My March 23 post listed all of the Federal Reserve’s major moves to keep the economy going amid the COVID-19 crisis. All those moves, through March 20, were entirely appropriate: providing more liquidity across a broad swath of financial markets is exactly what the Fed should do in a liquidity crisis.
But I warned that the Fed’s March 23 creation of the Primary Market Corporate Credit Facility was a troubling departure from the norm because it meant that the Fed would be lending directly to private companies. Perhaps worse, they would be doing it just as the shutdowns were threatening to create a major solvency crisis.
Lending to solvent but illiquid financial firms is one thing; lending directly to commercial businesses as they are failing is completely different. As I argued then, if Congress wants to provide money to failing firms, they should do it directly rather than pass the buck off to the unelected officials who work at the Federal Reserve.
After that post, the economic situation continued to worsen.
By April 20, more than 40 state governors had issued some type of “shutdown” or “stay at home” order, closing all “non-essential” workplaces. As Congress passed new legislation, the Federal Reserve continued its aggressive response. Here is a list of the Fed’s announcements made since March 23.
- March 23 – the creation of the Primary Market Corporate Credit Facility (PMCCF). Through the PMCCF, the New York Fed will lend money to a legal entity known as a special purpose vehicle (SPV) that will, in turn, buy corporate bonds directly from U.S. companies and extend loans directly to those same companies. The bond issuing companies must have a credit rating of at least BBB-/Baa3 to be eligible for funding through this program. The U.S. Department of the Treasury used its Exchange Stabilization Fund to make an initial $10 billion equity investment in this SPV. Depending on the credit rating of the issuer, the PMCCF will purchase a maximum of between 110 and 140 percent of an issuer’s outstanding bonds. The program is set to end no later than September 30, 2020.
- March 23 – the formation of the Secondary Market Corporate Credit Facility (SMCCF). To establish the SMCCF, the New York Fed will lend to an SPV that will, in turn, purchase corporate bonds and corporate bond portfolios in the form of exchange traded funds in the secondary market (i.e., from investors that have already purchased bonds from the firms that originally sold them). Treasury used its Exchange Stabilization Fund to make an initial $10 billion equity investment in this SPV. The SMCCF will not purchase more than 10 percent of an eligible issuer’s maximum outstanding bonds during the last year, and the SMCCF will not purchase more than 20 percent of the assets of any exchange traded fund. The program is set to end no later than September.
- March 23 – establishment of the Term Asset-Backed Securities Loan Facility (TALF). The TALF will make loans (with 3-year terms) to companies that hold asset-backed securities (ABS) backed by “student loans, auto loans, credit card loans, loans guaranteed by the Small Business Administration (SBA), and certain other assets.” The TALF will make, in aggregate, up to $100 billion in loans through an SPV at the New York Fed. Eligible borrowers are all “U.S. companies that own eligible collateral [certain ABS issued after March 23] and maintain an account relationship with a primary dealer.” Treasury will make an equity investment of $10 billion in the SPV.
- March 23 – the expansion of the Money Market Mutual Fund Liquidity Facility (MMLF). Created on March 18, the MMLF (administered by the Boston Fed) provided loans to banks that issue certain money market funds so that they could meet redemption demands as “households and other investors” redeemed their funds for cash. Treasury provided $10 billion of “credit protection” to the Fed for the MMLF through the exchange stabilization fund. On March 23, the Fed announced that it would expand the MMLF by accepting as collateral “a wider range of securities, including municipal variable rate demand notes (VRDNs) and bank certificates of deposit.”
- March 23 – the expansion of the Commercial Paper Funding Facility (CPFF). Created on March 17, the CPFF provides loans, through an SPV, to U.S. issuers of commercial paper. In other words, the Fed uses the CPFF to buy commercial paper. Treasury provided $10 billion of “credit protection” to the Fed for the CPFF through the exchange stabilization fund. On March 23, the Fed announced that the CPFF would also lend to issuers of high-quality, tax-exempt commercial paper, and that the pricing would be reduced. The CPFF loan pricing will be based on the current 3-month overnight index swap rate plus, depending on the rating of the commercial paper, 110 to 200 basis points. The CPFF will lend to issuers through March 17, 2021 unless the Fed extends the facility.
- March 31 – established a temporary foreign and international monetary authorities (FIMA) Repo Facility. This facility will allow FIMA account holders, “which consist of central banks and other international monetary authorities with accounts at the Federal Reserve Bank of New York, to enter into repurchase agreements with the Federal Reserve.” Through this facility, the Fed purchases treasuries from FIMA account holders who promise to repurchase the treasuries at a later date.
- April 6 – announced a program to facilitate lending to small businesses via the Small Business Administration's Paycheck Protection Program (PPP). Under the PPP, banks make loans to small businesses (those with 500 or fewer employees) and the loans are fully guaranteed by the Small Business Administration. This lending program, known as the Paycheck Protection Program Liquidity Facility (PPPLF), is administered by the Minneapolis Fed. Through the PPPLF, the Fed provides loans to the banks making the PPP loans. The PPP was enacted by the $2.3 trillion Coronavirus Aid, Relief, and Economic Security (CARES) Act, a law that authorized up to $349 billion in small business loans which, ultimately, can be fully forgiven.
- April 9 – established a Municipal Liquidity Facility. This facility allows any district Federal Reserve Bank to buy state and municipal bonds. Currently, the aggregate total allowed for this facility is $500 billion in debt. As with other Fed lending facilities, these purchases are conducted through an SPV. With some exceptions, the SPV can purchase debt “issued by or on behalf of a State, City, or County in one or more issuances of up to an aggregate amount of 20% of the general revenue from own sources and utility revenue of the applicable State, City, or County government for fiscal year 2017.” Treasury will make an initial equity investment of $35 billion in the SPV.
- April 9 – amended the TALF. In addition to the initial types of loans, the TALF now makes loans (with 3-year terms) to companies that hold ABS backed by leveraged loans and commercial mortgages. The Fed also provided more specificity – and slightly different prices for some ABS – than in the original announcement.
- April 9 – amended the PMCCF and the SMCCF. The combined maximum size of the PMCCF and the SMCCF will be $750 billion, and Treasury will make a $75 billion equity investment in the SPV to support both facilities (the initial allocation will be $50 billion to the PMCCF and $25 billion toward the SMCCF. The pricing for bond purchases will be “issuer-specific, informed by market conditions, plus a 100 bps facility fee.”
- April 9 – created the Main Street Lending Program which consists of the Main Street New Loan Facility (MSNLF) and the Main Street Expanded Loan Facility (MSELF). The Fed will use an SPV to implement both of these facilities, and the Treasury will make a $75 billion equity investment in the SPV (as appropriated to the Exchange Stabilization Fund via the CARES Act). For both new loans and expanded loans, private banks will facilitate the loan and then sell 95 percent of the loan (or the expanded loan amount) to the Federal Reserve. In other words, the Fed is effectively lending to private commercial firms. Eligible borrowers are U.S. companies that have no more than 10,000 employees or a maximum of $2.5 billion in 2019 annual revenues. Loans under both facilities have 4-year maturities, amortization of principal and interest deferred for one year, and have to be for at least $1 million (new loans have a maximum of $25 million and expansions have a maximum of $150 million). The maximum combined lending under these facilities is $600 billion.
Merits aside, between early March and late April, the Fed has created 11 new lending facilities. Although three of these facilities were created to facilitate loans authorized in the new CARES Act, all of the facilities were created without any amendments to the Federal Reserve Act. (Perhaps Dodd-Frank did not overly restrict the Fed’s emergency lending authority after all.)
While it is true that Treasury took an “equity stake” in most of these lending facilities, it was not required by the Federal Reserve Act or necessary as a matter of economics. The Fed is not a private bank, it does not have to meet capital requirements, and it does not have to redeem any of its liabilities. If the Fed loses money, it actually can just “print” more.
The economic constraint on the central bank printing more money is how much of its excess money creation the public will tolerate. That point of intolerance is not precisely knowable, but it is most likely reached only in limited circumstances, such as if the Fed creates an inflation problem or if citizens revolt against profligate bailouts and spending.
As a matter of law, the question of whether having the Federal Reserve or Treasury directly finance private companies is a little different.
During the New Deal era, Congress gave the Fed the legal authority to make such loans. The 1934 Industrial Advances Act created Section 13(b) in the Federal Reserve Act, and it authorized the District Banks to provide loans directly to industrial and commercial businesses, for periods of up to five years without any limitations as to the type of collateral. By 1939, the district banks had provided nearly $200 million in working capital loans to nearly 3,000 applicants.
But things did not work out so well, and the Federal Reserve Board itself appealed to Congress to eliminate the Section 13(b) authority. It took years, and Congress finally obliged in 1958, when Fed Chairman William McChesney Martin testified to Congress that the Fed should not provide capital to institutions and that its primary objective should be “guiding monetary and credit policy.”
At best, making these loans blurred the line between fiscal and monetary policy, and they were, in the words of noted economist Anna J. Schwartz, “a sorry reflection on both Congress's and the Fed's understanding of the System's essential monetary control function.” (This problem is even worse now).
Legally, this question comes down to who has the power of the purse. (George Selgin has an excellent discussion at Atl-M.) If the Fed’s new lending facilities lose the money that Treasury provided as equity investments, then there’s no problem in the sense that Congress openly appropriated those funds.
If, on the other hand, losses exceed the appropriated funds, then Congress could appropriate additional funds or the Fed would have to cover the losses. Naturally, this latter course would mean that the Fed would have to pay more than Congress appropriated. Whether the Fed or the Small Business Administration has to pay more than Congress appropriates to cover a lending program is irrelevant. The Fed’s additional expenditure would be outside of the normal budget process, but that’s a technical matter.
Both agencies’ actions would be in direct conflict with the underlying structure of the U.S. government—the Constitution gives the power of the purse to the elected members of Congress. This sort of off-budget slight-of-hand begs for Congress to start using the central bank as a piggy bank.
The fact that the Federal Reserve’s post-2008 operating framework divorces their monetary policy stance from the size of the Fed’s balance sheet makes this situation that much more troubling. The new framework is designed to allow the Fed to purchase as many assets as it would like, all while paying firms to hold on to the excess cash that these purchases create.
It is ripe for allowing the Fed to be a pawn of Congress (or the Treasury), enabling the government to paper over larger and larger deficits, a trick that cannot continue indefinitely. Moreover, while the Fed is now facing enormous pressure to disclose which firms are receiving funds through its emergency programs, that pressure is nothing compared to what it would face if it were regularly providing direct financing at the direction of Congress and Treasury while paying enormous sums to banks in an effort to control inflation.
As my last post argued, if Congress wants to send money to everyone and make loans to businesses, they should stand up and do it rather than pass the buck off to the unelected officials who work at the Federal Reserve.
This piece originally appeared in Forbes https://www.forbes.com/sites/norbertmichel/2020/04/27/the-federal-reserve-should-not-help-congress-duck-its-responsibilities-part-2/#40d07255ec5a