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NEW YORK — The Federal Reserve, which prides itself on never having lost a dime on a loan it made, is sitting on almost $1 billion of debt in a hotel chain that filed for bankruptcy court protection.
The disclosure of that surprising news came not from the central bank, but from this week's bankruptcy filing by Extended Stay Hotels. It listed an entity controlled by the Fed as the company's third-largest creditor, an investment it reluctantly inherited after the collapse of Bear Stearns last year.
For the Federal Reserve, which has pledged to be more forthcoming about how hundreds of billions of dollars of its funds are being used to bail out the financial system, this lack of transparency is troubling.
It's also a sobering reminder to members of Congress, some of whom are already questioning the Obama administration's proposal to boost the power of the U.S. central bank as part of a broad overhaul of the financial regulatory system.
The Fed's primary role has long been to manage the nation's money supply and oversee the U.S. banking system. It can influence the direction of the economy through monetary policy by raising or lowering interest rates.
Over the last two years, the central bank has used its emergency powers to establish various programs to lend or buy debt to help mend the financial system and lift the country out of recession. In the process, its balance sheet holdings have more than doubled since September and now total more than $2 trillion.
Those programs have saddled the Fed with massive credit risk, but the public has largely been unaware of what's behind the numbers.
The Fed just last week started releasing monthly figures for its credit and liquidity programs that began in the summer of 2007. While that's a step in the right direction toward boosting transparency, it doesn't go far enough.
"A lot of what is presented have valuations that are already outdated," said Robert Eisenbeis, chief monetary economist at the portfolio management firm Cumberland Advisors and a former director of research at the Federal Reserve Bank of Atlanta.
Details in the monthly reports are also skimpy. Eisenbeis points to disclosures about the holdings of Maiden Lane LLC, which was formed by the Fed in the spring of 2008 to facilitate Bear Stearns' fire sale to JP Morgan Chase & Co. As part of that arrangement, the Fed supplied a line of credit to Maiden Lane to fund the purchase of Bear Stearns assets.
As a result, the $29 billion in assets that landed on the Fed's books include commercial and residential loans and other mortgage-related securities. As of March 31, the Fed valued those holdings at $25.3 billion. That's a loss on paper of almost $4 billion, but Eisenbeis thinks the losses are even bigger since those numbers are almost three months old — an eternity in today's financial world.
Bundled in the Maiden Lane holdings is some of the debt of Extended Stay Hotels, headquartered in Spartanburg, S.C. The hotel chain has been battered by a plunge in spending among business travelers. But most of its woes are self-inflicted; its debt burden ballooned after a 2007 takeover that was financed by $7.4 billion in loans.
The Fed wound up with $744 million of various junior classes of Extended Stay's debt and $153 million of senior debt.
It isn't yet known what the Fed will be entitled to as Extended Stay reorganizes under Chapter 11 bankruptcy court protection, which it entered on Monday. A spokesman for the Federal Reserve Bank of New York declined comment.
But the bankruptcy filing values the reorganized company at $3.3 billion, not even worth the $4.1 billion of its first mortgage loans. That means creditors will likely have to take a haircut.
The case of Extended Stay exemplifies what kind of junk could be littering the Fed's balance sheet outside of public view. There is plenty more that also hasn't been disclosed — like which banks are borrowing from the Fed or details surrounding the hiring and work of BlackRock, which is managing the distressed assets acquired by the Fed.
The central bank has been resistant to reveal too much granular information, which officials say is confidential. They also contend it could rattle investors or depositors of a particular bank seeking emergency funds if that information is made public.
But those excuses don't hold up.
"The Fed hasn't given a good rationale for why so much information has been kept secret," said Dean Baker, co-director for the Center for Economic Policy and Research, a liberal think tank. "I understand that it doesn't want to cause panic, but it still should have to disclose details after the fact."
All this may have to change before Congress grants new powers to the Fed. Under the regulatory overhaul proposal announced on Wednesday, the central bank would have broad oversight of the entire U.S. financial system. That would allow it to monitor risk by regulating some of the largest and most interconnected institutions in the financial world.
The White House is pressing for such changes to try to prevent future financial crises of today's magnitude. It also wants to boost confidence about the health and oversight of the financial system.
Removing the Fed's shroud of secrecy should be a first step in getting that done.
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Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck(at)ap.org
