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Fed Bazooka Morphs Into A Cannon

The scourge of the novel coronavirus and the draconian measures required to tame it will inflict damage on the US economy such as has not been seen since the Great Depression. Unprecedented threats call for unprecedented measures, and on Monday morning the Federal Reserve delivered.

While Congress squabbles about details of a massive spending bill and the White House sends conflicting signals over mobilizing production of essential supplies, the Federal Reserve Board announced a suite of aggressive and somewhat experimental weapons in the battle to stabilize the economy and the markets. In essence, the message is this: we have unlimited capacity and intend to use it.

Only a week ago, the central bank announced a new $700 billion plan to purchase Treasury bonds and mortgage securities in an effort to get money flowing into the system. Having blown through half of that in just a few days, all limits are off and the Fed balance sheet is primed to balloon far beyond the level reached after the financial crisis. But that’s just for starters.

For the first time ever, the Fed will purchase bonds from and issue loans directly to eligible US corporations in a new program called the Primary Market Corporate Credit Facility. Previously, the central bank has purchased only government bonds and mortgage securities and briefly guaranteed the issue of bonds by the large banks, but has never loaned money directly to companies. And for the first 6 months, principal and interest may be deferred (paid in kind) at the borrower’s request.

Another new mechanism called the Secondary Market Corporate Credit Facility will allow the Fed to purchase existing corporate bonds in the secondary market, in an effort to restore normal functioning of the bond and money markets. Both of these new purchase programs specify that eligible securities are of investment grade, including the lowest notch, BBB-. This suggests the intriguing (and near certain) prospect that with continued credit downgrades, the US Federal Reserve will be holding junk bonds in its portfolio. On can practically hear Alexander Hamilton railing from the grave, but this is truly uncharted territory.

Since by law it cannot hold assets of private companies, the Fed will create separate pools (called special purpose vehicles) capitalized by Fed loans and backstopped by $30 billion in Treasury guarantees. The SPVs will then purchase and hold the corporate bonds for up to 4 years.

But wait, there’s more. A 2008-era emergency lending facility will be resurrected to support business and consumer credit markets by promoting the securitization of credit cards, student loans and auto financing and ensure sufficient capital is available for lending.

The central bank is also moving aggressively to support short-term lending to corporations and municipalities as well as providing additional liquidity to money market mutual funds.

Finally (well likely not finally), the Fed announced plans to create a new Main Street Business Lending Program with the objective of helping small and medium-sized enterprises keep the doors open throughout this incredibly stressful period. The details are pending but will be supported by another backstop from the Treasury as stipulated in the final Coronavirus bill on Capitol Hill.

These are truly remarkable steps which are being implemented much more urgently than previous rescue operations in 2008. One of the lessons of the Great Depression was that the Federal Reserve acted to slowly (or counterproductively) to quell the panic. Ben Bernanke learned the lesson and was said to have had a bazooka, but still could have moved with more dispatch in response to the financial crisis. This time the Fed has rolled out Big Bertha and has opened fire.

Christopher A. Hopkins, CFA

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