- The Fed has announced measures that will provide up to USD 2.3 trillion in loans to support the US economy during the COVID-19 crisis.
- These measures are the latest in a series of aggressive policy steps to provide liquidity and maintain order in financial markets. Under the terms of this initiative, the Fed will buy an array of financial assets, and provide loans and financial support to businesses.
- On 23 March, the Fed took the historic decision to purchase corporate credit (something it did not do during the 2008-2009 financial crisis). It has now announced it will also buy high-yield exchange-traded funds (ETFs). This further underlines its willingness to do whatever it takes to support financial markets.
With this package, the Fed is blurring the boundaries between monetary and fiscal policy. The CARES Act, a fiscal package that provides income support and business subsidies worth USD 2 trillion, included an authorisation of USD 454 billion to the US Treasury to support Fed programmes.
Hand in hand with the Treasury
Therefore, the Fed has established these facilities under the authority of the Federal Reserve Act with approval of the Treasury Secretary and with funding authorisation from Congress. To put it another way, the Fed's programme of measures is backstopped by the US Treasury, which answers to the US President.
The Fed initiatives will involve several trillion dollars of loans. Fed lending will be made available to eligible businesses, states or municipalities by purchasing obligations directly from issuers; purchasing obligations in secondary markets or otherwise; and making loans, including loans or other advances secured by collateral.
The Fed initiatives
The Main Street Lending Programme
It offers four-year loans to companies employing up to 10,000 workers or with revenues of less than USD 2.5 billion, with interest and principal payments deferred for one year.
Firms receiving these loans are required to commit to efforts to maintain payrolls. The US Treasury is providing USD 75 billion for this programme.
The Paycheck Protection Programme Lending Facility
The Federal Reserve Banks will lend to eligible borrowers, taking PPP Loans as collateral.
This will create space for banks to originate more loans.
Increased size and scope of the Primary and Secondary Market Corporate Credit Facilities
Established on 23 March 2020, both purchase select corporate bonds.
- The PMCCF, through a special purpose vehicle (SPV), purchases qualifying bonds as the sole investor in a bond issue, and buys portions of syndicated loans or bonds at issuance.
- The SMCCF, through a SPV, purchases in the secondary market eligible individual corporate bonds as well as eligible corporate bond portfolios in the form of ETFs.
The Fed is now expanding the scope of the programme to issuers that were rated at least BBB-/Baa3 as of 22 March 2020, but that were subsequently downgraded to a credit rating of at least BB-/Ba3 as of the date on which the facility makes a purchase.
That would include bonds from recently downgraded companies such as Ford, so-called fallen angels that have lost their investment-grade ratings. This measure should put to rest investor concerns over how the US high-yield market would absorb a wave of ‘fallen angels’. The announcement sparked the biggest rally in US high-yield since the Great Financial Crisis.
In both instances, the US Treasury, using the Exchange Stabilization Fund, will make an equity investment in each SPV and will be in a ‘first loss’ position. That means arguably that it is the US Treasury rather than the Fed that is buying the securities and backstopping the loans while the Fed provides the financing.
The Fed has increased the total size of both facilities to USD 750 billion, backed by USD 75 billion from the US Treasury.
A Municipal Liquidity Facility that purchases select municipal debt
The Fed will purchase up to USD 500 billion of short-term notes (with a maturity of up to 24 months) directly from states, counties and cities.
The Treasury will make an initial equity investment of USD 35 billion in the SPV. The Fed will continue to monitor developments in primary and secondary municipal markets to determine if additional action is needed.
The SPV will stop purchasing eligible notes on 30 September 2020, but the Fed and the Treasury have the right to extend the programme if they deem it necessary.
Expansion of the Term Asset-Backed Securities Loan Facility
The TALF now includes the triple-A rated tranches of both outstanding commercial mortgage-backed securities (MBS) and newly issued collateralised loan obligations (CLO) as eligible collateral.
This builds on the existing TALF that provides financial support for the issuance of asset-backed securities (ABS) for a variety of consumer and small business loans. The size of this facility remains USD 100 billion.
Whatever it takes… again
These measures once again demonstrate the US central bank's willingness to do whatever it takes to support financial markets. Such measures, however, raise issues of moral hazard (i.e. that bailing out bad debtors encourages others to borrow imprudently), but to keep financial markets functioning the Fed appears to be putting aside such concerns.
Read more on central banks and monetary policy, and recent measures in reaction to the COVID-19 crisis.
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