Leo Rassieur is a Senior in the College double-majoring in Government and Economics with a minor in French and serves as a Managing Editor at GUULR.
Throughout the 2008 crisis, the Fed came under much scrutiny for its extension of credit to large non-bank financial institutions like American International Group and Bear Stearns. Meanwhile, ordinary Americans still struggled to access credit, culminating in the 2010 Dodd-Frank regulations, which curtailed the Fed’s ability to lend domestically in this way. Interestingly, though the Fed’s provision of liquidity overseas was arguably a larger overstep of its legal authority than this domestic lending, its ability to do so has not been seriously scrutinized by Congress or by the courts. Therefore, it is relatively unsurprising that, in the midst of the COVID-19 crisis, the Fed has drastically expanded foreign bank access to USD liquidity. These Fed “swap lines” are not remarkable merely because they are new—in fact, they date back to 1962—but because they elicit little to no congressional or judicial scrutiny despite forming a central pillar of the global financial crisis response procedure.
By extending a swap line, the Federal Open Market Committee (FOMC) authorizes the contractual and temporary swap of a given quantity of dollars for the domestic currency of a foreign central bank. The initial purchase of currencies is the “spot leg” while the subsequent repurchase, terminating the swap, is the “forward leg.” To execute the spot leg, the Fed deposits dollars in the foreign central bank’s account with the Federal Reserve Bank of New York (one of twelve regional Federal Reserve Banks). This institution acts as the agent of the FOMC by implementing the transaction. Simultaneously, the foreign central bank deposits the foreign currency in the Fed’s account. The foreign central bank is then free to distribute the dollars to borrowers through its own selection process, in which the Fed has no oversight. Included in the liquidity swap contract is the agreement to repurchase the currencies on a given future date at the same nominal rate as the initial transaction, with the Fed receiving an additional preset fee for interest. The money created by the two central banks is thus removed from circulation. The Fed’s swap lines promote global economic stability pre-crisis by mitigating fears of foreign central bank failure and, by extension, the failure of the foreign financial institutions relying on those central banks for USD liquidity, and doubly serve to repair damage post-crisis by rescuing foreign central banks and other financial institutions.
However, the term “swap line” does not appear in the original FRA or its amendments. Nonetheless, the notion that the Fed’s swap line authority is provided by Section 14 of the FRA is taken for granted at the highest levels of government, though less so in legal scholarship. As originally codified, Section 14 of the FRA of 1913 enumerates the powers of Federal Reserve Banks under the rules and regulations of the Board, including to “purchase and sell in the open market, at home or abroad, either from or to domestic or foreign banks, firms, corporations, or individuals, cable transfers and bankers’ acceptances and bills of exchange” and to “open and maintain banking accounts in foreign countries … whatsoever it may deem best for the purpose of purchasing, selling, and collecting bills of exchange.” This language is essentially the same today, with Section 14 only having been significantly amended by the Banking Act of 1933 (Glass-Steagall) and the Banking Act of 1935, which structured the Fed’s modern Board of Governors and the FOMC, and by the Monetary Control Act of 1980, with respect to the Fed’s oversight of non-member banks.
Much of the Fed’s legal mandate to engage in foreign liquidity swap lines therefore relies on the contextualization of the Federal Reserve Act, particularly whether swap lines fall under the purpose of the Fed as defined by its so-called “dual mandate” to promote stable prices and maximum employment. The dual mandate is a normative framework for the Fed’s monetary policy responsibilities that stems from the Federal Reserve Reform Act of 1977. Amid the Great Inflation of the 1970s, Congress amended the Federal Reserve Act to task the Board and the FOMC with “maintain[ing] long-run growth of the monetary and credit aggregates commensurate with the economy’s long-run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” Broadly speaking, senior officials at the Fed have interpreted the dual mandate as tacitly including the goal of financial stability, which cannot help but have a global dimension, as the international financial system is largely denominated in dollars.
Judicial perspectives and, relatedly, congressional views on the Fed’s swap lines have thus far largely and voluntarily constrained themselves to not intervene in what the Fed claims is sound monetary policy, particularly in relation to the international financial system. This peculiar difference stems from two related doctrines. The first, a legal one, derives from a line of court cases establishing the unique legal independence of the Fed and the Federal Reserve Banks that execute the Fed’s policies from judicial review. The second, a widely accepted principle in international political economy, is the notion of central bank independence (CBI). This policy rests on the idea that sound monetary policy cannot take place unless a nation’s central bank is shielded from the political process, including the short-term incentives that might guide politicians.
If the legal dilemma of the Fed’s actions is then left to Congress, it is likely no action will be taken soon. This is especially true given the generally accepted principle of CBI, meaning that the Fed should manage its highly technical and long-term responsibilities without oversight from politicians concerned with re-election or from judges who lack qualifications in monetary policy. Since the Chevron doctrine in 1984, the Supreme Court and lower courts have committed to deferring to a federal agency for interpreting the meaning of a statute that Congress has tasked it with enforcing or implementing, particularly when understanding the statute “depend[s] upon more than ordinary knowledge.” The courts’ treatment of the Fed is the quintessential application of the Chevron doctrine within the domain of monetary policy. In Board of Governors of FRS v. First Lincolnwood, which preceded Chevron by six years, the Supreme Court held that “the [Fed]’s authority is bolstered by reference to the principle that an agency’s long-standing construction of its statutory mandate is entitled to great respect, especially when Congress has refused to alter the administrative construction.” Hence, Congress’ general apathy toward swap lines and other Fed powers reinforces the courts’ deference to the Fed, which results in a positive feedback loop. Both Congress and the courts likely hold onto CBI as a principle for this heightened deference to the Fed, which as expressed by the Second Circuit, means that “mak[ing]the courts, rather than the Federal Reserve Board, the supervisors of the Federal Reserve System” is “a cure worse than the malady” of mistaken policy.
The Fed and its swap lines are thus a unique artifact of our dollar-denominated system of global capitalism. The breakdown of Bretton Woods left the Fed, particularly the FOMC, in the peculiar position of managing the response to global financial crises despite lacking an international mandate, let alone an explicit domestic one with substantive political, judicial, or popular oversight. In essence, the extra-legality (or, arguably, illegality) of swap lines perfectly encapsulates the fact that the Fed’s de facto role as global lender of last resort and monitor of financial stability is not written in law. The extraordinary independence of the Fed in executing this responsibility is perhaps a function of lawmakers and jurists’ valuing of CBI, thus explaining why they might subvert a legal framework that could easily be challenged.
