Most of the time, the Federal Reserve occupies an unusual role within government. It is a tool of state power, yet it remains a bit distant from the usual mechanisms of control. Though the Fed is ultimately responsible to the president and Congress, by law and tradition the central bank receives the space to carry out its assigned goals mostly as it thinks best.
But in extreme situations, those lines get blurred, or obliterated. When America set out to win World War II, the Federal Reserve became not a building full of technocrats operating at arm’s length from the rest of the government, but a crucial part of the war effort, helping ensure the United States had the necessary economic resources.
Now seems such a time. The economy is in grave peril from coronavirus, and Americans are watching, in real time, as Fed leaders consider whether to abandon some of their usual rules and how closely they ought to collaborate with the executive and legislative branches.
Leaders of the central bank will try to maintain certain bright lines that they will not cross. Fed officials view bailouts of individual firms or industries, or direct payments to individuals, as outside their purview — those are choices for elected officials to make.
But it is becoming clear that to address aspects of the coronavirus crisis that are part of its job, the Fed may need to go beyond even its extraordinary actions of the 2008-9 global financial crisis.
The Fed can do little about the astronomical rise in unemployment that appears to be a foregone conclusion. What it can do is try to create the conditions under which the economy can snap back once the forced closure of much of the economy ends. That is, to help ensure that credit flows freely enough that the economy can get back to normal quickly, rather than suffer a prolonged series of cascading bankruptcies.
Will businesses, governments and individuals whose finances were sound at the start of the year be able to obtain the cash they need to emerge on the other side of the crisis intact and return to the pre-crisis norm? Or will a global scramble for cash put a freeze on lending and result in a longer, more severe recession — depression, potentially — than is needed?
That is the immediate crisis the Fed is facing. In the last two weeks, access to cash has been drying up, with interest rates spiking for corporations, state and local governments, individuals who might want a mortgage — and even, for a time, the United States Treasury, the most worrying trend of all.
The Fed has a power no other entity in the world possesses: the capacity to create dollars out of thin air. It is beginning to use it to try to prevent the coronavirus crisis from also becoming a financial crisis.
In just the last several days, it has deployed that power to pump those dollars into the financial system to combat this freeze, including by buying vast sums of Treasury bonds and mortgage-backed securities, extending “swap lines” to international central banks to ensure dollars are available around the world, and reintroducing programs from the 2008 crisis to prop up short-term corporate borrowing and money market mutual funds. On Friday morning, it expanded its money market fund program to help support lending to state and local governments.
That is a breakneck speed for the typically cautious, deliberative central bank. Programs that in the 2008 crisis were rolled out over the course of many months have been introduced in just a few days.
Yet the Fed still keeps finding itself behind. It is the equivalent of a runner sprinting at top speed but still lagging in the race.
What might catching up to the scale of the crisis really look like?
One answer could be expanding the Fed’s support of corporate borrowing to include more types of companies and more types of debt. Already, the Fed this week reintroduced a crisis-era program to make dollars available to companies that issue “commercial paper,” a form of short-term debt, in conjunction with the Treasury Department.
The Treasury directed money toward that program to protect the Fed from losses caused by bad loans. The same principle could be used more broadly, potentially allowing the Fed to keep borrowing costs from spiking for creditworthy companies because of the liquidity freeze-up.
That would primarily benefit very large companies that have access to the corporate debt market. A bigger challenge is how to support lending to small and midsize businesses.
The Fed could emulate an innovative program that the Bank of England announced this week called the Covid Corporate Financing Facility. That program will offer one-year loans to firms so that they can continue making payroll and other payments through virus-related disruptions.
Something equivalent in the United States would require extensive cooperation with the Treasury Department, which under the laws governing the Fed would need to take on the risk of loss. And it would be complex to create and administer quickly, since it would involve evaluating the pre-crisis creditworthiness of thousands of businesses.
But if it works, it goes to the nub of the problem the economy is facing: Businesses are being forced to cut back expenses and potentially go bankrupt because of circumstances beyond anyone’s control.
In the U.S. context, it might also be helpful to emulate a program from the 2008 crisis known as the Term Asset-Backed Securities Loan Facility, which invited private investors to put up money that was then supplemented with resources from the Treasury and the Fed.
That program was mainly aimed at consumer lending. But a version more focused on small-business lending might be a way for the government to push cash into businesses in need — while letting private investors decide which firms are creditworthy.
Beyond corporations, the Fed may need to overcome its long resistance to supporting the markets for municipal bonds, one of the few types of markets it did not directly prop up in 2008. States and localities are most likely headed for severe cash shortfalls, as tax revenue plummets and the cost for social benefits spikes.
The Fed tries to stay out of the politics of bailing out cities and states — notably during the New York City fiscal crisis in the 1970s and Detroit’s 2013 bankruptcy. But when the problem is a generalized freeze-up in credit, it may find itself with little choice.
All of these would involve the Fed’s getting more engaged in the details of allocating credit in the economy than it would prefer. And all would open it up to political attack and widespread criticism.
But the reality of 2020 is that the economy is facing catastrophe, for at least the near future. And the central bank faces, for the second time this century, a whatever-it-takes moment to try to make sure it is a short-lived one.
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