New Tool Kit
The Fed has pledged an unlimited amount of quantitative easing (QE) or asset purchases. Those efforts are focused on the Treasury bond, mortgage-backed securities markets and commercial mortgage-backed securities. The Fed announced $700 billion in just Treasury and mortgage-backed securities on March 15 but was on track to use up those funds this week. These new efforts will help keep the Treasury and mortgage market liquid for consumers looking to refinance and commercial builders hoping to stay afloat. The Fed seems to be sending the message to Congress that it is willing to monetize debt needed for stop-gap measures. We are actually learning, not emulating Japan here. Japan suffered stagnation and deflation because of its unwillingness to go bigger and more aggressively on QE when its crisis started in the late 1980s (Yes, that is how long ago that bubble burst). The Fed’s balance sheet is already at a record-breaking $4.7 trillion and will expand rapidly in the weeks and months to come. The goal will be to restart and reinflate a deflating economy.
The Fed will start buying corporate bonds with ratings of at least BBB/Baa3. That is just above the investment grade level and includes the largest share of corporate bonds. The loans are four years or less and prohibit firms from using the funds for stock buybacks or dividends. They exclude businesses that are getting direct assistance from Congress. The shale industry is under particular strain given its more than $300 billion in BBB-rated debt; oil prices have dropped below break-even for the U.S. industry and are expected to stay there for some time (as much as a year), depending on the size and length of the demand shock tied to COVID-19 combined with the price war now underway between Russia and Saudi Arabia; both countries would like to see our shale industry idled.
The Fed will provide liquidity for outstanding corporate bonds including those in exchange traded funds (ETF). These loans go up to five years in duration and exclude businesses that are getting direct assistance from Congress; again, no stock buybacks or dividends during the length of the loan.
The Fed resurrected a crisis-era facility from 2008-09 that allows it to extend three-year loans to businesses. Collateral accepted to back these loans includes car loans, student loans, credit cards and small business loans. This is designed to ease the upfront crunch on cash flow with easier terms for borrowers.
The Fed will support money markets including municipal bonds. This is to narrow credit spreads and make it easier for state and local governments, who are on the front line battling COVID-19, to fund their operations; these are 12-months in duration. The Fed will support three-month commercial paper including municipalities. Foreign banks operating in the U.S. can participate. The mounting costs of this crisis to state and local governments are risking massive cuts to government budgets, which will inhibit their ability to fight the crisis and could accelerate layoffs and cut critical services.
The Fed is planning to launch a direct-lending program to consumers and small and medium-sized businesses. This will be done via the Federal Reserve’s regional bank network, where loans can be better assessed and expedited.
The bulk of these actions are designed to stay in place until September 30. Dates can change but this underscores an important message: The health crisis itself has an end date.
These moves are in addition to actions the Fed has already taken, which include cutting short-term interest rates to zero, eliminating reserve requirements to get banks to lend more aggressively and regulatory changes that encourage lenders to go easier on affected borrowers. The Fed is encouraging lenders to work with borrowers to waive late fees, defer payments and restructure loans without fees to help get borrowers through the cash crunch. The Fed has started to provide liquidity for money market funds, which are critical to the funding of the short-term commercial paper market. Layoffs surged when those markets seized up during the global financial crisis in 2008-09.
The Fed is doing its job and then some. The Fed’s focus is to help firms, local governments and individuals who are suffering at no fault of their own, due to the mandatory work stoppages needed to contain the spread of the virus. Congress needs to step up, pass what they can agree on to get funds out the door, set up a way to vote remotely (many are now quarantined) and develop a pipeline of stop-gap measures to keep the process going. Members can’t allow their differences to delay votes on what’s necessary.
Measuring current economic conditions to help plot and adjust course
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