In response to the 2008 financial crisis, the Federal Reserve implemented a bevy of lending programs that dramatically altered the composition of the central bank’s balance sheet and helped restore dollar liquidity in certain distressed markets both at home and abroad.
A major reason the world avoided an unmitigated international banking disaster was the Fed’s injection of trillions of dollars of liquidity into the global banking system.
One of the Fed’s most innovative facilities during the crisis was its revival of foreign central bank liquidity swaps (or swap lines). In broad strokes, the Fed used swap lines during the financial crisis to lend substantial amounts of U.S. dollars to foreign central banks, which in turn distributed the borrowed currency to dollar-needy financial institutions in their respective jurisdictions.
These swap lines have largely flown under the radar in public discourse, despite some expert opinions that “the swap lines with which the Fed pumped dollars into the world economy were perhaps the decisive innovation of the crisis.”
The Fed first used foreign central bank liquidity swaps in the early 1960s as a tool to protect the value of the dollar in foreign exchange markets during the Bretton Woods era.
More recently, the Fed repurposed the swap lines during the financial crisis to help address disruptions in dollar funding of banks in foreign jurisdictions.
The swap lines have continued to serve this purpose ever since. In May 2010, amid the Eurozone crisis, the Fed reestablished temporary liquidity swap facilities with four major central banks to “help improve liquidity conditions in U.S. dollar funding markets and to prevent the spread of strains to other markets and financial centers.”
Shortly after, in 2013, the Fed transformed this web of currency swaps into standing arrangements as part of “a prudent liquidity backstop” to “ease strains in financial markets and mitigate their effects on economic conditions.”
These swap lines have constituted a significant portion of the Fed’s balance sheet,
and the Fed operates with stark autonomy in authorizing foreign central bank liquidity swaps.
Despite the modern expansion of swap lines and the corresponding shift in their use, the Fed has continued to rely upon an attenuated interpretation of Section 14 of the Federal Reserve Act
that was developed in the 1960s as authority to create and enter into liquidity swaps.
In light of the extensive and controversial
power wielded by the Fed in entering into foreign central bank liquidity swaps, the academic discussion of the Federal Reserve’s legal basis for using these arrangements has been surprisingly sparse.
The Fed contends that Congress has provided tacit approval for the Fed’s swap lines since their initial use in the early 1960s.
To the contrary, this Note argues that the Fed’s legal theory supporting its foreign central bank liquidity swaps is inadequate to justify the swap network in its current form. To legitimize the Fed’s use of foreign central bank liquidity swaps, Congress should provide clear legislative authority for the Fed to issue and maintain swap lines. In the absence of such explicit direction, this Note contends that the current statutory framework contains a firmer legal basis that can justify the Fed’s liquidity swaps. As the ensuing analysis seeks to demonstrate, the Fed would be on stronger footing if it reconstructed its liquidity swap framework as an emergency power under Section 13(3) of the Federal Reserve Act, as amended by the Dodd–Frank Wall Street Reform and Consumer Protection Act (Dodd–Frank).
This Note proceeds in three parts. Part I explains the mechanics of foreign central bank liquidity swaps, the circumstances that prompted the Fed to first use liquidity swaps in the 1960s, and the subsequent evolution of the swap lines during and after the financial crisis. Part II outlines the Fed’s current legal basis for the swap lines and analyzes a number of instances when Congress has amended relevant provisions of the Federal Reserve Act, pushing back against the argument that Congress has tacitly approved the swap lines in their current form. Finally, Part III analyzes Section 13(3) and the Fed’s emergency powers as an alternative and superior legal basis for the Fed’s central bank liquidity swaps.