Why Expiring Fed Programs Is No Emergency

The US Treasury made waves last Thursday after deciding not to extend several Fed emergency lending programs. Some disagreed with the decision, including the Fed. With many reactions and analyses politically charged, we urge readers to put political biases aside when assessing the pros and cons of the Treasury’s decision. We aren’t here to argue whether these programs should or shouldn’t continue, as that is a policy debate, and as always, we are politically agnostic. Our analysis is solely to assess the potential economic and market impact of this news. In our view, the expiration of these Fed programs, should that come to pass, shouldn’t imperil the economy or stocks—the recovery doesn’t depend on central bank aid.

Beginning in mid-March, the Fed set up 13 emergency lending facilities to support financial markets and the broader economy during the COVID-19 pandemic. In short, the alphabet soup of programs aimed to:

• Provide credit to primary dealers
• Provide liquidity to commercial paper and money market funds
• Purchase investment-grade corporate bonds and investment-grade corporate bond ETFs
• Enable and fund securitization of student, auto, credit card and Small Business Administration (SBA) loans
• Buy state and municipal debt
• Support small-business lending through the SBA’s Paycheck Protection Program (PPP)
• Lend to small and medium-sized businesses and nonprofits

Most of these schemes were originally set to expire September 30, but the Treasury and Fed previously agreed to extend them to December 31. However, per 2010’s Dodd-Frank Act, the Treasury has final approval on any Fed emergency lending program. With year-end approaching, the Treasury extended four of the lending facilities for another 90 days—specifically those backstopping commercial paper and money market mutual funds—and allowed the other nine to expire.

That decision triggered a sharp reaction. The Fed publicly stated it preferred to keep the full suite of measures in place. Others worried the Fed was losing critical tools to combat future market stresses. Several Democratic politicians claimed Treasury Secretary Steve Mnuchin’s move was a politically driven tactic to hurt the economy before President-elect Joe Biden enters office in January.

But getting beyond the politically tinged debate, a review of the lending facilities’ impact reveals mixed results, in our view. Some programs may have aided certain segments of the corporate debt market. For example, the Fed’s pledge to purchase corporate debt—perhaps particularly “fallen angels” (i.e., bonds that lost their investment-grade credit ratings)—may have quelled fears over a mass inability to rollover maturing debt. However, no counterfactual exists to confirm or disprove this. Would markets have stabilized without the Fed’s March announcement? Based on our research and experience, it seems likely—but perhaps the program sped this along, producing a net benefit. Many pundits also claim the Fed’s extraordinary measures bolstered confidence and boosted sentiment during a turbulent time. Yet we think it is equally possible some of March’s surprise announcements stoked panic by implying the Fed saw imminent financial collapse. Either way, the sentiment effect is hard to quantify.

However, the hard data are more clear-cut—and they show the Fed’s lending facilities were lightly tapped. Under the CARES Act, Congress allocated $454 billion to the Treasury to backstop Fed loans. Mnuchin made $195 billion available for five different lending facilities, including the Main Street Lending Program and the corporate debt-buying programs. Combining the Treasury’s commitment and Fed’s funding, these five facilities had about $2 trillion in lending capacity. Yet as of November 13, the total amount of outstanding loans across these five facilities was about $24 billion.^[i] For the Main Street Lending Program, total outstanding loans were just under $5 billion—even though the program had $600 billion available, backed by $75 billion authorized by the CARES Act.^[ii] Similarly, the two corporate debt lending facilities have a combined capacity of $750 billion—but the total amount of outstanding loans was $13.5 billion.^[iii]

Some experts think the Fed’s announcement sufficiently bolstered investor confidence, so the central bank didn’t have to intervene and purchase as many assets as it offered. Perhaps. But vehicles like the Main Street Lending Program didn’t garner much interest for more straightforward reasons: Banks didn’t have a lot of incentive to lend, and borrowers struggled to meet terms. Consider: At October’s end, the Fed lowered the minimum loan size from $250,000 to $100,000 and changed the fee structure to encourage banks to make smaller loans—illustrative of the program’s issues. We don’t doubt the Fed’s measures helped some, but the numbers suggest lending facilities haven’t been used enough to support claims they are materially bolstering recovery.

That point should help allay fears that removing policymakers’ “support” will upend economic growth. Even beyond this, the Treasury wants the Fed to return unused funds provided by the CARES Act so Congress can re-appropriate them for other COVID relief. While we always recommend taking politicians’ words with a pinch of salt, Mnuchin has been pushing for looser fiscal policy as Congress negotiates another COVID spending bill. The Treasury’s move would free up funds without adding new spending—appeasing many Republican Senators’ objections. Moreover, although critics argue Mnuchin is deliberately hamstringing his successor, the Fed can always request Treasury approval to restart these programs. With President-elect Joe Biden planning to nominate former Fed head Janet Yellen as Treasury secretary, some are already forecasting she will reverse Mnuchin’s decision. We don’t recommend trying to predict what a politician will do, but it is a possibility worth acknowledging today.  

As well-intentioned as the Fed’s efforts may be, these emergency programs aren’t going to help businesses make money if they can’t operate. For all the talk of these programs as “stimulus,” they don’t create or augment demand. They are more of a lifeline for some and a bailout for others. Our view remains the same: The biggest economic boost comes not from the Fed, but from getting back to something resembling normalcy as businesses and people get back to regular lives. Stocks are likely already anticipating that to an extent.