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Fed Pulls Out All Stops to Shore Up Economy

Chris Gaetano
Published Date:
Mar 23, 2020

The Federal Reserve, in a bid to fight off an impending economic crisis, has announced unprecedented measures to shore up the economy, including removing multibillion-dollar limits on its bond-buying program, judging them to be insufficient.

Last week, the central bank announced it would be cutting interest rates to near zero, buying up $500 billion in U.S. Treasury bonds and $200 billion in mortgage-backed securities, lowering the dollar swap rate to encourage lending internationally, and making it easier to for banks to directly borrow from the Fed. This seemed to calm jittery markets a little, although major indicies continued to slide and credit remained increasingly difficult to come by.

Now the Fed has removed all limits from its bond buying program, making it effectively unlimited, by going from a hard number to saying it will basically be buying assets as needed. Further, purchases of mortgage-backed securities will be expanded to include agency-backed commercial mortgage-backed securities as well. An agency mortgage-backed security is one that is guaranteed by Freddy Mac, Fanny Mae or Ginnie Mae, as opposed to a non-agency one, which carries no guarantees and is usually considered riskier. This move indicates that the Fed is concerned that even support from a federal agency is not enough to ensure the safety of these investments.

The Fed also announced a slew of further measures meant to bolster other areas of the economy that have taken a beating.

One of the biggest is corporate bonds and, consequently, corporate debt. While credit has flowed loose and free for most of this past decade, leading firms everywhere to take on unprecedented amounts of debt, the outbreak has rained cruel, savage blows on the bond market, introducing new borrowing costs on entities that, previously, rarely had to consider costs at all. As the coronavirus freezes large sections of the economy, lenders are suddenly much more risk averse, which has meant that all but the most venerable of blue chips are unable to issue new bonds, leading some to max out their bank financing as they desperate scour the world looking for even the tiniest hint of liquidity.

As a result, the Federal Reserve is opening up two new market facilities meant to provide a backstop for the corporate bond market. The first, dubbed the Primary Market Corporate Credit Facility, will directly buy investment-grade corporate bonds with maturities of four years or fewer, provided they are U.S. companies with material operations in the United States. Eligible issuers do not include companies that are expected to receive direct financial assistance under pending federal legislation. It will also extend loans to corporations, though each borrower will be limited to between 110 and 140 percent of all outstanding bonds and loans over the past year, depending on credit scores. The Fed said that, for now, this facility is intended to stay open only until September.

The Secondary Market Corporate Credit Facility
does similar things but on the secondary debt market. (A bond is either issued on the primary market, which rolls out new debt, or on the secondary market, in which investors may purchase existing debt via brokers or other third parties.) The Fed will purchase eligible individual corporate bonds as well as eligible corporate bond portfolios in the form of exchange traded funds. Like the first program, it too is currently scheduled to end in September.

The Federal Reserve is also reopening the Term Asset-Backed Securities Loan Facility (TALF), which was last used during the 2008 financial crisis, as a way to reinforce the consumer loan market as well. This program had previously been (ahem) credited with kickstarting lending markets and preventing the collapse of several major companies. The program centers around asset-backed securities, which are a major component of funding the consumer credit market. For years, lenders have operated by selling pools of loans to a remote special-purpose vehicle, which then funds the purchase of the underlying loans by selling various classes of securities, which are in turn secured by the loans in the special purpose vehicle, thus creating an asset-backed security. The Fed's TALF program now, as it did in 2008, will allow the central bank to issue loans that use these securities as collateral. But this program applies only to securities backed by auto loans, student loans, credit card receivables, equipment loans, floorplan loans, insurance premium finance loans, certain small business loans guaranteed by the Small Business Administration, and eligible servicing advance receivables.

These most recent steps join numerous other measures the Fed has taken in recent weeks to settle the economic chaos brought by the coronavirus. These include:

  • The establishment of the Commercial Paper Funding Facility (CPFF), the Money Market Mutual Fund Liquidity Facility (MMLF), and the Primary Dealer Credit Facility;

  • The expansion of central bank liquidity swap lines;

  • Steps to enhance the availability and ease terms for borrowing at the discount window;

  • The elimination of reserve requirements;

  • Guidance encouraging banks to be flexible with customers experiencing financial challenges related to the coronavirus and to utilize their liquidity and capital buffers in doing so;

  • Statements encouraging the use of daylight credit at the Federal Reserve.

In addition to the steps above, the Federal Reserve expects to announce soon the establishment of a Main Street Business Lending Program to support lending to eligible small-and-medium sized businesses, complementing efforts by the SBA.

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