Kathryn Judge on the Importance of Emergency Lending Facilities at the Federal Reserve

Kathryn Judge is a law professor at Columbia University and a legal scholar of the Federal Reserve and financial policy. Kathryn returns to the show to discuss the Fed’s Emergency Lending Facilities, or 13(3) and current happenings at the Federal Reserve. 

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This episode was recorded on March 27th, 2025

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Welcome to Macro Musings where each week we pull back the curtain and take a closer look at the most important macroeconomic issues of the past, present, and future. I am your host, David Beckworth, a senior research fellow with the Mercatus Center at George Mason University, and I’m glad you decided to join us. 

Our guest today is Kathryn Judge. Kate is a law professor at Columbia University and a legal scholar of the Federal Reserve and financial policy. Kate has a new paper with Rich Clarida that looks at the emergency lending facilities, or 13(3), of the Federal Reserve and lessons learned from its use since the Great Financial Crisis. Kate joins us today to discuss the paper as well as other potential institutional changes happening at the Fed. Kate, welcome back to the program.

Kathryn Judge: It’s great to be back.

Beckworth: It’s great to have you back on. This is your third time, so you’re a regular. We’ve got to get you a special jacket you can put on for someone who’s been on this many times.

Judge: I’d wear it with pride.

Beckworth: Yes, and it’s great to have you on because this paper seems very timely and some of your other work as well we’ll talk about. There’s been a lot happening. In fact, Kate, it’s been really hard for me to keep up with everything. It used to be I could go on Twitter, I could open up the Wall Street Journal, Financial Times, Wall Street Journal, and that was sufficient. I feel like that’s not enough anymore.

Things are happening so fast, so many executive orders, so many back and forths, I just can’t keep up with it all. It’s great to have someone like you who’s up in New York City, you’ve got your ear to the ground, you’re feeling what’s happening, and you can help inform me and our listeners.

Judge: Yes, I think we’re all a little bit overwhelmed at the moment.

History of Section 13(3)

Beckworth: You have a paper with Rich Clarida and the title of the paper is “Emergency Lending by the Federal Reserve.” This deals with Section 13(3), which is a very important part of it. Walk us through maybe the history of 13(3). What is it and how did it evolve from a dormant authority into the central pillar of the crisis toolkit today?

Judge: Yes, so Section 13(3) was originally added to the Federal Reserve Act in connection with the Great Depression. At the time, it was fairly broadly worded in part because it was meant to allow the Fed to provide liquidity not just to banks, as it always has at the discount window, but to a broader set of nonbanks. That could include financial institutions that are nonbanks, but also nonfinancial institutions.

It had relatively limited usage when it was first adopted, in part because there were a lot of other more effective tools that were then deployed. The Fed had other lending that it was doing. Quite importantly, at the time, there was a separate structured program known today as REFCORP, the Reconstruction Finance Corporation, that was designed to provide credit throughout the financial system. It bought preferred stock also in banks. Then it also provided a lot of credit to the nonfinancial system.

There were a lot of tools that were better suited to deal with the challenges of the time. 13(3) had been adopted. It allowed the Fed to make collateralized loans to nonbank institutions, nonmember institutions in unusual and exigent circumstances. Then it really did lie dormant. It was invoked, but not actually used a few times in connection with the S&L crisis. It wasn’t actually used again until the Great Financial Crisis.

It was used starting in 2008 and in 2009 to try to contain the effects of the Great Financial Crisis. We thought it might be dormant again. It was reformed a little bit in Dodd–Frank. Then instead, it ended up being very heavily used in 2020. While it’s beyond the scope of our paper, it was also used in 2023 in connection with the regional bank turmoil.

Increasing Use of 13(3)

Beckworth: Does this increasing use tell us anything? When you mentioned in the paper, after the Great Financial Crisis, everyone thought, okay, we’ll wait another 80 years, maybe it’ll happen again. Just 12 years later, boom, we need it. Then as you just mentioned, the banking stress in 2023, it was invoked again. Does this tell us anything about the nature of the financial system, the global dollar system?

Judge: I think it certainly tells us some things. How much we want to read into it is hard to know. One of the key things that it tells us is we are now in a world where the banks are still an important part, a vital part of the financial system, but only a part of the financial system. We now have a very extensive nonbank financial intermediation system. I do think we should anticipate that, in the face of a significant shock to the economy and in the face of the possibility that breakdowns in the financial system could exacerbate the size of the shock and the consequences in ways that are harmful to the macroeconomy, that it very well might be the case that the Fed has to not only make collateralized loans to banks through the discount window, but might also have to engage in providing some support to the nonbank financial system to deal with liquidity charges through Section 13(3) facilities.

Other lessons I think are actually more difficult. I think COVID was just an incredible, incredible shock to the system. That was in some ways an exogenous event, but we are also living, I think in fundamentally potentially more fragile times. The types of shocks that might require emergency actions could well be coming more frequent.

Beckworth: We couldn’t have prevented COVID like we could have, say, 2008. That was a product of choices made along the time path of our financial history. It does speak to, as I think you’re suggesting, the globalized nature of our economy. We’re more interconnected than ever before. I will throw out there just the role of a global dollar system that continues to grow, grow, grow over time. Maybe these interventions actually encourage this growth.

I actually think that’s a good thing on balance. I know we have friends who think that’s a bad thing on balance, but I think having the reach of the dollar grow as an American actually supports our policy. I think it’s something we need to be mindful of, that we don’t lose it. Also the Treasury market, I think the fact that we have these ongoing budget deficits and projected ones puts a lot of strain and all the regulations—Dodd–Frank, Basel after 2008—have constrained the balance sheets and the capacity of them.

The Fed has to step in, it seems like, more and more with that as well. I see it as a symptom, maybe something else happening. But like you said, COVID, nothing would have prepared us for COVID. There is no perfect system, perfect response to that. Let’s go back to 13(3). You already mentioned one key element where it can be invoked is under unusual and exigent circumstances. Who has the authority to define that? Just is it, well, I think it when I see it. Is there some official standard for it?

Unusual and Exigent Circumstances

Judge: This is part of what’s interesting is the Fed internally has a sense of what it means by unusual and exigent. If we look at the rarity of the usage, I think for a while it was not legally developed, but it was understood to be a very high bar. I think 2008—but of course, they didn’t invoke this right away. We think about the crisis starting really in August, 2007. This wasn’t actually invoked until actually just before the failure of Bear Stearns. Then it was used more aggressively subsequent to that.

It was well into the 2008 financial crisis, where that time liquidity conditions were clearly such that the unusual and exigent was satisfied. COVID, also easily satisfied. A bank term funding policy, as I said, it’s outside scope for paper. I’ll speak just for myself. I think there it’s somewhat harder to see, but you have to look at it in connection with the fact that you did have a determination by the FDIC, by the Treasury secretary and consultation with the president, by the Fed board, that all of the conditions were met for using the systemic risk exception to the obligation that FDIC otherwise has to wind down a bank in the way that is least costly to the deposit insurance fund.

If you think, okay, well, whatever the conditions were, the conditions satisfy the systemic risk exception, then I don’t think it’s that much of a stretch to suggest that those same set of conditions potentially justified using 13(3). The key check is, it’s this language of unusual and exigent, but it’s also a supermajority of the board of governors. At least five of the seven governors must vote in favor of implementing the facility.

I think partly the idea, similar to the systemic risk exception, is we’re going to create a high procedural hurdle. We’re going to have a language, but a high procedural hurdle. Then we want the Fed governors to be exercising their independent and expert judgment in trying to decide whether or not those conditions are actually satisfied.

Changes to 13(3)

Beckworth: Going from 2008 and the Great Financial Crisis to 2020, there were some changes that were made. We’ve touched on them, but one of the big ones has to be broad-based eligibility. You can’t just go after one firm like they did in Great Financial Crisis. Also, the Treasury secretary has to sign off on it. A little more, I guess, accountability, I think they’re thinking. What else was the idea behind that? Why add these new restrictions on 13(3)? Was the Fed too reckless or was this just things we hadn’t thought of before so we need to be careful moving forward?

Judge: A little bit of both, but I think what’s also really important to note about the reforms that were embedded in the Dodd–Frank Act is I think it did more to actually protect than to limit the capacity of the Federal Reserve to use 13(3) in the ways that it had over the course of 2008 with a notable exception. It is a very notable exception of saving individual financial institutions. Dodd–Frank did bring a bunch of changes, and you mentioned the most significant.

One is any facility that is created, and regulations have now said this has to be like a half dozen entities that have to be eligible, have to be for purposes of providing a broader set of institutions access to liquidity. The other is a formalization of something that the Fed actually had been doing throughout the Great Financial Crisis, which is getting the approval of the Treasury secretary. Now that’s being done in a way that is transparent, where the Treasury secretary, again, in consultation with the president, language that’s probably not necessary, but helps clarify the political accountability, has to actually sign off on all of these facilities.

There’s also some really important additional disclosure to make sure that once these loans are made, that with an appropriate delay, so you don’t exacerbate the dysfunction. A delay of up to two years, the information about who borrowed what eventually is going to be made public.

Beckworth: What about the other emergency aspects of the Federal Reserve Act? By that I mean the discount window, and your paper doesn’t focus on these, but I’m just going to bring those up for our listeners. I think of the discount window, and that’s for banks. 13(3) is more of the nonbank financial intermediaries. Then also I think of the currency swap lines. Both of those, I believe, are in the Section 14. They’re in a different section altogether.

If you had to rank these in terms of importance, like going forward, we have another shock, 2008, that hits us, which ones do you think are the most important? How would you at least rank them? Like, “Got to make sure this one’s functional, then this one, then the next one.”

Judge: I think they play complementary roles. It’s hard to say one is more important than the other, but I do think it is a great framing to think what are the different tools that we have available for the Fed to provide liquidity. I would also say given the way that these facilities were used for other parts of government to intervene and help facilitate the flow of credit, if we think that that’s actually what a situation requires.

I do think one of the takeaways from the paper is that we want to potentially minimize the set of circumstances in which Section 13(3) facilities are required. We can do that in part by making sure all of these other structures, like the discount window, are functioning well. I think a lot of what we saw in 2023 helped us to realize that the discount window wasn’t doing what we wanted it to do. Many of us knew that well in advance.

I’m very much of the camp that banks are potentially regulated institutions. We have the easiest way of dealing with a moral hazard that might arise from access to liquidity. Really, this is a core part of what banks do. The Fed provides them liquidity so that they can provide liquidity into the broader financial system and to their clients. I think we want to make sure that the discount window is operational and that banks actually feel comfortable using it in a broader set of circumstances than they actually do right now.

Beckworth: It sounds like you’re in the same camp I’m in, that Bill Nelson’s in, Stephen Kelly, Peter Conti-Brown, that we’ve erred too much on the side of worrying about moral hazard and we don’t use the discount window enough. We don’t want to go all the way, but we want to maybe put some more balance into that and make it more accessible. The recent push, which I found very hopeful, of parking collateral there, let it count against your liquidity regulations and just making it a standard operating function would, I think, go a long way in addressing many of our problems.

Classification of the Facilities

Let’s move on in your paper to the classification of the facilities. There were a number of them that occurred in 2008 and then in 2020, some were added to them. We can come back and maybe spell out exactly when this all happened, but a common two-bucket system that I’ve used that after reading your paper, I realized was not precise enough was credit facility and liquidity facility. Liquidity facilities, all those things, the money market funds, commercial paper, all those things that keep the money markets open and running. And the credit facility, I always said, well, Main Street lending, truly credit orientated activity. I know I’m not alone. Many of us, several of our previous guests have used that. In fact, I think I got that idea from a previous guest, but you and Rich, you say, no, no, no. We need to be more precise and careful. I really like the buckets that you come up with. Tell us about the buckets and why we should be more precise.

Judge: Yes, so first of all, I think that dichotomy at least is much richer than some of the conversation that folks have had around Section 13(3). I think it’s a critical step in the right direction. Part of the reasons we’re trying to be a little bit more precise is to try to better understand, just as a descriptive matter, the contingencies that allow the Fed to make the decisions that they did and were present in ways that potentially might inform—again, I’m not making any hard-predictive determinations here—like what they might do in the future.

Again, I should say for purposes of the show, I’m speaking entirely for myself. I’m not speaking on Rich’s behalf. Even for purposes of the paper, of course he’s speaking entirely in his individual capacity. What we see in both 2008 and 2020, the first facilities that were implemented most quickly were ones where they were providing what is the equivalent of discount window lending, but to the primary dealers.

We have a set of counterparties that already are counterparties that the Fed deals with some frequency. Again, 2008 was a little different because it set up the term auction facility to try to get around the stigma problems for the discount window. Then they set up something similar for the primary dealers there. What we see the first step is the Fed intervening in a way that involves very little risk to the Fed and that is dealing with the reality that you have a nonbank financial system that is engaging in intermediation in ways where lack of liquidity can have adverse spillover effects.

As they’re coming in, they’re helping to provide the liquidity that allows the system to continue to function. Part of what’s significant as well with those counterparties is they are providing liquidity into the financial system in a whole variety of different ways. They’re engaging in market-making and a host of other activities. There’s very little allocational effect. You’re making an allocational decision we should acknowledge respect to who has access to the facilities. In terms of the impact on the real economy, there’s very little decision being made by the Fed or capacity to make that type of decision. That’s like the first tier. Significantly we see the Fed undertaking those facilities without requiring any funding from the Treasury Department typically. That’s significant.

The next tier that we start to see are ones that involve more targeted efforts. Again, I’m overly simplifying for purposes of these buckets, but more targeted efforts to support particular components of this nonbank financial intermediation system. There, in particular, we had challenges both in 2008 and 2020 relating to money market mutual funds and other types of assets that were core to the functioning of the short-term markets as a by-product of the money market mutual funds.

There we see some differences actually between 2008 and 2020, where 2008, I think they tried to get some Treasury funding or weren’t able to do so. Instead use a fee structure to build up a little bit of an equity cushion. In 2020, they demanded and were provided funds from the Treasury Department from its exchange stabilization fund. There’s a finite amount of money that’s sitting there that provided the backstop that allowed the Fed to make sure that another requirement that the reserve bank operating the facility felt that it was a secure to its satisfaction. You have a little bit of an equity cushion from Treasury that, at least in theory, even though it didn’t need to, could absorb some of those losses.

Then just really quickly. We can get to the other types of facilities, but the last bucket for our purposes right now—I want to put PPP in the different buckets. We can come back to that if we want to because I think that’s actually a really interesting and important bucket. I think the last big bucket that I’ll talk about right now are in situations where there was actually a breakdown potentially in the flow of credit in ways that there were concerns over what the consequences might be.

We saw this in 2008 with TALF where you had just the securitization markets ceasing to function. They were providing credit to critical areas in the real economy: auto loans and credit cards. The Fed, partly because you already had a securitization structure in place, was able to come in and take a senior position. There the Treasury Department did provide funding that they actually had allocated to it as part of the Emergency Economic Stabilization Act. Specific funds that the Treasury Department was able to access. Then we saw that at a whole different scale in 2020.

Again, that was in significant part because Congress made a decision, the Treasury Department made a decision in connection with the CARES Act to give the Treasury Department a lot of money, $454 billion that it could use quite specifically for purposes of backstopping 13(3) facilities with the idea that the Fed would then intervene in a way that helped to facilitate the flow of credit to all kinds of different sectors in the real economy.

Beckworth: We have these different buckets or categories for facilities for 13(3). Again,13(3) is the emergency lending facility or emergency facility the Fed can use and it can invoke with now authority or approval from the Treasury secretary and some other conditions. In the paper, you mentioned before 2008, they had this thing called the doomsday book. When the Fed comes into 2008, do they have these facilities in mind? Are they making up as they go along? Are they opening the doomsday book? How are these 13(3) facilities evolving over time?

Judge: I think there’s a lot of learning as time goes on. You asked earlier about whether or not they’re going to keep using 13(3). I think it did make a big difference. We can look at the rate at which they put these facilities together. 2008, it took a lot of legal creative work. They certainly have thought about, okay, things can go really bad. It’s not until things go really bad and also you know where and how they’re going bad, we started to figure out, well, what are the tools that we need to help deal with it?

We saw a lot of learning, I would say, occur. We also saw them create facilities that ended up not being used. They learned what worked and what didn’t work. They got input from market participants. There was a lot of learning that happened. We saw then when 2020 hit, they could just go out because they already had the playbook. They already knew how to set up these special-purpose vehicles and to have that be just a mechanism that made it a little easier for them to facilitate some of the type of collateralized lending that they wanted to do. Part of it was, I think, a matter of learning over time.

Beckworth: Kate, we’ve gone through the history, the different ways to categorize 13(3) facilities, and between you and me and other people probably listening, this makes sense. It’s important to use them when the crisis hits.

Should the Fed Be Doing Emergency Lending?

There are some listeners out there who wonder, what business does the Fed have getting into all these other markets. Shouldn’t the Fed just stick to Treasuries? Is that the Fed’s job doing credit policies? They would call it credit policies. How do you respond to that? People who get worked up. We have good friends who have this view. How do you respond to that?

Judge: First of all, I agree with a lot of that concern. I share some of the concerns. One of the motivations for the paper is an effort to say, “Look, there was a unique set of circumstances that were present, both in terms of the magnitude of the economic crisis, but also this very significant role that Congress played and Treasury played and the nature of a crisis that—oftentimes credit is not actually what’s going to allow companies to get to the other side of the crisis; oftentimes credit is just going to weigh companies down—you had a very unique structure to the economic hit that potentially made this warranted under the circumstances and given the uncertainty of the time.” 

Actually, I do think a little bit of wariness over how much of a role the Fed ought to be playing in this regard is actually part of what’s motivating the paper. Again, they just did all of these creative things in 2020, they were facing a crisis. I think when you’re in the middle of a crisis, you do what you can to try to contain the adverse consequences. That’s healthy. That’s appropriate.

After 2008, we had a decade-plus of conversations and conferences about what the Fed had done, what was healthy, what was not healthy, what changes we should make in the law, and also changes in norms and practices. Part of what’s been striking is just the dearth of conversation along those lines after 2020, despite the far greater variety of facilities that the Fed created, again, in conjunction with other actors.

Beckworth: That’s a great observation because if I look back, I definitely remember lots of conferences and conversations after 2008. That’s when the Fed first went and got mortgage-backed securities. That was like crossing the Rubicon of sorts for the Fed. 2020 was far more radical. You’re right, I don’t recall as many conversations. You guys are doing the Lord’s work here, reminding us that we need to come back to this. 

The point you’re making here is this was a very unique situation. I think of it like World War II. You’re fighting a war, a public health war in this case. All hands on deck. Some of the rules are going to be broken because it’s a war. There’s concern about overuse of fiscal policy. I’m critical there, too. I also think if you’re doing the war analogy, man, there was a lot of overuse of fiscal policy in World War II as well. Yes, there was fiscal dominance in World War II. 

Probably you could argue 2021, 2022, some fiscal dominance as well. Maybe that’s what it took. Maybe we could calibrate it better next time. Your point, I think you’re saying, is don’t compare 2020 to a normal period. Normal periods, yes, we should be much more cautious and wary of using these facilities.

Judge: Yes, I think that’s certainly part of it. Also part of what’s striking here is other much more politically accountable actors were making independent judgments. That is part of what enabled the Fed to take the actions that they did. I think that part is really critical. As you said, unusual and exigent is a little bit of a subjective standard.

The Fed has had a very high burden for it. They also tried to limit the effect by trying to get out of these facilities in a timely way and through other features of the facilities. Another key part here, which I view as a feature, and I think some of your other guests have viewed as a bug, is the role that the Treasury Department is playing. Then separately, the fact that Congress chose to provide the fiscal support that it did.

I think part of going to your World War II analogy is to show, look, the Fed can play an important role as part of a whole-of-government response when you’re facing the type of crisis or shock to the economy that requires a whole-of-government response. To draw out that they did so while still remaining independent because they were able to work closely with others, but they worked closely with others in ways where they were constantly also able to exercise their own independent judgment about whether the conditions for using 13(3), for example, were satisfied and the appropriateness of the terms and structures of the facilities that they implemented.

Feature or Bug?

Beckworth: Let’s go back to that point about, is this a feature or a bug? Because we have a good friend, Stephen Kelly. He was on the show not too long ago. He was making the opposite case that having the Treasury involved with the Fed creates political problems. Your point is it provides political cover, provides equity as well. It absorbs any shocks the Fed’s balance sheet might take.

His argument is, yes, but look what Mnuchin did. He set the terms of what facilities were possible. Then at the very end, he pulled the plug. He made sure the funds that were left over from the CARES Act couldn’t be used for anything else. Maybe it was warranted. Maybe, we’re beyond the point where you’d want to use them. His point is, it’s potentially dangerous to have it so politicized. You’re taking the other side of this. How do you respond to Stephen’s observation?

Judge: It actually connects to the other critics you talked about earlier. First of all, it’s important that we don’t talk about the Fed as a monolith. I think there’s a tendency to say, “There’s this thing called the Fed. It’s a monolith, and it’s important for it to be independent.” That’s not how it’s structured. It’s not how it actually operates.

Of course, we have the Federal Reserve System. We have different parts of that system. What’s important here is, first of all, you have the Federal Open Market Committee, which is the part of the Fed that is making determinations with respect to monetary policy, operating separate from this. It’s important to acknowledge you have overlap. You have reserve governors who are part of approving these facilities. Ultimately, it’s a reserve bank or more than one reserve bank that is tasked with implementing the facilities. Structurally, it’s a different process that happens. Part of what’s important here is it actually sets up in the statutory scheme and then even further in the provision of equity, the contours of engagement between the Federal Reserve and the Treasury Department.

It does, I think, give the Treasury Department more voice in how a facility is structured when the Treasury Department is providing equity that has been provided through separate fiscal means by Congress, whether it’s through the ESF or whether it’s through funds that were provided specifically in connection with that crisis. They do have more of a voice, but the voice is then contained to the structure of that particular facility, or at least it ideally ought to be. It creates a mechanism for engagement.

Again, going back to the different aims and part of the typology, we do see the Fed now playing a role helping to set up facilities that inevitably are not neutral with respect to who has access to credit. As a practical matter, even if you’re trying to do a neutral way, there’s a bunch of credit intermediation systems that operate very differently across different parts of the economy. If you go back to 2008 for securitization, it wasn’t like they said, “Oh, we really care about auto loans or credit cards.” Then the housing—two-part—but housing was probably apart from that.

Those were the areas where securitization has played this critical role. They were responding and reacting to the nature of the credit intermediation systems that existed. I think if you look at something like 2020 as a practical matter, the interventions did a lot more to help big companies than it did to help small companies, not because the Fed wanted to at all—they did a lot with PPP separately—but because there was already a deep secondary market for a lot of the types of debt instruments that support long, larger companies. The ways that they could come in were just a lot easier.

The very process of saying they were going to come in, we know, had a huge impact on the liquidity in those markets because there was an implicit understanding that the Fed was going to play a role helping to absorb the liquidity risk, which is oftentimes a significant risk in the bond market. First of all, Main Street lending was not small companies, it was these large companies, just companies that aren’t significantly big. They’re issuing the syndicated debt or the publicly traded bonds. There they had to revise it and they had to revise it and they had to revise it. It was one of the most difficult facilities to set up. 

I think what we really see is not because of any intention, but the Fed is inherently responsive and reactive when it’s setting up a 13(3) facility. Again, it’s an iterative process. We should have a separate conversation in a different episode about when you have to come in for 13(3), when does that actually suggest the need for regulatory reform? I think that’s an important set of conversations that would clearly flag as important, but outside the scope of our paper. 

We’re talking about starting to engage in ways that inevitably affect access to credit across different parts of the economy. Having a more politically accountable actor play a role in that, I think, is key to preserving the long-term independence of the Fed. What I want is the Fed particularly effective long-term policy to maintain its independence. I think it’s threatened right now.

I think finding ways to say, “Look, we can work with other actors. We have worked with other actors very productively in circumstances when it’s appropriate.” That’s entirely consistent with the Federal Reserve System. Maintaining its independence on matters of monetary policy is, I think, important to understand.

Beckworth: Great points. Now, before we move on to some other topics, are there any recommendations you would give to Congress for changing the Federal Reserve Act, for changing 13(3)? Or maybe even a different federal agency that could—you mentioned the Reconstruction Finance Corporation. Are there potential policy fixes you could foresee making this management of crisis conditions better?

Judge: It’s a great question and it goes a little bit beyond the paper. I do think that we’re pushing on the Fed in part because we didn’t have other structures in place to potentially facilitate the flow of credit. We do in a lot of other areas. We look at housing, we look at small businesses, but we didn’t actually have the institutional capacity to scale those structures up or to have them reach new domains.

I think if we are going to have situations where we think the government ought to play a role easing frictions in the credit markets, whether just during periods of distress or because for small businesses or housing, we think there’s other reasons to do so. The more that can be set up through alternative mechanisms than Federal Reserve lending, I think the better off we’re going to be.

Beckworth: Okay, so nothing specific on 13(3) you would tweak right now?

Judge: No, I’ve talked previously. Again, I personally would actually like to have the Treasury Department have more of a role in short-term guarantees. Not necessarily 13(3), but alternative mechanisms. I think part of the way we reduce the pressure on the Fed is to create both emergency guarantee authorities and credit facilitation flows that go outside the Federal Reserve, partly because I think this is not the area where the Fed has the right set of tools to do what people want it to do.

I think people will now look at this and like, “Oh, why isn’t the Fed lending more money in this area, more money in this area?” I think those questions are inevitable once the Fed starts on this path. I would not close it off because I do think it’s played a really important role during periods of distress. I think trying to figure out what the alternative mechanisms are, trying to beef up the discount window, I think those are really where the reform needs to take place.

Beckworth: In other words, we can almost have fewer conversations about 13(3) if we’ve got everything else done better. Set up these other federal agencies, maybe other parts of the Fed, discount window, better use, so forth. Then we rely less on 13(3); 13(3) becomes our crutch when everything else isn’t doing what it’s supposed to do.

Judge: Yes. I think government competence and capability and institutional capacity elsewhere would be a step in the right direction.

Beckworth: State capacity at the financial institution.

Judge: It might not be the right time or popular time. That is still where I’m at.

Fed Independence

Beckworth: That’s a nice segue into something else I want to talk to you about, and that is Fed independence. How we use these facilities—it’s a big deal and there’s a lot happening. I mentioned at the top of the show, a lot of executive orders flying out of the White House. Again, faster than I can keep up with them. One of them dealt specifically with bank regulation and it mentioned moving all of the bank regulations at least for review to some office in the White House that would sign off on them.

Number one, there’s also been talk about consolidating all of the bank regulators or at least maybe reducing them and taking the Fed’s banking responsibilities out of the Federal Reserve and parking them somewhere else. I’ve heard people say this and I understand where they’re coming from. If the Fed has this blank paycheck, it has seigniorage, it can do what it wants to do. It doesn’t go to before Congress for appropriations. That makes sense for monetary policy, but not for regulation, some would say.

You say regulations should be more accountable, more democratic. The flip side of that, I talked to Jeff Lacker about this and he said, “as long as you got the discount window at the Fed, it’s really hard to separate the two, take them apart.” Maybe let’s start with that one first and we’ll move on to some other maybe potentially troubling developments. Bank regulators, what sense can we make of everything that’s happening? Do these suggestions even make sense?

Judge: There’s a lot there, probably because you’re dealing with the structure of bank regulation, along with the structure of the executive overseeing bank regulation. I think one of the most significant executive orders that we’ve seen with respect to Fed independence and bank regulation is the effort, writ large, to cease to allow independent agencies to really operate as independently as they have historically. We do have a current president and White House, an executive branch, where generally there’s a much more expansive view of the executive authority and the nature and extent of executive authority that Article II of the Constitution vests in the president.

That we’re seeing come to life in efforts to remove officers from other agencies who have poor cause removable protections. One of the ways it’s come to life is the effort to say not just bank regulators, but SEC and any other independent regulator for purposes of litigation, for purposes of some budgeting purposes, and for purposes of rulemaking, the White House is now going to play a much bigger role overseeing your activities and reviewing that in a way that we have for a very long time with respect to executive agencies.

What it actually means is a little bit uncertain still. There’s a lot of language that’s pro forma language saying, “subject to law, subject to law, subject to law.” If it’s subject to statutory law, then that’s recognizing Congress has chosen to give the Fed more control over its budget and litigation. If it’s subject to statutory law as modified by constitutional constraints, as understood by this administration, then it’s really invasive. As you further alluded to indirectly, there’s an effort, even within the context of that executive order to separate regulatory policy on the one hand and monetary policy on the other.

I don’t have to go into it, but I’ll explain why I think that that effort to create that dichotomy is not long-term sustainable in a way that protects Fed independence, in a way that we need to protect Fed independence. The other thing I would note is that dichotomy also completely ignores the absolutely critical role that the Fed plays as a lender of last resort to both banks and nonbanks. 

We talked about dollar dominance earlier and swap lines. I think that doesn’t fit into either of those buckets but is absolutely critical to the willingness of many people to hold Treasury Department Treasuries, for example. Are they going to have access to either swap line or something like the FEMA facility, which allowed other central banks to post Treasury as collateral and have immediate access to liquidity during periods of distress?

Beckworth: That is what I was wondering too. It seems like the Fed is the only one who can really do currency swap lines efficiently and effectively. You could argue that’s part of financial stability. It definitely affects monetary policy conditions, but you could argue on the surface it’s a financial stability mandate. Do we take that discount window from the Fed? Do we take the repo facilities from the Fed? Then, on the other hand, you need the Fed’s balance sheet to make those things work. It’s hard to see how you disentangle them.

Although, again, I understand people wanting more accountability on some of those platforms. That’s interesting to see happen. Now, something I’d love to get your take on is the recent dismissal of the FTC, I believe, commissioners, two Democrats, I believe. Is this a precedent that will stand? Let’s do this in the context of the Federal Reserve, the Board of Governors. My understanding, correct me if I’m wrong, you’re a legal scholar here, is that the president can dismiss for cause the vice chair, but not the chair, and the governors, it’s much trickier. What are the potential implications if this does stand?

Judge: First of all, I should disclose right now that along with three of my colleagues in the legal academy, Jeff Gordon and Lev Menand, who’s also at Columbia, and then John Cote, who is at Harvard, we have submitted a number of amicus briefs in connection with some of the litigation for some of the FTC, but also other commissioners who are protected by poor cause protection, largely basically trying to make sure that we are protecting the independence of the Fed.

I would support agency independence more generally, but really trying to get into this heated issue of does Congress have the authority to set up structures that allow some degree of independence. It’s never complete independence. There’s lots of limitations on what agencies can do when they’re subject to judicial oversight, congressional oversight, and White House oversight through different mechanisms, even when they’re independent. Does Congress have the ability to set up independent agencies?

I think for me, the answer to that is yes, but I also think there’s particular reasons to make sure that we protect that in connection with the Fed. In terms of the Fed’s actual independence and how that’s legally protected, it’s actually interesting. It’s more complex than many people realize. There’s really a couple of pieces to bring to the table here. 

One, historically, the regional reserve banks were an absolutely fundamental component of how we structured the Federal Reserve’s independence. I think they can and should continue to play a really meaningful role in that regard. If you think back to the founding of the Fed in 1913, part of the reason we didn’t have a central bank at that time is there was just so much concern about centralized power associated with having a central bank. The only way we managed to get one through—it took six years between the panic of 1907 and the adoption of the Federal Reserve Act in 1913—was to create a very decentralized structure where we had basically a dozen reserve banks across the country and a relatively thin body of oversight in DC.

That proved partly to decentralize when the Great Depression hit, along with having other errors in policymaking. Also, FDR, as part of the New Deal, wanted to have a little more centralized control. I think oftentimes people think about the 1935 act, which is the foundation of the structure of today’s Federal Reserve, as giving Federal Reserve governors 14-year terms, which is an incredibly long term for any agency official to have. They have poor cause, explicit poor cause removal protection.

They’re like, “Oh, well, that’s how you got that independence.” What’s really interesting at the time is that’s also where we got the setup of the FOMC, where you still have the 12 reserve banks. They still have significant operational autonomy and funding control, where you do have five of the 12 on a rotating basis with the New York Fed, it’s the consistent seat, voting on the FOMC. Then you have seven members of the Board of Governors. What you’re actually getting there is a little bit of a shift in power toward a more centralized regime, but still helping to protect this decentralized structure as one of the ways that we get independence. I can talk more about the role they play there. 

In terms of the leadership, this is where it gets a little more difficult. The chair, the vice chair, the vice chair for supervision, they are all grouped together in one clause in the Federal Reserve Act. They are all given four-year terms, and there is no explicit poor cause removal protection. There’s been a long-standing norm that treats the Federal Reserve chair as not removable except poor cause. There is some earlier legal precedent suggesting that if you have a four-year term or a term of years, that arguably allows you to say that you can’t be removed earlier than that without cause.

The Supreme Court was not willing to endorse this reading, but willing to accept the party’s acceptance of this reading for purposes of the SEC in one of the cases revolving a removal for the Public Company Accounting Oversight Board. One of the things that’s striking is that it really is a chair-driven agency, and yet the removal protection that’s most firm is at the level of the governorship, not the level of the chair.

Beckworth: If the dismissal of the FTC officials stands, what would it take to stand? Would it go before court—so they’d say, “Okay, Trump, you have the power”? Then Trump would say, “Okay, let’s see, I want to get rid of Michael Barr because I want some more appointments.” Is that how this would unfold? Is that the domino story?

Judge: Yes. Probably the question is, what is the court, and really we’re talking about the Supreme Court here, what are they going to want to do? We know that there are certain members of the Supreme Court—there’s a core tension between some early Supreme Court cases. One, Myers says, yes, the president has broad removal authority, at least as a default matter, and that there’s limitations on the ability of Congress to limit that, potentially just limiting it though to circumstances where Congress itself, retains for itself, control over that removal.

Then you have this other early case, that was also a New Deal case, where FDR had tried to remove the head of the Federal Trade Commission, the FTC, and actually, he sustained because he’d passed away. He said, “We’re entitled to back pay because you didn’t actually have the authority to remove him because he’s got poor cause removal protection.” The court upheld that removal protection in that case. Now, doctrinally how they got there has been reworked over time. Those are the two-court tensions.

You’ll hear a lot of discussion of Humphrey’s Executor, and Humphrey’s Executor is the 1935 case that really was seen as clarifying Congress’s ability to create independent financial agencies with the defining characteristic of independence being the ability to provide leadership protection from being removed for purely policy reasons. The question going forward is, is the court going to overrule Humphrey’s Executor or are they going to narrow it? My instinct is that they’re going to narrow it.

If they overruled it entirely, I think we’d have a lot of reasons to worry about the Fed. There are some theories over how you might distinguish the Fed even if they want to overrule it, and we can go through that. I think the in-between case are circumstances where you would actually have it potentially overruled but narrowed, and then questions raised. I think there’s also just a lot of questions over what are the norms. Part of independence is a product not only of law, but practices.

There’s conventions that have existed for a very long time that have built over time. The Fed Treasury Court is not something that we would say would have legal force in terms of protecting its independence because it’s an agreement between two agencies. There’s no way an agreement between two agencies could be subsequently binding. In practice, it’s been incredibly significant in shaping the nature of the relationships between those bodies and between the White House and the Federal Reserve.

I do think we are at a moment of time where those arrangements, both legally and as a matter of convention, are potentially in flux in a way that they have not been for quite a long time.

Beckworth: The norms might be up for change, whether we want them or not. Then also legally, Humphrey’s Executor, that will also be coming up before the Supreme Court, you think?

Judge: I think it is very likely to come up before the Supreme Court partly because we have seen these other removals. The question is what they will do with it, whether they narrow it, whether they affirm it. We can get into the weeds on that. There’s also the interesting question, in the meantime, something like an executive order. This is why removal is so important. The way traditionally the White House exercises authority over an agency is to say, “I can remove you if I don’t like the policy decisions you’re making.”

That’s why I think the efforts to split the baby on regulation and monetary policy are so hard because it’s very hard to figure out how you have a Fed chair who says, “Yes, I will be entirely subservient to the White House when it comes to regulatory policy. Even if I see an emerging threat to stability, even if I have the right tool and I know I could go after it, I’m just not going to exercise that tool. I promise I’ll do what— Also be sufficiently credible to say, “When it comes to monetary policy, even when I’m doing something that the White House really doesn’t like, I promise I’m going to stake my ground.”

Again, as long as Chair Powell is there, I think that part of the reason we haven’t seen the immediate disruption is he has earned the trust of the market that he is going to exercise independent judgment. I think once his term runs up or if there’s questions over possibility of his removal, I do think these arrangements are going to potentially be at the forefront of debates in ways that could be.

Beckworth: Jay Powell could thread that needle pretty well right now. That’s no guarantee who comes after him will be able to do that. We can’t just bank on having the right person all the time who can successfully navigate those political waters. That is a great point about, you really can’t have an individual having two masters. That would be the challenge if, indeed, every regulatory decision was under review from the White House, and then you somehow were able to independently do monetary policy.

I hadn’t thought about that. I’ve thought more about the facilities, the tools. The leadership itself would be torn because you know you’re going to hear grief from the president if you do this thing over here, which may affect this other thing over there. Now, what a tough situation to be in. 

Regionalism of the Fed

In the time I have left, I want to go back to what you were saying earlier about the regional banks, the importance that they play in preserving independence. They bring a voice that’s not heard at the Board of Governors. You could think of the Board of Governors as being part of inside the Beltway mindset. Maybe they don’t get enough perspective from outside. You and Lev Menand, another former guest of the show, and he’s a colleague of yours there at Columbia, have a great article out, we’ll provide a link to it, called “Regionalism and the Federal Reserve Banks.” You go into this, and you tell the importance of it. You also have some suggestions for reforms. Once again, just briefly remind us, why is it good to have this diverse view coming from around the country?

Judge: I like the way you put that, because it’s actually two values that you simultaneously put together. One is a diversity of views. We’re making really difficult policy calls. We’ve seen monetary policy has just been incredibly difficult over the past five years, the past decade. Having a diversity of perspectives, where they actually have also their own research arm, so they can do their own work to try to figure out how we understand and frame the challenges that we’re facing is incredibly valuable.

The second is the sync role of regionalism. Here, the virtues really go two ways. One is they’re bringing perspectives that they are seeing on the ground. They get embodied in things like the Beige Book. They are engaging in local communities that are bringing a regional perspective into those conversations as they’re making monetary policy. They are also the face of the Federal Reserve System in their regions. They actually do oftentimes a remarkable amount of both research that helps people better understand the economic conditions in their local regions.

They also play a really important role reaching out to leaders in ways that potentially legitimate a body that is constantly mired in controversy and there’s constant concerns about the amount of power it’s exercising and how it’s exercising it. Again, this is how we managed to get a central bank. We’ve seen after 2008 and in other periods of time, a lot of questions about the power that central bank has. I think this decentralized structure for a country like the US that has a history of just being so skeptical of more centralized power has been really critical to the ongoing viability of the institution.

Beckworth: I love going onto LinkedIn and looking at all the different regional presidents. They really do make an effort to go out and engage with their constituents. Now, you and Lev, though, do have some suggestions for reform and let’s maybe end on that because it’s always good to throw new ideas out there. 

Judge: A lot of the proposals we have are things that Congress would have to do and we don’t get through all of them. One, I think eventually we should try to figure out can we create a map for the 12 banks that actually reflects the nature of where economic activity is happening today rather than as of 1914 when we were implementing the original system. There’s no reason that Missouri, as fine a state as it is, actually should have two reserve banks and then have San Francisco be the only one serving the entire West and West Coast. One is, let’s just draw a map that makes more sense. 

Second, part of what we like about the Federal Reserve is when it comes to monetary policy, what you have is a regional structure, but a uniform policy that’s adopted and then implemented. This is the opposite of the way law professors normally think about regionalism. Regionalism oftentimes means, the folks in DC come up with a policy, but we implement it in different ways that take regional differences into account.

What we have with the Fed instead is actually uniform policy, but by giving a voice, an actual vote to a rotating mix of the presidents, we also give them just much more of a voice in the public debates and public discussions, and we give them resources to back that up. That plays a role of legitimating and structuring the system. Let’s go ahead and have that overall structure of uniform rules where uniform rules make sense and preserving autonomy to the extent it makes sense.

For us, there are some areas where that model doesn’t work that well right now. Master accounts is one that we hone in on. The structure of the current system, the board has issued detailed guidelines, but the final determination currently rests with the regional reserve banks. That is our determination because when somebody has a master account, they have access to the system. That’s a determination that we think instead ought to be uniform and not subject to heterogeneity across different parts of the system. That I would actually—and again, I think this would be a congressional act—move those types of determinations to the board, probably not even to the FOMC. Potentially to the FOMC, but probably to the board level. 

Then we have, really wanting to also promote things like the regionalism. We do really want to see regional bank presidents that are engaged with the regions, which I think they traditionally have been, but to help to reaffirm that dynamic.

Beckworth: You’re fine with the 12 regional bank presidents? They still get to vote. You mentioned they all vote, maybe less weight. Would they need to be appointed by the president or continue to be appointed the way that they are?

Judge: The way that they are currently appointed is they are chosen by the board of directors of the bank, subject to review by the Federal Reserve. There is this office of legal or counsel opinion from the first Trump administration that suggests that they are inferior officers for constitutional purposes and that they could be removed at will by the board. I don’t know if that’s the best reading of the statutory act and it’s not one I would support. I do think actually making sure that they are regionally accountable is the better approach.

My optimal approach to governance would not actually be the current system if I’m honest. That being said, the current system—and one of the reasons we don’t tackle that, even though I think it is a suboptimal feature of the current system, is the current system has existed with a small modification in Dodd–Frank. The current system has existed as it has since the founding of the Federal Reserve. For the Supreme Court, the fact that something has worked for over a century carries a lot of weight.

I would actually preserve the current structure, even though I think it’s suboptimal because I think it’s the way that we get some decentralization. And again, the idea here is, let’s create democratic accountability, but let’s have a richer understanding of democratic accountability. Let’s understand whether it’s Lorie Logan or Raphael Bostic, when they are out and they are talking to businesses in their communities, they are directly engaging with the people who are actually most directly affected by the Federal Reserve policies.

They are both getting feedback, but also helping to explain what the Federal Reserve is doing and why. The board structure at least does connect them to the business community. It does give outsized weight to smaller banks as opposed to larger banks in the various regions. They don’t actually elect the president but they’re shaping the board. It’s imperfect, but I think it’s better than a situation where the system tries to become entirely centralized. I also think it’s one of the ways we potentially help to protect the Federal Reserve independence, even in an overall moment in time where agency independence is under threat.

Beckworth: Great point. The idea that they reach out to their community, their constituents is important too. I think of Mary Daly; she has such a huge district where she has to go out. That goes to your earlier point, let’s reform the districts of the Federal Reserve so that it better meets the populations. 

With that, our time is up. Our guest today has been Kate Judge. Thank you so much for coming on the program.

Judge: Thank you for having me.
 

Beckworth: Macro Musings is produced by the Mercatus Center at George Mason University. Dive deeper into our research at mercatus.org/monetarypolicy. You can subscribe to the show on Apple Podcasts, Spotify, or your favorite podcast app. If you like this podcast, please consider giving us a rating and leaving a review. This helps other thoughtful people like you find the show. Find me on Twitter @DavidBeckworth and follow the show @Macro_Musings.