naked capitalism

It must be nice to be like the Fed and be able to chose when you are public or private to suit your convenience.

Many readers like to rail that the Fed is a private institution, but it has a weird public/private structure that has the nasty effect of putting it beyond the reach of Constitutional processes, which is a legitimate reason to push for more transparency and accountability.

One of the interesting aspects of the Wall Street Journal story tonight on how the Fed got paid out by Lehman in full on its loans, while all the other creditors are fighting over scraps, is how the Fed is treated under the law. While (from what I can infer) the Board of Governors is subject of Freedom of Information Act requests, the twelve regional Feds, and that includes the New York Fed, are not, although they appear to be losing ground on that front. The Freedom of Information Act suit filed by Bloomberg seeking more details on the Fed’s emergency lending programs (which are held on the balance sheet of the New York Fed) has been approved by two courts. The Fed is now appealing it to the Supreme Court, which suggests it might have something to hide. But the Supreme Court is more political than lower courts, so the Fed may still prevail.

But the Fed, in the Bloomberg suit, is playing primarily on the idea that it would be detrimental to release the loan information. Ahem. Lots of big banks are seriously in hock to the Fed. The markets are going to fall over if we get the sordid details? It has already been established that no big bank is going to be permitted to fail. So what is the worst we can learn? That Citi is a garbage barge? All more disclosure might do is confirm some suspicions.

But we digress. Back to the matter at hand. The Lehman bankruptcy case is intriguing. First is the fact that the Fed got all its money back:

Billing records filed with the court show the examiner is investigating an issue that has angered many of Lehman’s creditors: how the Federal Reserve and the New York Fed — which lent Lehman $46 billion in cash and securities before its bankruptcy filing last September — were paid promptly and in full, while tens of billions of dollars in other debts were left to be sorted out in court. It remains unclear when and how much Lehman creditors will be repaid.

Yves here. And we get this later in the piece:

Details on the examiner’s work remain scant, and it is possible no actions will be brought. Should the examiner determine that the Fed got preferential treatment, bankruptcy administrators could pursue court claims to recover assets for Lehman’s creditors from the Fed, on the theory those assets should have remained with Lehman when it filed for bankruptcy last September.

Yves here. I love the artful wording: “should the examiner determine that the Fed got preferential treatment.” Um, let’s see. Lehman is bankrupt. That means it has a stay of all creditor claims. But the Fed asks to be paid and gets sent a check pronto. If this isn’t preferential treatment, pray tell what is it? Back to the article:

Such a finding would have little legal precedent and could turn politically fraught, bankruptcy lawyers say. Yet it could bring a focus to one of the unresolved questions of the financial crisis: just how much special treatment the federal government receives above private-market players when it becomes a direct participant in the markets…

Many legal experts said bringing claims against the Fed would be an uphill battle, because the Fed would qualify under a long-held standard of sovereign immunity. That concept generally holds that the government can’t be held legally accountable for its actions.

But Lehman’s estate could have an opening, because by the standards of bankruptcy law, the government isn’t supposed to receive immunity, said Richard Levin, a partner at law firm Cravath, Swaine & Moore LLP who helped write the U.S. bankruptcy code. “The Lehman estate could sue the Fed,” Mr. Levin said, adding that the Fed would likely argue it can’t be held liable.

So the Fed can claim sovereign immunity even though it is kinda-sorta private and subject to no checks of any type (well, its chairman and some of its officials can get summoned by Congress and prodded a bit). And that may mean that even if what it did was 100% illegal, it may be able to get away with it.

Willem Buiter has railed at how the Fed has become expert at regulatory arbitrage and loophole-exploitation, and is assuming a role that it at least inappropriate in a democracy, and possibly engaging in impermissible activities. The Lehman case supports his theory. Banana republic, here we come.