Moreover, even if these purchases were consistent with the Federal Reserve Act, they still have, in Bernanke's own words, "a fiscal component." This makes them unconstitutional. The Fed cannot simply make transactions that have a "fiscal component" - such as buying bad debt to make what Bernanke calls a "money-financed gift to the private sector" - unless that expenditure is the consequence of appropriations made by law (per Article 1, Section 9 of the Constitution). Congress never intended such "money financed gifts." When you read the Federal Reserve Act itself, there are numerous provisions to explicitly prevent transactions that would risk the loss of principal, or that would perpetually roll over debt with no expectation of final payment.
c) Open Market Operations
With respect to Open Market Operations (Section 14), the restrictions in the Federal Reserve Act are important, and should probably be memorized by Congress, because I suspect that the next place the Fed may look to do "quantitative easing" will be in the area of municipal bonds, and Bernanke has demonstrated a clear willingness to ignore the obvious intent of the Act:
Notice the conservative way that the Federal Reserve Act is written. Section 14.1 (Purchase and Sale of Obligations of United States, Counties etc., and of Foreign Governments) allows the Federal Reserve (boldface mine):
1. To buy and sell, at home or abroad, bonds and notes of the United States, bonds issued under the provisions of subsection (c) of section 4 of the Home Owners' Loan Act of 1933, as amended, and having maturities from date of purchase of not exceeding six months , and bills, notes, revenue bonds, and warrants with a maturity from date of purchase of not exceeding six months, issued in anticipation of the collection of taxes or in anticipation of the receipt of assured revenues by any State, county, district, political subdivision, or municipality in the continental United States, including irrigation, drainage and reclamation districts, and obligations of, or fully guaranteed as to principal and interest by , a foreign government or agency thereof, such purchases to be made in accordance with rules and regulations prescribed by the Board of Governors of the Federal Reserve System. Notwithstanding any other provision of this chapter, any bonds, notes, or other obligations which are direct obligations of the United States or which are fully guaranteed by the United States as to the principal and interest may be bought and sold without regard to maturities but only in the open market.
2. To buy and sell in the open market, under the direction and regulations of the Federal Open Market Committee, any obligation which is a direct obligation of, or fully guaranteed as to principal and interest by, any agency of the United States .
Note: Ginnie Mae is an agency of the U.S. Government. Fannie Mae and Freddie Mac are "government sponsored enterprises," but are private corporations that lack agency status, and whose securities are not guaranteed as to principal and interest by the U.S. government (at least those maturing beyond 2012).
Let me be clear - if Congress decides by a vote of its members to defend Fannie Mae and Freddie Mac, and to give their securities the full faith and credit of the United States, with an appropriation as to the cost of doing so, then there is no legal or constitutional problem. It may not be good policy - I'd prefer to let Fannie and Freddie pay on the existing mortgage pools without recourse for losses, and start fresh with a far more risk-based and capital-regulated entity to keep the mortgage market going - but in any event, any bailout should result from the representative will of the American people. No government bureaucrat should have the ability to take what amount to fiscal actions without an appropriation by Congress.
To revisit Bernanke's own words from his 1999 speech "Japanese Monetary Policy - A Case of Self-Induced Paralysis?":
“In thinking about nonstandard open-market operations, it is useful to separate those that have some fiscal component from those that do not. By a fiscal component I mean some implicit subsidy, which would arise, for example, if the BOJ purchased nonperforming bank loans at face value (this is of course equivalent to a fiscal bailout of the banks, financed by the central bank). This sort of money-financed “gift” to the private sector would expand aggregate demand for the same reasons that any money-financed transfer does. Although such operations are perfectly sensible from the standpoint of economic theory, I doubt very much that we will see anything like this in Japan, if only because it is more straightforward for the Diet to vote subsidies or tax cuts directly. Nonstandard open-market operations with a fiscal component, even if legal, would be correctly viewed as an end run around the authority of the legislature, and so are better left in the realm of theoretical curiosities.”
d) Discounting
As for the Maiden Lane transactions, the Fed uses Section 13.3 of the Federal Reserve Act to justify the creation of off-balance sheet shell companies to purchase private debt of uncertain quality and undisclosed valuation. This is illegal, because it is neither authorized by, nor consistent with, the provisions of the Act.
To see this, it's essential to understand the word "discount" as it is used in the Federal Reserve Act. Discounting relates to providing short-term liquidity, and is much like providing a check-cashing service. To "discount" a note, draft, bill or other security is to purchase it at slightly less than the face value that will be delivered at a slightly later date. Think about Treasury securities. The only ones that trade on a "discount" basis are Treasury bills with maturities of less than a year. For example, if you buy a one-year Treasury at $98 and it pays $100 at maturity, you'll earn 2.04% in "interest."
