-475]
(Washington, D.C.: Apr. 27, 2010); Troubled Asset Relief Program:
Status of Government Assistance Provided to AIG, [hyperlink,
http://www.gao.gov/products/GAO-09-975] (Washington, D.C.: Sept. 21,
2009); and Federal Financial Assistance: Preliminary Observations on
Assistance Provided to AIG, [hyperlink,
http://www.gao.gov/products/GAO-09-490T] (Washington, D.C.: Mar. 18,
2009).
[141] In contrast to a cash CDO, which invests in fixed income
securities, a synthetic CDO is a form of CDO that invests in CDS or
other noncash assets to gain exposure to fixed income securities and
then issues synthetic CDO securities to match the underlying exposure.
[142] In our work on the financial crisis, Securities and Exchange
Commission officials told us that neither they nor the broader
regulatory community anticipated this development and that SEC had not
directed the five large broker-dealer holding companies to plan for
the unavailability of secured funding in their contingent funding
plans. SEC officials stated that no financial institution could
survive without secured funding. Rumors about clients moving cash and
security balances elsewhere and, more importantly, counterparties not
transacting with Bear Stearns also placed strains on the firm's
ability to obtain secured financing. See GAO, Financial Markets
Regulation: Financial Crisis Highlights Need to Improve Oversight of
Leverage at Financial Institutions and across System, [hyperlink,
http://www.gao.gov/products/GAO-09-739] (Washington, D.C.: Jul. 22,
2009).
[143] The loan was made through JPMC under FRBNY's discount window
authority under section 10B of the Federal Reserve Act. However,
recognizing that the ultimate borrower was Bear Stearns, a
nondepository institution, the Board of Governors voted on the
afternoon of March 14, 2008, to authorize the loan under section 13(3)
authority. Federal Reserve Board officials explained that the use of
JPMC as an intermediary was not strictly required as section 13(3)
permitted a direct loan to Bear Stearns. However, they used the back-
to-back loan structure because this was the structure FRBNY lawyers
had prepared for in developing required legal documentation late on
Thursday, March 13, 2008.
[144] Timothy F. Geithner, testimony before the U.S. Senate Committee
on Banking, Housing and Urban Affairs (Washington, D.C., Apr. 3, 2008).
[145] Under the terms outlined in this letter and approved by the
Federal Reserve Board, FRBNY agreed to lend up to $30 billion to JPMC
against eligible Bear Stearns's collateral listed in an attachment to
the letter. The types and amounts of eligible collateral under this
agreement were broadly similar to the assets ultimately included under
the final lending structure, Maiden Lane LLC. The agreed price of the
collateral was to be based on Bear Stearns's valuation of the
collateral as of March 16, 2008, regardless of the date of any lending
to JPMC under this agreement. JPMC would not have been required to
post margin in any amount to secure any borrowing under this
agreement. The letter also included certain regulatory exemptions for
JPMC in connection with its agreement to acquire Bear Stearns. For
example, the Federal Reserve Board granted an 18-month exemption to
JPMC from the Federal Reserve Board's risk-based and leverage capital
requirements for bank holding companies. The exemption would allow
JPMC to exclude the assets and exposures of Bear Stearns from its risk-
weighted assets for purposes of applying the risk-based capital
requirements at the parent bank holding company.
[146] In June and November 2009, the House of Representatives
Subcommittee on Domestic Policy, Committee on Government Oversight and
Reform, held hearings on the events that led to federal government
assistance to protect Bank of America against losses from Merrill
Lynch assets. Committee members expressed concerns about the reasons
for this intervention when Bank of America had already agreed to
acquire Merrill Lynch without government assistance.
[147] Bank of America agreed to issue FDIC and Treasury $4 billion in
preferred stock with an 8 percent dividend rate and warrants with an
aggregate exercise value of 10 percent of the total amount of
preferred stock issued.
[148] See GAO, Troubled Asset Relief Program: Bank Stress Test Offers
Lessons as Regulators Take Further Actions to Strengthen Supervisory
Oversight, [hyperlink, http://www.gao.gov/products/GAO-10-861]
(Washington, D.C.: Sept. 29, 2010).
[149] See [hyperlink, http://www.gao.gov/products/GAO-10-100].
[150] Citigroup issued FDIC and Treasury approximately $3 billion and
$4 billion of preferred stock, respectively, for bearing the risk
associated with the guarantees.
[151] Adrian, T., K. Kimbrough, and D. Marchioni. "The Federal
Reserve's Commercial Paper Funding Facility." FRBNY Economic Policy
Review (2010).
[152] FDIC charged a fee for its guarantee that depended on the term
of the unsecured commercial paper. FDIC's fee for 3-month unsecured
commercial paper initially was 50 basis points.
[153] On September 19, 2008, Treasury announced the Temporary
Guarantee Program for Money Market Funds, which temporarily guaranteed
certain investments in money market funds that decided to participate
in the program. Treasury's Temporary Guarantee Program for Money
Market Funds expired on September 18, 2009. Treasury guaranteed that
upon liquidation of a participating money market fund, the fund's
shareholders would receive the fund's stable share price of $1 for
each fund share owned as of September 19, 2008. Participating funds
were required to agree to liquidate and to suspend shareholder
redemptions if they broke the buck. Most money market funds elected to
participate in the program.
[154] These foreign central banks were the Bank of Canada, the Bank of
England, the European Central Bank, the Bank of Japan, and the Swiss
National Bank.
[155] Michael Fleming and Nicholas Klagge, "The Federal Reserve's
Foreign Exchange Swap Lines," Federal Reserve Bank of New York Current
Issues, vol. 16, no. 4 (New York, NY, April 2010).
[156] If the debt instruments of a financial institution held by an
SPV were no longer eligible assets due to a debt rating downgrade, the
SPV would have been required to cease all asset purchases until all of
the SPV's assets issued by that financial institution had matured.
Upon a payment default of any asset held by an SPV, the SPV would have
been required to cease all asset purchases and repayments on
outstanding ABCP; proceeds from maturation of the SPV assets would be
distributed to FRBNY and subordinated note holders according to
program terms and conditions.
[157] 2a-7 MMMFs are required to adhere to the restrictions of the
maturity, quality, and diversification of their assets defined under
the Securities and Exchange Commission rule 2a-7.
[158] Additional newly eligible investors included U.S. dollar-
denominated cash collateral reinvestment funds, portfolios, and
accounts associated with securities lending transactions that were
managed or owned by a U.S. bank, insurance company, pension fund,
trust company, or a Securities and Exchange Commission-registered
investment advisor.
[159] TALF loans were made without recourse to the intermediary
borrower. However, under the TALF lending agreement, if FRBNY found
that the collateral provided for a TALF loan or a borrower who had
participated in the program was found to be ineligible, the
nonrecourse feature of the loan would become inapplicable.
[160] TALF collateral was required to have a AAA rating from a minimum
of two rating agencies and was further required to have a AAA rating
from all eligible rating agencies that rated the security.
[161] In addition, for legacy CMBS, FRBNY reserved the right to reject
any ABS if the legacy ABS did not meet the explicit requirements
stated in the TALF terms and conditions. In addition, FRBNY conducted
due diligence on major participants in CMBS transactions, including
issuers, loan sellers, and sponsors of mortgage borrowers and reserved
the right to reject any legacy or newly issued CMBS based on its
assessment of fraud exposure or other risks. FRBNY did not disclose
its selection criteria to reduce the likelihood that only the poorest-
performing collateral would be put forward for TALF loans.
[162] Treasury and the Federal Reserve Board later reduced these
lending commitments to up to $4.3 billion from TARP and up to $38.7
billion from FRBNY, respectively.
[163] For more information about how FRBNY administered the TALF
program, see GAO, Troubled Asset Relief Program: Treasury Needs to
Strengthen Its Decision-Making Process on the Term Asset-Backed
Securities Loan Facility, [hyperlink,
http://www.gao.gov/products/GAO-10-25] (Washington, D.C.: Feb. 5,
2010).
[164] TALF agents were primary dealers or designated broker-dealers
whose responsibilities included conducting due diligence on TALF
borrowers and making representations to FRBNY regarding eligibility of
TALF borrowers and their collateral, submitting TALF loan requests and
supporting documentation to FRBNY and the TALF custodian on behalf of
borrowers, delivering administrative fees and collateral from TALF
borrowers to FRBNY, and distributing the TALF borrower's share of
principal and interest payments paid on the collateral backing the
TALF loan.
[165] FRBNY defined material investors as investors with at least a 10
percent ownership stake in the entity borrowing from TALF.
[166] Extensions of Credit by Federal Reserve Banks, 72 Fed. Reg.
71202 (Dec. 17, 2007).
[167] The Federal Reserve Board set the minimum bid rate and initially
determined the minimum bid rate based on a measure of the average
expected overnight federal funds rate over the term of the loans being
auctioned.
[168] For all TAF auctions from October 2008 through the end of the
program, the TAF interest rate awarded was the minimum bid rate set by
the Federal Reserve Board because demand for TAF loans was below the
amount offered at auction.
[169] At each examination of a depository institution performed by
federal financial regulators, examiners assign a supervisory CAMELS
rating, which assesses six components of an institution's financial
health: capital, asset quality, management, earnings, liquidity, and
sensitivity to market risk. An institution's CAMELS rating is known
directly only by the institution's senior management and appropriate
regulatory staff.
[170] On October 6, 2008, the Federal Reserve Board announced that
pursuant to new authority granted by the Emergency Economic
Stabilization Act of 2008, Reserve Banks would begin to pay interest
on required and excess reserve balances depository institutions held
at the Reserve Banks. In a January 2009 speech, the Chairman of the
Federal Reserve Board said, "In principle, the interest rate the Fed
pays on bank reserves should set a floor on the overnight interest
rate, as banks should be unwilling to lend reserves at a rate lower
than they can receive from the Fed. In practice, the federal funds
rate has fallen somewhat below the interest rate on reserves in recent
months, reflecting the very high volume of excess reserves, the
inexperience of banks with the new regime, and other factors. However,
as excess reserves decline, financial conditions normalize, and banks
adapt to the new regime, we expect the interest rate paid on reserves
to become an effective instrument for controlling the federal funds
rate. Ben S. Bernanke, lecture given at the London School of Economics
(London, England, Jan. 13, 2009).
[171] For more information about the potential causes and impacts of
downward price spirals, see [hyperlink,
http://www.gao.gov/products/GAO-09-739].
[172] Before the crisis, FRBNY ran an overnight securities lending
facility, the terms of which involved the lending of certain Treasury
securities by FRBNY to primary dealers against other Treasury
securities as collateral. Certain of the legal infrastructure for the
traditional securities lending program was used for TSLF. Other legal
and operational infrastructure had to be created specifically for TSLF.
[173] In FRBNY's open market operations repurchase agreement
transactions, the collateral pledged by dealers was subject to a
haircut schedule. Similar to the discount window and TAF margin
tables, these margins were derived using value-at-risk methodology,
but the margins were not identical to discount window margin tables.
Value-at-risk is a statistical measure of the potential loss in the
fair value of a portfolio due to adverse movements in underlying risk
factors. The measure is an estimate of the expected loss that an
institution is unlikely to exceed in a given period with a particular
degree of confidence.
[End of section]
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