March 25, 2008
How Does the Fed Have the Legal Authority to Bail out Bear?
Posted by David Zaring

In the last week, the Fed has a) engineered a sale of Bear, and b) opened its discount window to a number of investment banks, which it does not regulate.  What legal authority does it have to do these things?  Could a competing financial institution or Bear shareholder sue the Fed under the Administrative Procedure Act to reverse these actions?

Here's a start to that analysis.  Section 13 of the Federal Reserve Act creates the discount window.  The Fed has interpreted that act to allow it to open the window to not just banks but other institutions in emergencies. That's 12 C.F.R.  § 201.4d. So that's one way to get the Fed to the legal authority it needs to extend credit to investment banks.

What about engineering a merger? The Fed, after all, doesn't weigh in on bank mergers like the FCC does in telecommunications.  But here too, the Fed has some precedent for its actions.  My sense is that in other countries, cajoling one bank to buy another one would be considered obviously within the purview of a central bank.  Nor is it clear that persuading one company to purchase another would be the sort of order reviewable in federal court.  As for the tangible administration action that the Fed did take pursuant to the merger: the guarantee the Fed gave JPMorgan for Bear's illiquid assets is rarely invoked, but was invoked in the Great Depression.

Most importantly, while they haven't said that Fed decisions are unreviewable as a matter of law, courts have steered clear of reviewing both monetary policy decisions and bailouts very substantively.  Augustus Hand concluded that he couldn't guess at what might be wrong with a legally constituted bank making loans to other banks and setting interest rates for those loans in Raichle v. Federal Reserve Bank, 34 F.2d 910 (2d Cir. 1929).  And after the Franklin National Bank failed, and was bailed out by the Fed, the Second Circuit concluded that

Absent clear evidence of grossly arbitrary or capricious action on the part of [the Fed or the Treasury Department] ... it is not for the courts to say whether or not the actions taken were justified in the public interest, particularly where it vitally concerned the operation and stability of the nation's banking system.

Huntington Towers, Ltd. v. Franklin National Bank, 559 F.2d 863, 868 (2d Cir. 1978).

Nonetheless, it's a lot of authority for one agency.  The always interesting Andrew Ross Sorkin notes that even when the Fed grudgingly agreed let JPMorgan pay more for Bear,

the Fed’s fingerprints were all over the new pact. In an action almost unprecedented in takeover history, JPMorgan bought 39.5 percent of Bear on the spot to ensure that it would have close to a majority of the votes to approve the deal. That agreement completely disregards New York Stock Exchange’s rules that prevent anyone from buying more than 20 percent of company without a shareholder vote. Other parts of the new agreement either stretch the rules or disregard years of precedent in Delaware, where both banks are incorporated.

Trashing the rules of other regulators when you think you need to is pretty serious stuff.  But, then, agencies don't come much more powerful than the Fed, do they?

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