The Federal Reserve responded rapidly to the coronavirus crisis. In addition to its traditional monetary policy, the Fed opened an array of emergency lending facilities. Of course, these measures were intended to be temporary. “When this crisis is behind us,” Fed Chair Jerome Powell said in May, “we will put these emergency tools away.” He made similar statements a week later and again in June.
Now three months after making that promise, the Fed’s lending facilities are still ongoing. In fact, some are just getting started.
The crisis period is now behind us. The need for these facilities, if ever there was one, is now past. It’s time to put away the emergency lending tools.
The Fed’s initial actions were swift and decisive. From March 4th to 15th, the Federal Open Market Committee cut its target for the federal funds rate to the range of zero to 1/4 percent. On March 23rd, the Fed announced “extensive new measures to support the economy.” In the following months, it purchased more than $2 trillion in Treasuries and mortgage-backed securities. It opened a variety of emergency lending facilities such as the Term Asset-Backed Securities Loan Facility (TALF), the Primary Market Corporate Credit Facility (PMCCF), and the Secondary Market Corporate Credit Facility (SMCCF).
Some of these facilities were previously used to support financial markets during the 2008 financial crisis. It’s not clear, however, that they were needed in 2020.
The Fed’s emergency lending powers under section 13(3) of the Federal Reserve Act may only be used “for the purpose of providing liquidity to the financial system.” Yet there was little evidence in 2020 of illiquidity in financial markets. Credit spreads and indicators of uncertainty, such as the Treasury-Eurodollar (TED) spread and the Office of Financial Research’s Financial Stress Index, were elevated to their 2001 levels but remained far below the heights of 2008. Some measures of volatility were elevated in mid-March, but this was due to high trading in financial markets—the opposite of illiquidity.
On April 9th, the Fed announced “additional actions to provide up to $2.3 trillion in loans to support the economy,” based on new powers granted in the Coronavirus Aid, Relief, and Economic Security (CARES) Act. Though described as “liquidity facilities,” many of the Fed’s new programs do not provide liquidity to the financial system. They involve lending to nonfinancial entities that do not make loans or create liquidity in the economy.
Through the Municipal Lending Facility (MLF), the Fed provides direct funding to states and municipalities, an area former Fed Chairs Ben Bernanke and Janet Yellen said was outside the Fed’s authority. When asked in 2011 Congressional testimony if the Fed would provide assistance to municipal governments, Bernanke said the Fed had “no expectation or intention to get involved in state and local finance” since it “is really a political, fiscal issue.” In 2015, Yellen similarly testified that municipal lending is something the Fed “shouldn’t be involved in.”
Rather than creating liquidity, many Fed programs merely reallocate credit by dictating which companies are and are not eligible to receive funds. The Main Street Lending Program (MSLP) supports bank lending to small and medium-sized businesses. The SMCCF buys corporate bonds in the secondary market, while the PMCCF lends directly to large companies. These programs allocate credit to specific nonfinancial businesses. They do nothing to improve general liquidity in financial markets.
Prudent central banks typically avoid lending to nonfinancial companies. When asked in 2008 if the Fed would lend to failing auto makers, Bernanke said, “The Federal Reserve would be extremely reluctant to extend credit,” since nonbank lending is an area that “has traditionally been outside the range of our responsibilities.”
More than four months since their announcement, many of the Fed’s emergency lending programs have just recently become active. For the controversial MLF, MSLP, PMCCF, and SMCCF programs, the most recent data as of August 19th show that only 5.3% of their authorized lending capacity has been used. Given their late implementation and low levels of adoption, the Fed’s facilities do not appear to be creating much, if any, benefit.
With the economy now recovering and still no signs of illiquidity, the fragile arguments for these emergency programs are becoming weaker still. Nonfarm payrolls increased by 4.8 million in June and another 1.8 million in July despite restrictive lockdown policies. The unemployment rate declined to 10.2%, putting it on schedule to beat the Fed’s forecast of 9.3% by the end of 2020. Uncertainty remains, to be sure, but these improvements indicate that the “emergency” period has passed.
While the CARES Act authorizes lending to nonfinancial entities, the Fed is not required to do so. The Federal Reserve Act only allows such facilities (1) in times of emergency and (2) to support financial market liquidity, neither of which applies today. Closing these facilities would minimize damage to the economy and help preserve the Fed’s independence.