With latest moves, Fed becomes creditor in chief for U.S. business
In undertaking what will undoubtedly be its largest rescue effort ever, the Federal Reserve on Monday announced programs that represent a never-before-seen intervention by the central bank into the heart of the “real” American economy.
Chair Jerome Powell and his colleagues, in a desperate gambit to prevent outright economic calamity during the coronavirus pandemic, are on the cusp of redefining the long-established role of the U.S. central bank, extending its “lender of last resort” power from Wall Street to Main Street and City Hall.
With many details still being hammered out as to just how it pulls off such a historic effort, the Fed – in partnership with the U.S. Treasury – aims to cast a financial lifeline to millions of American companies both large and small and potentially hundreds of local governments as it battles a crisis of still unknown proportions.
But the numbers are massive, with some analysts saying that an expanded Treasury commitment, leveraged by the Fed, could make $4 trillion or more in loans to nonfinancial firms.
“This is the Fed taking a really huge step to try to backstop the financing of real activity,” said Bill English, a Yale School of Management professor and former head of the Fed’s monetary affairs division. The programs “can be ramped up. They can take on more risk. It is a suite of programs that is pretty complete.”
Karen Petrou, managing partner at Federal Financial Analytics, was more blunt: “This isn’t helicopter money – it’s the Fed becoming a B1 bomber, dropping hundreds of billions into a desperate economy. When the funds land, they will do a lot of good.”
“Thereafter, central banking will be forever redefined.”
WHO WILL BUY? THE FED WILL
Just over a decade ago the Fed was pressed to take hitherto unheard of actions to keep the financial system from collapse, then too expanding the boundaries of traditional central banking.
To that moment, central banks largely operated on the assumption that setting short-term interest rates was sufficient to help manage business cycles.
But the Fed helped bail out banks, plugged holes deep in the financial system, bought trillions of dollars in bonds and engineered a low-interest rate landscape that helped foster an arduous recovery from the 2007-2009 financial crisis and recession.
The Fed’s new efforts are meant to have enough combined sweep to let ordinary businesses of any size survive through the unprecedented drop in commerce required to halt the spread of the coronavirus.
If it has a parallel, it may be more akin to famed banker J.P. Morgan’s pledge in 1907 – more than half a decade before the Fed was brought into existence – to buy any assets brought to his door in an effort to stem a panic.
Though still cast in the usual Fed language of ensuring “liquidity” and keeping financial markets moving, the implications are more profound – of central bank loans scaled to such a point that they undergird payrolls, rents, and firm survival as the coronavirus economic shock rolls through.
The effort nonetheless shows the Fed casting aside constraints on several fronts to ensure that companies can issue bonds and get loans and limit the risk that the halt in business required to combat the health crisis leads to widespread failures and bankruptcies.
Compared with the crisis fight a decade ago, when the Fed rolled out bondbuying programs a step at a time in the face of political opposition to central bank “overreach,” the Fed has now pledged upfront to buy whatever amount of Treasury and other government-backed securities it decides is needed to keep long-term borrowing costs down.
It has found workarounds for restrictions on buying corporate debt directly by establishing a “special purpose vehicle” that will make those purchases – with money borrowed from the Fed and with Treasury providing capital to be used in case there are losses.
There may be limits to how far the Fed’s reach extends there.
The corporate bond purchases will be confined to companies with an “investment grade” credit rating, a standard some firms may fail to meet in coming weeks as business erodes. Non-investment grade companies – so-called “junk bond” issuers – are not covered at all.
But the thrust is to keep defaults and failures to a minimum.
MORE DETAILS TO COME
For smaller firms, without access to corporate credit markets, details of a program are still being worked out with Congress and the Small Business Administration, but could provide hundreds of billions of dollars more in lending to “Main Street.”
Many of the programs introduced so far follow the playbook of the 2007 to 2009 crisis, with the central bank again agreeing to accept bundled groups of assets secured by auto loans, credit cards and other more standardized types of bank lending as collateral for loans from the Fed. Those programs were all gradually wound down after the crisis eased, and generally earned the central bank a profit.
But those programs also ushered in a new normal in which the Fed gradually acknowledged that it would always own several trillions of dollars in government bonds in order to manage the economy, and that interest rates would likely remain low.
“Normal” is again being redefined as the Fed now stands to become the chief creditor for even the narrowest parts of the economy, and with its timeline for leaving that role anything but certain.
“There are going to be a lot of questions about exit at the end of this,” said English, with the answer framed by how effective the programs are in stabilizing the economy and helping it restart.
“The economy could recover very quickly after this. The financial knock-on effects – the failure of business and households – could make it a more protracted downturn, and that is what you are trying to avoid.”