The Fed Has Already Injected $2.3 Trillion Into the Economy — and it’s Just Getting Started

The Federal Reserve may not be done with its all-out blitz to help the U.S. economy survive a coronavirus-induced shutdown, even after launching an unprecedented $2.3 trillion in lending programs.

The central bank used up only about 40% of the as much as $454 billion in seed capital that Congress provided it in extending help to small and mid-sized businesses, state and local governments and some risky corners of the financial markets on Thursday.

That leaves roughly $250 billion it could potentially lever up as much as ten times to bulk up existing programs or launch new ones. The money — if it’s not otherwise used by the Treasury Department — could also be available to cover unexpected losses in the facilities it’s already set up.

“We are deploying these lending powers to an unprecedented extent, enabled in large part by the financial backing from Congress and the Treasury,” Fed Chairman Jerome Powell said in an online presentation to the Brookings Institution from the central bank’s headquarters in Washington. “We will continue to use these powers forcefully, proactively, and aggressively until we are confident that we are solidly on the road to recovery.”

Investors largely welcomed the Fed’s moves Thursday. Prices for stocks, high-yield debt and municipal bonds all rose in the wake of the central bank’s announcement — even as more staggering data emerged Thursday on job losses in the nation.

But in extending its aid to more and riskier borrowers, the Fed is opening itself up to criticism that it’s overstepping its bounds and entering territory where elected officials, not technocrats, should be deciding who does — and does not — get help. It also risks accusations that it’s encouraging dodgy borrowing or investing by ensuring against losses — what economists call moral hazard.

For now, though, the pressure from many politicians and investors is for the central bank to do more, not less.

Munis, Mortgage Servicers

One area that the Fed itself flagged for potential further action: state and local government financing. Among the unparalleled steps it unveiled on Thursday was a Municipal Liquidity Facility under which it will buy up to $500 billion in short-term notes directly from U.S. states, counties and cities.

On top of that, the Fed said it “will continue to closely monitor conditions in the primary and secondary markets for municipal securities and will evaluate whether additional measures are needed to support the flow of credit and liquidity to state and local governments.”

Another area potentially ripe for help is mortgage service providers, although there it is the Treasury and the Federal Housing Financing Agency, not the Fed, that is taking the lead.

“We’re watching carefully the situation with the mortgage servicers,” Powell said. “We certainly have our eyes on that as a key market that does support households and consumer spending.”

Junk Bonds

Krishna Guha, head of central bank strategy at Evercore ISI, called Thursday’s announcement by the Fed “stunning in its scope.”

“The Fed is at war against the virus and this is a wartime degree of commitment to credit policy,” he said in a note to clients.

That commitment includes the potential purchase for the first time of so-called junk bonds, those with lower than investment-grade ratings. Under details released Thursday, debt will be eligible for purchase so long as the company that issued it was rated as investment grade as of March 22.

While risky, the Fed saw the step as necessary to help companies that, but for the coronavirus, would still be more highly rated.

The Fed estimated that $40 billion of junk bonds currently fit that description, though the debt must also mature in less than five years to be eligible. The central bank had no estimate for what portion satisfied both criteria.

Bond ETFs

The limited push into junk bonds will also open the door to some purchases of exchange-traded funds that invest in those bonds. Because such funds may include even riskier holdings, the Fed will backstop the purchases at a ratio of $1 to every $3 spent. That’s a much more stringent ratio than any other area of asset purchasing or lending the Fed has undertaken.

The foray into the junk or high yield bond market drew criticism from some in the markets.

“Companies go high yield for a very specific reason. They choose not to generate any free cash flow — they want to juice their shareholder returns,” said Lale Topcuoglu, a senior fund manager at JOHCM USA, which manages $38.5 billion in assets. “To sit there and hope for a Fed bail out, I think it’s a very wrong call.”

The Fed has deployed a raft of measures since March to try and help keep lending flowing in the economy — as businesses shuttered to stem the spread of the virus. It’s unleashed programs used in the 2008-2009 crisis to improve liquidity in the financial markets, and entered unchartered territory to support American businesses, states and local governments. It’s also cut short-term interest rates effectively to zero.

Julia Coronado, co-founder of MacroPolicy Perspectives LLC in New York said the Fed wasn’t waiting “until all the Is are dotted and Ts are crossed” on its programs in its push to get cash into the economy.

“The capacity of these programs is substantial,” she added, describing the actions the Fed has already taken or promised. Yet for all that, “there’s still substantial firepower remaining.”

—With assistance from James Crombie.