On August 2, the Board of Governors of the IMF approved the creation of approximately $650 billion of Special Drawing Rights (SDRs)—the IMF-created reserve currency—to boost global liquidity and support the ongoing pandemic response in emerging markets. This was the largest increase the U.S. treasury secretary could approve without the issuance being subject to an approving vote in the U.S. Congress. Yet, because of its IMF quota, the U.S. will receive 17% of the new SDRs when the IMF distributes them on August 23; that’s $113 billion. This money does not go to the Treasury’s General Fund, to be used for carrying out spending bills passed by Congress. Instead, it lands in the Exchange Stabilization Fund (ESF), a somewhat archaic fund solely under the purview of the executive branch that has increasingly been used for domestic crisis management. While members of Congress argue over the benefits and drawbacks of this issuance for U.S. foreign policy, the ESF will be more than doubling in size. This may have big domestic implications for future financial rescues and bailouts if Congress doesn’t act sooner to provide stronger guidelines on proper usage of the ESF.
The Exchange Stabilization Fund
Congress established the ESF in the Gold Reserve Act of 1934 as a tool to stabilize the exchange value of the dollar and, more broadly, to support “orderly exchange arrangements and a stable system of exchange rates.” When the International Monetary Fund (IMF) created Special Drawing Rights (SDRs) in 1969, Congress provided that the Treasury would hold any SDRs in the ESF. At the treasury secretary’s request, the Fed is legally obligated to convert SDRs into dollars.
The treasury secretary has discretion over the use of the ESF, subject only to the president’s approval. In pursuit of orderly exchange rates, the secretary can use ESF funds to “deal in gold, foreign exchange, and other instruments of credit.” In 1976, as the world moved to floating exchange rates, Congress amended the Gold Reserve Act to specifically task the treasury secretary to use the ESF to fulfill the U.S.’s obligations to the IMF. Article IV of the IMF Articles of Agreement calls on members to “seek to promote stability by fostering orderly underlying economic and financial conditions and a monetary system that does not tend to produce erratic disruptions.”
The upshot: the treasury secretary has very broad discretion to use ESF funds for financial stability purposes.
Bailout Policy is Stabilization Policy
While originally used very narrowly to intervene in foreign exchange markets and provide bridge loans to foreign countries, Treasury has interpreted its ESF authority more broadly in recent decades:
- After Congress rejected a proposal for a loan to Mexico during its economic crisis in the mid-1990s, the Clinton administration announced a rescue package that included up to $20 billion in loans from the ESF (the DOJ then provided further analysis supporting a broad reading of the treasury secretary’s ESF authorities).
- In September 2008, Treasury used the entirety of the approximately $50 billion in the Fund as an insurance reserve to provide a sweeping guarantee and stem the run on money market mutual funds.
- At the onset of the pandemic, the Federal Reserve announced several Section 13(3) emergency lending facilities. Before Congress passed the CARES Act, the Treasury committed $50 billion of existing ESF funds to equity investments and credit protection for many of these facilities. These funds were to provide first-loss protection to the facilities to assist the Fed in meeting the legal requirement that its 13(3) facilities are “secured to the satisfaction” of the Fed. Later, the Treasury replaced $30 billion of that funding with CARES Act funds, while non-CARES ESF funds remained committed to the Commercial Paper Funding Facility (CPFF) and Money Market Mutual Fund Liquidity Facility (MMLF).
With the winding down of the CPFF and the MMLF, the ESF has returned to having roughly $95 billion of available funds. After the IMF executes its $650 billion SDR issuance, assigning $113 billion to the U.S., the fund will sit at approximately $208 billion.
Sidelining Congress from Future Bailouts?
Even with a much smaller ESF, lawmakers on both sides of the aisle have at various times referred to the ESF as a “slush fund.” With an ESF at over $200 billion, an investment on the scale of TARP’s most famous and important capital injection—$125 billion for the nine largest banks over Columbus Day weekend in 2008—could leave Congress finding out about it from the next morning’s papers.
With the ESF investments in the Fed’s 2020 lending facilities, there is a clear precedent that ESF transactions—dealings “in gold, foreign exchange, and other instruments of credit”—can take the form of equity investments. In 2008, Treasury lawyers rejected the use of the ESF for the individual bailouts of Bear Stearns (p. 155) and AIG (p. 193), but ultimately signed off on its use for a more systemic purpose in the bailout of money market funds. It stands to reason that a broad-based program like TARP, or the FDIC’s 2008 programto guarantee all newly issued bank debt, could easily meet that standard as well.
The passage of TARP in 2008 only followed highly contentious political battles, with a key problem being that Treasury Secretary Hank Paulson’s initial draft legislation contained limited oversight provisions. Similarly, per the Dodd-Frank Act of 2010, the FDIC now needs congressional approval for it to repeat a system-wide bank debt guarantee program. Yet, as the current ESF statute states, “Decisions of the Secretary are final and may not be reviewed by another officer or employee of the Government” (31 U.S.C. § 5302).
To be sure, there is a lot to like about a discretionary fiscal fund available to the executive branch in crisis. If that’s what Congress wants, however, it should take care to set up exactly that, with its desired guardrails on transparency, oversight, limits to authority, etc. Congress could even finance such a fund from the ESF if it so chooses.
An increasing supply of SDRs is an important resource to developing economies and a global public good; indeed, as IMF Managing Director Kristalina Georgieva noted, the new allocation will help “address the long-term global need for reserves.” But given the quota system of the IMF, addressing the global need for reserves will always come with a disproportionate increase in U.S. SDR holdings, bolstering what has become a regular tool for domestic crisis management. As the ESF surpasses $200 billion later this month, Congress should disentangle these two policy responses and give future crisis-fighters clear fiscal powers to intervene in future emergencies.
Steven Kelly is a Research Associate at the Yale Program on Financial Stability. (steven.kelly@yale.edu)
I have dubbed the economic damage caused by the virus the “mandated recession”. The current recession – and, indeed, we are in a recession . The financial meltdown that started with the bursting of the U.S. housing bubble had worldwide economic repercussions, including recessions, far-reaching.