Federal Reserve System: Opportunities Exist to Strengthen Policies and Processes for Managing Emergency Assistance
Published: 2011-10-04T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Dodd-Frank Wall Street Reform and Consumer Protection Act directed GAO to conduct a one-time audit of the emergency loan programs and other assistance authorized by the Board of Governors of the Federal Reserve System (Federal Reserve Board) during the recent financial crisis. This testimony summarizes the results of GAO's July 2011 report (GAO-11-696) examining the emergency actions taken by the Federal Reserve Board from December 1, 2007, through July 21, 2010. For these actions, where relevant, this statement addresses (1) accounting and financial reporting internal controls; (2) the use, selection, and payment of vendors; (3) management of conflicts of interest; (4) policies in place to secure loan repayment; and (5) the treatment of program participants. To meet these objectives, GAO reviewed program documentation, analyzed program data, and interviewed officials from the Federal Reserve Board and Reserve Banks (Federal Reserve System).
section_title: What GAO Found
paragraphs: On numerous occasions in 2008 and 2009, the Federal Reserve Board invoked emergency authority under the Federal Reserve Act of 1913 to authorize new broad-based programs and financial assistance to individual institutions to stabilize financial markets. Loans outstanding for the emergency programs peaked at more than $1 trillion in late 2008. The Federal Reserve Board directed the Federal Reserve Bank of New York (FRBNY) to implement most of these emergency actions. In a few cases, the Federal Reserve Board authorized a Reserve Bank to lend to a limited liability corporation (LLC) to finance the purchase of assets from a single institution. In 2009 and 2010, FRBNY also executed large-scale purchases of agency mortgage-backed securities to support the housing market. The Reserve Banks, primarily FRBNY, awarded 103 contracts worth $659.4 million from 2008 through 2010 to help carry out their emergency activities. A few contracts accounted for most of the spending on vendor services. For a significant portion of the fees, program recipients reimbursed the Reserve Banks or the fees were paid from program income. The Reserve Banks relied more extensively on vendors for programs that assisted a single institution than for broad-based programs. Most of the contracts, including 8 of the 10 highest-value contracts, were awarded noncompetitively, primarily due to exigent circumstances. These contract awards were consistent with FRBNY's acquisition policies, but the policies could be improved by providing additional guidance on the use of competition exceptions, such as seeking as much competition as practicable and limiting the duration of noncompetitive contracts to the exigency period. FRBNY took steps to manage conflicts of interest for its employees, directors, and program vendors, but opportunities exist to strengthen its conflict policies. In particular, FRBNY expanded its guidance and monitoring for employee conflicts, but new roles assumed by FRBNY and its employees during the crisis gave rise to potential conflicts that were not specifically addressed in the Code of Conduct or other FRBNY policies. As the Federal Reserve System considers revising its conflict policies given its new authority to regulate certain nonbank institutions, GAO recommended it consider how potential conflicts from emergency lending could inform any changes. FRBNY managed vendor conflict issues through contract protections and actions to help ensure compliance with relevant contract provisions, but these efforts had limitations. While the Federal Reserve System took steps to mitigate risk of losses on its emergency loans, opportunities exist to strengthen risk management practices for future crisis lending. The Federal Reserve Board approved program terms and conditions designed to mitigate risk of losses and one or more Reserve Banks were responsible for managing such risk for each program. Reserve Banks required borrowers under several programs to post collateral in excess of the loan amount. For programs that did not have this requirement, Reserve Banks required borrowers to pledge assets with high credit ratings as collateral. For loans to specific institutions, Reserve Banks negotiated loss protections with the private sector and hired vendors to help oversee the portfolios that collateralized loans. While the Federal Reserve System took steps to promote consistent treatment of eligible program participants, it did not always document processes and decisions related to restricting access for some institutions. GAO made seven recommendations to the Federal Reserve Board to strengthen policies for managing noncompetitive vendor selections, conflicts of interest, risks related to emergency lending, and documentation of emergency program decisions. The Federal Reserve Board agreed that GAO's recommendations would benefit its response to future crises and agreed to strongly consider how best to respond to them.

section_title: Letter
paragraphs: My statement today is based on our July 2011 report. We completed this  work in response to a mandate contained in Title XI of the Dodd-Frank  Wall Street Reform and Consumer Protection Act. Table 1 lists all  programs covered by our review, including the broad-based programs  and assistance extended to individual institutions. For these emergency  programs or actions, where relevant, I will discuss (1) the Reserve Banks’  controls over financial reporting and accounting; (2) the Reserve Banks’  policies and practices for the use, selection, and payment of vendors;   (3) the effectiveness of policies and practices for identifying and  managing conflicts of interest for Reserve Bank employees, Reserve  Bank vendors, and members of Reserve Banks’ boards of directors; (4)  the effectiveness of security and collateral policies in place to mitigate risk  of losses; and (5) the extent to which program implementation resulted in  consistent and equitable treatment of eligible participants.
To conduct the work for our report, we reviewed documentation supporting  the Federal Reserve Board’s authorizations for the emergency programs,  Federal Reserve System documents and press releases describing the  purpose of the programs, and other relevant program documentation,  including announced terms and conditions. To assess Reserve Banks’  controls over financial reporting and accounting, we developed an audit  strategy designed to leverage, to the extent possible, the audit work  specific to the emergency programs performed by the Federal Reserve  System’s external and internal auditors. For example, we reviewed the  external auditor’s key audit documentation including audit strategy,  planning, and accounting memoranda; internal control and account balance  testing audit procedures and results; and summary memoranda. We  evaluated the quality of this documentation against relevant auditing  standards. To evaluate the Reserve Banks’ policies and practices for the  use, selection, and payment of vendors, we analyzed Reserve Banks’  acquisition policies and guidance, vendor contracts, and vendor payment  information. To evaluate the effectiveness of Reserve Bank polices and  practices for managing conflicts of interest, we reviewed relevant Reserve  Bank policies, including FRBNY’s Code of Conduct, and relevant statutory  prohibitions on conflicts of interest that apply to federal government and  Federal Reserve System employees and federal government guidance for  agencies’ management of employee conflicts of interest. To assess the  effectiveness of security and collateral policies in place to mitigate risk of  losses, we reviewed relevant documentation to identify key features of  security and collateral policies and determine how these policies were  designed to mitigate risk of losses for each emergency program. We  obtained and analyzed documentation of steps taken by the Reserve  Banks to develop risk governance structures and practices needed to  manage the risks associated with the emergency programs. To examine  the extent to which program implementation resulted in consistent and  equitable treatment of eligible participants, we reviewed and analyzed  documentation of the basis for the Federal Reserve Board’s decisions  about which types of institutions would be eligible to participate in the  emergency programs. To determine the extent to which the Reserve Banks  offered the same terms and conditions to all participants, which for some  programs included financial institutions affiliated with Reserve Bank  directors, we reviewed documentation of program terms and conditions and  obtained and analyzed program transaction data. For parts of our  methodology that involved the analysis of computer-processed data, we  assessed the reliability of these data and determined that they were  sufficiently reliable for our purposes. For all objectives, we interviewed staff  at the Federal Reserve Board, FRBNY, the Federal Reserve Bank of  Boston, and the Federal Reserve Bank of Richmond.
The work on which this statement is based was conducted from August  2010 through July 2011 in accordance with generally accepted  government auditing standards. Those standards require that we plan  and perform the audit to obtain sufficient, appropriate evidence to provide  a reasonable basis for our findings and conclusions based on our audit  objectives. We believe that the evidence obtained provides a reasonable  basis for our findings and conclusions based on our audit objectives.
subsections: section_title: Background
paragraphs: The Federal Reserve Act of 1913 established the Federal Reserve System  as the country’s central bank. The Federal Reserve System consists of the  Federal Reserve Board located in Washington, D.C.; 12 Reserve Banks,  which have 24 branches located throughout the nation; and the Federal  Open Market Committee (FOMC), which is responsible for directing open  market operations to influence the total amount of money and credit  available in the economy. Each Reserve Bank is a federally chartered  corporation with a board of directors. The Federal Reserve Act authorizes  the Reserve Banks to make discount window loans, execute monetary  policy operations at the direction of the FOMC, and examine bank holding  companies and member banks under rules and regulations prescribed by  the Federal Reserve Board, among other things.
The Federal Reserve Board and the Reserve Banks are self-funded  entities that deduct their expenses from their revenue and transfer the  remaining amount to Treasury. Federal Reserve System revenues  transferred to Treasury have increased substantially in recent years,  chiefly as a result of interest income earned from the Federal Reserve  System’s large-scale emergency programs. To the extent that Reserve  Banks suffer losses on emergency loans, these losses would be  deducted from the excess earnings transferred to Treasury.
Between late 2007 and early 2009, the Federal Reserve Board created  more than a dozen new emergency programs to stabilize financial  markets and provided financial assistance to avert the failures of a few  individual institutions. The Federal Reserve Board authorized most of this  emergency assistance under emergency authority contained in section  13(3) of the Federal Reserve Act. Three of the programs covered by this  review—the Term Auction Facility, the dollar swap lines with foreign  central banks, and the Agency Mortgage-Backed Securities Purchase  Program—were authorized under other provisions of the Federal Reserve  Act that do not require a determination that emergency conditions exist,  although the swap lines and the Agency MBS program did require  authorization by the FOMC. In many cases, the decisions by the Federal  Reserve Board, the FOMC, and the Reserve Banks about the  authorization, initial terms of, or implementation of the Federal Reserve  System’s emergency assistance were made over the course of only days  or weeks as the Federal Reserve Board sought to act quickly to address  rapidly deteriorating market conditions. FRBNY implemented most of  these emergency activities under authorization from the Federal Reserve  Board. In a few cases, the Federal Reserve Board authorized FRBNY to  lend to a limited liability corporation (LLC) to finance the purchase of  assets from a single institution. The LLCs created to assist individual  institutions were Maiden Lane, Maiden Lane II, and Maiden Lane III. In  2009, FRBNY, at the direction of the FOMC, began large-scale purchases  of mortgage-backed securities (MBS) issued by the housing government- sponsored enterprises, Fannie Mae and Freddie Mac, or guaranteed by  Ginnie Mae. Purchases of these agency MBS were intended to provide  support to the mortgage and housing markets and to foster improved  conditions in financial markets more generally. Most of the Federal  Reserve Board’s broad-based emergency programs closed on February  1, 2010. Figure 1 provides a timeline for the establishment, modification,  and termination of Federal Reserve System emergency programs subject  to this review.
section_title: The Federal Reserve System and Its Emergency Activities Were Subject to Multiple Audits and Reviews
paragraphs: The Reserve Banks’ and LLCs’ financial statements, which include the  emergency programs’ accounts and activities, and their related financial  reporting internal controls, are audited annually by an independent  auditing firm. In addition, the Federal Reserve System has a number of  internal entities that conduct audits and reviews of the Reserve Banks,  including the emergency programs. As shown in figure 2, these other  audits and reviews were conducted by the Federal Reserve Board’s  Division of Reserve Bank Operations and Payment Systems (RBOPS),  the Federal Reserve Board’s Office of Inspector General, and individual  Reserve Bank’s internal audit function. The independent financial  statement audits and other reviews did not identify significant accounting  or financial reporting internal control issues concerning the emergency  programs.
section_title: Reserve Banks Would Benefit From Strengthening Guidance for Noncompetitive Contracts Awarded in Exigent Circumstances
subsections: section_title: Reserve Banks Relied Extensively on Vendors to Establish and Operate the Emergency Programs, Particularly Those Designed to Assist Single Institutions
paragraphs: From 2008 through 2010, vendors were paid $659.4 million across 103  contracts to help establish and operate the Reserve Banks’ emergency  programs. The 10 largest contracts accounted for 74 percent of the total  amount paid to all vendors. FRBNY was responsible for creating and  operating all but two emergency programs and assistance and therefore  awarded nearly all of the contracts. See table 2 for the total number and  value of contracts for the emergency programs and assistance.
As shown in table 2, the Reserve Banks relied on vendors more  extensively for programs that assisted single institutions than for broad- based emergency programs. The assistance provided to individual  institutions was generally secured by existing assets that either belonged  to or were purchased from the institution, its subsidiaries, or  counterparties. The Reserve Banks did not have sufficient expertise  available to evaluate these assets and therefore used vendors to do so.  For example, FRBNY used a vendor to evaluate divestiture scenarios  associated with the assistance to AIG. It also hired vendors to manage  assets held by the Maiden Lanes. For the broad-based emergency  programs, FRBNY hired vendors primarily for transaction-based services  and collateral monitoring. Under these programs, the Reserve Banks  purchased assets or extended loans in accordance with each program’s  terms and conditions. Because of this, the services that vendors provided  for these programs were focused more on assisting with transaction  execution than analyzing and managing securities, as was the case for  the single institution assistance.
section_title: Reserve Banks Awarded Largest Contracts Noncompetitvely and Would Benefit From Additional Guidance on Seeking Competition
paragraphs: Most of the contracts, including 8 of the 10 highest-value contracts, were  awarded noncompetitively, primarily due to exigent circumstances. These  contract awards were consistent with FRBNY’s existing acquisition policy,  which applied to all services associated with the emergency programs  and single-institution assistance. Under FRBNY policy, noncompetitive  processes can be used in special circumstances, such as when a service  is available from only one vendor or in exigent circumstances. FRBNY  cited exigent circumstances for the majority of the noncompetitive  contract awards. FRBNY officials said that the success of a program  was often dependent on having vendors in place quickly to begin setting  up the operating framework for the program. FRBNY’s policy did not  provide additional guidance on the use of competition exceptions, such as  seeking as much competition as practicable and limiting the duration of  noncompetitive contracts to the exigency period. To better ensure that  Reserve Banks do not miss opportunities to obtain competition and  receive the most favorable terms for services acquired, we recommended  that they revise their acquisition policies to provide such guidance.
section_title: Vendor Fees Generally Came from Program Income or Participants
paragraphs: From 2008 through 2010, vendors were paid $659.4 million through a  variety of fee structures. For a significant portion of the fees, program  recipients reimbursed the Reserve Banks or the fees were paid from  program income. The Reserve Banks generally used traditional market  conventions when determining fee structures. For example, investment  managers were generally paid a percentage of the portfolio value and law  firms were generally paid an hourly rate. Fees for these contracts were  subject to negotiation between the Reserve Banks and vendors. For  some of the large contracts that were awarded noncompetitively, FRBNY  offered vendors a series of counterproposals and was able to negotiate  lower fees than initially proposed.
section_title: Opportunities Exist to Strengthen Conflict Policies for Employees, Directors, and Program Vendors
paragraphs: During the crisis, FRBNY took steps to manage conflicts of interest  related to emergency programs for its employees, program vendors, and  members of its Board of Directors, but opportunities exist to strengthen its  conflicts policies.
subsections: section_title: During the Crisis, FRBNY Expanded Its Efforts to Manage Employee Conflicts
paragraphs: Historically, FRBNY has managed potential and actual conflicts of interest  for its employees primarily through enforcement of its Code of Conduct,  which outlines broad principles for ethical behavior and specific restrictions  on financial interests and other activities, such as restrictions on  employees’ investments in depository institutions and bank holding  companies, and incorporates the requirements of a federal criminal statute  and its regulations. During the crisis, FRBNY expanded its guidance and  monitoring for employee conflicts. However, while the crisis highlighted the  potential for Reserve Banks to provide emergency assistance to a broad  range of institutions, FRBNY has not yet revised its conflict policies and  procedures to more fully reflect potential conflicts that could arise with this  expanded role. For example, specific investment restrictions in FRBNY’s  Code of Conduct continue to focus on traditional Reserve Bank  counterparties—depository institutions or their affiliates and the primary  dealers—and have not been expanded to further restrict employees’  financial interests in certain nonbank institutions that have participated in  FRBNY emergency programs and could become eligible for future ones, if  warranted. Given the magnitude of the assistance and the public’s  heightened attention to the appearance of conflicts related to Reserve  Banks’ emergency actions, existing policies and procedures for managing  employee conflicts may not be sufficient to avoid the appearance of a  conflict in all situations. During our review, Federal Reserve Board and  FRBNY staff told us that the Federal Reserve System plans to review and  update the Reserve Banks’ Codes of Conduct as needed given the Federal  Reserve System’s recently expanded role in regulating systemically  significant financial institutions. In light of this ongoing effort, we  recommended that the Federal Reserve System consider how potential  conflicts from emergency lending could inform any changes.
section_title: FRBNY Primarily Used Contract Protections to Manage Risks Related to Vendor Conflicts, and the Lack of a Comprehensive Policy Created Certain Limitations
paragraphs: FRBNY managed risks related to vendor conflicts of interest primarily  through contract protections and oversight of vendor compliance with  these contracts, but these efforts have certain limitations. For example,  while FRBNY’s Legal Division negotiated contract provisions intended to  help ensure that vendors took appropriate steps to mitigate conflicts of  interest related to the services they provided for FRBNY, FRBNY lacked  written guidance on protections that should be included to help ensure  vendors fully identify and remediate conflicts. Rather than requiring  written conflict remediation plans that were specific to the services  provided for FRBNY, FRBNY generally reviewed and allowed vendors to  rely on their existing enterprisewide policies for identifying conflicts.  However, in some situations, FRBNY requested additional program- specific controls be developed. Further, FRBNY’s on-site reviews of  vendor compliance in some instances occurred as far as 12 months into a  contract. In May 2010, FRBNY implemented a new vendor management  policy but had not yet finalized more comprehensive guidance on vendor  conflict issues. As a result, we recommended that FRBNY finalize this  new policy to reduce the risk that vendors may not be required to take  steps to fully identify and mitigate all conflicts.
section_title: Reserve Bank Directors Are Generally Subject to the Same Conflict Rules as Federal Employees and a Few Directors Played a Limited Role in Risk Oversight of the Programs
paragraphs: Individuals serving on the boards of directors of the Reserve Banks are  generally subject to the same conflict-of-interest statute and regulations as  federal employees. A number of Reserve Bank directors were affiliated with  institutions that borrowed from the emergency programs, but Reserve Bank  directors did not participate directly in making decisions about authorizing,  setting the terms, or approving a borrower’s participation in the emergency  programs. Rather FRBNY’s Board of Directors assisted the Reserve Bank  in helping ensure risks were managed through FRBNY’s Audit and  Operational Risk Committee. According to the Federal Reserve Board  officials, Reserve Banks granted access to borrowing institutions affiliated  with Reserve Bank directors only if these institutions satisfied the proper  criteria, regardless of potential director-affiliated outreach or whether the  institution was affiliated with a director. Our review of the implementation of  several program requirements did not find evidence that would indicate a  systemic bias towards favoring one or more eligible institutions.
section_title: Opportunities Exist to Strengthen Risk Management Policies and Practices for Future Emergency Programs
paragraphs: The Federal Reserve Board approved key program terms and conditions  that served to mitigate risk of losses and delegated responsibility to one or  more Reserve Banks for executing each emergency lending program and  managing its risk of losses. The Federal Reserve Board’s early broad- based lending programs—Term Auction Facility, Term Securities Lending  Facility, and Primary Dealer Credit Facility—required borrowers to pledge  collateral in excess of the loan amount as well as other features intended to  mitigate risk of losses. The Federal Reserve Board’s broad-based  programs launched in late 2008 and early 2009 employed more novel  lending structures to provide liquidity support to a broader range of key  credit markets. These later broad-based liquidity programs included Asset- Backed Commercial Paper Money Market Mutual Fund Liquidity Facility,  Commercial Paper Funding Facility, Money Market Investor Funding  Facility, and Term Asset-Backed Securities Loan Facility. These liquidity  programs, with the exception of the Term Asset-Backed Securities Loan  Facility, did not require overcollateralization. To help mitigate the risk of  losses, the Term Asset-Backed Securities Loan Facility, as well as the  programs that did not require overcollateralization, accepted only highly- rated assets as collateral. In addition, Commercial Paper Funding Facility,  Money Market Investor Funding Facility, and Term Asset-Backed  Securities Loan Facility incorporated various security features, such as the  accumulation of excess interest and fee income to absorb losses, to  provide additional loss protection. Also, for the assistance to specific  institutions, the Reserve Banks negotiated loss protections with the  institutions and hired vendors to help oversee the portfolios collateralizing  loans. For each of the Maiden Lane transactions, FRBNY extended a  senior loan to the LLC and this loan was collateralized by the portfolio of  assets held by the LLC. JP Morgan Chase & Co. agreed to take a first loss  position of $1.15 billion for Maiden Lane and AIG agreed to assume a  similar first loss position for Maiden Lanes II and III. As of July 2011, most  of the Federal Reserve Board’s emergency loan programs had closed and  all of those that had closed had closed without losses. Moreover, currently,  the Federal Reserve Board does not project any losses on FRBNY’s  outstanding loans to Term Asset-Backed Securities Loan Facility borrowers  and the Maiden Lane LLCs.
subsections: section_title: Opportunities Exist for the Reserve Banks to Continue to Strengthen Policies for Future Emergency Programs
paragraphs: To manage risks posed by the emergency programs, Reserve Banks  developed new controls and FRBNY strengthened its risk management  practices over time. In particular, FRBNY expanded its risk management  function and enhanced its risk reporting and risk analytics capabilities. For  example, in summer 2009, FRBNY expanded its risk management  capabilities by adding expertise that would come to be organized as two  new functions, Structured Products and Risk Analytics. Although FRBNY  has improved its ability to monitor and manage risks from emergency  lending, opportunities exist for FRBNY and the Federal Reserve System  as a whole to strengthen risk management procedures and practices for  any future emergency lending. Specifically, neither FRBNY nor the  Federal Reserve Board tracked total potential exposures in adverse  economic scenarios across all emergency programs. Moreover, the  Federal Reserve System’s existing procedures lack specific guidance on  how Reserve Banks should exercise discretion to restrict or deny program  access for higher-risk borrowers that were otherwise eligible for the Term  Auction Facility and emergency programs for primary dealers. To  strengthen practices for managing risk of losses in the event of a future  crisis, we recommended that the Federal Reserve System document a  plan for more comprehensive risk tracking and strengthen procedures to  manage program access for higher-risk borrowers.
section_title: While the Federal Reserve Board Took Steps to Promote Consistent Treatment of Participants, It Lacked Guidance and Documentation for Some Access Decisions
paragraphs: The Federal Reserve Board and the Reserve Banks took steps to  promote consistent treatment of eligible program participants and  generally offered assistance on the same terms and conditions to eligible  institutions in the broad-based emergency programs. However, in a few  programs, the Reserve Banks placed restrictions on some participants  that presented higher risk but lacked specific guidance to do so. Further,  certain Federal Reserve Board decisions to extend credit to certain  borrowers were not fully documented.
subsections: section_title: The Federal Reserve Board Designed Program Eligibility Requirements to Target Assistance to Groups of Institutions Facing Liquidity Strains
paragraphs: The Federal Reserve Board created each broad-based emergency  program to address liquidity strains in a particular credit market and  designed program eligibility requirements primarily to target significant  participants in these markets. The emergency programs extended loans  both directly to institutions facing liquidity strains and through intermediary  borrowers. For programs that extended credit directly, the Federal  Reserve Board took steps to limit program eligibility to institutions it  considered to be generally sound. For example, Term Auction Facility  loans were auctioned to depository institutions eligible to borrow from the  discount window and expected by their local Reserve Bank to remain  primary-credit-eligible during the term the Term Auction Facility loan  would be outstanding. For programs that provided loans to intermediary  borrowers, the Federal Reserve Board based eligibility requirements in  part on the ability of borrowing institutions, as a group, to channel  sufficient liquidity support to eligible sellers. For example, eligible Term  Asset-Backed Securities Loan Facility borrowers included a broad range  of institutions ranging from depository institutions to U.S. organized  investment funds. Federal Reserve Board officials told us that broad  participation in Term Asset-Backed Securities Loan Facility was intended  to facilitate the program goal of encouraging the flow of credit to  consumers and small businesses.
section_title: While Reserve Banks Generally Offered the Same Terms to Eligible Participants, Some Programs Lacked Documented Procedures to Systematically Apply Special Restrictions
paragraphs: The Federal Reserve Board promoted consistent treatment of eligible  participants in its emergency programs by generally offering assistance  on the same terms and conditions to all eligible participants. For example,  institutions that met the announced eligibility requirements for a particular  emergency program generally could borrow at the same interest rate,  against the same types of collateral, and where relevant, with the same  schedule of haircuts applied to their collateral. As previously discussed,  for a few programs, FRBNY’s procedures did not have specific guidance  to help ensure that restrictions were applied consistently to higher-risk  borrowers. Moreover, the Federal Reserve Board could not readily  provide documentation of all Term Auction Facility restrictions placed on  individual institutions. By having written procedures to guide decision- making for restrictions and suggestions for documentation of the rationale  for such decisions, the Federal Reserve Board may be able to better  review such decisions and help ensure that future implementation of  emergency lending programs will result in consistent treatment of higher- risk borrowers. Our review of Federal Reserve System data for selected  programs found that incorrect application of certain program requirements  was generally infrequent and that cases of incorrect application of criteria  did not appear to indicate intentional preferential treatment of one or more  program participants.
section_title: The Federal Reserve Board Did Not Fully Document the Basis for Extending Credit to a Few Affiliates of Primary Dealers
paragraphs: The Federal Reserve Board did not fully document the basis for its  decisions to extend credit on terms similar to those available at PDCF to  certain broker-dealer affiliates of four of the primary dealers. In  September and November of 2008, the Federal Reserve Board invoked  section 13(3) of the Federal Reserve Act to authorize FRBNY to extend  credit to the London-based broker-dealer subsidiaries of Merrill Lynch,  Goldman Sachs, Morgan Stanley, and Citigroup, as well as the U.S.  broker-dealer subsidiaries of Merrill Lynch, Goldman Sachs, and Morgan  Stanley. Federal Reserve Board officials told us that the Federal Reserve  Board did not consider the extension of credit to these subsidiaries to be  a legal extension of PDCF but separate actions to specifically assist these  four primary dealers by using PDCF as an operational tool. Federal  Reserve Board officials told us that the Federal Reserve Board did not  draft detailed memoranda to document the rationale for all uses of section  13(3) authority but that unusual and exigent circumstances existed in  each of these cases as critical funding markets were in crisis. However,  without more complete documentation, how assistance to these broker- dealer subsidiaries satisfied the statutory requirements for using this  authority remains unclear. Moreover, without more complete public  disclosure of the basis for these actions, these decisions may not be  subject to an appropriate level of transparency and accountability. The  Dodd-Frank Act includes new requirements for the Federal Reserve  Board to report to Congress on any loan or financial assistance  authorized under section 13(3), including the justification for the exercise  of authority; the identity of the recipient; the date, amount, and form of the  assistance; and the material terms of the assistance. To address these  new reporting requirements, we recommended that the Federal Reserve  Board set forth its process for documenting its rationale for emergency  authorizations.
section_title: The Federal Reserve Board Generally Has Not Provided Documented Guidance to Reserve Banks on Types of Program Decisions That Require Consultation with the Federal Reserve Board
paragraphs: In authorizing the Reserve Banks to operate its emergency programs, the  Federal Reserve Board has not provided documented guidance on the  types of program policy decisions—including allowing atypical uses of  broad-based assistance—that should be reviewed by the Federal  Reserve Board. Standards for internal control for federal government  agencies provide that transactions and other significant events should be  authorized and executed only by persons acting within the scope of their  authority. Outside of the established protocols for the discount window,  FRBNY staff said that the Federal Reserve Board generally did not  provide written guidance on expectations for types of decisions or events  requiring formal Federal Reserve Board review, although program  decisions that deviated from policy set by the Federal Reserve Board  were generally understood to require Board staff consultation. In 2009,  FRBNY allowed an AIG-sponsored entity to continue to issue to the  Commercial Paper Funding Facility, even though a change in program  terms by the Federal Reserve Board likely would have made it ineligible.  FRBNY staff said they consulted the Federal Reserve Board regarding  this situation, but did not document this consultation and did not have any  formal guidance as to whether such continued use required approval by  the Federal Reserve Board. To better ensure an appropriate level of  transparency and accountability for decisions to extend or restrict access  to emergency assistance, we recommended that the Federal Reserve  Board document its guidance to Reserve Banks on program decisions  that require consultation with the Federal Reserve Board.
section_title: The Federal Reserve Board Took Steps to Prevent Use that Would Be Inconsistent with Its Policy Objectives
paragraphs: To assess whether program use was consistent with the Federal Reserve  Board’s announced policy objectives, we analyzed program transaction  data to identify significant trends in borrowers’ use of the programs. Our  analysis showed that large global institutions were among the largest  users of several programs. U.S. branches and agencies of foreign banks  and U.S. subsidiaries of foreign institutions received over half of the total  dollar amount of Commercial Paper Funding Facility and Term Auction  Facility loans (see fig. 3).
According to Federal Reserve Board staff, they designed program terms  and conditions to discourage use that would have been inconsistent with  program policy objectives. Program terms—such as the interest charged  and haircuts applied—generally were designed to be favorable only for  institutions facing liquidity strains. Use of the programs generally peaked  during the height of the financial crisis and fell as market conditions  recovered (see fig. 4). Within and across the programs, certain  participants used the programs more frequently and were slower to exit  than others. Reserve Bank officials noted that market conditions and the  speed with which the participant recovered affected use of the program  by individual institutions. As a result of its monitoring of program usage,  the Federal Reserve Board modified terms and conditions of several  programs to reinforce policy objectives and program goals.
section_title: Concluding Observations
paragraphs: During the financial crisis that began in the summer of 2007, the Federal  Reserve System took unprecedented steps to stabilize financial markets  and support the liquidity needs of failing institutions that it considered to  be systemically significant. To varying degrees, these emergency actions  involved the Reserve Banks in activities that went beyond their traditional  responsibilities. Over time, FRBNY and the other Reserve Banks took  steps to improve program management and oversight for these  emergency actions, in many cases in response to recommendations  made by their external auditor, Reserve Bank internal audit functions, or  the Federal Reserve Board’s RBOPS. However, the Reserve Banks have  not yet fully incorporated some lessons learned from the crisis into their  policies for managing use of vendors, risk of losses from emergency  lending, and conflicts of interest. Such enhanced policies could offer  additional insights to guide future Federal Reserve System action, should  it ever be warranted. We made seven recommendations to the Chairman  of the Federal Reserve Board to further strengthen Federal Reserve  System policies for selecting vendors, ensuring the transparency and  consistency of decision making involving implementation of any future  emergency programs, and managing risks related to these programs. In  its comments on our report, the Federal Reserve Board agreed to give  our recommendations serious attention and to strongly consider how to  respond to them.
Mr. Chairman, Ranking Member Clay, and Members of the  Subcommittee, this completes my prepared statement. I am prepared to  respond to any questions you or other Members of the Subcommittee  may have at this time.
section_title: GAO Contact and Staff Acknowledgments
paragraphs: If you or your staff have any questions about this testimony, please  contact me at (202) 512-8678 or williamso@gao.gov. Contact points for  our Offices of Congressional Relations and Public Affairs may be found  on the last page of this statement. GAO staff who made major  contributions to this statement include Karen Tremba (Assistant Director),  Tania Calhoun, and John Fisher.
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