The Fed Partially Lifts the Veil on Its Discount Window

For most of its 98-year history, the Federal Reserve has operated with all the transparency and enthusiasm for change of the Vatican. Now the ultra-secretive Fed is starting to alter its ways, if somewhat grudgingly. Some of the new openness, such as Chairman Ben Bernanke's plan for quarterly press briefings, is the central bank's idea. Much of it comes under duress.

On Mar. 31 the Fed was expected to disclose which banks borrowed from its discount window during the darkest moments of the 2008-09 financial crisis. This unprecedented view of the emergency loans the Fed extended to hundreds of banks is the result of a Mar. 21 Supreme Court decision that left intact lower court rulings ordering disclosure in lawsuits filed by Bloomberg, the owner of this magazine, and News Corp.'s (NWS) Fox News Network. Still, the Fed won't disclose the collateral it accepted, which would reveal the risks it took. Future discount window borrowings will be made public, though only after a two-year delay, thanks to the new Dodd-Frank financial reform law.

Given the prominent role the world's biggest banks played in causing financial losses worldwide, largely because of what investors didn't know or didn't understand, some say the loans should be made public at once. Only then, the reasoning goes, would investors and counterparties of a Fed borrower be able to manage their own risks. "The free-market system only works if it's fully informed," says Lynn E. Turner, who battled the Fed over disclosure issues while serving as the Securities and Exchange Commission's chief accountant from 1998 to 2001. "There's a lot of similarity between the Fed and an SUV with blacked-out windows."

The Fed says such calls threaten its core function: preserving market confidence by acting as a lender of last resort. Publicizing the names of discount window borrowers could spark bank runs or discourage sick banks from seeking help until they are fatally compromised. "The 'full monty' may not be a good thing," says Frederic S. Mishkin, a former Fed governor.

For the Fed, keeping information from investors is nothing new. Congress last year had to pry loose the details of $3.3 trillion worth of crisis-fighting programs that relied on the central bank's vault. In the late 1990s the Fed successfully resisted the SEC's attempt to require banks to stop using hidden funds, or "cookie jar reserves," to smooth quarterly earnings, says Turner.

The discount window is the Fed's oldest lending channel and traditionally its most secretive. Banks have been free to use it without publicly revealing the fact since the Fed's 1913 birth. Loan demand varies, depending on market conditions and seasonal factors. In January 2007, before the financial crisis erupted, banks owed the Fed just $1.3 billion for discount window loans. By October 2008, borrowings peaked at $111 billion. One bank, Chicago-based Park National, owed the Fed $345 million before regulators shut it down in October 2009, according to data gleaned from a Freedom of Information Act request. The most recent data, for Mar. 23, show banks owing just $13 million.

Some former Fed insiders say the public should routinely be clued in when private institutions tap the public purse, in the same way the SEC requires companies to inform investors of major financial events. "This should be material information. Investors should have the right to know," says Roberto Perli, a former Fed board economist who is managing director of International Strategy & Investment in Washington.

Banks traditionally have been reluctant to use the window, fearing that savvy investors could tell by following clues in weekly totals of Fed loan data by district. In 2003 the Fed said banks would no longer have to show an inability to raise private funds to tap the discount window, hoping to end the stigma. But when the initial wave of distress swept the financial industry in 2007, banks still shied away. "We had no luck in encouraging banks to use the window," says Donald Kohn, a Fed vice-chairman at the time.

During the worst of the financial crisis, banks paid extra to borrow to avoid the discount window's taint by participating in a new Fed program, the Term Auction Facility. That allowed them to bypass the window and still get emergency money by bidding for it in group auctions. At its March 2009 peak, TAF provided banks with $493 billion in short-term credit—more than four times the highest volume of discount window lending, which occurred five months earlier.

Today's Fed is undeniably more open. Until 1994 the central bank didn't even publicly disclose when it changed the benchmark lending rate, leaving the market to figure that out for itself. Former Fed Chairman Alan Greenspan cultivated an image as an oracle who delighted in obscuring rather than explaining. Today, interest rate changes are announced in public statements after the policy-making Open Market Committee meets. Presidents of regional Fed banks give dueling public speeches on monetary policy. Bernanke has even taken 60 Minutes on a tour of his Dillon (S.C.) hometown. The chairman's plans for quarterly press briefings, scheduled to begin on Apr. 27, mark a further evolution in the Fed's public outreach.

With its profile higher than ever, demands for greater accountability will only continue. William Greider, author of the 1989 Fed history Secrets of the Temple, says the bank is losing the battle to maintain its traditional mystique. "What has happened in the last three years is the mask has been torn away from the central bank," he says. "And they can't put it back on."

The bottom line: As the Fed insists on better risk management by banks, pressure may grow for it to release timely data on discount window lending.

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