The Federal Reserve’s Coronavirus Crisis Actions, Explained (Part 6)

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Yves here. We’ve been so pre-occupied with trying to understand coronavirus and its progress that we’ve wound up neglecting important topics that would normally be at the heart of our beat, such as “What is the Federal Reserve up to?” with its many big ticket programs. Fortunately, Nathan Tankus has been all over many of the technical aspects of the coronavirus rescue initiatives, such as they are.

By Nathan Tankus. Originally published at Notes on the Crises

I apologize for the long delay in posting this free post. Between the new announcements and some personal issues, it took me much longer than expected to finish it. I’ll endeavor to avoid delays in the future, especially by having “reserve” posts ready in case something interrupts me finishing posts in the future. My second premium post should be up tomorrow evening.

This is part 6 of my ongoing coverage of the Federal Reserve’s Coronavirus actions. You can read Part 1 here, Part 2 here, Part 3 herePart 4 here& Part 5 here.  It has been two weeks since I covered Federal Reserve crisis actions so I figured it was time to provide an update. Most of the recent actions have been relatively minor up until Monday’s expansion of the Municipal Liquidity Facility and Thursday’s expansion of the Main Street Lending Program. I’ll be analyzing them near the end of the post (feel free to skip to those sections).

April 14th

That Tuesday the Federal Reservejoined fellow financial regulators in loosening appraisal requirements for property mortgages. Recall that, as I discussed in my #MonetaryPolicy101 post on Central Bank Collateral Policy, collateral worthiness is an important aspect of securing financing. Sometimes, collateral worthiness can justify originating a loan to a completely uncreditworthy borrower. In normal times, this leads to the importance of determining a collateral price. In our current property mortgage system, collateral prices are determined by appraisals by professional appraisers which are notionally related to market prices. However, appraisals (and thus appraisers) themselves have big impacts on market prices. This mutually reinforcing feedback loop makes control of appraisers a powerful tool of financiers committed to creating a housing boom and housing price inflation. Indeed, blacklisting and coercing real estate appraisers was an essential part of the systematic mortgage fraudepidemic that caused housing price inflation leading up to the great recession.

All that is simply to say that appraisal is an important component of the collateral formation process in real estate. In this case, there is an interesting dual dynamic happening. On one hand real estate appraisal is not an essential activity and risks infection. Without any rule change, mortgage credit would be inhibited by the inability to get required appraisals (thus illustrating how qualitative requirements are critical for grasping how “easy” credit is). On the other hand, more frequent appraisals (and thus less “stale” i.e. old market prices embedded in collateral prices) reinforces the feedback loop between appraised prices and market prices. As a result, the Federal Reserve and other financial regulators have announced that financial institutions can defer appraisals for 120 days. Importantly, the appraisals are not canceled. Their announcement frames the issue around the first issue, but it is hard to believe that regulators aren’t also thinking about the stabilizing influence on real estate markets of collateral prices not experiencing immediate downward adjustments.

April 16th

That Thursday’s announcementsimply announced that the Paycheck Protection Program Liquidity Facility was now operational. While this facility makes sense, as I said in the last entry in this series, its existence says extremely negative things about the program design Congress went abou regarding the PPP and congress’s encouragement of a separate Main Street Lending Program:

This facility on one level makes sense- the Federal Reserve should do all it can to support congress’s program to help small businesses. On another level, it drives me absolutely crazy. If we were simply going to have banks originate loans and then have the Federal Reserve purchase them, why did we bother with congressional appropriations in the first place? This could have simply been a part of the Federal Reserve’s Main Street Lending Program. The political football that is the losses the Federal Reserve would have taken from forgiving loans could have been fixed by alternative accounting gimmicks. Instead of equity stakes into Federal Reserve SPVs, congress could have simply said that all losses should be booked in a separate emergency facility account that doesn’t count when calculating the Federal Reserve’s net-worth. Simply having the Fed manage and implement this program would have been far simpler than trying to roll out this program and have the Fed come in to fix technical issues in the background. This is a clear case where congress didn’t adequately think through program design and their initial design has been rendered incoherent by subsequent events.

This question remains relevant to this day. I plan to write more about this specific issue in the future. A minor point worth noting is that this program is run by the Federal Reserve Bank of Minneapolis. A strange feature of the Federal Reserve’s structure is that discount window lending- i.e. direct bilateral lending by the Federal Reserve to sub-federal governmental and private entities- is not under the direct control of the Federal Reserve Board. This doesn’t operationally make much difference today (though historically relatively minor differences between regional discount window policies have had macroeconomic effects) but it is legally quite important. This structure has partially shielded the Federal Reserve in past court cases from Freedom of Information Act requests, albeit under specious reasoning. Further, those who go hunting for crisis facility information will need to target at least three regional Federal Reserve Banks by my count.

April 17th

That week ended with an announcementof a technical regulatory rule change to facilitate small business participation in the PPP. Earlier in April, the Small Business Administration clarified that banks can make loans to businesses which are owned by major shareholders of the bank and members of their board of directors. This is allowed with “certain limits and without favoritism”. How favoritism is prevented, isn’t said. Yet the SBA can’t deal with this issue on their own, as they are not bank regulators and bank regulations have limitations on board of director and major shareholder lending as well. Thus, this announcement adjusted Federal Reserve regulation to be consistent with the SBA’s new rules. Fitting the pattern of lack of governmental coordination or congressional planning, this rule change came the same day that the PPP ran out of money. This is yet another example where administration by banks (and administration by both financial regulators and the SBA) has been complicated and slowed down the loan origination process. Banks are not good intermediaries for government action and we don’t need credit assessments at all.

April 23rd 

The next week was a quiet one for the Fed, with a flurry of relatively minor announcements on Thursday. The first announcementwas a significant one for transparency. Under pressure from an external campaign, led by Cares Act oversight commissioner Bharat Ramamurti, the Federal Reserve announced that it would publish:

  • Names and details of participants in each facility;
  • Amounts borrowed and interest rate charged; and
  • Overall costs, revenues, and fees for each facility.

These publications will be posted on their website and come every 30 days. As discussed, this is important because legislation over Freedom of Information Act requests and Federal Reserve Banks is complex and takes years. It is a very good thing that the Fed is conceding to this political pressure, though there is likely a lot more information that is worth bringing to the attention to the public.

The second announcementis an expansion of intraday credit. This time, the Federal Reserve is completely uncapping uncollateralized loans for chartered banks. As I’ve written in the past, the necessity for these policies in crisis makes a strong argument for making them permanent. The third announcementis simply that the Federal Reserve is working to expand access to the Paycheck Protection Program Liquidity facility to non-chartered banks. The need for these rolling and complex rule changes plus the discriminatory history of bank lending strongly suggests that banks need to be abandoned as policy intermediaries.

April 27th

The most important announcement covered in this post is far and away the expansion of the Municipal Liquidity Facility on Monday. This announcement is clearly a response to criticism of how high the population requirements were when the program was initially announced. I played a minor role in these criticisms by amplifying criticisms Aaron Kleinof Brookings made on twitter, which he later wrote up in a Brookings report. Some of my criticisms, and even a post of mine(!!!), made it into Congressman Bill Pascrell’s letterto Federal Reserve chairman Powell. The same day, a far more politically potent letter was sent by 5 Democratic senators (including Elizabeth Warren and Chuck Schumer) echoing Klein’s points about the “arbitrary population cutoffs” and their racial implications.

Thus, it’s no surprise that the main way the Fed expanded the MLF is by lowering the population cutoffs. Now cities with a minimum of 250,000 residents and counties with a minimum of 500,000 residents can access the Municipal Liquidity Facility. This expansion is really rather large. I still think they could expand the program more by requiring the largest political subdivision in a state to administer loans to small counties and municipalities if the state government will not. However, this criticism is far smaller than the initial criticisms of the MLP, which would have really hampered its effectiveness. This program also expands the maximum maturity of a loan to 36 months.

Like other programs, eligible issuers who have experienced coronavirus rating downgrades are “grandfathered” in. The remaining largest problem with the program is the requirement of an investment grade rating. Local governments are not private businesses and the “moral hazard” of “bailing out” these sub-federal governments should be treated orders of magnitude differently. This is especially the case as so many lives hang in the balance of what state and local governments spend today. It’s hardly conceivable of a scenario where loosening financial constraints today as much as possible doesn’t provide large net positive outcomes. The size of the purchases also remain at 500 billion dollars, which should be expanded further (or even uncapped).

Finally, The Federal Reserve announced that it was

considering expanding the MLF to allow a limited number of governmental entities that issue bonds backed by their own revenue to participate directly in the MLF as eligible issuers

This opens the door to providing direct support to public universities. I plan on writing about this in the future, but one way to approach such a proposal would be to have universities issue payment anticipation notes which are receivable for all payments to universities and have the Federal Reserve purchase them, similar to my local currency proposal. Universities are a major site of state and local austerity and relieving their burdens through their own local currencies has rhetorical, as well as practical, benefits.

April 29th 

This past Wednesday, the Federal Open Market Committee- the Federal Reserve committee which determines the policy path of interest rate and liquidity policy- put out a regularly scheduled statement. The statement doesn’t say much except that they are holding interest rates and purchase programs where they are. I will write more about FOMC statements in the future.

April 30th

As if Monday’s announcement wasn’t enough, the Federal Reserve announced an expansion of the Main Street Lending Programthis past Thursday. This program was changed in three essential respects:

  1. It was expanded to include businesses with $5 billion dollars in revenue and up to 15,000 employees (up from $2.5 billion and 10,000 maximum employees)
  2. Lowering the minimum loan size to $500,000 dollars
  3. Creating a third loan option for riskier loans which banks in turn take a greater stake in (15%).

In the abstract, the first two changes are fine. The concrete policy concern is that the first two changes, when combined with the third change, is a de-facto rescue of the oil and gas sector. These concerns are heightened because the Trump administration had just been discussingproviding Oil and Gas companies direct support, even suggesting they may use the Federal Reserve to do it. Again, commissioner Bharat Ramamurtiis leading the charge on this issue. Energy secretary Brouillette even tweetedabout the announcement that it was “[g]reat news out of the Fed today in support of struggling U.S. energy companies”.

This issue shakes up the debate over “green central banking” as now we have the question of how much the Federal Reserve should be acting to accomplish environmental policy goals when providing emergency liquidity to financial markets and financial institutions. It was one thing for the Federal Reserve to claim that it was the job of congress or other regulators to implement preferences for “green” production as opposed to “brown” production. It is quite another for the Federal Reserve to use emergency authority to provide subsidized emergency liquidity directly to fossil fuel companies. It becomes much harder at that point to claim that the Federal Reserve isn’t making active choices in this area. If we are not inclined to provide Oil and Gas companies subsidized credit, what other options are there that will deal with problems in this sector in an orderly fashion? This is a big question for policy analysts in the coming months and even years.

Finally, the increasing reliance of this program on loan originators retaining a portion of the loan on their balance sheets seems likely to enhance discrimination. Banks are not good intermediaries and the more you rely on banks using up their own balance sheet for your loans, the more dysfunctional the program will become. As discussed earlier, it’s not clear that the MSLP is ready to function properly. Meanwhile, reliance on loans cuts out the most leveraged companies and ensures procyclical behavior on businesses. Who wants to keep 15% of a loan on their books which won’t be repaid in any way for at least a year?

Conclusion

With that, we’re caught up through the rest of April. Sans a big announcement in the coming week, I doubt I’ll be returning to this series until mid-May. The big theme of this set of announcements is expanding already announced programs. The big expansions this time around came in the Municipal Liquidity Facility and the Main Street Lending Program. The MLF’s expansion was clearly a big net positive, though some problems remain. The MSLP expansion is more mixed and brings up pointed climate change concerns in a sharp matter. The other expansion that’s happened is over Federal Reserve transparency. That is a hard-won public good, especially in the middle of crises. We need to fundamentally restructure the Fed’s relationship to FOIA. In the midst of all this, the problem remains the same- the economy has lost a huge amount of income and no one is replacing it at a remotely adequately scale to prevent depression.

Stay Safe!

-Nathan

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19 comments

  1. JBird4049

    Thanks for this. I shall have to read the whole series even though reading about the Fed’s actions in detail is about as fun for me as eating uncooked plain kale. Maybe I will have some ice cream while reading. :-)

    >>”In the midst of all this, the problem remains the same- the economy has lost a huge amount of income and no one is replacing it at a remotely adequately scale to prevent depression.”

    Also, just why is the Fed, the Treasury, Congress, the Easter Bunny, etc prancing around at edges with silly stuff like interest rates, more loans, more of everything, but hardly doing much to replace nonexistent income? No income, no business means no business, no income. You need both at the same time for an economy to function. Without making sure that everyone from someone living in their car to the owners of the biggest local businesses get some guaranteed income to stay alive and maybe a little more besides, there will not be a functioning economy very soon especially as the unemployment rate is already above 24%. Is it some sort of ideological death wish?

    Reply
  2. Ignacio

    Sometimes, collateral worthiness can justify originating a loan to a completely uncreditworthy borrower.

    This prompted me to stop and comment. This suggests what the credit market is in reality. It is not about allocating money in the real economy but about the allocation of money in securitization and financial secondary markets. These are the real drivers of credit markets aren’t they?

    Reply
    1. Samuel Conner

      I’m not sure that this is what NT was implying in the remark. Asset-backed lenders (at least at the time I had some awareness of the business) lend (at above typical bank rates) to distressed (and therefore highly risky — uncreditworthy in the sight of conventional bank lenders) borrowers who can offer the security of high quality collateral. Owners of distressed businesses (there are many of them at the moment) may be desperate for liquidity and willing to risk losing everything in the hope that a high cost infusion will allow them to recover. And I think the collateral value is haircut so steeply that the lender makes a profit even if the borrower defaults. His point in mentioning this is, I think, that in ordinary times, assessing the market value of collateral is really important for credit formation. Asset-backed lending is the starkest illustration of this, because in such cases, collateral value is all there is to justify the extension of credit.

      But I think that your inference is valid. The point, any more, of the credit formation system appears to be to generate profits through various forms of engineering (plain vanilla securitization being the simplest form of this). There does need to real economy economic actors at the base of this “food pyramid” to generate earnings from real economic activity which fund the income flows into the lowest layer of financial instruments, but whether or not the real economy actors thrive is not of much concern to the apex predators. A sick host may be able to support a flourishing population of parasites; doubtless there is a Laffer-curve-like relation between the size of the financial and real economies.

      It feels a bit like what health-care provision has become in US.

      Reply
    2. Susan the other

      That line set me off too. Thinking back over 65 years of real estate inflation which started in the US 10 years before the Vietnam War, it’s a little hard for me to swallow that premise – when Nathan (and everyone else) calls this “mortgage fraud”. It was more like long accepted financial practice. And my prejudices tell me that there was always a imperative for it – which was that the entire economy was inflating due to the world-wide efforts of our MIC. A very expensive undertaking when you’re trying to balance the books. So naturally everything had to “inflate” – it really annoys me that suddenly, after 65 years, the housing industry, and it’s enabler the mortgage industry, are getting the blame for the entire 20th century of mismanaged capitalism. Or perhaps I should say mismanaged imperialism. The reason we had the 2008 “mortgage and housing crisis” was because there literally was no place left for profits to go – we had inflated the financial world seeking returns on investment, to make everything look balanced, until we couldn’t come up with any more “investment vehicles.” It was always only financial fraud, spread throughout the entire economy.

      Reply
      1. periol

        Susan, I find your comments to be full of gentle wisdom.

        As you say, the problems with mortgages and the housing market are a feature, not a bug, of the current system. There’s lots of spin and misdirection in the media to get people to look elsewhere, but there is no doubt things have been working largely as intended, even the crashes.

        When you draw the housing market shenanigans out just a bit farther, you really start to get to one of the main reasons for the surge in homelessness in America of late. It’s not because the homeless can’t pull themselves up by their bootstraps, it’s that there is literally nowhere for them to go.

        Edit to add: I have been waiting for confirmation that the government was going to bail out the shale industry. All the media talk about capitalism and private enterprise notwithstanding, the shale industry has always been coddled by the feds – it is essentially a state-supported industry that enriches a few insiders along the way.

        Reply
      2. Susan the other

        But to get back to Nathan’s main point which is how do you value “collateral worthiness” – that’s the big question. To my thinking, as long as collateral represents the product of real work, it’s good. So that means the question isn’t about collateral, it’s about the effort it took to create the item. Is it real or is it paper? Has it been built up over many years? Is it important to the economy; to society? But clearly if we ask limited collateral to carry an over-burden of value just so the economy (aka the currency) doesn’t crash we’ve got a problem. Because there isn’t enough collateral for the task. Congress might easier put a price on everyone’s head. And literally helicopter the wealth. It is completely justified socially and economically because we are all consumers; what else can create demand? So with that in mind maybe we should stop appraising and rehypothecating collateral altogether. And just go ahead and nationalize the banks.

        Reply
        1. skippy

          So many roads lead back to Plaza and the advent of the shadow sector where banks had their share of capital formation stripped which led then to innovation [tm] in the C/RE sector et al.

          Whack on a bit of atomatistic individualism investor skin in the game or die and now you have the proverbial ‘Reality what a Trip’ microwaved hamster skit.

          Anywho tis old but short and concise:

          The main points of neo-liberalism include:

          THE RULE OF THE MARKET. Liberating “free” enterprise or private enterprise from any bonds imposed by the government (the state) no matter how much social damage this causes. Greater openness to international trade and investment, as in NAFTA. Reduce wages by de-unionizing workers and eliminating workers’ rights that had been won over many years of struggle. No more price controls. All in all, total freedom of movement for capital, goods and services. To convince us this is good for us, they say “an unregulated market is the best way to increase economic growth, which will ultimately benefit everyone.” It’s like Reagan’s “supply-side” and “trickle-down” economics — but somehow the wealth didn’t trickle down very much.

          CUTTING PUBLIC EXPENDITURE FOR SOCIAL SERVICES like education and health care. REDUCING THE SAFETY-NET FOR THE POOR, and even maintenance of roads, bridges, water supply — again in the name of reducing government’s role. Of course, they don’t oppose government subsidies and tax benefits for business.

          DEREGULATION. Reduce government regulation of everything that could diminsh profits, including protecting the environmentand safety on the job.

          PRIVATIZATION. Sell state-owned enterprises, goods and services to private investors. This includes banks, key industries, railroads, toll highways, electricity, schools, hospitals and even fresh water. Although usually done in the name of greater efficiency, which is often needed, privatization has mainly had the effect of concentrating wealth even more in a few hands and making the public pay even more for its needs.

          ELIMINATING THE CONCEPT OF “THE PUBLIC GOOD” or “COMMUNITY” and replacing it with “individual responsibility.” Pressuring the poorest people in a society to find solutions to their lack of health care, education and social security all by themselves — then blaming them, if they fail, as “lazy.”

          Hell of a thing to consider everything is the result of PR/marketing dressed up as cobbled together metaphysics to reach some promised* land ….I guess you’ll get that when some are devout about immutable “Laws of Economics” [see aforementioned]. Its manic, even now I’ve had conversations with card carrying members only to be told* those – truths – dictate every possible option available to sort society out – so OT.

          Wellie back to another old Q’lder house, lady of the house has been working at home and works for a private health distribution mob. Funnie conversations with her as she is part of the financial prediction team E.g. why does the painter have so much information about this stuff and beyond … maybe I could halo into a bunch of Zoom meetings … that would be worth it just for the looks on some faces …

          Reply
          1. JBird4049

            Thing is that an immense amount of wealth for at least 80 years has invested into creating this neoliberal groupthink. It is why public schools, colleges, and universities have been stripped of their liberal arts components because it helps prevent groupthink or at least show to students that they are other ways of doing things.

            Reply
            1. skippy

              Well antiquated with the history aspect from being informed and watching it personally over some almost 60 years.

              Best is watching anything that might threaten it get folded into it.

              Reply
  3. NoBrick

    “…when calculating the Federal Reserve’s net-worth. ”
    Beyond reality/truth is what “we” say it is, how does one assign a finite value to infinity?

    Reply
  4. K teh

    Productivity keeps falling and sunk cost assets keep inflating for a reason and the functionaries in DC have nothing to do with it, which this case should make obvious.

    No one capable of real operational leverage is going to work for electronic money or the landlords. That’s a false choice created by government regulation to the end of corporations.

    Trump, for example, was just a fork in the eye of the establishment. If he were really a nationalist, he would be promoting independent, free-floating currencies, not employing SWIFT as a weapon like everyone else (not that competitors would do otherwise).

    This circus can only grow, exponentially. Collateral assessment and debt covenants have been a joke for decades. When the landlords use the word conservation, what they mean is price control and financial ghetto development.

    Reply
  5. Jeremy Grimm

    I am mesmerized by the complexity of allocating the peanuts bag of federal money ostensibly proffered to help small and medium scale business, and cities, and governmental entities, and supposedly help employees and individuals. While trying to fathom this complexity I have lost track of where the giant-sized bag of federal money is going. I am also a little surprised at how casually such broad and far-reaching powers have been ceded-given to the FED. The FED doesn’t answer to or care about the Populace [although I fear neither do the ‘elected’ or ‘appointed’ portions of the Government].

    As I read this post one sentence, actually from an enclosed extract under the April 16th heading of this post, caught my attention: “This is a clear case where congress didn’t adequately think through program design and their initial design has been rendered incoherent by subsequent events.” I think this is a most generous characterization of congress in light of the speed with which the CARES Act appeared and became law. Did congress give any thought to the design of the programs in the CARES Act? Somebody did and my impression is that they gave almost all their thought to designs for handling the giant-sized bag of federal money which seems to be flowing somewhere with remarkable efficiency. The peanuts bag appears — to me — to have been tossed into the CARES Act as a useful distraction.

    Reply
    1. JBird4049

      Yes, as complexity equals confusion equals opaqueness, which means that the grift can be unhindered. Only problem is that they don’t realize just how bad things are. If everything collapsed, money is just paper.

      Reply
      1. Jeremy Grimm

        And I would add to your apt observation that ownership — which is based on paper — is not possession.

        Reply
  6. Kirk Seidenbecker

    The lack of transparency of a uniform real estate assessment system is the nut of how lending facilities gain leverage.

    https://michael-hudson.com/2001/10/the-land-residual-vs-building-residual-methods-of-real-estate-valuation/

    https://michael-hudson.com/2001/03/where-did-all-the-land-go-the-feds-new-balance-sheet-calculationsa-critique-of-land-value-statistics/

    Lawson Purdy wrote about best assessment practices a hundred years ago –

    https://archive.org/search.php?query=Lawson%20Purdy

    Reply

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