The extraordinary actions of the Federal Reserve on Monday morning can be boiled down to two sentences: There is a rapidly developing shortage of dollars across the economy. And the Fed will do anything it needs to, on any scale imaginable, to end this shortage.
Its announcement was phrased in the dry bureaucratese typical of statements from a central bank. But it contains a powerful idea. The Fed, the one entity in the world with the power to create dollars out of thin air, has every intention of doing so at whatever magnitude is necessary to try to reduce the severity and limit the duration of the coronavirus economic crisis.
“The Federal Reserve is committed to using its full range of tools to support households, businesses and the U.S. economy over all in this challenging time,” the statement begins.
Unlike some past grand statements from central bankers promising to do “whatever it takes” to solve a crisis, this one was accompanied with actions matching the scale of the words.
It’s really two distinct crises the Fed is trying to solve, with overlapping tools.
One is an already-underway crisis in which financial markets are breaking down, failing in some of the same ways they did in the 2008 financial crisis — and thus threatening to make the economic crisis worse. The other is the threat of widespread business failures that could create mass bankruptcies, leaving millions of Americans jobless even once the virus is contained.
The Fed’s new open-ended quantitative easing — signaling it will buy Treasury bonds and mortgage-related securities in whatever quantities are needed — is aimed at the first goal, of making financial markets function more like usual. In the last three weeks, financial markets have frozen up as all sorts of investors hoard cash and dump everything else.
A vicious cycle is underway: Fearful investors sell assets to raise cash, which drives down the prices of those assets, which spurs more fear and desire to hoard cash. That, in turn, has caused credit to dry up, or to be available only at soaring costs, for nearly everyone: corporations, state and local governments, people seeking a mortgage loan, and even, at times, the U.S. government itself.
At the very time the Fed wants to make lending more freely available to help the economy, the opposite is happening.
The Fed’s response is very much in line with its actions in 2008 and 2009, aimed at creating a wall of money that stops that cycle. Eight days ago, the central bank announced $700 billion in bond purchases to serve as that wall. Now it is saying that could be higher, plausibly in the trillions of dollars.
For context, the initial phase of crisis response in the fall of 2008 increased the size of the Fed’s balance sheet by $1.3 trillion. Analysts at Evercore ISI estimated Monday that the increase in this episode could end up being in the ballpark of $5 trillion.
But returning the financial markets to more normal functioning won’t be enough, given the peril facing U.S. business. And that’s where the second part comes in.
To address the cash flow crisis that millions of companies are facing, the central bank is following a multipronged strategy to try to funnel lending on favorable terms to businesses facing trouble, with a lot of help from the U.S. Treasury.
To benefit the large companies that are able to borrow money by issuing debt on financial markets, the Fed is creating two new programs to buy corporate bonds. Another program, this one dusted off from the 2008 crisis, will pump money into lending to consumers and small businesses.
Intriguingly, the Fed intends to create a “Main Street Business Lending Program” to funnel money to smaller businesses lacking access to Wall Street debt markets. The idea is that small companies can borrow money to help meet payroll, rent and other obligations during the crisis, with no interest or principal payments for six months and repayment over the next four years.
A central economic challenge right now is ensuring that otherwise sound small businesses do not succumb to the crisis — that even if their revenue plummets or they must close temporarily, they can reopen when it passes and return to their productive role in the economy. Loans on favorable terms could help them do just that.
These programs rely on new “special purpose vehicles,” which also include an investment from the Treasury Department. In effect, the Treasury is putting money at risk with the Fed pumping in the bulk of the money. Initially, those sums total up to $300 billion, which could reach higher if Congress gives Treasury additional capital in stimulus negotiations underway now.
The political situation on Capitol Hill is fluid, and some Democrats are reluctant to give the Trump administration what amounts to a blank check. And we don’t know how effective the Fed programs will be at getting money into the hands of cash-poor businesses and preventing a cascade of failures.
But what is becoming clear is that the test for Chairman Jerome Powell and his colleagues is no longer whether they appreciate the scale of the crisis the economy is facing. It’s evident that they do. Now it’s about making the bureaucratic details work well enough to get money where it is needed.