The loans through the so-called discount window transformed a little-used program for banks that run low on cash into a source of long-term financing for troubled institutions, some of which borrowed regularly from the Fed for more than a year.
The central bank took little risk in making the loans, protecting itself by demanding large amounts of collateral. But propping up failing banks can increase the eventual cleanup costs for the Federal Deposit Insurance Corporation because it keeps struggling banks afloat, allowing them to get even deeper in debt. It also can clog the arteries of the financial system, tying up money in banks that are no longer making new loans.
County Bank, the largest bank in Merced County, California, took a $4.8 million loan from the discount window in March 2008 after announcing the first annual loss in its 30-year history, news that prompted depositors to withdraw $52 million.
By the fall of 2008, the bank was borrowing regularly from the Fed, taking more than two dozen loans in amounts that peaked above $60 million. It continued borrowing until the day it failed, taking a final loan for $55 million on Friday, Feb. 6, 2009.
Thomas Hawker, the former chief executive, said that the loans helped keep the bank in business, providing needed cash as deposits dwindled. But he said that it was clear in retrospect that County Bank was dead on its feet the whole time, thanks to its once-lucrative focus on financing construction of new homes in the Central Valley of California.
“I think in most cases it is a lifeline that kind of provides a bridge to survival,” said Mr. Hawker, who left the bank in 2008. “In the case here, Merced County was ground zero for everything that could possibly have gone wrong with the economy.”
The discount window is a basic feature of the central bank’s original design, intended to mitigate bank runs and other cash squeezes. But access to it historically has been limited to healthy banks with short-term problems.
Those limits moved from custom to law in 1991, when Congress formally restricted the Fed’s ability to help failing banks. A Congressional investigation found that more than 300 banks that failed between 1985 and 1991 owed money to the Fed at the time of their failure. Critics said the Fed’s lending had increased the cost of those failures.
The central bank was chastened for a generation but in 2007, facing a new banking crisis, the Fed once again started to broaden access to the discount window. It reduced the cost of borrowing and started offering loans for longer terms of up to 30 days.
More than one thousand banks have taken advantage. A review of federal data, including records the Fed released last week, shows that at least 111 of those banks subsequently failed. Eight owed the Fed money on the day they failed, including Washington Mutual, the largest failed bank in American history.
The Fed has said that it complied fully with the law in all of its emergency loans, and that its actions, including lending from the discount window, were intended to limit the impact of the crisis.
Charles Calomiris, a finance professor at Columbia University who has studied discount window lending during previous crises, said the Fed had not released enough information for the public to determine whether some of the recipients were propped up inappropriately and should have been allowed to fail more quickly.
“Do we know whether the Fed did that? No, we don’t,” he said. “But the Fed has become more politicized than at any point in its history, and I do worry very much that a lot of Fed discount window lending may just be part of a political calculation.”
In some cases the Fed’s lending had clear benefits, whether or not the loans meant going beyond the mandate.
The F.D.I.C. almost always seizes banks on Friday evenings, so the new owners have two days before reopening. In some cases the Fed kept banks alive until the next Friday. The Bank of Clark County in Vancouver, Wash., took its first discount window loan on Monday, Jan. 12, 2009. It borrowed $8 million Monday, Tuesday and Wednesday, then $14 million on Thursday and Friday. Then the F.D.I.C. closed its doors.
In other cases, the Fed stopped lending to banks as the extent of their financial problems became clear. Alton Gilbert, a former official at the Federal Reserve Bank of St. Louis who wrote a widely cited study of the Fed’s discount window lending in the 1980s, said that few banks failed with Fed loans on their books during the recent crisis. The central bank often suspended lending several months before they failed.
Still, some experts said additional scrutiny was warranted for a subset of banks that received sustained support even though they faced clear problems.
The most frequent visitors at the window were three subsidiaries of FBOP, a bank holding company based in Oak Park, Ill.
Park National Bank in Chicago borrowed regularly from April 2008 until the day of its failure in October 2009, taking 129 loans in amounts that peaked at $345 million — the longest period of sustained support for any bank that failed during the crisis. Park used some of the money to finance the acquisition of assets from other banks, expanding its own balance sheet and potentially increasing the cost of its eventual failure. Bloomberg News first reported the details of the Fed’s discount window lending to the company.
Two other failed banks owned by FBOP also took more than 100 loans from the discount window, California National Bank of Los Angeles and Pacific National Bank of San Francisco, although both stopped borrowing several months before failing.
Marvin Goodfriend, a professor of economics at Carnegie Mellon University, said that such lending placed the Fed in the inappropriate position of deciding the fate of individual banks, choices that he said should be made by elected officials.
“What I think is the lesson from this is that the Congress needs to clarify the boundaries of independent Fed credit policy,” Professor Goodfriend said. “There should be a mechanism so that the Fed doesn’t have to make these decisions on behalf of taxpayers.”
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