When markets melted in March, the Federal Reserve introduced novel programs designed to keep credit flowing to states, midsize companies, and large corporations, and Congress gave Treasury Secretary Steven Mnuchin $ 454 billion to support the effort.
Nine months later, Senate Republicans are trying to make sure those same programs can’t be restarted after Mnuchin allows them to end on Dec. 31. Beyond preventing its reincarnation under the Biden administration, Republicans are seeking to insert language into a pandemic stimulus package that will limit the Fed’s powers in the future, potentially preventing it from granting loans to companies and municipalities in future crisis.
The last-minute measure has drawn Democratic ire and jeopardized the fate of aid legislation that economists say is badly needed as homes and businesses face a dark pandemic winter. Here’s a rundown of how the Fed’s credit powers work and how Republicans seek to change them.
The Fed can keep credit flowing when conditions are really bad.
The main and best known job of the Fed is to set interest rates to guide the economy. But the central bank was created in 1913 largely to avoid banking problems and financial panics, when people get nervous about the future and rush to withdraw their money from bank accounts and sell stocks, bonds, and other investments. Congress dramatically expanded the powers of the Fed to combat panic during the Great Depression, adding Section 13-3 to the Federal Reserve Act.
The section allows the Fed to act as a lender of last resort during “unusual and demanding” circumstances – in short, when markets do not function normally because investors are exceptionally concerned. The central bank used those powers extensively during the 2008 crisis, including to support politically unpopular bailouts of financial companies. Later, Congress amended the powers of the Fed so that it would need Treasury approval to implement new emergency loan programs or materially change existing ones.
Programs provide trust as much as credit.
During the 2008 crisis, the Fed served primarily as a true lender of last resort: it mainly backed the various financial markets by offering to intervene if conditions got badly off.
The 2020 emergency loan programs have been much broader. Last time, the Fed focused on parts of Wall Street that most Americans know little about, like the commercial paper market and primary dealers. This time, he reintroduced those measures, but also unveiled new programs that have kept credit available in virtually every sector of the economy. It has offered to buy municipal bonds, has supported bank loans to small and medium-sized businesses, and has bought corporate debt.
The broad package was a response to a real problem: Many markets crashed in March. And the new programs generally worked. While the terms were not very generous and relatively few state and local companies and borrowers have benefited from these new programs, their existence gave investors confidence that the central bank would avoid a financial meltdown.
But things started to get complicated in mid-November.
Most lawmakers agreed that the Fed and Treasury had done a good job of reopening credit markets and protecting the economy. But Senator Patrick Toomey, a Republican from Pennsylvania, began asking questions this summer about when the programs would end. He said he was concerned that the Fed could push its limits and replace private lenders.
After the election, other Republicans joined Toomey’s push to end the programs. Mnuchin announced on November 19 that he believed Congress intended the five programs backed by the $ 454 billion Congress authorized to stop lending and buying bonds on December 31. He shut them down, while leaving a handful of mostly older programs open, and asked the Fed to pay back the money it had loaned to the central bank.
The Fed issued a statement saying it was not satisfied with its choice, but agreed to return the money.
Democrats criticized the measure as designed to limit the options of the incoming Biden administration. They began to discuss whether they could recover the funds and restart the programs once President-elect Joe Biden took office and his Treasury secretary was confirmed, as Mnuchin’s decision to shut them down and recover the funds rested on dubious legal grounds.
The new Republican measure would cut off that option. Legislative language circulating early Friday suggested that it would prevent “any program or facility that is similar to any established program or facility” from using the 2020 allocation. While that would still allow the Fed to provide liquidity to Wall Street during a crisis, it could seriously limit the central bank’s freedom to lend to businesses, states and localities in the future.
In a statement, Sen. Elizabeth Warren, a Massachusetts Democrat, called it an attempt to “sabotage President Biden and our nation’s economy.”
Toomey has defended his proposal as an effort to protect the Fed from politicization. For example, he said Democrats could try to make the Fed’s programs much more generous to state and local governments.
The Secretary of the Treasury would need to get approval from the Fed to improve terms and help favored borrowers. But the central bank may easily disagree, as it has generally approached its powers with caution to avoid attracting political scrutiny and to maintain its status as a nonpartisan institution.
Fed officials have avoided intervening in the ongoing congressional showdown.
“I will have nothing to say about it beyond what we have already said: that Secretary Mnuchin, as Secretary of the Treasury, would like the programs to end as of December 31” and that the Fed will return the money as requested. . Richard Clarida, Fed Vice Chairman, said Friday on CNBC.
More generally, he added that “we believe the 13-3 facility” has been “very valuable.”
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