Ben Bernanke gave a speech today where he intimated that Lehman didn't have the collateral the Fed needed to save it:

the firm could not post sufficient collateral to provide reasonable assurance that a loan from the Federal Reserve would be repaid, and the Treasury did not have the authority to absorb billions of dollars of expected losses to facilitate Lehman's acquisition by another firm.

Felix Salmon thinks this collateral thing is bunk.  And I am inclined to agree.  We've been hearing this claim that the Fed must be assured that it will be repaid a lot from Bernanke.  I'm honestly confused as to where he is finding this requirement.  Magic section 13 of the governing statute says:

In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, by the affirmative vote of not less than five members, may authorize any Federal reserve bank, during such periods as the said board may determine, at rates established in accordance with the provisions of section 14, subdivision (d), of this Act, to discount for any individual, partnership, or corporation, notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal Reserve bank

Secured to the satisfaction of the bank looks like the Fed has absolutely unreviewable discretion to accept whatever security it likes in exchange for the opening of the discount window.  So Bernanke's claim that the Fed had to have sufficient capital is disengenous, unless I'm missing something.

But the law does constrain some government action.  Salmon thinks that "Treasury had the resources to prevent the failure of a financial institution all along. It did it with Frannie; it did it with AIG."  Not so.  It only took over Fannie and Freddie because Congress passed legislation in July permitting it to do so.  And it didn't bail out AIG - the Fed did that.  Treasury also doesn't have a massive budget.  Sure, the Fed could have bailed out Lehman - it can print however much money it likes, I suppose.  And it probably didn't bail out Lehman because Paulson and Bernanke didn't want to.  But if Paulson did, and Bernanke didn't, Paulson would have been out of luck.

It's not just nitpicking.  If you just look at the language of the Federal Reserve Act and the Fed's prior interpretations of its loanmaking function, the Fed's discount window powers (used on AIG and Bear) means that it didn't need the TARP at all.  I assumed that Paulson and Bernanke wanted a Congressional imprimatur for massive government intervention and that the Fed wanted Treasury to take action.  But if it really did think that it couldn't make loans unless it could be repaid, then the discount window has a limit, and the TARP legislation really was necessary.  But you tell me, dear reader, where you think Bernanke gets his hands tied by his governing statute.

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