Update 432 — Fed’s Flurry of Credit Facilities:
$6 Trillion Balance Sheet Arsenal Explained
The Fed unveiled a panoply of programs this month and last designed to alleviate deteriorating credit access nationwide. The programs range from a backstop for the $4 trillion money-market industry to direct bridge loans for businesses.
Which of these is tried and true, which less certain because they are new? Which will maintain the financial infrastructure and which ones are targeted at firms, and which firms? We sort out the facilities, their operations and utility below.
Financial markets plunged in late February, anticipating the economic fallout from the coronavirus. In response, the Federal Reserve slashed interest rates to near zero. This didn’t exhaust its weapon shed. Going back to its 2008 playbook, over the weeks since, the Fed has rapidly revived some emergency lending facilities and spun up several new ones.
These are massive programs that involve Fed lending with first loss equity investments from the Treasury. Below we examine the effectiveness of these programs, considering efficiency, risk, and improvements to the macroeconomy.
Fed Facilities Tried and True…
Revamping 2008 financial crisis-era facilities has stemmed some bleeding and may be prescient policymaking. Below are the recently-revived Fed initiatives in operation as of today.
- Commercial Paper Funding Facility (CPFF) — Potential of $100 billion leveraged on $10 billion Treasury investment.
On March 17, the Fed revived its CPFF, which backstops lending markets and ensures credit availability for businesses and households. Commercial paper is a common type of unsecured, short term debt instrument. Businesses issue commercial paper to fund operations including payroll and overhead. In reviving the CPFF, the Fed will purchase commercial paper and hold it until maturity, giving businesses and households much-needed credit and liquidity. Should short-term rates hold stable, the revival will have been successful.
- Primary Dealer Credit Facility (PDCF)
That same day that the Fed revived the CPFF, it also revived its PDCF, a discount window (where the central bank lends to lenders) for primary dealers. Through PDCF, the Fed will offer short-term loans to 24 (pre-authorized) nonbank Wall Street firms.
In 2008, the Fed created a similar PDCF, and recipients repaid funds in full. We should expect nothing less today.
- Money Market Liquidity Facility (MMLF) — Potential of $100 billion leveraged on $10 billion Treasury investment.
On March 19, the Fed announced it would create the MMLF. Under this facility, the Fed will lend to U.S. depository institutions and bank holding companies in exchange for collateral the borrowers purchase from prime money market mutual funds.
This is similar to the Money Market Investor Funding Facility created in 2008. COVID-19 related investor panic is hitting money markets hard. The Fed has the sole authority to make loans to prime money market funds, which in turn invest in very short-term corporate debt, commercial paper, reverse repurchase agreements, and other forms of short-term debt.
Prime money market funds are low-risk, but since 2008, they have been vulnerable to runs from skittish investors. Such funds are vital sources of financing for U.S. businesses and banks. In 2008, runs occurred and threatened financial markets’ stability. The SEC considered creating stricter capital buffer rules but backed down under pressure from Wall Street. The MMLF may be necessary to shore up these critical funds, but the SEC should again consider capital buffer requirements.
- Term Asset-Backed Securities Loan Facility (TALF) — Limit of $100 billion leveraged on $10 billion Treasury investment.
On March 23, the Fed announced it would revive TALF. Through TALF, the Fed will issue asset-backed securities (ABS) to boost consumer spending, jumpstart the economy, and shore up the ABS market. TALF will facilitate $100 billion in loans through September 2020.
The Fed originally stood up TALF in late-2008, and over its 15-month lifespan, all TALF loans were repaid. We should expect the revamped TALF to likewise stabilize and stimulate the economy, unfreeze credit markets, and incur few to no losses.
… and Facilities that are New
The Fed’s response to the coronavirus has arguably been more aggressive than its 2008 response. The Fed’s new lending facilities, listed below, put it in unchartered territory.
- Corporate Bond Facilities — Limit of $750 billion leveraged on $75 billion Treasury investment.
The Fed created two facilities to support the corporate bond market, the Primary Market Corporate Credit Facility (PMCCF) and the Secondary Market Corporate Credit Facility (SMCCF). The PMCCF will be able to make up to $500 billion in direct bond purchases from companies, while the SMCCF can purchase up to $250 billion on the secondary market. When the Fed announced the facilities in March, they were only for investment-grade bonds. On April 9, the Fed said it would also buy non-investment grade “fallen angel” bonds that were investment grade as of March 22.
Initial signs show that these moves helped provide liquidity to corporate debt markets. But it’s not clear these facilities will be enough to stem the rising rate of corporate defaults, especially for speculative-grade companies.
- Municipal Liquidity Facility (MLF) — Limit of $500 billion leveraged on $35 billion Treasury initial investment.
During the 2008 financial crisis, the Fed avoided purchasing municipal debt. Municipal bonds are not nearly as uniform as Treasuries, and the Fed fears that its bond purchases may unfairly create political winners and losers. Even with these concerns, the Fed stood up a new municipal debt facility. The Fed announced it would only buy bonds from states, cities with more than 1 million residents and counties with more than 2 million residents. This facility may help relatively large and well-positioned state and local governments who will not pose a credit risk but leave out those who most need relief.
- Paycheck Protection Program Liquidity Facility (PPPLF) — Potentially $349 billion in loans as of April 22.
While the Small Business Administration (SBA) oversees the $349 Paycheck Protection Program (PPP), banks make the loans. The Fed announced it would serve as a backstop to the PPP and provide liquidity to banks servicing PPP loans by purchasing the loans off of their balance sheets. The program is already up and running with the Fed charging a 0.35 percent interest rate for the service.
With Congress negotiating another round of PPP funding, it will be critical that banks will have room on their balance sheets to process more loans. The program will be successful if banks don’t experience liquidity restraints in the next round of funding.
- Main Street Lending Program (MSLP) — Limit of $600 billion leveraged on $75 billion Treasury investment.
This program is available to businesses with up to 10,000 employees or $2.5 billion in annual revenues. It will contain two facilities, one for purchasing new loans originated by banks and another for purchasing existing “upsized” loans. Under both facilities, the minimum loan size is $1 million and the Fed will have the banks retain 5 percent of each loan.
The program could be up and running in a few weeks. It’s unlikely to be attractive to small businesses given the $1 million minimum and the fact that interest payments can only be deferred for one year. Medium-sized businesses with nowhere else to go may seek this program, but these businesses may be wary of taking on more non-forgivable debt.
The $454 billion fund from the CARES Act that backstops the Fed’s lending facilities does not impose meaningful oversight and accountability measures. The Fed is free to lend to businesses without specifying them to the public. The Fed announced it will publish some general data but are claiming an interpretation that seeks to skirt full Congressional oversight. The next legislative package needs more effective oversight in this area, lest hundreds of billions of federal resources go unaccounted for or worse.