Steven Kelly on the Challenges of Treasury Equity Funding for 13(3) Facilities

Episode Summary

Executive Summary: Stephen Kelly argues that the Fed’s growing reliance on Treasury equity in emergency lending often adds politics without much practical benefit. Tracing facilities from 2008, 2020, and 2023, he shows Treasury funding frequently constrained the Fed more than it empowered it, and suggests the Fed should rely less on Treasury money and more on its own lending authority.

Main Topics: Treasury Equity Model of Emergency Lending (Priority: 5/5): Kelly defines the model as Fed emergency facilities backed by junior Treasury capital, intended to absorb first losses and expand lending capacity. Legal and historical basis of Section 13(3) (Priority: 5/5): The discussion reviews how 13(3) authorizes broad-based emergency lending in unusual and exigent circumstances, with repayment expected in most states of the world. Great Financial Crisis origins (Priority: 5/5): The Bear Stearns, CPFF, and TALF episodes show the Fed experimenting with Treasury support, but often finding Treasury unnecessary, unavailable, or politically restrictive. COVID-19 facilities and Treasury politics (Priority: 5/5): In 2020 the Treasury and CARES Act supplied large equity buffers for Fed facilities, but Mnuchin’s oversight and later clawback illustrated how Treasury money could limit Fed flexibility. Bank Term Funding Program in 2023 (Priority: 4/5): The BTFP is presented as a quasi-discount-window facility that relied on Treasury support and par valuation of collateral, yet still reflected a tendency to seek Treasury backing out of habit. Policy recommendation for the Fed (Priority: 4/5): Kelly advises the Fed to separate Treasury approval from Treasury funding and avoid assuming Treasury equity is necessary for effective lender-of-last-resort operations.

Key Arguments: The Fed’s 13(3) authority is meant for secured, broad-based emergency lending, not grant-like fiscal transfers; facilities should expect repayment in most states of the world. Treasury equity often does not materially expand lending because many facilities are already designed so conservatively that Treasury money is not needed ex ante. In several episodes, Treasury money came with political strings that constrained the Fed more than it helped, especially in 2020 under Mnuchin. Dodd-Frank’s broad-based requirement and pooling mechanisms reduced some legal need for Treasury support by making facilities portfolio-based rather than single-firm rescues. The Fed should stop treating Treasury equity as routine; Treasury approval is required by law, but Treasury capital should be used only when the Fed truly needs additional loss-absorption capacity. The BTFP showed the Fed can design a backstop around bank solvency and franchise value without treating Treasury as the sole source of risk capacity. The swap lines are contrasted as a cleaner, less politicized international tool because the Fed trusts other central banks to manage their own counterparty risk.

Data Points: Section 13(3) usage history: Dormant for decades; invoked many times in 2008, many times in 2020, and again in 2023 - Fed emergency lending history discussed by Kelly Great Depression lending under 13(3): $1.5 billion - Historic lending under the authority before it went dormant Bear Stearns/ Maiden Lane loan: $29 billion Fed loan against $30 billion of assets - Structure of the Maiden Lane facility in 2008 J.P. Morgan first-loss layer: $1 billion - Equity piece in the Maiden Lane structure for Bear Stearns assets Treasury request for CPFF: $10 billion - Fed wanted Treasury support for the commercial paper funding facility, but Paulson refused TALF Treasury equity: $20 billion - Treasury junior funding into a $200 billion Fed lending facility TALF leverage ratio: 10 to 1 - Implied leverage from Treasury equity into Fed lending capacity COVID ESF balance: $95 billion - Amount in the Exchange Stabilization Fund at the start of COVID facility design CARES Act ESF allocation: $454 billion - Congressional funding for Treasury support of Fed programs in 2020 Expected Fed lending capacity: Up to $4 trillion - Public statement by Powell and Mnuchin about leveraging Treasury money BTFP lending volume: $165 billion - Approximate size of the bank term funding program cited in the discussion BTFP ESF support: $25 billion - Treasury equity provided to back the BTFP Earlier CPFF surcharge: 100 basis points - Extra fee charged to unsecured commercial paper issuers when Treasury support was unavailable Treasury support in TALF compared with lending: $20 billion vs. $200 billion - Illustrates scale of Treasury equity to Fed lending in the TALF Maturity of BTFP loans: One year - Compared with the discount window’s maximum of four months Discount window collateral collateralization: About $3 trillion of collateral - Unused collateral at the Fed, discussed as being valued at zero in liquidity regulations

Pivotal Quotes: "the Fed should sort of rethink this relationship" — Stephen Kelly: Conclusion of the paper’s argument about Treasury equity and emergency lending "you’re kind of in an abusive relationship with the Treasury" — Stephen Kelly: Metaphor used to describe how Treasury funding can constrain Fed facilities "the treasury secretary must approve, not treasury secretary must provide funds" — Stephen Kelly: Policy recommendation for future Fed emergency lending practice

Implications: The Fed may be better served by using Treasury approval only when necessary, not Treasury capital by default. For future crises, clearer rules could preserve Fed flexibility, reduce politicization, and improve emergency lending credibility.