On Thursday, Treasury secretary Steve Mnuchin sent a coherent and benign letter to Federal Reserve chairman Jerome Powell that made the case for bringing some of the emergency credit facilities established in March 2020 at peak levels of COVID-induced distress in capital markets to conclusion. Mnuchin also requested a return of excess funds not used by these facilities. Specifically, while the Treasury Department called for an extension in the Commercial Paper Funding Facility, the Primary Dealer Credit Facility, the Money Market Liquidity Facility, and the Paycheck Protection Program (PPP) Liquidity Facility, it also called for the expiration at the planned date of December 31 of the Corporate Credit Facilities, the Municipal Liquidity Facility, the Main Street Lending Facility, and the Term Asset-Backed Securities Loan Facility (TALF) program. Approximately $450 billion of unused funds were asked to be returned to the Treasury for re-deployment into fiscal programs and COVID stimulus/relief efforts.
To say the response to Mnuchin’s letter has been hysterical would be an understatement. Carl Weinberg, the chief economist at High Frequency Economics, said Mnuchin’s request was equivalent to stripping the Titanic of its lifeboats. CNN said that Mnuchin had effectively “pulled the plug” on “businesses that have been struggling as the pandemic wreaks havoc on the U.S. economy.” Bharat Ramamurti, an Elizabeth Warren protégé on the oversight body of CARES ACT Treasury programs, said “the Fed can and should reject the request” to send back the funds. The Fed took a more sober approach, but still disagreed with the decision, saying that it “would prefer that the full suite of emergency facilities established during the coronavirus pandemic continue to serve their important role as a backstop for our still-strained and vulnerable economy.”
That $74 billion remains in the Exchange Stabilization Fund and can be used for any purposes deemed important for financial market stabilization has not gotten a lot of attention. But what seems to have gotten even less attention is that the $600 billion Main Street Lending Program has given a grand total of $3.7 billion of loans as of the end of the last month, equaling just 4.9 percent of the equity the Treasury Department injected into the program, and less than 1 percent of the total capacity of the program at full leverage. Most noteworthy is the Corporate Credit Facility realities, where spreads for investment-grade bonds have come in from over 4 percent at the peak of the pandemic to less than 1.5 percent today. High-yield bond spreads are south of 5 percent now, down from over 10 percent at peak crisis levels.
There simply is no rational basis for continuing the Corporate Credit Facility program, and ample discussion ought to be had regarding whether it was necessary or advisable (adjusted for moral-hazard costs) when it was extended. The program exists for mega-cap companies to access debt markets at an even lower cost than they already are able to, and is not remotely needed at this point in time “to assure liquidity.” How Apple’s cost of funds relates to COVID relief is beyond me, but saying it does is not a plausible or good-faith argument even from those feigning outrage over Mnuchin’s letter.
The real controversy now is not whether unused and unneeded emergency facilities can or should be allowed to expire — of course they can and should. The conversation instead ought to center on the role the Fed plays in times of crisis in our national economy. Its objective to serve as the “lender of last resort” is alive and well, and it should be so, though it is important that we not confuse “desired liquidity” for “desired price.” If we are going to have a country where we accept the role of a central bank in stabilizing market malfunctions, we have to have a limiting principle lest we end up with systemic mispricing of risk and subsequent misallocation of capital. Market dependency, after all, is a market malfunction, too. What does it mean to have the Fed be a lender of last resort, and what does it mean for the Fed to maintain market functioning across credit and money markets? It seems to me that this conversation is a more pressing one than the silly debate about these liquidity facilities. And yet it’s one we can’t have in the middle of a crisis, because all anyone wants to do is stop the bleeding.
Another question a serious Congress would address with the gift of hindsight is whether the so-called Volcker-rule provision of Dodd-Frank is doing more harm than good. The answer seems self-evident to those paying attention to capital markets, where banks are unable to make markets in corporate debt and municipal debt, necessitating these silly Fed facilities to begin with. Liquidity crises happen, but it should not be controversial to say that we clearly are not in a liquidity crisis now, and certainly not in these asset classes. Moreover, there’s a real question as to whether or not the liquidity crisis we did have at the start of the pandemic was self-created to begin with. The Volcker rule was a non-sequitur if there ever was one, blaming the poor capital reserves and excess leverage of banks that had fallen into the social cult of homeownership on the mere concept of proprietary investment. Market-making was never a systemic risk, and there is simply no way that the Fed’s liquidity measures would have been needed this past spring if banks had not been forbidden from participating in this silo of capital markets. Re-visiting the Volcker rule is exponentially more important than fighting about whether a Fed facility no one needs and no one is using should be maintained.
Those criticizing Secretary Mnuchin for his letter are not serious people. The areas in need of continued financial support have seen said support extended. Borrowing spreads have materially tightened. Any facility that has passed its expiration date now but is deemed needed later on can always be re-visited if circumstances warrant. There are funds authorized by Congress for deployment to COVID relief, and Treasury can use these funds now to do just that, generating a far more impactful response than they would sitting on the shelves at the Fed. What is needed is a limiting principle in what the Fed’s degree of control over the U.S. economy really is.
But as many of us have been saying for decades, the role of the Fed in the economy is itself a mere symptom of the bigger problem: the lack of a limiting principle in the role of the government itself in economic life. Solve one, and you inevitably solve the other.