Cumberland Advisors Market Commentary – Fed Vacancies – the Dilemma As of 11/23/2020

Author: Robert Eisenbeis, Ph.D., Post Date: November 23, 2020

As the Biden administration begins to float the names of potential cabinet members, an interesting scenario and potential dilemma faces the Federal Reserve Board.

Federal Reserve Building

Normally, there are seven members of the Federal Reserve Board, but at present there are only five, with two vacant positions. One vacancy has existed since March 2014 when Sarah Bloom Raskin retired, and the other has existed since February 2018 when Janet Yellen retired. Two nominees – Judy Shelton and Chris Waller – were put forward on January 28, 2020, by President Trump and voted out of the Senate Judiciary Committee. Judy Shelton was nominated to fill a term that expires in January 2024, and Chris Waller from the Federal Reserve Bank of St Louis was nominated to fill a term expiring January 2030.

Chris Waller’s is not a controversial nomination, whereas Judy Shelton’s nomination has been contentious and is opposed by many, including more than 100 economists (including 7 Nobel Prize laureates) who signed a letter urging senators to vote against her nomination. Senator McConnell scheduled a vote on Judy Shelton’s nomination before the full Senate on November 17, and the nomination was rejected by a vote of 50-47, given opposition from three Republican senators – Alexander, Collins, and Romney – and the absence of Senators Scott and Grassley, who  were in quarantine. (Senator Alexander was absent for personal reasons.) Faced with rejection, Senator McConnell also voted against the nomination in a parliamentary move to retain the option to bring the nomination back to the Senate floor at a later date.

But time is running out, since the Senate is now in recess until November 30; and when it returns, Arizona Republican Senator McSally will be replaced by Democratic Senator Mark Kelly. Kelly’s win further narrows the Republican margin from 52 to 51 versus 47 Democrat members and 2 independents (Bernie Sanders and Angus King, both of whom caucus with the Democrats), bringing the post-Thanksgiving balance of power in the Senate to 51 Republicans and 49 senators voting with the Democrats. If the three Republicans who opposed Judy Shelton’s nomination continue in opposition, there is no hope for a post-Thanksgiving vote in favor of her nomination. With the new Congress’s coming into session in 2021, the nominations will expire. In that case then President Biden will have to make two nominations, and the vetting and approval process will start over. Of course, should Georgia elect one or two Democratic senators, then the balance of power in the Senate could change, making it difficult for Republicans to thwart new nominations.

These developments are interesting from the perspective of the conduct of Fed policy. Current Governor Lael Brainard is now being mentioned as a candidate for Secretary of the Treasury. (She held the position of Under Secretary of the Treasury for International Affairs from 2009 to 2013. Should she be appointed Secretary of the Treasury and the other two Fed vacancies not be filled, which now seems increasingly likely, this outcome would leave the Board of Governors with only four board members for a time.

The significance of the status of these appointments lies in the FOMC’s most recent statement, in which the Fed pledged to use its full array of tools to deal with possible negative economic consequences and economic uncertainties. These tools include its emergency lending programs. However, should the need arise to extend or modify those programs, the Fed may not legally be able to act. The lending programs were put in place pursuant to Section 13 of the Federal Reserve Act to extend credit to nonbank firms. Section 13 was invoked by the Fed during the 2007–2009 financial crisis and was used to prove credit to primary dealers and to support the commercial paper market. In response to the COVID virus, the Fed created several other lending facilities under the same authority, including the Main Street Lending Programs, the Municipal Liquidity Facility, the Corporate Credit Facility, and the Paycheck Protection Program, just to name a few. As we know, the Treasury has requested return of unused funds, and this move is now being interpreted as a termination of those special lending programs. (We will say more on this matter in a later section of this commentary.)

Should the Fed need to modify, extend, or add to the programs, it would be precluded from doing so because there would be only four sitting Governors on the Board. The reason is that Section 13(3)(A) states:

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 participant in any program or facility with broad-based eligibility, 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…

So, if the Senate does not approve the two existing nominees before the current Congress expires, then the two nominations expire. Should Governor Brainard go to the Treasury, then according to Section 13(3), the Board may not be able to act using its emergency lending powers at just the time that those powers may be most needed. However, things may not stand as Section 13(3) appears to dictate, and in that case the Fed will not be hamstrung, the language in Section 13(3) notwithstanding.

Richard Jones, General Council FRB Atlanta, and François Henriquez, General Council FRB St Louis, have independently confirmed that the five-vote requirement does not apply when there are fewer than five sitting governors. In particular, they cite Section 11(r ) of the Federal Reserve Act 12 USC 248(r), which states that “Pursuant to Section 11(r)(1), the Board of Governors may take any action authorized by the FRA with a unanimous vote of all governors then in office if there are less than 5.”

Thus if there are only four governors in office, a unanimous vote of the four can take any action authorized by the FRA; and if there were only two sitting governors, then they too could act by a unanimous vote and take emergency action under Section 13(3). Of course, if someone else, such as Janet Yellen or Roger Ferguson, is nominated for the Treasury slot, then there would still be five sitting governors, and the concern would be resolved.

Lastly, a couple of thoughts on the Treasury’s recent request for the Fed to return unused funds associated with the emergency lending programs put in place earlier this year. The Treasury made an equity investment in several of the emergency lending programs, including the Municipal Liquidity Facility, the Money Market Municipal Facility, the Main Street Lending Facilities, the Term Asset-Backed Securities Loan Facility, the Corporate Credit Facilities, and the Commercial Paper Funding Facility. These equity investments were designed to protect the Fed against losses should they occur. Section 13(3) of the Federal Reserve Act governing such special programs does not require injection of funds by the Treasury but does require Treasury approval to establish such programs. In this case, there is no reason that, when the programs are set to expire, the Fed couldn’t seek Treasury approval to continue them without any Treasury equity investments. In this regard, when the programs were first instituted during the 2007–2008 financial crisis, there were no Treasury funds involved; and the Dodd-Frank 2010 revisions to the authority contain no requirement for a Treasury backstop. Finally, worst case, should losses occur, the Fed can, instead of writing down its capital, create a negative asset account and curtail remittances to the Treasury until that account is extinguished, thereby shifting those losses to the Treasury.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
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