Federal Reserve Sets Dangerous Precedent with COVID-19 Intervention
“When it comes to lending, we are not going to run out of firepower. That doesn’t happen” said Federal Reserve Chairman Jerome Powell in an interview with NBC News on March 26th (Timiraos). Claiming to have limitless lending firepower is one thing, but backing that claim with a $2.2 trillion dollar stimulus bill and a promise of unprecedented financial policy is another thing. Many question whether the actions the Fed has and continues to take will lead to an irreversible standard for bailing out corporations during future financial crises.
Unlike the 2008 financial crisis, the United States financial system is currently plagued by a worldwide pandemic. That, in and of itself, calls for unconventional government intervention. During the 2008 financial crisis, the worst recession since the Great Depression at its time, the Federal Reserve dug deep into its bag and pulled out new policies such as quantitative easing, where the Fed buys long term securities to increase the money supply and encourage investment and borrowing. However, during the 2008 crisis, the central banks stayed true to strictly purchasing investment grade debt in order to boost the money supply and the banks’ reserves, and drop the fed funds rate. They did not go as far as buying any debt that was rated below investment grade (Cecchetti).
Since making claims about its lending ability, the Federal Reserve has taken action, some of it warranted and some of it unprecedented. The Fed has cut interest rates to near zero and has instituted the Coronavirus Aid, Relief, and Economic Security Act which is a $2.2 trillion dollar stimulus package to support those impacted by the virus, doubling the stimulus package passed in 2009. 30% of the bill will be sent to individuals and families who earn up to $75,000 (Routley). In addition to families and individuals, the Fed has allocated $500 billion of that stimulus to big businesses and corporations that have been severely impacted, such as airlines. Boeing and Delta are two of the major airlines receiving significant relief from the CARES act and while their employees are relatively satisfied with the compensation, the executives are far from pleased with the regulatory strings attached to the billions of dollars received. The $50 billion aid received is split half and half, loans and payroll assistance. Airline executives, who assumed the aid would be in the form of a grant were surprised to find out that, “30% of that money is to be repaid and that they will need to offer stock warrants on about 10% of the loan amount, which the government could convert to shares later” (Sider). Regardless of the strings attached, with passenger volume down 95%, it is certainly hard to tell whether this influx of cash has helped airlines.
The Federal Reserve’s most unprecedented action is its expansion into corporate securities, most specifically those that are not rated AAA. On Tuesday May 12th, the Federal Reserve implemented the Secondary Market Corporate Credit Facility program and began purchasing corporate debt that was “rated investment grade as of March 22nd but has since downgraded to no lower than BB-” (Condon). This specific program is focused on helping those fallen angels recover, mitigating the effects of the virus. In addition to buying corporate securities, the Federal Reserve is now allowing business development companies such as Prospect Capital Corp, and Apollo Investment Corp., which are the typical source of lending for small and midsize companies, to report their loans at December 31 prices. Valuing the loans at today’s price points would lead to a markdown in valuation and limit further lending from the BDC’s. The Fed’s recent action allows these companies to report adjusted numbers to help preserve lending ability, but does so at the cost of the accuracy of their financial statements (Marks).
The actions that the Fed has taken during the current economic slowdown certainly pioneer into uncharted territory. Given the uncertainty of the situation, there is no denying that the central banks needed to react quickly to the economic slowdown. However, claiming limitless lending power and implementing unprecedented programs not only raises questions as to whether that amount of power is permissible, but also sets the stage for serious moral hazard. Companies are now being generously aided by the government, even if current economic conditions are causing them to fail. This intervention eliminates the fear that forces business owners to avert unnecessary risk on a daily basis. The caution that investors typically take is what helps the free market work and this recent intervention by the Fed sets the precedent that businesses hurt by taking too much risk will be saved by the government.
The self-proclaimed mission of the Fed is, “to promote a strong U.S. economy. The Congress has directed the Fed to conduct the nation's monetary policy to support three specific goals: maximum sustainable employment, stable prices, and moderate long-term interest rates” (www.federalreserve.gov). The central banking system had to react rapidly to the evolving pandemic’s effect on the economy and it did so in dramatic fashion. Despite historical unemployment statistics, the Fed has certainly done its part to accomplish its stated goals. Slashing the interest rates, as well as passing the CARES act, proves the Fed’s continued allegiance to its mission. This intervention, as extreme as it may be, provides a much needed cushion for the American people. However many Americans are left wondering if the Fed has overstepped its bounds and taken away the role of the free market by doing so. In the past few months, the Fed has set a precedent in which if the going gets tough, the central banking system will heavily intervene (Marks). This dangerous precedent may cause businesses to be less risk averse knowing they have the backing of the central banks when the next recession comes. With that knowledge, investors must keep in mind our current crisis, as well as the 2008 crisis. Although these have both proved that the central banks have the ability to heavily intervene, investors should continue to be wary when distributing loans or investing in companies. Failure to do so may result in a hazardous investor behavior caused by the Fed’s recent and drastic intervention which may lead to even more frequent and intense recessions down the line. In future recessions, worldwide pandemic or not, the Fed will have to take responsibility when businesses expect the same kind of intervention that is being provided in the current economic slowdown.
Sources:
Board of Governors of the Federal Reserve System, www.federalreserve.gov/faqs/what-economic-goals-does-federal-reserve-seek-to-achieve-through-monetary-policy.htm.
Cecchetti, and Stephen G. “Crisis and Responses: the Federal Reserve and the Financial Crisis of 2007-2008.” NBER, 27 June 2008, www.nber.org/papers/w14134.
Condon, Christopher, et al. Bloomberg.com, Bloomberg, 9 Apr. 2020, www.bloomberg.com/news/articles/2020-04-09/fed-unleashes-fresh-steps-for-as-much-as-2-3-trillion-in-aid.
JeffCoxCNBCcom. “The Fed Is Starting Its Program to Purchase Corporate Bond ETFs.” CNBC, CNBC, 12 May 2020, www.cnbc.com/2020/05/12/the-fed-is-starting-up-its-program-to-purchase-corporate-bond-etfs.html.
Marks, Howard. “Knowledge of the Future.” Knowledge of the Future, 14 Apr. 2020.
Routley, Nick. “The Anatomy of the $2 Trillion COVID-19 Stimulus Bill.” Visual Capitalist, 30 Mar. 2020, www.visualcapitalist.com/the-anatomy-of-the-2-trillion-covid-19-stimulus-bill/.
Sider, Alison, and Kate Davidson. “Airlines Hesitate Over Coronavirus Stimulus Package's Aid Terms.” The Wall Street Journal, Dow Jones & Company, 12 Apr. 2020, www.wsj.com/articles/airlines-hesitate-over-stimulus-packages-aid-terms-11586728272.
Timiraos, Nick. “The Fed Transformed: Jay Powell Leads Central Bank into Uncharted Waters.” The Wall Street Journal, Dow Jones & Company, 30 Mar. 2020, https://www.wsj.com/articles/the-fed-transformed-jay-powell-leads-central-bank-into-uncharted-waters-11585596210
