Special Note: See the yellow highlighted area. This loan program is anticipated to provide $5 billion in Illinois’ recently passed budget. Interestingly the article indicates the bonds must be investment grade. Illinois bonds on the edge of that criteria.
What’s the Fed doing in response to the COVID-19 crisis? What more could it do?
Jeffrey Cheng, Dave Skidmore, and David WesselThursday, April 30, 2020Editor's Note:
This post will be updated throughout the ongoing coronavirus pandemic. It was most recently updated on April 30, 2020. For a summary of what the European Central Bank has done in response to the coronavirus pandemic, check out this post.
Jeffrey Cheng
Research Analyst - Hutchins Center on Fiscal & Monetary Policy, The Brookings Institution
Dave Skidmore
Consultant - Economic Studies, The Brookings Institution
Former Assistant to the Board - Board of Governors of the Federal Reserve System
David Wessel
Director - The Hutchins Center on Fiscal and Monetary Policy
Senior Fellow - Economic Studies
The coronavirus crisis in the United States—and the associated business closures, event cancellations, and work-from-home policies—has triggered a deep economic downturn of uncertain duration. The Federal Reserve has stepped in with a broad array of actions to limit the economic damage from the pandemic, including up to $2.3 trillion in lending to support households, employers, financial markets, and state and local governments. “We are deploying these lending powers to an unprecedented extent [and] … will continue to use these powers forcefully, proactively, and aggressively until we are confident that we are solidly on the road to recovery,” says Jerome H. Powell, Chair of the Federal Reserve Board of Governors. Powell also discussed the Fed’s goals during a webinar with Brookings’ Hutchins Center on Fiscal and Monetary Policy.
WHAT IS THE FED DOING TO SUPPORT THE U.S. ECONOMY AND FINANCIAL MARKETS?
Near-Zero Interest Rates
- Federal funds rate: The Fed has cut its target for the federal funds rate, the rate banks pay to borrow from each other overnight, by a total of 1.5 percentage points since March 3, bringing it down to a range of 0 percent to 0.25 percent. The federal funds rate is a benchmark for other short-term rates, and also affects longer-term rates, so this move is aimed at lowering the cost of borrowing on mortgages, auto loans, home equity loans, and other loans, but it will also reduce the interest income that savers get.
- Forward guidance: Using a tool honed during the Great Recession of 2007-2009, the Fed has offered forward guidance on the future path of its key interest rate, saying that rates will remain low “until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.” Such forward guidance on the overnight rate puts downward pressure on longer-term rates.
Supporting Financial Market Functioning
- Securities purchases (QE):The Fed has resumed purchasing massive amounts of securities, a key tool employed during the Great Recession, when the Fed bought trillions of long-term securities. Treasury and mortgage-backed securities markets have become dysfunctional since the outbreak of COVID-19, and the Fed’s actions aim to restore smooth market functioning so that credit can continue to flow. The Fed initially said it would buy at least $500 billion in Treasury securities and $200 billion in government-guaranteed mortgage-backed securities over “the coming months.” But, on March 23, it made the purchases open-ended. It also expanded purchases to include commercial mortgage-backed securities. And, it issued forward guidance to reassure markets that it will “purchase Treasury securities and agency mortgage-backed securities in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy.” Although the Fed is not calling it “quantitative easing” (QE), everyone else is calling it that.
- Lending to securities firms: Through the Primary Dealer Credit Facility (PDCF), a program revived from the global financial crisis, the Fed will offer low interest rate (currently 0.25 percent) loans up to 90 days to 24 large financial institutions known as primary dealers. The dealers will provide the Fed with equities and investment grade debt securities, including commercial paper and municipal bonds, as collateral. The goal is to keep the credit markets functioning at a time of stress when institutions and individuals are inclined to avoid risky assets and hoard cash, and dealers may encounter barriers to financing rising inventories of securities they may accumulate as they make markets. To re-establish the PDCF, the Fed had to obtain the approval of the Treasury Secretary to invoke emergency lending authority under Section 13(3) of the Federal Reserve Act for the first time since the crisis.
- Backstopping money market mutual funds: The Fed has re-launched the crisis-era Money Market Mutual Fund Liquidity Facility (MMLF), which lends to banks against collateral they purchase from prime money market funds, the ones that invest in corporate short-term IOUs known as commercial paper, as well as in Treasury securities. At the outbreak of COVID-19, investors withdrew from money market funds en masse. To meet outflows, these funds sold securities, but disruptions in the financial markets made it difficult to sell, even if the securities were all of high quality and very short maturities. The Fed said that the facility “will assist money market funds in meeting demands for redemptions by households and other investors, enhancing overall market functioning and credit provision to the broader economy.” The Fed invoked Section 13(3) and obtained permission from Treasury, which provided $10 billion from its Exchange Stabilization Fund to cover potential losses.
- Repo operations: The Fed has vastly expanded the scope of its repurchase agreement (repo) operations to funnel cash to money markets and is now essentially offering an unlimited amount of money. The repo market is where firms borrow and lend cash and securities short-term, usually overnight. Disruptions in the repo market affect the federal funds rate, the Fed’s primary tool for achieving its price stability and employment mandate. The Fed’s facility makes cash available to the primary dealers in exchange for Treasury and other government-backed securities. Before coronavirus turmoil hit the market, the Fed was offering $100 billion in overnight repo and $20 billion in two-week repo. It has greatly expanded the program—both in the amounts offered and the length of the loans. It is offering $1 trillion in daily overnight repo, and $500 billion in one month and $500 billion in three-month repo.
Encouraging Banks to Lend
- Direct lending to banks: The Fed lowered the rate that it charges banks for loans from its discount window by 1.5 percentage points, from 1.75 percent to 0.25 percent, lower than during the Great Recession. These loans are typically overnight—meaning that they are taken out at the end of one day and repaid the following morning—but the Fed has extended the terms to 90 days. Banks pledge a wide variety of collateral (securities, loans, etc.) to the Fed in exchange for cash, so the Fed is not taking on much risk in making these loans. The cash allows banks to keep functioning: depositors can continue to withdraw money, and the banks can make new loans. Banks are sometimes reluctant to borrow from the discount window because they fear that if word leaks out, markets and others will think they are in trouble. To counter this stigma, eight big banks agreed to borrow from the discount window.
- Temporarily relaxing regulatory requirements: The Fed is encouraging banks—both the largest banks and community banks—to dip into their regulatory capital and liquidity buffers, so they can increase lending during the downturn. The reforms instituted after the financial crisis require banks to hold additional loss-absorbing capital to prevent future bailouts. But these capital buffers can be used during a downturn to stimulate lending, and the Fed is encouraging that now, including through a technical change to its TLAC (total loss-absorbing capacity) requirement, which includes capital and long-term debt. (To preserve capital, big banks also are suspending buybacks of their shares.) The Fed also eliminated banks’ reserve requirement—the percent of deposits that banks must hold as reserves to meet cash demand—though this is largely irrelevant because banks currently hold far more than the required reserves. The Fed also relaxed the growth restrictions previously imposed on Wells Fargo, as part of an enforcement action related to widespread consumer protection violations, so that the bank could increase its participation in the Fed’s lending programs for small- and mid-sized businesses.
Supporting Corporations and Businesses
- Direct lending to major corporate employers: In a significant step beyond its crisis-era programs, which focused mainly on financial market functioning, the Fed on March 23 established two new facilities to support highly rated U.S. corporations. The Primary Market Corporate Credit Facility (PMCCF) allows the Fed to lend directly to corporations by buying new bond issuances and providing loans. Borrowers may defer interest and principal payments for at least the first six months so that they have cash to pay employees and suppliers. But during this period, borrowers may not pay dividends or buy back stocks. And, under the new Secondary Market Corporate Credit Facility (SMCCF), the Fed may purchase existing corporate bonds as well as exchange-traded funds investing in investment-grade corporate bonds. These facilities will “allow companies access to credit so that they are better able to maintain business operations and capacity during the period of dislocations related to the pandemic,” the Fed said. Initially supporting $100 billion in new financing, the Fed announced on April 9 a massive expansion—the facilities will now backstop up to $750 billion of corporate debt. And, as with previous facilities, the Fed invoked Section 13(3) of the Federal Reserve Act and received permission from the U.S. Treasury, which provided $75 billion from its Exchange Stabilization Fund to cover potential losses.
- Commercial Paper Funding Facility (CPFF): Commercial paper is a $1.2 trillion market in which firms issue unsecured short-term debt to certain money market funds and others, to finance day-to-day operations. Through the CPFF, another reinstated crisis-era program, the Fed buys commercial paper, essentially lending directly to corporations for up to three months at a rate between 1 to 2 percentage points higher than overnight lending rates. “By eliminating much of the risk that eligible issuers will not be able to repay investors by rolling over their maturing commercial paper obligations, this facility should encourage investors to once again engage in term lending in the commercial paper market,” the Fed said. “An improved commercial paper market will enhance the ability of businesses to maintain employment and investment as the nation deals with the coronavirus outbreak.” As with other non-bank lending facilities, the Fed invoked Section 13(3) and received permission from the U.S. Treasury, which put $10 billion into the CPFF to cover any losses.
- Supporting loans to small- and mid-sized businesses:
The Fed’s Main Street Lending Program, announced on April 9 and expanded on April 30, aims to support businesses too large for the Small Business Administration’s Paycheck Protection Program (PPP) and too small for the Fed’s two corporate credit facilities. Through three programs—the New Loans Facility, Expanded Loans Facility, and the Priority Loans Facility—the Fed will fund up to $600 billion in four-year loans. Businesses with up to 15,000 employees or up to $5 billion in annual revenue can participate. In the first two facilities, lenders retain 5 percent of the loans. The third and newest of the programs, the Priority Loans Facility, allows riskier companies to borrow but requires lenders to retain 15 percent of the loans. As with other facilities, the Fed invoked Section 13(3) and received permission from the U.S. Treasury, which through the CARES Act, put $75 billion in to the three Main Street Programs to cover losses. Borrowers are subject to restrictions on stock buybacks, dividends and executive compensation. See here for additional operational details. The Fed also announced the Paycheck Protection Program Liquidity Facility that will facilitate loans made under the PPP. Bank lending to small businesses can borrow from the facility using PPP loans as collateral.
Supporting Households and Consumers
- The Fed on March 23 restarted the crisis-era Term Asset-Backed Securities Loan Facility (TALF). Through this facility, the Fed supports lending to households, consumers, and small businesses by lending to holders of asset-backed securities collateralized by new loans. These loans include student loans, auto loans, credit card loans, and loans guaranteed by the SBA. In a step beyond the crisis-era program, the Fed expanded eligible collateral to include existing commercial mortgage-backed securities and newly issued collateralized loan obligations of the highest-quality. Like the programs supporting corporate lending, the TALF will initially support up to $100 billion in new credit. To restart it, the Fed invoked Section 13(3) and received permission from the Treasury, and the Treasury allocated $10 billion from the Exchange Stabilization Fund.
Supporting State and Municipal Borrowing
- Direct lending to state and municipal governments:
During the 2007-2009 financial crisis, the Fed resisted backstopping municipal and state borrowing, seeing that as the responsibility of the Administration and Congress. But, in the current crisis, the Fed is lending directly to state and local governments through the Municipal Liquidity Facility, which was created on April 9 and updated on April 27. The municipal bond market was under enormous stress in March, and state and municipal governments found it increasingly hard to borrow as they battled COVID-19. The Fed’s facility will lend to U.S. states, including the District of Columbia, counties with at least 500,000 residents, and cities with at least 250,000 residents. Substantially more local governments can borrow from the facility under the updated plan than under the initial plan. The Fed will purchase up to $500 billion of investment-grade notes tied to future tax revenues with maturity of less than three years—up from two years previously. The Fed invoked Section 13(3) with the approval of the U.S. Treasury, which will use the CARES Act to provide $35 billion to cover any potential losses. See here for additional details.
- Supporting municipal bond liquidity: The Fed is also using two of its credit facilities to backstop munis. It expanded the eligible collateral for the MMLF to include highly rated municipal debt with maturities of up to 12 months, and also included municipal variable-rate demand notes. It also expanded the eligible collateral of the CPFF to include high-quality commercial paper backed by tax-exempt state and municipal securities. These steps will allow banks to funnel cash into the municipal debt market, where stress has been building due to a lack of liquidity.
Cushioning U.S. Money Markets from International Pressures
- International swap lines: Using another tool that was important during the Great Recession, the Fed is making U.S. dollars available to other central banks, so they can lend to banks that need them. The Fed gets foreign currencies in exchange, and charges interest on the swaps. The Fed has cut the rate it charges on those swaps with central banks in Canada, England, the Eurozone, Japan, and Switzerland, and extended the maturity of those swaps. It has also extended the swaps to the central banks of Australia, Brazil, Denmark, Korea, Mexico, New Zealand, Norway, Singapore, and Sweden.
- The Fed also is offering dollars to central banks that don’t have an established swap line through a new repo facility called FIMA (for “foreign and international monetary authorities”). The Fed will make overnight dollar loans to the central banks, taking U.S. Treasury debt as collateral.
WHY ARE THE FED’S ACTIONS IMPORTANT?
The steps that have been taken by federal, state, and local officials to mitigate the spread of the virus will limit spending and hurt the incomes of businesses and households, leading to a recession. The Fed is trying to ensure that credit continues to flow to households and businesses during this difficult time and that the financial system doesn’t amplify the shock to the economy. It also wants to do what it can to limit the permanent damage to the economy so that when the pandemic recedes, the economy can grow again, and supply goods and services to meet demand. As our colleague Ben Bernanke, the former Fed chair, said (in so many words) during the Great Recession: We didn’t set out to save Wall Street, but in order to save Main Street, we had to save Wall Street.
In many other countries, most of the credit flows through the banks. In the U.S., a lot flows through the capital markets, so the Fed is trying to keep them functioning as smoothly as possible. As another one of our colleagues, Don Kohn, former Federal Reserve Vice Chair, said recently:
“The Treasury market in particular is the foundation for trading in many other securities markets in the U.S. and around the world; if it’s disrupted, the functioning of every market will be impaired. The Fed’s purchase of securities is explicitly aimed at improving the functioning of the Treasury and MBS markets, where market liquidity had been well below par in recent days.”
When financial markets are clogged, firms tend to draw on bank lines of credit, and that can lead banks to sell Treasury and other securities or pull back on other loans. The Fed is supplying unlimited liquidity to the banks, so they can meet credit drawdowns and relieve any balance sheet strain.
WHAT MORE CAN THE FED DO?
The Fed’s powers and tools, as impressive as they are, aren’t sufficient to cope with the economic harm of the COVID-19 crisis. That’s why there has been a big—at least $2 trillion—fiscal response from Congress and the President—support for businesses and checks to every household. As Powell said when the Fed cut rates nearly to zero, “Monetary policy has a role… [but] we do think fiscal response is critical.”
But the Fed may have a few more moves left.
On the monetary policy front, there’s not a lot left. The Fed could cut interest rates below zero—essentially charging a fee for any bank that puts money on deposit at the Fed. Several other central banks have moved to negative rates, but the Fed has said it probably won’t.
It is also unlikely to buy government debt directly from the government as opposed to buying in the secondary market—a process known as monetizing the debt—as the Bank of England has agreed to do, temporarily.
Still, as Ben Bernanke and Janet Yellen, both former Fed chairs and now our colleagues at the Hutchins Center, outlined recently in the Financial Times, there is more that the Fed could do.
Here are some steps the Fed could take:
- The Fed still has room to expand its lending facilities. The Treasury initially pledged $50 billion from its Exchange Stabilization Fund to protect the Fed from losses. The $2.2 trillion CARES Act provided Treasury with an additional $454 billion that can be used to backstop the Fed’s programs and the new and expanded programs announced April 9 used $185 billion of that.
- Restart the Term Auction Facility, an alternative to the discount window. “Many banks were reluctant to borrow at the discount window out of fear that their borrowing would become known and would be erroneously taken as a sign of financial weakness,” the Fed said. Under the TAF, the Fed auctioned 28-day and, later, 84-day loans to U.S. and foreign banks in generally sound condition. “The TAF enabled the Federal Reserve to provide term funds to a broader range of counterparties and against a broader range of collateral than it could through open market operations. As a result, the TAF helped promote the distribution of liquidity when unsecured bank funding markets were under stress. It also provided access to term credit without the stigma that had been associated with use of the discount window.” Discount window borrowing peaked at a little more than $100 billion during the crisis; TAF borrowing at $450 billion.
- Broaden the range of financial firms that can borrow from the PDCF beyond the two dozen firms designated as primary dealers, to include hedge funds and other institutions not currently eligible.
- Once an economic recovery is underway, strengthen its forward guidance for maintaining near-zero interest rates and massive securities purchases, either by pledging to continue its extraordinary measures until a specific date or until specific economic or financial conditions are achieved.
The authors did not receive financial support from any firm or person for this article or from any firm or person with a financial or political interest in this article. They are not currently an officers, directors, or board members of any organization with a financial or political interest in this article. Prior to his consulting work for Brookings, Dave Skidmore was employed by the Board of Governors of the Federal Reserve System.
