Dying Banks Kept Alive Show Secrets Fed's Data Will Reveal for First Time

U.S. regulators closed Chicago- based Park National Bank in October 2009 when it owed $345 million to one of the lowest-cost lenders in town: the Federal Reserve’s discount window. Park National had been a constant customer at the window for more than 18 months before it failed, records show.

That glimpse into the loan program, gleaned through the Freedom of Information Act, will be expanded this week with an unprecedented view of the secret lifelines the Fed extended to hundreds of banks. Officials plan to release documents that amount to more than 6,000 pages, according to court records. Bloomberg LP, the parent company of Bloomberg News, and News Corp.’s Fox News Network LLC requested the records under FOIA, then sued after the central bank refused to release them.

Without identifying them as of yet, Fed officials say all the discount window loans made during the worst financial crisis since the 1930s have been repaid with interest. Cases such as Park National’s show how the lending amounted to a secret public subsidy, with few questions asked.

“Solvency is the big issue,” said Arthur Wilmarth, a professor at George Washington University Law School in Washington. “Was the Fed keeping banks alive when they should have died?”

Banks were able to tap the window for loans at rates below the market after subprime mortgage defaults contributed to record losses for them and credit markets began to seize up.

Inexpensive Funding

“The Fed really provided an inexpensive source of funding,” Daniel Watts, the former executive vice president at Park National in charge of all business lines, said in a telephone interview. The Federal Deposit Insurance Corp. estimates Park National’s closure cost its insurance fund $656 million. The FDIC typically repays discount window loans in the process of resolving a failed bank.

The Fed is expected to release this week documents related to discount window lending from August 2007 to March 2010, including the peak month of October 2008, when loans hit $111 billion.

The disclosures, the first of their kind for a lending program that dates to 1914, will provide the fullest view yet of which banks needed the most public help during the crisis. From now on, data about the program will be available only after a two-year lag, under provisions in the Dodd-Frank financial regulatory law that Congress adopted last year.

Prospective Audits Only

Dodd-Frank also exempted past discount window lending from an audit by the Government Accountability Office that’s examining much of the central bank’s other crisis-era programs. Discount window loans are also generally beyond the scope of the Fed’s Office of Inspector General.

Charles Young, a spokesman for the GAO, says the Dodd-Frank Act gives the agency authority to audit the discount window’s operational integrity and controls “prospectively only.”

“It’s surprising that the Congress didn’t say they wanted the GAO to confirm that discount window borrowers were solvent,” said Wilmarth, the George Washington University law professor.

For more than two years, the Fed resisted releasing the information that’s due to come out this week. It argued that its lending records shouldn’t be subject to the open-records law known as FOIA in part because revealing which banks were tapping the discount window might attach a stigma to those banks and stir depositor runs or roil markets.

Former House Financial Services Committee Chairman Barney Frank, for whom the legislation is named, said the measure exempted discount window data from FOIA to prevent timely releases of information about any bank’s borrowing. Such disclosures might have “a negative market effect,” he said.

Two-Year Delay

“If people saw the data the next day, they come to the conclusion that the bank must be in trouble,” Frank, a Massachusetts Democrat, said in an interview. Releasing it after a two-year delay “means a significant gain in public information.”

Lobbying in the Senate successfully exempted past discount window lending from audit and disclosure requirements that Dodd- Frank applied to other crisis-era Fed lending programs. The Fed released details about $3.3 trillion worth of assistance from those facilities in December.

“We had a lot of support,” said Warren Gunnels, senior policy adviser to Senator Bernard Sanders, the Vermont independent who wrote some of the bill’s Fed transparency language. “But then we were getting calls, and senators were hearing from other senators that they were concerned” about including the discount window in the disclosure requirements.

Echoing Arguments

Objections that poured into Sanders’ office, as Gunnels described them, echoed arguments the Fed advanced as it fought the media lawsuits: If a bank was known to be a borrower at the discount window, that could raise suspicions about its health and cause a run, some senators told Sanders and his staff.

That’s not a concern when the borrowing bank has already failed. Eight banks closed in 2009 with outstanding discount window loans, according to a list Bloomberg obtained through a separate FOIA request. Interviews with executives who managed some of these banks provide a partial view of how the discount window worked during the crisis.

Ordinarily, the discount rate is set at a penalty, or above market rates, to prevent overuse of government credit. It was 1 percentage point higher than the federal funds rate -- that is, the overnight lending rate for banks -- for most of 2007. When default rates on subprime mortgages began to increase that year, Federal Reserve Chairman Ben S. Bernanke and the Board of Governors in Washington reduced the discount rate.

Cutting Spread

They cut its spread over the federal funds rate by half on August 17, 2007. Loan terms were extended to 30 days from overnight.

As the cost of Fed credit fell, discount window borrowings rose to $1.1 billion by Sept. 19, 2007, from just $4 million on Aug. 15, 2007, before Fed officials cut the rate. By the first week of December, they totaled $2.1 billion.

“By increasing the liquidity of the banking system, discount window lending helped prevent an even broader banking crisis and thereby reduced the resolution costs to the” FDIC, William Nelson, deputy director in the Fed Board’s Division of Monetary Affairs said in an e-mailed statement.

After the collapse of Bear Stearns Cos. in March 2008, the Fed’s Board of Governors in Washington continued to slash the spread. On March 16, 2008, Fed governors cut it to a quarter- point over the federal funds rate and extended the term of the loans to 90 days.

Below Market Rates

By December 2008, the discount rate stood at just 0.5 percent, below the market rates paid by many banks for funds. The average 3-month consumer deposit rate that banks were paying at that time was 1.44 percent, according to Bankrate.com. The cost of borrowing dollars for three months in London, or the 3- month Libor rate, averaged 1.48 percent in the last two weeks of the year.

The discount rate amounted to a public subsidy -- and as such, the loans need to be disclosed, said Robert A. Eisenbeis, a former Atlanta Fed research director who is now chief monetary economist at Cumberland Advisors Inc., an investment management firm based in Sarasota, Florida.

“When it comes to openness and transparency, it is incumbent for the Fed or any agency for that matter that is providing subsidies with taxpayer monies to be accountable for their actions,” he said.

The discount window “was so much cheaper than the consumer deposits at the time,” said Watts, the former Park National executive who is now president of Forest Park National Bank & Trust Co. in Forest Park, Illinois.

Borrowing $1 Billion

As it was borrowing at the window, Park National’s total assets rose from $4.6 billion in June 2008 to $4.9 billion in December. The bank’s discount window borrowings rose to $1 billion by the end of 2008, Watts said, noting government filings. That was about 23 percent of total liabilities.

“Park was not using the advances to originate new deals,” said Watts. The discount window provided “substantial liquidity” for the bank and allowed Park National to acquire assets of sister banks that were shrinking to increase capital ratios, he said.

Bank regulators recognized that Park National had “serious troubles” as of July 2009, according to testimony that Jennifer Kelly of the Office of the Comptroller of the Currency gave the House Financial Services Subcommittee in January, 2010.

Negative Trends

“Absent a dramatic -- and unforeseen -- reversal of its trends and current condition, it was evident that grounds would soon exist for” closing the bank, Kelly, the OCC’s senior deputy controller for Midsize and Community Bank Supervision, told the panel.

Watts said in an e-mail to Bloomberg News that he disagrees with the OCC’s characterization of the bank. “Park’s capital levels were more than adequate,” Watts said. “Liquidity was sufficient and building.”

Federal Reserve Bank of Chicago spokesman Douglas Tillett declined to comment on Park National.

First Bank of Idaho in Ketchum established its discount window borrowing program with the San Francisco Fed in May 2008, according to Peter Minford, the former chief financial officer. He said the program “was very easy to administer.”

“Basically, once the line was established, no questions were asked when draws were requested,” said Minford, now president of Data Informatics LLC, a Ketchum, Idaho-based firm that provides accounting software to community banks.

No Delivery Required

The central bank’s procedures for primary credit borrowers, the Fed’s term for healthy banks that can borrow at the lowest discount rate, meant that the Idaho lender didn’t even have to physically deliver the collateral to the San Francisco Fed to get credit. San Francisco Fed officials accepted certified statements by management that the loans existed, Minford said.

Regulators closed First Bank of Idaho on April 24, 2009, with an outstanding discount window credit of $72 million, records show. A follow-up report by the U.S. Treasury’s Inspector General criticized the bank’s “unstable funding structure” that produced a reliance on federal borrowings.

“The Fed kept the tap running and that kept the bank running. That is the whole issue,” said Mark Williams, an executive in residence at Boston University School of Management and a former Fed bank examiner. “What is the Fed’s role here -- to protect risky banks or taxpayers and the overall economy?”

The FDIC estimates that First Bank of Idaho’s failure cost the deposit insurance fund $176 million. The San Francisco Fed hasn’t experienced a loss from its discount window lending, said spokeswoman Carol Eckert.

“Our discount window lending to institutions in declining or in poor financial condition is temporary, heavily administered and well-secured,” Eckert said. “Our overarching principle is that discount window lending be in the public interest.”

To contact the reporters on this story: Craig Torres in Washington at Ctorres3@bloomberg.net; Bob Ivry in New York at bivry@bloomberg.net.

To contact the editors responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net Gary Putka at gputka@bloomberg.net.

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