The Federal Reserve and the 2020 Economic and Financial Crisis

This Article provides a comprehensive legal analysis of the Federal Reserve\u27s response to the 2020 economic and financial crisis. First, it examines the sixteen ad hoc lending facilities that the Fed established to fight the crisis and sorts them into two categories. Six advance the Fed\u27s monetary mission and were designed to halt a run on financial institutions. Ten go beyond the Fed\u27s traditional role and are designed to directly support financial markets and the real economy. Second, it maps these programs onto the statutory framework for money and banking. It shows that Congress\u27s signature crisis legislation, the CARES Act, suspended several existing restrictions on Fed lending sub silentio. And it reveals how the Fed\u27s lending to securities dealers and foreign central banks, a practice dating back more than fifty years, has never been expressly authorized by Congress. Third, it argues that these tensions reflect deficiencies in our contemporary economic and financial architecture. Finally, it suggests reforms targeted at improving the government\u27s response to future economic and financial emergencies

Why Supervise Banks? The Foundations of the American Monetary Settlement

Administrative agencies are generally designed to operate at arm’s length, making rules and adjudicating cases. But the banking agencies are different: they are designed to supervise. They work cooperatively with banks and their remedial powers are so extensive they rarely use them. Oversight proceeds through informal, confidential dialogue. Today, supervision is under threat: banks oppose it, the banking agencies restrict it, and scholars misconstrue it. Recently, the critique has turned legal. Supervision’s skeptics draw on a uniform, flattened view of administrative law to argue that supervision is inconsistent with norms of due process and transparency. These arguments erode the intellectual and political foundations of supervision. They also obscure its distinguished past and deny its continued necessity. This Article rescues supervision and recovers its historical pedigree. It argues that our current understanding of supervision is both historically and conceptually blinkered. Understanding supervision requires understanding the theory of banking motivating it and revealing the broader institutional order that depends on it. This Article terms that order the “American Monetary Settlement” (“AMS”). The AMS is designed to solve an extremely difficult governance problem—creating an elastic money supply. It uses specially chartered banks to create money and supervisors to act as outsourcers, overseeing the managers who operate banks. Supervision is now under increasing pressure due to fundamental changes in the political economy of finance. Beginning in the 1950s, the government started to allow nonbanks to expand the money supply, devaluing the banking franchise. Then, the government weakened the link between supervision and money creation by permitting banks to engage in unrelated business activities. This transformation undermined the normative foundations of supervisory governance, fueling today’s desupervisory movement. Desupervision, in turn, cedes public power to private actors and risks endemic economic instability

Too Big to Supervise: The Rise of Financial Conglomerates and the Decline of Discretionary Oversight in Banking

The authority of government officials to define and eliminate “unsafe and unsound” banking practices is one of the oldest and broadest powers in U.S. banking law. But this authority has been neglected in the recent literature, in part because of a movement in the 1990s to convert many supervisory judgments about “safety and soundness” into bright-line rules. This movement did not entirely do away with discretionary oversight, but it refocused supervisors on compliance, risk management, and governance—in other words, on internal bank processes. Drawing on the rules versus standards debate, this Article develops a taxonomy for parsing the various approaches to banking law and documents a shift in supervisory policy over the last thirty years. It shows how today’s focus on internal bank processes, a policy called risk-focused supervision (RFS), was the result of a deregulatory agenda that reconceptualized the role of banks in the economy and led to the emergence of large, complex banking organizations (LCBOs). Unlike traditional banks, LCBOs engage in a wide range of nonmonetary financial activities, including market making in derivatives and corporate securities and investing in private equity funds. The policymakers who designed this new system believed that government oversight of LCBOs was costly and unnecessary—if even possible. Therefore, they constructed a new legal framework based on facilitating market discipline through RFS and risk-based capital requirements. Although most officials today repudiate “market discipline” and the philosophy underlying the pre-crisis legal framework, the pillars of that framework remain intact. Moreover, the future of the Fed’s innovative stress tests – which represent a resurgence in traditional safety and soundness oversight is in doubt. Ultimately, today’s conglomerates, which engage in both monetary and nonmonetary activities, may be, as policymakers in the 1990s first postulated, too big to supervise in the traditional sense. This is a problem because a framework that relies on market oversight or rules alone is unlikely to prevent excessive risk taking and the procyclical expansion of bank balance sheets. It is time, therefore, to reconsider the proper role of banks in the economy and our legal strategies for ensuring a stable and efficient monetary system

The Logic and Limits of the Federal Reserve Act

The Federal Reserve is a monetary authority subject to minimal executive and judicial oversight. It also has the power to create money, which permits it to disburse funds without drawing on the U.S. Treasury. Since 2008, it has leveraged this power to an unprecedented extent. It has rescued teetering financial conglomerates, purchased trillions of dollars of mortgage-backed securities, and opened numerous ad hoc lending facilities to support ordinary businesses, nonprofits, and municipalities. This Article identifies the causes and consequences of the Federal Reserve\u27s expanded footprint by recovering the logic and limits of its enabling act. It argues that to understand the Federal Reserve — including its independence, expansion, and capacity — it is necessary first to understand the statutory scheme for money and banking. Congress chartered investor-owned banks to issue most of the money supply and established the Federal Reserve for a limited purpose: to administer the banking system. Congress equipped the Federal Reserve with an interrelated set of tools to achieve a specific objective: ensure that the banking system creates enough money to keep economic resources productively employed nationwide. The rise of shadow banks — firms that issue alternative forms of money without a bank charter — has impaired the Federal Reserve’s tools. As the Federal Reserve has scrambled to adapt, it has taken on tasks it was not built to handle. This evolution has prompted calls for the Federal Reserve to tackle even more policy challenges. It has also undermined the Federal Reserve’s ability to effectively achieve its core goals. An overloaded Federal Reserve is understandable, but not desirable. Congress should modernize the Federal Reserve Act, and the banking laws on which it depends, to improve monetary administration in the United States

Stilling the Pendulum: Regulatory, Supervisory, and Structural Approaches

Financial regulation is often described as a swinging pendulum. A crisis occurs, and some number of years are spent crafting reforms to prevent another crisis from striking. Unfortunately, all too aware of the enormous costs of the recent disruption, policymakers go too far, stifling salutary financial activity and slowing economic growth. As memories fade, policymakers become increasingly focused on the costs of regulation. Stability is taken for granted, and restrictions are loosened. Markets stay stable and retrenchment continues. Regrettably, however, policymakers err again, and to our collective shock and horror, another crisis hits and the cycle repeats. If this model were accurate, we should all stop trying to reform the financial system and devote ourselves to minimizing the harms of the intermittent calamities. But it’s not. Panics are not inevitable market phenomena. They are man-made, a by-product of the multifaceted legal regime enabling complex financial activity to occur over time. This regime includes laws governing property, contracts, and incorporation, as well as laws conferring upon certain entities the right to issue deposits, laws restricting the activities of these entities (banks), and laws providing assurances to others that the government will stand behind them (e.g., as the lender of last resort)

Shadow Digital Money

Promises by media platforms to provide digital transaction services will likely lead to a flood of new money. While these developments are potentially valuable, under current law the money created is unsound. It is not insured by the government, nor is it backed by safe assets. We should not yoke good technology to unsound money. Federal regulation is needed to guarantee safety and soundness, to restore monetary control to the Federal Reserve, and to prevent a race to the bottom between competing state regulatory regimes. With modest changes to the U.S. Code, innovation in payments will be just that—innovation in payments—and not also unsupervised and unsound money issuance

Recovering the Lost History of Presidential Removal Law

On March 3, 2020, the Supreme Court heard argument in Seila Law v. CFPB, the biggest removal law case since Free Enterprise Fund v. PCAOB was decided a decade ago. The petitioner challenges the constitutionality of the Consumer Financial Protection Bureau, the independent agency established by the 2010 Dodd-Frank Act (DFA) to protect consumers from harmful financial products. Seila Law, a California firm under investigation by the CFPB for its debt-relief marketing practices, argues that statutory limits specifying that the president can fire the CFPB director only for “inefficiency, neglect of duty, or malfeasance in office” (INM) violate the separation of powers. The CFPB, now headed by a Trump appointee and represented by the Justice Department, agrees. To defend the statute, the Court appointed seasoned Supreme Court litigator Paul Clement. The justices’ questions during oral argument suggest the Court is considering several ways to resolve the case. One possibility would be to avoid the merits by holding that because the challenged conduct — a CFPB demand for information and documents — was subsequently ratified by the Bureau’s acting director, who was removable at will, Seila’s alleged injury cannot be traced to the removal provisions in question. Another possibility would be to dismiss the case, accepting Clement’s argument that such a weighty constitutional question should not be decided in a case where both parties are “in violent agreement” regarding the statute’s unconstitutionality

Money and the Public Debt: Treasury Market Liquidity as a Legal Phenomenon

The market for U.S. government debt (Treasuries) forms the bedrock of the global financial system. The ability of investors to sell Treasuries quickly, cheaply, and at scale has led to an assumption, in many places enshrined in law, that Treasuries are nearly equivalent to cash. Yet in recent years Treasury market liquidity has evaporated on several occasions and, in 2020, the market’s near collapse led to the most aggressive central bank intervention in history. This Article pieces together what went wrong and offers a new account of the relationship between money issue and debt issue as mechanisms of public finance. It argues that a high degree of convertibility between Treasuries and cash generally requires intermediaries that can augment the money supply, absorbing sales by expanding their balance sheets on both sides. The historical depth of the Treasury market was in large part the result of a concerted effort by policymakers to nurture and support such balance sheet capacity at a collection of nonbank broker-dealers. In 2008, the ability of these intermediaries to augment the money supply became impaired as investors lost confidence in their money-like liabilities (known as repos). Subsequent changes to market structure pushed substantial Treasury dealing further beyond the bank regulatory perimeter, leaving public finance increasingly dependent on high-frequency traders and hedge funds — “shadow dealers.” The near money issued by these intermediaries proved highly unstable in 2020. Policy makers are now focused on reforming Treasury market structure so that Treasuries remain the world’s most liquid asset class. Successful reform likely requires a legal framework that, among other things, supports elastic intermediation capacity through balance sheets that can expand and contract as needed to meet market needs

Federal Corporate Law and the Business of Banking

The only profit-seeking business enterprises chartered by a federal government agency are banks. Yet there is barely any scholarship justifying this exception to state primacy in U.S. corporate law. This Article addresses that gap. It reinterprets the National Bank Act (NBA) the organic statute governing national banks, the heavyweights of the financial sec- tor-as a corporation law and recovers the reasons why Congress wrote this law: not to catalyze private wealth creation or to regulate an existing industry, but to solve an economic governance problem. National banks are federal instrumentalities charged with augmenting the money supply-- a delegated sovereign privilege. Congress recruited private shareholders and managers to run these instrumentalities as a check on monetary overissue and to prevent politicized asset allocation by government officials-a form of premodern agency independence. Viewing the NBA as a corporation law yields surprising dividends. First, it exposes a major flaw at the heart of U.S. banking jurisprudence. In recent decades, the Supreme Court and the Office of the Comptroller of the Currency (OCC), the chartering authority for national banks, have interpreted national banks\u27 corporate powers expansively, allowing them to enter a vast range of new business lines. But the corporate powers provision of the NBA is not a regulatory statute to which courts should apply Chevron deference, nor is it part of the OCC\u27s enabling act. It is part of the corporate charters of national banks. Accordingly, the opposite, settled rule of construction applies: ambiguity is construed strictly against the corporation. Second, interpreting the NBA as a corporation law reveals that the OCC\u27s current campaign to unhitch national bank charters from the deposit business lacks a statutory basis and threatens an unprecedented colonization of U.S. enterprise law by a federal government agency that is ill-suited to this mission and was never congressionally tasked with it

The Banker Removal Power

The Federal Reserve (“the Fed”) can remove bankers from office if they violate the law, engage in unsafe or unsound practices, or breach their fiduciary duties. The Fed, however, has used this power so rarely that few even realize it exists. Although major U.S. banks have admitted to repeated and flagrant lawbreaking in recent years, the Fed has never removed a senior executive from one of these institutions. This Article offers the first comprehensive account of the banker removal power. It makes four contributions. First, drawing on a range of primary sources, it recovers the power’s statutory foundations, showing that Congress created the authority to better align the interests of senior bankers and the public. Second, using a novel dataset obtained through Freedom of Information Act requests, it maps the actual practice of banker removal – who is removed, how often removal occurs, and for what reasons. It reveals that the Fed now uses the removal power mostly to prevent already-terminated, low-level employees from working at other banks, even though Congress never intended for the power to be used primarily in this way. Third, harnessing corporate law theory, the Article defends the legislative design. It argues that removal of senior bank executives for unsound management practices is a critical component of effective bank supervision, filling gaps left by regulatory rules and traditional corporate governance measures. Finally, the Article concludes by assessing obstacles to the use of the removal power against bank leadership and suggesting policy responses