WASHINGTON (Reuters) – When the Federal Reserve polled Wall Street about financial stability risks last fall, “global pandemic” didn’t make the list.
But the coronavirus outbreak has triggered virtually every other shock that was mentioned – from a stock market rout to a looming global recession – and is forcing the U.S. central bank and the U.S. Treasury to triage a system springing leaks by the day.
Compared with the 2007-2009 meltdown, which was centered in the mortgage and financial markets, the current crisis is a massively more complex problem with the Fed pulled to intervene in virtually every aspect of U.S. household and corporate commerce and finance.
The challenge now facing the central bank, in consultation with the Treasury, is prioritizing which market, set of companies or group of institutions to help next as it plans how to leverage more than $450 billion of seed money from the Treasury into perhaps $4.5 trillion in credit programs.
It is an uncomfortable role that could push the Fed beyond its traditional job of keeping financial markets open and running smoothly, to picking winners and losers in whatever economy emerges from a pandemic that has brought business activity to a virtual standstill.
“You’ve entered not just the world of accepting credit risk but of allocating it as well,” said Mark Spindel, a Fed historian who is the chief executive officer of Potomac River Capital. Through the emergency $2.3 trillion legislation passed last week, “Congress and Treasury have decided to cast the Fed as the only balance sheet large enough” for the measures that might be needed.
In the extreme, that could include roughly $26 trillion in debt held by non-financial companies and households – $16 trillion if home mortgages are excluded.
DEEPER DOWN THE CURVE
Where the Fed will ultimately draw the line remains uncertain. Even after rolling out half a dozen sometimes groundbreaking new programs and trillions of dollars in promised help, there is more new ground to break as the Fed lays plans to backstop not just large corporations with publicy traded stocks and bonds, but thousands of smaller corporations whose finances may be harder to efficiently evaluate.
That “Main Street Lending Program” is expected soon and analysts say it may provide up to $1 trillion for businesses with between 500 and several thousand employees – too big for small business programs but too small to issue bonds or get loans from public capital markets.
Treasury Secretary Steven Mnuchin on Wednesday said Treasury and Fed officials were meeting daily to get that effort running.
“It’s a very big priority … We want to make sure that mid-market companies have access to liquidity,” he said.
Boston Fed President Eric Rosengren, also speaking on Wednesday, told Bloomberg TV it will be a couple of more weeks before the Main Street program is ready for launch.
But if the aim is to have a post-pandemic economy where conditions match the steady growth and historically low unemployment of earlier this year, as Fed officials hope, the list of other problems to address is a long one.
The Fed in all likelihood will “go deeper down the credit curve,” said Donald Kohn, a former Fed vice chair who is now a fellow at the Brookings Institution think tank. But just how far depends on “how much risk is the Treasury willing to take?” Kohn said. “How far down the credit scale do you want to go?”
The riskier the debt – for example, corporate “junk” bonds are currently excluded – the more money the Fed will ask Treasury to provide to cover losses, Kohn said, potentially exhausting even the large pool of funds Congress has authorized.
State and local governments are singled out in the rescue legislation for more help. In a sign of the trouble they are facing, the Standard & Poor’s rating agency said Wednesday it now has a negative outlook for all U.S. public-sector borrowers.
It remains to be seen how broad the Fed’s assistance for them will be. A proposal offered by Democratic leaders in the U.S. House of Representatives in an initial draft of the rescue bill suggested the Fed directly finance purchases of medical equipment and other costs of responding to the pandemic, an open-ended commitment to keeping states and cities afloat.
Analysts increasingly feel the Fed will be forced to expand the borders of its operations to arrest what Moodys Analytics’ chief economist, Mark Zandi, called a “vicious circle” of stalled business leading to credit decay that would disqualify otherwise healthy companies from Fed help.
LIMITS TO SUCCESS
Retailers and restaurateurs, meanwhile, have appealed broadly for more assistance.
In a letter last week to Mnuchin and Fed Chair Jerome Powell, National Retail Federation CEO Matthew Shay asked that upcoming programs be broadened to help larger retail companies with poor credit, include the purchase of longer-term corporate bonds currently excluded from the Fed’s plans, assist smaller retailers, and cover more types of consumer loans in the collateral accepted for Fed credit.
“Our members’ access to the programs contained in the relief package is paramount not only to their financial survival, but to the relief package’s ability to successfully stimulate the economy,” Shay wrote.
Veteran Fed analysts and former officials say it is almost a given the central bank will expand what is already a historic set of programs that for now are limited by strict credit standards. In principle, the Fed is supposed to protect itself against losses by only backing credit for solvent firms, and getting cash from the Treasury to absorb expected losses.
But those red lines may prove both impractical and arbitrary in a situation where businesses risk collapse because of public health edicts.
Setting up the new programs will prove not just philosophically challenging for a central bank expected to only extend credit when it feels it is secure, but a logistical stretch for an organization used to working through a handful of major financial companies, said Roberto Perli, a Cornerstone Macro analyst.
“It’s feasible,” Perli said. But “it’s complicated … It’s an enormous thing that the Fed is not set up to do.”
(Reporting by Howard Schneider; Editing by Dan Burns and Paul Simao)