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Study Exonerates Federal Reserve's Crisis-Era Bailouts

reuters.comMay 4, 2012

By Jonathan Spicer

(Reuters) - A study by economists at one of the regional Federal Reserve banks has found that the U.S. central bank didn't break any laws in its handling of the 2007-09 U.S. financial crisis, and that, in fact, it handled that crisis better than the savings and loan collapse of the 1980s.

The Federal Reserve had attracted scorn when it loaned hundreds of billions of dollars to troubled banks during the 2007-09 crisis, with some critics suggesting the bailout broke the law.

"The authors find no evidence that the Federal Reserve ever exceeded statutory limits during the recent financial crisis, recession, and recovery," said the study by the St. Louis Fed bank, which sought to find out whether the Fed had violated "the letter or spirit of the law" by lending to undercapitalized banks.

The financial crisis was, in part, brought on by aggressive securitization by financial institutions, lax regulations, and a bursting of the subprime mortgage-market bubble in 2007.

At the height of the crisis - which spread to international markets and sparked a brutal global recession - the Fed took unprecedented emergency actions well beyond its traditional use of interest rates to backstop both banks and the market.

It bought an array of financial securities to keep rates low and markets liquid, aggressively lent money to banks and brokers, facilitated Bear Stearns' fire sale to fellow bank JPMorgan, and rescued giant insurer AIG, among other steps that some criticized as excessive or illegal.

The central bank also established a new so-called Term Auction Facility (TAF) to make funds available to banks. Those outstanding loans peaked at $493 billion.

Chairman Ben Bernanke has said the Fed had such powers based on Great Depression-era laws, and needed to act to avoid another Depression. Today, U.S. unemployment remains high and the economy is still recovering from the recession, the worst since the 1930s, even as major banks have again become profitable.

Critics also argued the Fed in 2008 violated the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), which limits Fed lending to undercapitalized banks.

But the study found "no instances in which the Fed provided credit to an undercapitalized or critically undercapitalized bank for more than the maximum number of days specified in FDICIA." It also concluded that few banks that failed between 2008-2010 borrowed from the Fed in their last year running.

"As a group, the banks that failed during the 2008-10 period relied less on the Federal Reserve as a source of credit during their last 52 weeks than did the banks that failed during 1985-90," said the study, which was published on the St. Louis Fed's website.

(Editing by Bernadette Baum)

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