When it comes to the Federal Reserve’s emergency lending powers, the crucial word is “solvent,” because both by tradition and, since the passage of the Dodd-Frank Act, by law, the Fed can use its emergency powers to make loans only to a solvent institution, according to an analysis in the The New York Times Friday. In 2008, that’s why Bear Stearns and AIG, both deemed solvent by the Fed, were bailed out — while Lehman Brothers, said to be insolvent, was left to fail. But what did “solvent” mean to those officials? Recent testimony in the continuing litigation over the government’s rescue of AIG — its former chairman and CEO, Maurice Greenberg, claims that the bailout was unconstitutionally punitive — suggests that solvency had little or nothing to do with the Fed’s decision to lend. Numerous firms deemed insolvent nonetheless got emergency loans, while Lehman alone was denied one before it went bankrupt. Judging by their actions, Fed officials seemed to have defined solvency on a case-by-case basis. Consider the testimony of Timothy Geithner, who later served as Treasury secretary. As president of the Federal Reserve Bank of New York when the financial crisis unfolded, Geithner had to make the crucial determination of which firms under his jurisdiction (which included Wall Street) were solvent and thus eligible for emergency relief. “Even the solvent can be illiquid in that context, and that would make them insolvent,” Geithner testified.
