Congressional Research Service IF11474.3 (Treasury’s Exchange Stabilization Fund and COVID-19)

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A Congressional Research Service product, IF11474 (version 3), updated April 10, 2020, on Treasury's Exchange Stabilization Fund (ESF) and COVID-19. It states that the CARES Act (P.L. 116-136), signed into law on March 27, 2020, appropriates $500 billion to the ESF to support loans, loan guarantees and investments for businesses affected by COVID-19, and temporarily permits the ESF to guarantee money markets, as occurred in the 2008 financial crisis. It notes that ESF assets have been pledged in 2020 to backstop emergency lending facilities created by the Federal Reserve. It describes the fund's original purpose of stabilizing the value of the dollar and the rule that ESF loans may not exceed six months unless the President notifies Congress of "unique or exigent circumstances".

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Updated April 10, 2020
Treasury’s Exchange Stabilization Fund and COVID-19
As part of the U.S. government’s economic response to the “being consistent with U.S. obligations in the IMF
Coronavirus Disease 2019 (COVID-19), the Coronavirus regarding orderly exchange arrangements and a stable
Aid, Relief, and Economic Security Act (CARES Act; H.R. system of exchange rates” was inserted. As a consequence
748/P.L. 116-136), was signed into law on March 27, 2020. of this change, the Secretary of the Treasury (with the
It appropriates $500 billion to the U.S. Department of approval of the President) has almost unlimited authority to
Treasury’s Exchange Stabilization Fund (ESF) to support “deal in gold, foreign exchange, and other instruments of
loans, loan guarantees, and investments for businesses credit and securities.” Decisions of the Treasury Secretary
affected by COVID-19. In addition, the act temporarily are final and may not be reviewed by another government
permits the use of the ESF to guarantee money markets, as official. Nevertheless, Treasury is required to provide
occurred in the 2008 financial crisis. ESF assets have monthly reporting on the ESF’s operations to Congress.
already been pledged in 2020 to backstop several ESF loans are not open-ended. When Congress expanded
emergency lending facilities created by the Federal Reserve the scope of the ESF’s authority in 1978, it added a
(Fed) in response to COVID-19. restriction that ESF loans could not exceed six months
unless the President notified Congress that “unique or
The original purpose of the ESF was to give the United exigent circumstances” were present. Such notifications
States adequate financial resources to stabilize the value of were provided regarding ESF credit exposure to Mexico in
the dollar by buying and selling foreign currencies and 1982 and in 1995 and to Brazil in 1998.
gold. In the exigencies of the 2008 financial crisis, the ESF
was used differently as Treasury sought a source of “Consistent with the obligations of the Government in
unfettered money to quickly stop a run on money markets the International Monetary Fund on orderly exchange
that threatened further financial instability. Although arrangements and a stable system of exchange rates,
legislation subsequently forbid Treasury from using the the Secretary ... with the approval of the President
ESF for this purpose in the future, the ESF is being looked may deal in gold, foreign exchange, and other
to today as a tool to address financial unrest. instruments of credit and securities…” – 31 U.S. Code
§5302. Stabilizing exchange rates and arrangements
Background
The ESF was established by Section 10(a) of the Gold In addition to its initial capitalization ($2 billion), Congress
Reserve Act of January 30, 1934 (31 U.S.C. §5302) to allowed the ESF to remain outside annual appropriations
stabilize the exchange value of the dollar. Similar funds of and imposed no overall size limit. Instead, the ESF retains
European countries were heavily intervening in foreign all of the earnings from its operations. The main limitation
exchange markets at that time, engaging in competitive on the ESF’s ability to intervene to impact the value of the
currency devaluations. The ESF was established with $2 dollar is the amount of dollar-denominated assets in its
billion appropriated from profits realized from the Gold portfolio, which are $22.67 billion as of February 2020. To
Reserve Act’s revaluation of U.S. gold holdings from secure more dollars for foreign exchange operations,
$20.67 per troy ounce to $35. Treasury could (1) seek an additional appropriation from
Congress; (2) monetize its holdings of IMF special drawing
During the 1930s, the ESF was actively used to manage the rights (SDR, an international reserve asset), valued at $50
foreign exchange rate of the U.S. dollar. After World War billion, by temporarily selling them to the Fed; or (3)
II, when the International Monetary Fund (IMF) was engage in a currency swap arrangement called
established, the ESF was the source of funds for the U.S. “warehousing”—in which the ESF sells foreign currency to
contribution. As provided in the Bretton Woods Agreement the Fed and agrees to repurchase it at a later date, during
Act of 1945 (31 U.S.C. § 5302), $1.8 billion of the ESF’s which the Fed credits dollar reserves to the ESF for the
capital of $2 billion was used to make a partial payment on duration of the swap. The limit on warehousing is $5
the U.S. subscription to the IMF. The Bretton Woods billion, but this limit was temporarily raised to $10 billion
Agreement Act of 1945 also included permanent authority in 1989 and $20 billion in 1995. The last use of the
for the ESF. warehousing arrangement was from 1988 to 1992.
In 1973, with the demise of the post-World War II gold ESF Use Before 2008
standard, where the dollar was pegged to gold and other The ESF’s primary use until 2008 was to finance short-term
countries’ currencies were pegged to the dollar, the explicit loans to foreign countries facing a financial crisis, including
purpose of stabilizing the exchange value of the dollar was Brazil and Mexico, primarily in Latin America and the
stricken from the ESF’s statute, and its purpose was Caribbean. The ESF has also been used to provide bridge
expanded. Language alluding to “stabilizing the exchange loans to foreign countries while they were negotiating
value of the dollar” was deleted, and language referring to longer-term IMF financing.

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Treasury’s Exchange Stabilization Fund and COVID-19

Since moving to flexible exchange rates, the United States COVID-19 crisis has ended. There is speculation about
stopped intervening in foreign exchange markets, for the whether such a guarantee would be initiated in the current
most part, by the mid-1990s. Since then, the United States, crisis if the law were changed.
in coordination with other countries, has intervened on
three isolated occasions—in 1998, 2000, and 2011. CARES Act Funding to ESF
The CARES Act provides Treasury with up to $500 billion
2008 Money Market Guarantee through the ESF to make loans, loan guarantees, or
The 2008 financial crisis saw a novel and controversial investments to assist eligible businesses, states, and
pledge of the ESF for purposes that were not directly municipalities affected by COVID-19 until the end of
related to exchange rates or the value of the dollar—a 2020—referred to by some as “bailouts.”
money market guarantee.
Treasury can make loans and loan guarantees directly to
Money market mutual funds (MMFs) are a type of mutual companies in three industries: (1) up to $25 billion to
fund that generally invest in high-quality, short-term assets. passenger air travel; (2) up to $4 billion to cargo air
Often the value of a share is held at $1 per share, and fund carriers; and (3) up to $17 billion to businesses critical to
gains are paid out as dividends mimicking interest national security. Restrictions on executive compensation,
payments. Thus, they are seen as largely analogous to bank stock buybacks and dividends, conflicts of interest, and loan
deposits but are not guaranteed by the Federal Deposit forgiveness apply to this assistance. Borrowers must issue
Insurance Corporation (FDIC). financial protection (e.g., warrants) to Treasury to provide it
with potential financial upside.
As part of the market turmoil resulting from the bursting of
a nationwide housing bubble on September 16, 2008, an The remainder (at least $454 billion) is available to support
MMF called the Reserve Fund “broke the buck,” meaning facilities established by the Fed to provide liquidity to
the value of its shares had fallen below $1. This occurred businesses, states, and municipalities. To date, these funds
because of losses it had taken on short-term debt issued by have been used to cover potential future losses on Fed
the investment bank Lehman Brothers, which filed for emergency facilities created in response to COVID-19 for
bankruptcy on September 15, 2008. Money market corporate bonds, commercial paper, asset-backed securities,
investors had perceived “breaking the buck” to be highly money market funds, municipal debt, and loans to
unlikely, and its occurrence set off a generalized run on businesses with under 10,000 employees.
MMFs, as investors simultaneously attempted to withdraw
an estimated $250 billion of their investments—even from These facilities were authorized under the Fed’s emergency
funds without exposure to Lehman Brothers. lending authority (Section 13(3) of the Federal Reserve Act
(12 U.S.C. 343)). Some of these facilities resurrect ones
To stop the run, Treasury announced an optional program to created in 2008 in response to the financial crisis, which
guarantee deposits in participating money market funds. extended the Fed’s role as lender of last resort from the
Treasury would finance any losses from this guarantee with banking system to the overall financial system for the first
assets in the ESF. Treasury announced this program without time since the Great Depression. Although the Fed did not
seeking specific congressional authorization, justifying the rely on the ESF in 2008 and no 2008 facility experienced
program on the grounds that guaranteeing money market any losses, Treasury has pledged ESF assets to back several
funds would protect the value of the dollar. The program Fed facilities in 2020, in some cases before the CARES Act
expired after one year in September 2009. Funds utilizing was enacted.
the guarantee program paid fees for the guarantee of
between 0.015% and 0.022% of the amount guaranteed by ESF backing of Fed facilities may reflect the significant and
the program. uncertain economic risks associated with COVID-19. Use
of the ESF may be seen to allow these facilities to meet the
Over the life of the program, Treasury reported that no Dodd-Frank Act’s (P.L. 111-203) requirement that the
money market fund guarantees were invoked, and $1.2 Fed’s 13(3) lending is secured “sufficient[ly] to protect
billion in fees had been collected. The ESF was small taxpayers from losses”; although, given ESF losses would
compared to industry assets. More than $3 trillion of ultimately be borne by taxpayers, it is unclear if this
deposits were guaranteed and, according to the Bank for requirement is actually being met in a broader sense.
International Settlements, 98% of U.S. money market funds
were covered by the guarantee, with most exceptions being CRS Resources
funds that invested only in Treasury securities. However, a CRS Report R46301, Title IV Provisions of the CARES Act
guarantee was credible as long as the ESF was expected to (P.L. 116-136), coordinated by Andrew P. Scott
be larger than guaranteed losses.
CRS Report R44185, Federal Reserve: Emergency
The Emergency Economic Stabilization Act of 2008 (P.L. Lending, by Marc Labonte
110-343) included language that directed the Treasury
Secretary to reimburse the ESF for any funds used for the Marc Labonte, Specialist in Macroeconomic Policy
money market guarantee program and prohibited use of the Baird Webel, Acting Section Research Manager
ESF in the future for such a program. To date, a similar Martin A. Weiss, Specialist in International Trade and
MMF guarantee has not been created in 2020. The CARES
Finance
Act temporarily removes these restrictions until the

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Treasury’s Exchange Stabilization Fund and COVID-19

IF11474

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