By pushing the Federal Reserve into corners of financial markets it has mostly shunned in its 106-year history, Chairman Jerome Powell is running into some thorny questions.
Like, for instance, how to maintain independence from the U.S. Treasury when the economic-support package Congress passed says they should work together? Or whether the same guidelines for companies receiving federal aid, which range from compensation limits to off-shoring restrictions, apply to the Fed if it gets more money from Treasury? And how about which companies — and perhaps eventually, municipalities and states — are invited to borrow and at what cost?
These are some of the issues that probably will come up when Powell speaks at a webinar hosted by the Brookings Institution at 10 a.m. in Washington — in one of his few public appearances since the spread of the coronavirus took hold in the U.S.
Powell has already committed to going where no chairman in postwar history has ever stepped: lending broadly to the largest corporations and planning to buy up loans made to small businesses.
Congressional Democrats want the Fed to stretch its boundaries of power even further by purchasing low-rated municipal debt, while Wall Street economists are wondering what’s stopping the Fed from buying junk-rated securities.
“This is going to lead to a complete re-examination of the role of central banking and the Fed’s independence,” warns Karen Shaw Petrou, a managing partner at Federal Financial Analytics, a Washington research firm. The Fed’s steps into credit allocation are tantamount to “a complete redesign of central banking on the fly.”
Congress has authorized as much as $454 billion for the Treasury Department to use in consort with programs the Fed can leverage to loan up to $4.5 trillion. Some lawmakers and analysts see no reason why, with that power, the central bank shouldn’t reach into riskier corners of the market.
Prior to the crisis, the Fed purchased a narrow group of assets, mainly government bonds and those backed by government agencies, such as some mortgage financing.
While purchasing municipal bonds on the open market sounds simple, it would thrust the central bank into a thicket of what ultimately will be political choices: Who gets support? Only the highest-rated and richest municipalities? How are such decisions made?”
The questions are all the more acute as state and local governments lose tax revenue to an economic shutdown while first responders and medical systems strain resources to manage a pandemic that has already killedabout 15,000 Americans.
There are similar questions related to corporate debt. As it is funded now, the Fed is free to lend to whomever shows up and wants to pay the fees and rates, so long as the companies are investment grade. But if the Treasury kicks in money recently allocated by Congress, do lawmaker guidelines and restrictions on corporations apply? There’s also the issue of moral hazard. Now that investors and companies know the Fed has their back in a crisis, how do markets price debt risk in the future?
“The potential influence on the allocation of credit in corporate and municipal finance is massive,” said Peter Fisher, a clinical professor at Dartmouth College’s Tuck School of Business and a former official at both the Fed and the Treasury. He hopes they can draw some “chalk lines” to establish boundaries about what each institution is willing and not willing to do.
A Federal Reserve spokesperson declined to comment.
The central bank doesn’t discriminate about who uses its facilities but instead sets market criteria such as credit ratings, prices and fees as the yardstick for entry. For example, the Primary Market Corporate Credit Facility, which loans directly to large companies, requires them to have an investment-grade rating and pay a 1% fee up front.
There are also limits on how much debt the companies can issue. The Fed has said market conditions determine the rates companies pay.
What is likely to matter politically a year from now, however, is which companies show up and what cost they paid because Congress also is focused on helping just about anybody who requires aid.
“The emergency assistance needs to be broad-based, not just for the biggest companies or the wealthiest political jurisdictions,” said Andrew Levin, a Dartmouth professor and former adviser to the Fed board. “The Federal Reserve needs to be very attentive to issues of equity and fairness, especially when it’s engaging in truly extraordinary measures like this.”
With the $2 trillion stimulus bill, known as the CARES Act, to support the economy, Congress mandated the Treasury work with the Fed to support municipalities, states and businesses. The relationship already is expanding. The Fed said April 6 it will create a program to help speed the flow of funds to small companies by providing term financing to banks against loans issued under the Small Business Administration’s Paycheck Protection Program.
Just how this translates into the Treasury’s relationship with the central bank remains to be seen.
The CARES Act “forces the Fed into this almost intimate relationship with Treasury,” said Mark Spindel, co-author of a book about the relationship with Congress. “This is fiscal policy, picking winners and losers.”
And even though they would like to set broad-based criteria for who gets money, in the end their decisions will be subject to political review “in the extreme,” he added.
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