Conventional wisdom says the Fed is pretty much out of tools to support markets and an economy derailed by the coronavirus. But if things don’t stabilize soon or if the fiscal response is too slow, we expect the Fed to take on broad fiscal-like authority to funnel liquidity into struggling businesses and households.
In an all-out effort to support markets, the Federal Open Market Committee (FOMC) recently cut its benchmark rate to zero, resumed quantitative easing (QE) and committed to pump several trillion dollars into overnight repurchase markets if necessary. Many assume that the Fed has little left.
We think that’s half true.
Scraping the Bottom on Monetary Policy
The true half? The Fed’s monetary-policy options have dwindled. It doesn’t believe negative rates are appropriate, and it has already restarted QE, which helps the economy by lowering term interest rates and providing guidance on how long rates will stay low. But with rates already at record lows across the yield curve and rate hikes nowhere on the horizon, we don’t think QE will be very effective at boosting growth.
The Fed has a few other things it can try, mostly related to pushing inflation expectations higher, but inflation hasn’t responded to monetary policy so far in this cycle. Until the Fed can show that it can boost inflation, showing a willingness to do it is close to meaningless. From a monetary-policy perspective, we don’t think there’s anything left in the Fed’s tank.
How Section 13(3) Could Change the Game
However, we do think the Fed still has a role to play because of its ability to pitch in with crisis management. This role stems from a part of the Federal Reserve Act that hasn’t really been in play since the global financial crisis (GFC). It’s called section 13(3), and it gives the country’s central bankers the authority to:
“…discount for any participant in any program or facility with broad-based eligibility, notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal Reserve bank.”
In plain English, the Fed can create a facility to funnel money to distressed areas of the economy. It used this authority to save Bear Stearns, bail out AIG and create the primary dealer credit facility (PDLF), term securities loan facility (TSLF), term asset-backed securities loan facility (TALF) and commercial paper funding facility (CPFF) during the GFC.
Those moves reduced risk in the financial sector, and in our view helped keep the financial system from collapsing during that difficult period. Already this week, the Fed has restarted the CPFF and the PDCF, so it’s clear the central bank is willing to use 13(3) authority.
Funneling Money (Indirectly) to Troubled Sectors
To be clear, this crisis is different from the last one. Today’s distress isn’t yet centered on banks but on industries like travel, leisure and retail. The Fed has generally interpreted the scope of 13(3) as limited to financial firms, so it wouldn’t seem to apply today.
But we wouldn’t be so sure. The law was amended post-GFC to make it clear that a company-specific bailout would not be permissible, which explains the emphasis on “broad-based” programs. But even after the amendment, 13(3) doesn’t specify what types of firms are off limits.
The Fed could make a legal case that creating a broad-based fund to support systemically important industries and/or households is both legal and within the central bank’s mandate. Even if the Fed doesn’t want to support a given sector directly, it could create a broader program to funnel money through banks to sectors under pressure.
De Facto Fiscal Stimulus from the Central Bank
If this sounds like the Fed engaging in fiscal stimulus…well, in a lot of ways it is. The Fed would essentially be directing money through the economy in a way that’s typically reserved for fiscal authorities. But the Fed has to get Treasury Department approval to do it, so there would be no danger of a turf war. Quite the opposite, the Treasury Department would probably be thrilled to let the Fed do the work for it.
Why? It wouldn’t increase the budget deficit—the money would go into an off-balance-sheet line item on the Fed’s financial statements, with funding from the Fed itself. The moves wouldn’t require messy congressional approval. If and/or when they become unpopular, the Fed is an easy scapegoat…as it was after the GFC. Finally, the Fed would be issuing credit, not buying equity stakes, which would temper concerns about nationalization—a controversial topic during the bank bailout.
An Uncommon but Elegant Solution That May Be Needed
In many ways, section 13(3) authority is an elegant tool in an economic crisis. And it’s telling that Fed Chair Jay Powell refused to rule it out, saying in a recent press conference that 13(3) is “part of our playbook in any situation like this.” Powell went on to say the Fed is ready to use its powers to “support borrowing and lending in the economy. And hence, to support the availability of credit to households and businesses.”
With the US economic situation deteriorating daily and monetary policy at its limit, crisis management is the next policy priority—and 13(3) gives the Fed room to act. If the economic situation doesn’t improve in the near term or fiscal policymakers aren’t up to the task, we expect the Fed to go beyond the GFC playbook and create facilities to get money into the hands of those who need it.
- Eric Winograd
- Senior Economist—Fixed Income
Eric Winograd is a Senior Economist at AllianceBernstein (AB).