Senator Bunning sent in a written request to Bernanke following his re-confirmation hearing – and Bernanke has responded. You can read the entirety of both; I am going to focus this Ticker on one section that I have repeatedly opined upon, as there is apparent clarity here:
Bunning: 28. In response to a question posed by Senator Corker, you stated “On the mortgagebacked securities, we have a longstanding authorization to do that. I do not think there is any legal issue.” Please provide the Fed’s legal analysis on the authority to purchase such securities, particularly those issued by Fannie Mae and Freddie Mac, which are not full faith-and-credit obligations of the United States.
Bernanke: Section 14(b)(2) of the Federal Reserve Act (12 U.S.C. 355) authorizes the Federal Reserve Banks, under the direction of the FOMC, to “buy and sell in the open market any obligation which is a direct obligation of, or fully guaranteed as to principal and interest by, any agency of the United States.” The Board’s Regulation A (12 CFR 201) has long defined the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the Government National Mortgage Association (Ginnie Mae) as agencies of the United States for purposes of this paragraph. All mortgage-backed securities (MBS) acquired by the Federal Reserve in its open market operations are fully guaranteed as to principal and interest by Fannie Mae, Freddie Mac, and Ginnie Mae.
Sorry, that’s not sufficient.
§ 201.108 Obligations eligible as collateral for advances.
An ADVANCE is a loan – you don’t take collateral against a purchase, you take it against a loan. Note that this is the TITLE of the section in question.
(a) Section 3(a) of Pub. L. 90–505, approved September 21, 1968, amended the eighth paragraph of section 13 of the Federal Reserve Act (12 U.S.C. 347) to authorize advances thereunder to member banks “secured by such obligations as are eligible for purchase under section 14(b) of this Act.” The relevant part of such paragraph had previously referred only to “notes * * eligible * * for purchase”, which the Board had construed as not including obligations generally regarded as securities. (See 1962 Federal Reserve Bulletin 690, §201.103(d).)
(b) Under section 14(b) direct obligations of, AND obligations fully guaranteed as to principal and interest by, the United States are eligible for purchase by Reserve Banks. Such obligations include certificates issued by the trustees of Penn Central Transportation Co. that are fully guaranteed by the Secretary of Transportation. Under section 14(b) direct obligations of, and obligations fully guaranteed as to principal and interest by, any agency of the United States are also eligible for purchase by Reserve Banks.
That’s correct – The Fed can purchase securities that hold a full-faith-and-credit guarantee on The Credit of The United States. The operative clause here in the lead sentence, which controls (since there is no clause negating or making the second subservient) is AND.
Following are the principal agency obligations eligible as collateral for advances:
The Fed can LOAN against any of the below instruments – note that it did not say “elegible as collateral for advances or for purchase“:
(1) Federal Intermediate Credit Bank debentures;
(2) Federal Home Loan Bank notes and bonds;
(3) Federal Land Bank bonds;
(4) Bank for Cooperative debentures;
(5) Federal National Mortgage Association notes, debentures and guaranteed certificates of participation;
(6) Obligations of or fully guaranteed by the Government National Mortgage Association;
(7) Merchant Marine bonds;
(8) Export-Import Bank notes and guaranteed participation certificates;
(9) Farmers Home Administration insured notes;
(10) Notes fully guaranteed as to principal and interest by the Small Business Administration;
(11) Federal Housing Administration debentures;
FHA direct debt.
(12) District of Columbia Armory Board bonds;
(13) Tennessee Valley Authority bonds and notes;
(14) Bonds and notes of local urban renewal or public housing agencies fully supported as to principal and interest by the full faith and credit of the United States pursuant to section 302 of the Housing Act of 1961 (42 U.S.C. 1421a(c), 1452(c)).
(15) Commodity Credit Corporation certificates of interest in a price-support loan pool.
(16) Federal Home Loan Mortgage Corporation notes, debentures, and guaranteed certificates of participation.
(17) U.S. Postal Service obligations.
(18) Participation certificates evidencing undivided interests in purchase contracts entered into by the General Services Administration.
(19) Obligations entered into by the Secretary of Health, Education, and Welfare under the Public Health Service Act, as amended by the Medical Facilities Construction and Modernization Amendments of 1970.
(20) Obligations guaranteed by the Overseas Private Investment Corp., pursuant to the provisions of the Foreign Assistance Act of 1961, as amended.
I remain steadfast in my assertion: An advance is a LOAN, not a purchase.
The above says that any of the above paper is eligible for advances, not purchases (without recourse to the “emergency” authority of 13(3)). For the paper to also be eligible for purchase it must carry a full faith and credit guarantee binding on the credit of The United States. The word between the clauses is AND, not OR. Therefore the section you cited as justification does not apply.
While Bernanke can (and it appears has) twisted this language into allowing unlimited purchases for paper that in fact is exposed to credit risk – an act that is clearly contrary to the intent of both The Federal Reserve Act and the CFR section cited – both the intent and letter is, from my read, rather clear – and directly contrary to what is asserted.
The following section, sub(c) also makes quite clear the intent – that a full faith and credit guarantee by the government of the United States is the intended requirement:
(c) Nothing less than a full guarantee of principal and interest by a Federal agency will make an obligation eligible. For example, mortgage loans insured by the Federal Housing Administration are not eligible since the insurance contract is not equivalent to an unconditional guarantee and does not fully cover interest payable on the loan. Obligations of international institutions, such as the Inter-American Development Bank and the International Bank for Reconstruction and Development, are also not eligible, since such institutions are not agencies of the United States.
Again, you can try to weasel here, but the intent of the CFR is clear – the guarantee required is that of the full faith and credit of The United States. That is, recourse must be to the sovereign credit and be unconditional.
This distinction is not “ministerial” and while the language may be tortured, the intent certainly appears clear: instruments purchased by The Federal Reserve must carry the full faith and credit of the United States Government.
The section Bernanke cited provides an exception for the purpose of advances (loans), not purchases.
For purchases the question is simple:
Is the entity that issues the obligation a Federal Agency as defined at law, and do their various credit instruments carry an irrevocable guarantee as to full payment of both principal and interest?
The fact of the matter is this: The United States “official web site” does not list either Freddie or Fannie as **government agencies**. Ginnie Mae, however, is listed as an agency. Indeed, the 1968 Charter Act split Fannie Mae into two parts: Ginnie Mae AS A FEDERAL AGENCY and Fannie Mae as a government-sponsored private corporation. Freddie was never a federal agency.
The most recent Fannie 10Q and every prospectus makes clear that Fannie and Freddie paper is not carrying a full-faith and credit of The United States as a government agency. Specifically:
Fannie Mae is a government-sponsored enterprise (“GSE”) that was chartered by Congress in 1938. Fannie Mae has a public mission to support liquidity and stability in the secondary mortgage market, where existing mortgage loans are purchased and sold. We securitize mortgage loans originated by lenders in the primary mortgage market into mortgage-backed securities that we refer to as Fannie Mae MBS, which can then be bought and sold in the secondary mortgage market. We also participate in the secondary mortgage market by purchasing mortgage loans (often referred to as “whole loans”) and mortgage-related securities, including our own Fannie Mae MBS, for our mortgage portfolio. In addition, we make other investments that increase the supply of affordable housing. Under our charter, we may not lend money directly to consumers in the primary mortgage market. Although we are a corporation chartered by the U.S. Congress, and although our conservator is a U.S. government agency and Treasury owns our senior preferred stock and a warrant to purchase our common stock, the U.S. government does not guarantee, directly or indirectly, our securities or other obligations.
An agency relationship – complete with the credit of The United States – only exists if it really exists. You can’t define it into existence by bald claim where isn’t there, especially when Congress has explicitly declined to do so.
Fannie Mae is a corporation – NOT AN AGENCY!
The government could have (and still can) cure this deficiency any time it would like. Indeed, such an action was debated when Fannie and Freddie were taken into conservatorship but that action was specifically rejected as the CBO insisted that such an act would force the government to take these entities onto its balance sheet since the United States Government would then be legally responsible – full faith and credit – for Fannie and Freddie’s obligations.
Treasury desired to be able to limit the government’s exposure to the amount allocated in the “rescue”, that of $200 billion each, or approximately 8% of the total MBS and debt outstanding. This was judged an acceptable risk, but this explicit limitation on risk once again speaks to the lack of the required backing of the credit of The United States.
The reason for this restriction in Sections 13 and 14 of The Federal Reserve Act is clear – The Fed is forbidden to take credit risk, as it acts without specific appropriation of Congress. It is therefore required to loan against good collateral and purchase only that which contains a full-faith-and-credit protection traceable back to the United States Federal Government.
Let us contrast this with the guarantee provided by Ginnie Mae on their prospectuses:
GINNIE MAE GUARANTY
The Government National Mortgage Association (“Ginnie Mae”), a wholly-owned corporate instrumentality of the United States of America within HUD, guarantees the timely payment of principal and interest on the Securities. The General Counsel of HUD has provided an opinion to the effect that Ginnie Mae has the authority to guarantee multiclass securities and that Ginnie Mae guaranties will constitute general obligations of the United States, for which the full faith and credit of the United States is pledged.
Ginnie Mae paper clearly complies with the strictures of Section 14 of The Federal Reserve Act.
Fannie and Freddie paper does not.
The Fed has the clear statutory authority to purchase obligations of Ginnie Mae, because Ginnie is a Federal Agency and issues paper with the full faith and credit of The United States.
Fannie and Freddie ARE NOT Federal Agencies and DO NOT issue paper with the required full faith and credit guarantee. The limited exception cited by Bernanke applies only to the MAKING OF LOANS, not to the outright purchase of securities.
If Congress wishes to authorize The Fed to purchase (not loan against – that The Fed is permitted) Fannie and Freddie paper it must formally designate these entities as having a full-faith-and-credit guarantee with recourse to The United States as general obligations.
Congress, despite multiple opportunities to do so both prior and subsequent to these entities being taken into conservatorship, and prior to The Fed’s purchase of these MBS, has explicitly declined to provide that guarantee.
It was declined for the specific reason that doing so would obligate The Government to back the entirety of their $5 trillion balance sheet (between the two) with full recourse to the general fund.
I happen to believe, given the near-generation-long record of poor internal controls, accounting restatements and other evidence of both malfeasance and misfeasance Congress was exactly correct to refuse to provide that guarantee.
Absent that guarantee it remains my contention that The Federal Reserve has no authority to buy their paper, irrespective of the form it is in or the torture The Fed applies to the written word.