NEW YORK (NYTIMES) – The Federal Reserve on Monday (March 23) pledged to do, in essence, whatever it takes to keep the US economy from collapsing under the weight of the coronavirus pandemic.
The Fed’s announcement had lots of bureaucratic jargon and an alphabet soup of acronyms. But at its core, the central bank was making a simple promise, summed up in the first sentence of its news release: The Fed is “committed to using its full range of tools to support households, businesses and the US economy overall.”
Here’s a guide to understanding the Fed’s actions.
WHAT IS THE FED DOING?
Most of what the central bank announced Monday falls under the broad category of “buying debt.” The Fed was already buying vast quantities of Treasury bonds – debt issued by the federal government – and mortgage debt backed by government agencies like Fannie Mae and Freddie Mac. On Monday, it went further, promising to keep buying “in the amounts needed to support smooth market functioning.” It also expanded programs that will support debt issued by companies, state and local governments, and other entities (though it won’t buy municipal debt directly).
WHAT WILL THAT ACCOMPLISH?
The Fed’s actions won’t prevent thousands – perhaps millions – of businesses from shutting down, and almost certainly won’t prevent a recession. But they might limit the damage and allow for a faster recovery.
“You can’t prevent some of the losses that are occurring,” said Nellie Liang, a senior fellow at the Brookings Institution and a former director of financial stability for the Fed. “You want to make sure that at the end of the period where the economy is affected by this crisis and shut down, that you haven’t left everyone in such a bad place that you can’t recover quickly.”
The basic problem the Fed is trying to solve is that financial markets – particularly the bond market, where investors trade government and corporate debt – have nearly frozen up in recent days. Since no one is sure how bad the pandemic will be or how long it will last, investors are wary of buying any bonds, even ones that would normally be seen as safe havens. By promising to buy debt, the Fed is trying to get markets working again.
OK, BUT WHAT DOES THAT MEAN IN THE REAL WORLD?
Broadly speaking, American businesses right now fall into two groups. In the first category are companies, like airlines, hotel chains and cruise ship operators, that have seen their revenue more or less wiped out by the pandemic. Congress might step in to bail some of those companies out, but there isn’t much that the Fed can do for them.
Instead, the Fed’s actions are focused on the second set of businesses. These are companies that are basically healthy but in danger because of the freeze-up in financial markets. Some have been insulated from the outbreak’s effects but rely on debt as part of their normal operations. Others have lost business because of the virus but could survive if they could borrow to cover their expenses.
If those businesses start to fail, there will be more layoffs and still more business failures – an economic nose-dive that could be harder to pull out of. The Fed is trying to contain the damage and prevent that cascade effect.
“If these big corporations don’t have financing or they’re losing their access to credit, it means they’re going to have to close their doors and fire workers, and that multiplies into the real economy quickly and severely,” said Michelle Meyer, chief US economist for Bank of America Merrill Lynch. If that happens, she said, “this economic recession spirals and becomes deeper and much more prolonged.”
That explains the business debt. What about the other stuff?
Ordinarily, the Fed fights an economic slowdown by lowering interest rates. That encourages businesses and individuals to borrow, which encourages spending and investment.
Last week, the Fed cut its benchmark interest rate to nearly zero. But ultralow interest rates don’t do any good if no one will lend money, or if lenders demand a huge premium. That’s what was starting to happen in recent days.
“It was getting to a critical point,” said Julia Coronado, president of MacroPolicy Perspectives, an economic consultancy. “If corporations can’t get cash and mortgage markets aren’t functioning, your low rates don’t translate to households and businesses.”
By buying up government bonds and other safe assets, the Fed is trying to give investors sufficient confidence to put their money back into the bond market, which in turn should allow its interest-rate policies to work as intended.
HOW DOES THIS COMPARE WITH WHAT THE FED DID IN THE LAST FINANCIAL CRISIS?
A lot of what the Fed is doing under Jerome Powell, its chairman, is taken from the 2008-09 playbook of his predecessor Ben Bernanke. The Fed bought Treasury notes and mortgage bonds then, as it is doing now, though in the past it has always put a dollar figure on its bond-buying programs – it took the extreme uncertainty of the current moment for the Fed to pledge open-ended stimulus. The central bank is also reviving several other programs that made their debut during the last crisis.
But policymakers are also taking some novel steps. Most important, the Fed will effectively lend money directly to large corporations, something it has never done before. The central bank framed the program as “bridge financing” to help otherwise healthy companies keep their doors open and their workers employed during a period of disruption.
Not everyone thinks that is a good idea. Narayana Kocherlakota, a former president of the Federal Reserve Bank of Minneapolis, said that it made sense for the Fed to buy bonds to keep financial markets flowing smoothly, but that lending money directly to companies was the job of Congress.
“The way to deal with risk problems for corporations is for Congress to deal with it, not for the Fed,” Kocherlakota said.
WHAT ABOUT SMALL BUSINESSES?
Sales have abruptly dried up for restaurants, bars, independent retailers and other small businesses, and few have the savings to survive more than a few weeks without revenue. Moreover, small businesses can’t sell stock or issue debt to raise the cash to keep going.
Economists argue that in the long run, the Fed’s moves to cut interest rates and stimulate the economy should help small businesses as well as big corporations. But in the long run, many small businesses will be dead. So the Fed said Monday that it would establish the Main Street Business Lending Program to encourage lending to small and medium-size businesses.
The Fed released few details, saying only that it “expects to announce” the program soon. Economists said the move looked at least partly like an effort by the Fed to reassure the public that it wasn’t favoring big businesses over small ones.
“I think the Fed is well aware of the optics and the messaging,” Coronado said. “It’s not always clear to people that buying billions in mortgage securities helps them, even though it does.”
IS THE FED DOING ANYTHING ELSE?
The Fed, along with other financial regulators, on Sunday announced new steps intended to encourage banks and other lenders to cut borrowers some slack during the pandemic.
Imagine a small business that took out a loan last year to fund an expansion. Now the business has had to shut down temporarily because of the coronavirus outbreak, and the owner is having trouble making payments. Given the circumstances, the bank that made the loan may be willing to make some accommodations – deferring payments, perhaps, or extending the loan for a few months. But if the bank makes too many modifications, it could run into trouble with regulators concerned about excessive risk.
On Sunday, the Fed and other regulators basically said to go ahead and modify loans to help businesses survive. “The agencies encourage financial institutions to work with borrowers,” the regulators said, and “will not criticize institutions for doing so in a safe and sound manner.”
WILL IT WORK?
There is a consensus among economists that until the outbreak is brought under control, economic policy can do only so much. And while the Fed has greatly expanded its toolbox in recent years, there are steps that only Congress can take, like sending checks to individual households, cutting taxes or providing aid directly to state and local governments or to businesses.
But the Fed’s advantage, Meyer said, is speed.
“The Fed is moving quickly, they’re being creative, and they’re doing whatever they can to support the flow of credit in the economy,” she said.
Will that be enough? “Time will tell,” she said.
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