The Fed’s dilemma: picking the winners for $ 4 trillion in credit

WASHINGTON (Reuters) – When the Federal Reserve asked Wall Street about financial stability risks last fall, the “global pandemic” was not on the list.

FILE PHOTO: Federal Reserve Chairman Jerome Powell chats with U.S. Treasury Secretary Steven Mnuchin at the meeting of G20 finance ministers and central bank governors in Fukuoka, Japan June 8 2019. REUTERS / Kim Kyung-Hoon / Pool / File Photo

But the coronavirus outbreak has triggered virtually every other shocks that have been mentioned – from a stock market rout to a looming global recession – and is forcing the US central bank and the US Treasury to sort out a system that causes leaks every day.

Compared to the 2007-2009 collapse, which focused on the mortgage and financial markets, the current crisis is a much more complex problem, with the Fed having to intervene in virtually all aspects of trade and household finance. and American companies.

The challenge that the central bank now faces, in consultation with the Treasury, is to prioritize the market, the set of companies or the group of institutions to help next, because it plans how to raise more than 450 billion from seed money from the Treasury to perhaps $ 4.5 trillion in credit programs.

It’s an uncomfortable role that could push the Fed beyond its traditional job of keeping financial markets open and functioning, to pick winners and losers in any economy emerging from a pandemic. which practically crippled business activity.

“You have entered not only the world of accepting credit risk, but also its allocation,” said Mark Spindel, Fed historian and CEO of Potomac River Capital. Thanks to the $ 2.3 trillion emergency legislation passed last week, “Congress and the Treasury have decided to make the Fed the only balance sheet large enough” for any measures that may be needed.

At the extreme, this could include about $ 26 trillion in debt held by non-financial corporations and households – $ 16 trillion if you exclude mortgages.


Where the Fed will eventually draw the line remains unclear. Even after rolling out half a dozen sometimes groundbreaking new programs and billions of dollars in promised aid, there is still more ground to explore as the Fed plans to support not only large corporations with stocks and publicly traded bonds, but thousands of small businesses whose finances can be more difficult to assess effectively.

This “Main Street Loan Program” is due soon and analysts say it could provide up to $ 1 trillion to businesses with 500 to several thousand employees – too big for small business programs but too small to issue bonds or obtain loans on public capital markets.

Treasury Secretary Steven Mnuchin said on Wednesday that Treasury and Fed officials are meeting daily to move this effort forward.

“This is a very high priority … We want to make sure that middle market companies have access to liquidity,” he said.

Boston Fed Chairman Eric Rosengren, also speaking on Wednesday, told Bloomberg TV it will be a few more weeks before the Main Street program is ready to go.

But if the goal is to have a post-pandemic economy where conditions match the steady growth and historically low unemployment from the start of the year, as Fed officials hope, the list of other problems to it takes a long time to resolve.

In all likelihood, the Fed “will go further down the credit curve,” said Donald Kohn, former vice chairman of the Fed and now a member of the Brookings Institution think tank. But how far depends on “how much risk is the Treasury prepared to take?” Said Kohn. “How far do you want to go down the credit scale?” “

The riskier the debt – for example, “junk” corporate bonds are currently excluded – the more the Fed will ask the Treasury to provide money to cover losses, Kohn said, potentially depleting even the large pool of debt. funds authorized by Congress.

State and local governments are singled out in rescue legislation for further assistance. As a sign of the difficulties they are facing, the Standard & Poor’s rating agency said on Wednesday it now had a negative outlook for all U.S. public sector borrowers.

It remains to be seen how much the Fed will help them. A proposal presented by Democratic leaders in the US House of Representatives in a first draft bailout bill suggested that the Fed directly fund purchases of medical equipment and other pandemic response costs , an indefinite commitment to keep states and cities afloat.

Analysts increasingly believe that the Fed will be forced to expand the borders of its operations to stop what Moodys Analytics chief economist Mark Zandi has called a “vicious cycle” of activity leading to a standstill. credit deterioration that would disqualify otherwise healthy companies from Fed aid.


Retailers and restaurateurs, meanwhile, have widely asked for more help.

In a letter last week to Mnuchin and Fed Chairman Jerome Powell, National Retail Federation CEO Matthew Shay called for upcoming programs to be expanded to help large retail businesses with low credit, including buying longer-term corporate bonds currently excluded from Fed plans, helping smaller retailers, and hedging more types of consumer loans in the collateral accepted for Fed credit.

“Our members’ access to the programs contained in the relief program is critical not only for their financial survival, but also for the relief program’s ability to successfully stimulate the economy,” Shay wrote.

Senior Fed analysts and former officials say it is almost a given that the central bank will expand what is already a historic set of programs that are so far constrained by tight credit standards. In principle, the Fed is supposed to hedge against losses by supporting credit only to creditworthy companies and obtaining liquidity from the Treasury to absorb expected losses.

But these red lines can prove to be both impractical and arbitrary in a situation where businesses risk collapse due to public health decrees.

The implementation of the new programs will prove not only difficult from a philosophical point of view for a central bank supposed to grant credit only when it considers it safe, but also a logistical challenge for an organization. used to working with a handful of large financial firms, said Roberto Perli, a Core Macro Analyst.

“It’s doable,” Perli said. But “it’s complicated … It’s a huge thing the Fed is not set up to do.”

Reporting by Howard Schneider; Editing by Dan Burns and Paul Simao

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