The Bloomberg news organization has prevailed in a court action designed to force the Federal Reserve to disclose information about its emergency lending programs under the Freedom of Information Act. This is a remarkable and noteworthy outcome which you can read about here.

The Fed’s job is and always been to act as a lender of last resort in times of financial stress. More precisely, it’s there to lend money at generally high interest rates to institutions needing liquidity, so long as they present excellent collateral. Extraordinary and seasonal credit facilities are very seldom used in normal times, but the simple fact that they exist provides a very important psychological support to the financial system. This matters greatly, because psychology is precisely the reason that isolated panics can turn into liquidity crises.

The Fed, rightly, has always protected the identity of its borrowers and the nature of their collateral. This is information that can and will be misused by competitors, and will lead to even more liquidity problems for affected institutions.

This traditional argument was used by the Fed in defending itself against the Bloomberg organization’s desire to get raw material for news. This time, however, the argument didn’t fly. One suspects that the legal theory used in the court case turned on the Fed’s status as a quasi-independent, semi-governmental authority. While interesting, that side of the question is something of a red herring. And the news stories will certainly talk about how important “transparency” is.

There’s an awfully big difference between liquidity problems and insolvency. The Fed always has lent on excellent collateral because a solvent institution facing near-term illiquidity can be judged a good risk, and the emergency lending does have the effect of stabilizing markets. Usually, the Fed requires US Treasury securities as collateral, and even then it imposes a “haircut” (ie, you can only borrow up to a certain percentage of the value of your collateral).

But this crisis has been unusual in that the Fed began accepting a very different class of collateral, starting with the illiquid mortgage-backed and agency securities it accepted from Bear Stearns. As the economy skidded late last fall, they went even farther, directly purchasing securities in the open market that were backed by such risky things as car loans and credit-card receivables.

In all of this activity, the Fed did something it’s never done before, which is to directly take on credit risk. This isn’t the Fed’s job at all. It’s the job of the banks, but they stopped doing it, so the Fed decided to step in. The alternative would have been to see credit intermediation collapse further, resulting in an even weaker economy.

For the Fed to lend money on highly risky collateral is no longer simply an exercise in guaranteeing systemic liquidity. It’s an attempt to insulate the system from the effects of widespread insolvency and undercapitalization. That’s a very, very different role.

It would be very good to carefully discuss that role and whether it’s appropriate for the Fed have undertaken it, and to continue it as it is doing. We’ll do that another day. Let’s get back to the question at hand.

Should the Fed be forced to fully disclose the borrowers and the collateral in its emergency programs? If this were traditional, strong collateral, I’d say emphatically no, for all the traditional reasons.

But given that something very unusual is going on, I say yes. And I say that with full knowledge of the fact that some borrowers and their trading positions will certainly be harmed as a result.