Fed Goes All in With Quantitative Relief Program

Federal Reserve

While the bickering in Congress over a fiscal stimulus bill of enormous proportions continues, the Fed has thrown caution to the wind and will even be buying ETFs.

Given that the Federal Reserve has already gone to the felt with interest rate cuts, that doesn’t necessarily mean that they are finished. They do have some more tricks up their sleeve in addition to the $700 billion worth of treasury buying and the even larger sums that they have pumped into the repo market.

Both the 1.5% that they have cut interest rates by in their response to this crisis and buying treasuries are designed to stimulate borrowing, even though this does not really address the major problem that we are facing. They have come under criticism from many for putting the pedal to the metal with both these monetary tools, and it’s about to get bigger, perhaps much bigger.

The coronavirus panic is a completely different situation than anything we’ve ever faced. In normal times of economic contraction, we are put in a position where the amount of credit out there drops for organic reasons, comparable to your gas tank running too low and in need of more gas pumped into it. Our car has instead broken down, and a full tank of gas just isn’t going to help much.

Rate cuts allow us to borrow more than we normally could afford to because the cost of borrowing drops, and when the Fed charges less to banks to lend them money, they can in turn charge their clients less. Banks never run out of money to lend, at least normally, and the biggest job of the Fed is to make sure that banks can borrow as much as they want from the Fed at all times, which is why they need to keep the repo market, the fund that banks use to borrow from them, well stocked at all times.

Since credit is the new gold, if a client wants to borrow and there is no one to lend to them, this results in not just a lost opportunity to the lender, it’s far more serious. This is called a liquidity crunch, a crisis really, and this can take down the entire banking system and the economy in turn if left unaddressed.

The Federal Reserve therefore needs to make sure this doesn’t happen, and while they may put down rates like they recently have, for this to work, there must be enough supply of funds to satisfy the needs of this market. This is the plumbing of our banking and financial system and we do not want these pipes to burst, like they almost did during the financial crisis 4 years ago, where lending became curtailed for only a brief time and that led to the biggest panic of the crisis.

The Fed does seek to provide controls on this, but the controls are the rate, and they want to make sure that there is enough money to go around when banks come calling. The biggest issue when we have a liquidity crunch in the repo market is that this can curtail banks lending to one another, and that’s the point where the house can come down if the problem isn’t fixed immediately.

This is particularly important if the Fed wants to stimulate credit markets, as this is like a store holding a big sale but running out of merchandise to sell. That’s not going to drive the business like we need it to and while stores can shut down, banks cannot stop intra-bank lending as this is the backbone of the whole financial system.

Without this ability, you could not even buy anything with plastic anymore, because for this to work, banks must settle the payments. Seeing this go down would be an actual catastrophe, greater than anything we’ve ever seen, and we came dangerously close to this in 2008. If we can’t buy anything, this makes our current shutdown look like a party.

This is what all that repo money serves to do, and this is tweaked to demand, where you can’t really overdo this but you can underdo it. Seeing trillions poured into this market by the Fed should not alarm us no matter how much money is provided as this is like worrying about putting too much gas in your tank, and you will just burn what you need with the rest in reserve for another day.

Changes in the rate that this money is borrowed at is a different story. Having enough makes sure that the supply is sufficient at all times, but the rates affect the demand, with lower rates increasing it and higher rates restraining it. When we want to slow down the economy, we will put the rates up, and this allows us to borrow more, and creates new money that way. Putting the rates up slows down borrowing and puts the amount of credit in the system, the money supply, downward and the economy slows down.

The Fed buying and selling securities serves the same purpose, with their buying being the gas and their selling being the brakes on the economy. They have put the pedal all the way down to the floor with interest rates, but they can always buy more securities, and all they need is the will as they can basically buy all they want. The brakes part of this does involve them holding securities to sell, so that side does have limits, but if they empty their balance sheet, they can always turn to rate hikes to contract the economy to the desired level.

Using interest rate cuts are therefore limited on the expansionary side in practice, given that we really should not ever want to go below zero, but unlimited on the contractionary side, while securities buying is limited on the contractionary side but limited only by will on the expansionary side.

Right now, they are going all out to expand, and while they always set limits to how much buying they will do, like the $700 billion intention not long ago, the limits have now come off and they are just going to buy as much as they feel the need for now, which is a very big change.

This Time, the Government Deserves to Bail Us Out, as they are the Jailors

Given the hit our economy is taking from the big shutdown, this might sound pretty good to us until we realize that the current problem runs a lot deeper than just the need for cheap credit. All monetary policy is completely directed at expanding or contracting the credit market, increasing or decreasing borrowing levels, but this requires that there is enough demand for borrowing at prevailing rates, market rates and not Fed rates, to make this work.

Companies in distress would surely like to borrow more, but in times of crisis, capacity becomes an issue. Monetary policy does well when the issue is one of liquidity, in other words on the supply side of the equation, and this can stimulate demand as well, but just like we want to be careful not to borrow so much that this ends up exceeding our capacity to repay, companies need to do the same thing, and will be forced into this by the market.

Aside from the Fed rate, rates that companies borrow at are related to the risk that they represent, and no matter how low the Fed rate is, lenders need to account for the risk involved and have to price this into the cost of borrowing. A simple example would be a company in trouble needing to borrow more to keep things afloat, airlines for example, and with so many planes sitting idle and no concrete idea of when this will end, they will be charged more, whether by institutions or the corporate bond market, due to the greater risk involved.

While they are lining up with their hands out now, asking for bailout money, this can be necessary for their survival no matter how much monetary stimulus we have. A lot of people are four-square against bailouts and want the money put in their own pockets instead, but it is because they have no idea of the importance of these bailouts when they are really needed, and don’t get why giving these companies bailout money is a lot more important than seeing it being given to them and other Americans.

This goes far beyond just someone working for Boeing and losing their job. Boeing makes a huge contribution to the American economy, and if they go down, everyone gets hurt, and hurt in a way that would well surpass the comparative value of their pocketing the money instead.

Unfortunately, a lot of politicians don’t have a very good understanding of any of this, especially a lot of Democrats, who may mean well by wanting us to weigh the scale toward ordinary people but don’t really get the fact that we first and foremost have to prevent economic collapse. It wouldn’t take all that long to shut down this much business and see business failures occur at a rate that would put us in a very long and painful depression, and this is exactly what caused the Great one.

Bailouts were not at all optional in 2008 and they ended up saving us, and the wolves would have broken down the door and thrown us into a massive depression had we not acted the way we did. We’re not quite in this much danger this time, yet, but with the panic set to last for a while yet as we keep things closed and watch the infection rates climb each day, this is not something to be trifled with.

All the Fed’s horses and all the Fed’s men, and women, are not equipped to save us from this, or do very much to help us as it turns out, because monetary policy cannot put the money that these companies need to survive in their hands. They cannot control business risk, and that’s the real problem right now, and these companies would love to borrow at 0% but they cannot, and their rates are going up at an alarming rate instead.

The corporate bond market is a real battleground right now, and when this goes south enough that companies can no longer maintain their bond obligations, it’s time for the undertaker. This is an area that the Fed can indeed help significantly in a crisis like this, by more directly influencing the corporate debt market by writing some very big checks.

In order for this to work efficiently, the Fed needs to buy these corporate bonds directly from the companies, not on the secondary market. Increasing the demand on the secondary market won’t really do much good because it doesn’t matter what these bonds are trading at once they companies issue them, as they have already collected the proceeds of them before they even get traded.

This is similar to a company issuing stock to the market and getting the issue price, and then after that, the company itself doesn’t benefit or are harmed by where the stock goes to, although the officers and other major shareholders within the company sure are. That pertains to their personal wealth and not that of the company though, and it’s the companies that are in trouble here and in need of help.

Buying Their Bonds Can Help, But Only Handouts Will Keep Things Together

There’s still only so much you can do with the Fed buying bonds from companies directly, as their capacity to repay is still an issue, and helping companies borrow their way to their doom cannot be the goal here. Buying bond ETFs really don’t help these companies though, although this does help corporate bond investors by artificially driving up the price of these bonds so that they can be sold by them at higher prices than otherwise.

If we thought that the Fed was fiddling around too much with monetary policy, trying to fight a bear with a jackknife essentially, they aren’t even fighting the right problem when they buy bond ETFs, at least if we’re worrying about the health of the economy. This is a bizarre move actually, and they need to be giving the money to those who need it other than to provide bond investors with a nicer parachute should they feel the need to jump. It’s not that this isn’t a nice to have, but it pales compared to the need to haves.

Buying corporate bonds directly still only goes so far, and in these times, the companies don’t need a loan, they need rescuing. As vile as the 99% mob may see it, this bailout money ideally should not be expected to be paid back, as their capacity during normal times is limited, and they tend to drive close to the shoulder as it is. This is not money that they can afford to pay back unless we want them to be in pain later, and perhaps even enough to put their necks at risk once again.

Someone has to bear the loss here, and if it is the companies that do, we all pay the price for this as this can put a drag on our economy for years. Governments are responsible for all of this current pain, and it is very appropriate that they bear the full costs of remediation. We don’t need or want a payment plan for this that will prolong the pain of this for a long time.

If this mob really understood anything, they would be picketing Congress begging that enough bailout money be provided. However, if a lot of politicians don’t understand why this is so crucial, it is far too much to expect the average American to, who only see themselves sitting at home and out of work while they wait for this all to pass and the bills pile up in the meantime, while companies get trillions of dollars’ worth of what they see as welfare.

They need to be enlightened much more, like showing them what might happen to them if we do not do this, when they are out of work for real and getting their meals from a soup kitchen like they did during the last depression. We left businesses to die back then, instead of helping them, and even the Fed turned their back on who they are supposed to protect, the banks, and allowed far too many to go under. This produced 10 years of economic pain at a level that we had never seen before nor since.

Since we’ve chosen to imprison our economy, we can’t just let them starve and have to keep them fed while in jail. There is no alternative, and even if we take off the restrictions, people are still going to be too afraid to let business return anywhere near normal.

Just like in 2008, there is too much at stake for the Democrats to refuse to help, although we need to be careful that we help enough. If not, we’ll have a lot more to worry about than a few thousand people dying of the virus, as this will see us all infected by a financial virus that has the potential to infect our wallets in a way that will affect not only a very few of us, but all of us.

Andrew Liu

Editor, MarketReview.com

Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.