I apologize for the long delay in posting this free post. Between the new announcements and some personal issues, it took me much longer than expected to finish it. I’ll endeavor to avoid delays in the future, especially by having “reserve” posts ready in case something interrupts me finishing posts in the future. My second premium post should be up tomorrow evening.
This is part 6 of my ongoing coverage of the Federal Reserve’s Coronavirus actions. You can read Part 1 here, Part 2 here, Part 3 here, Part 4 here & Part 5 here. It has been two weeks since I covered Federal Reserve crisis actions so I figured it was time to provide an update. Most of the recent actions have been relatively minor up until Monday’s expansion of the Municipal Liquidity Facility and Thursday’s expansion of the Main Street Lending Program. I’ll be analyzing them near the end of the post (feel free to skip to those sections).
That Tuesday the Federal Reserve joined fellow financial regulators in loosening appraisal requirements for property mortgages. Recall that, as I discussed in my #MonetaryPolicy101 post on Central Bank Collateral Policy, collateral worthiness is an important aspect of securing financing. Sometimes, collateral worthiness can justify originating a loan to a completely uncreditworthy borrower. In normal times, this leads to the importance of determining a collateral price. In our current property mortgage system, collateral prices are determined by appraisals by professional appraisers which are notionally related to market prices. However, appraisals (and thus appraisers) themselves have big impacts on market prices. This mutually reinforcing feedback loop makes control of appraisers a powerful tool of financiers committed to creating a housing boom and housing price inflation. Indeed, blacklisting and coercing real estate appraisers was an essential part of the systematic mortgage fraud epidemic that caused housing price inflation leading up to the great recession.
All that is simply to say that appraisal is an important component of the collateral formation process in real estate. In this case, there is an interesting dual dynamic happening. On one hand real estate appraisal is not an essential activity and risks infection. Without any rule change, mortgage credit would be inhibited by the inability to get required appraisals (thus illustrating how qualitative requirements are critical for grasping how “easy” credit is). On the other hand, more frequent appraisals (and thus less “stale” i.e. old market prices embedded in collateral prices) reinforces the feedback loop between appraised prices and market prices. As a result, the Federal Reserve and other financial regulators have announced that financial institutions can defer appraisals for 120 days. Importantly, the appraisals are not canceled. Their announcement frames the issue around the first issue, but it is hard to believe that regulators aren’t also thinking about the stabilizing influence on real estate markets of collateral prices not experiencing immediate downward adjustments.
That Thursday’s announcement simply announced that the Paycheck Protection Program Liquidity Facility was now operational. While this facility makes sense, as I said in the last entry in this series, its existence says extremely negative things about the program design Congress went abou regarding the PPP and congress’s encouragement of a separate Main Street Lending Program:
This facility on one level makes sense- the Federal Reserve should do all it can to support congress’s program to help small businesses. On another level, it drives me absolutely crazy. If we were simply going to have banks originate loans and then have the Federal Reserve purchase them, why did we bother with congressional appropriations in the first place? This could have simply been a part of the Federal Reserve’s Main Street Lending Program. The political football that is the losses the Federal Reserve would have taken from forgiving loans could have been fixed by alternative accounting gimmicks. Instead of equity stakes into Federal Reserve SPVs, congress could have simply said that all losses should be booked in a separate emergency facility account that doesn’t count when calculating the Federal Reserve’s net-worth. Simply having the Fed manage and implement this program would have been far simpler than trying to roll out this program and have the Fed come in to fix technical issues in the background. This is a clear case where congress didn’t adequately think through program design and their initial design has been rendered incoherent by subsequent events.
This question remains relevant to this day. I plan to write more about this specific issue in the future. A minor point worth noting is that this program is run by the Federal Reserve Bank of Minneapolis. A strange feature of the Federal Reserve’s structure is that discount window lending- i.e. direct bilateral lending by the Federal Reserve to sub-federal governmental and private entities- is not under the direct control of the Federal Reserve Board. This doesn’t operationally make much difference today (though historically relatively minor differences between regional discount window policies have had macroeconomic effects) but it is legally quite important. This structure has partially shielded the Federal Reserve in past court cases from Freedom of Information Act requests, albeit under specious reasoning. Further, those who go hunting for crisis facility information will need to target at least three regional Federal Reserve Banks by my count.
That week ended with an announcement of a technical regulatory rule change to facilitate small business participation in the PPP. Earlier in April, the Small Business Administration clarified that banks can make loans to businesses which are owned by major shareholders of the bank and members of their board of directors. This is allowed with “certain limits and without favoritism”. How favoritism is prevented, isn’t said. Yet the SBA can’t deal with this issue on their own, as they are not bank regulators and bank regulations have limitations on board of director and major shareholder lending as well. Thus, this announcement adjusted Federal Reserve regulation to be consistent with the SBA’s new rules. Fitting the pattern of lack of governmental coordination or congressional planning, this rule change came the same day that the PPP ran out of money. This is yet another example where administration by banks (and administration by both financial regulators and the SBA) has been complicated and slowed down the loan origination process. Banks are not good intermediaries for government action and we don’t need credit assessments at all.
The next week was a quiet one for the Fed, with a flurry of relatively minor announcements on Thursday. The first announcement was a significant one for transparency. Under pressure from an external campaign, led by Cares Act oversight commissioner Bharat Ramamurti, the Federal Reserve announced that it would publish:
- Names and details of participants in each facility;
- Amounts borrowed and interest rate charged; and
- Overall costs, revenues, and fees for each facility.
These publications will be posted on their website and come every 30 days. As discussed, this is important because legislation over Freedom of Information Act requests and Federal Reserve Banks is complex and takes years. It is a very good thing that the Fed is conceding to this political pressure, though there is likely a lot more information that is worth bringing to the attention to the public.
The second announcement is an expansion of intraday credit. This time, the Federal Reserve is completely uncapping uncollateralized loans for chartered banks. As I’ve written in the past, the necessity for these policies in crisis makes a strong argument for making them permanent. The third announcement is simply that the Federal Reserve is working to expand access to the Paycheck Protection Program Liquidity facility to non-chartered banks. The need for these rolling and complex rule changes plus the discriminatory history of bank lending strongly suggests that banks need to be abandoned as policy intermediaries.
The most important announcement covered in this post is far and away the expansion of the Municipal Liquidity Facility on Monday. This announcement is clearly a response to criticism of how high the population requirements were when the program was initially announced. I played a minor role in these criticisms by amplifying criticisms Aaron Klein of Brookings made on twitter, which he later wrote up in a Brookings report. Some of my criticisms, and even a post of mine(!!!), made it into Congressman Bill Pascrell’s letter to Federal Reserve chairman Powell. The same day, a far more politically potent letter was sent by 5 Democratic senators (including Elizabeth Warren and Chuck Schumer) echoing Klein’s points about the “arbitrary population cutoffs” and their racial implications.
Thus, it's no surprise that the main way the Fed expanded the MLF is by lowering the population cutoffs. Now cities with a minimum of 250,000 residents and counties with a minimum of 500,000 residents can access the Municipal Liquidity Facility. This expansion is really rather large. I still think they could expand the program more by requiring the largest political subdivision in a state to administer loans to small counties and municipalities if the state government will not. However, this criticism is far smaller than the initial criticisms of the MLP, which would have really hampered its effectiveness. This program also expands the maximum maturity of a loan to 36 months.
Like other programs, eligible issuers who have experienced coronavirus rating downgrades are “grandfathered” in. The remaining largest problem with the program is the requirement of an investment grade rating. Local governments are not private businesses and the “moral hazard” of “bailing out” these sub-federal governments should be treated orders of magnitude differently. This is especially the case as so many lives hang in the balance of what state and local governments spend today. It's hardly conceivable of a scenario where loosening financial constraints today as much as possible doesn’t provide large net positive outcomes. The size of the purchases also remain at 500 billion dollars, which should be expanded further (or even uncapped).
Finally, The Federal Reserve announced that it was
considering expanding the MLF to allow a limited number of governmental entities that issue bonds backed by their own revenue to participate directly in the MLF as eligible issuers
This opens the door to providing direct support to public universities. I plan on writing about this in the future, but one way to approach such a proposal would be to have universities issue payment anticipation notes which are receivable for all payments to universities and have the Federal Reserve purchase them, similar to my local currency proposal. Universities are a major site of state and local austerity and relieving their burdens through their own local currencies has rhetorical, as well as practical, benefits.
This past Wednesday, the Federal Open Market Committee- the Federal Reserve committee which determines the policy path of interest rate and liquidity policy- put out a regularly scheduled statement. The statement doesn’t say much except that they are holding interest rates and purchase programs where they are. I will write more about FOMC statements in the future.
As if Monday’s announcement wasn’t enough, the Federal Reserve announced an expansion of the Main Street Lending Program this past Thursday. This program was changed in three essential respects:
- It was expanded to include businesses with $5 billion dollars in revenue and up to 15,000 employees (up from $2.5 billion and 10,000 maximum employees)
- Lowering the minimum loan size to $500,000 dollars
- Creating a third loan option for riskier loans which banks in turn take a greater stake in (15%).
In the abstract, the first two changes are fine. The concrete policy concern is that the first two changes, when combined with the third change, is a de-facto rescue of the oil and gas sector. These concerns are heightened because the Trump administration had just been discussing providing Oil and Gas companies direct support, even suggesting they may use the Federal Reserve to do it. Again, commissioner Bharat Ramamurti is leading the charge on this issue. Energy secretary Brouillette even tweeted about the announcement that it was “[g]reat news out of the Fed today in support of struggling U.S. energy companies”.
This issue shakes up the debate over “green central banking” as now we have the question of how much the Federal Reserve should be acting to accomplish environmental policy goals when providing emergency liquidity to financial markets and financial institutions. It was one thing for the Federal Reserve to claim that it was the job of congress or other regulators to implement preferences for “green” production as opposed to “brown” production. It is quite another for the Federal Reserve to use emergency authority to provide subsidized emergency liquidity directly to fossil fuel companies. It becomes much harder at that point to claim that the Federal Reserve isn’t making active choices in this area. If we are not inclined to provide Oil and Gas companies subsidized credit, what other options are there that will deal with problems in this sector in an orderly fashion? This is a big question for policy analysts in the coming months and even years.
Finally, the increasing reliance of this program on loan originators retaining a portion of the loan on their balance sheets seems likely to enhance discrimination. Banks are not good intermediaries and the more you rely on banks using up their own balance sheet for your loans, the more dysfunctional the program will become. As discussed earlier, it's not clear that the MSLP is ready to function properly. Meanwhile, reliance on loans cuts out the most leveraged companies and ensures procyclical behavior on businesses. Who wants to keep 15% of a loan on their books which won’t be repaid in any way for at least a year?
With that, we’re caught up through the rest of April. Sans a big announcement in the coming week, I doubt I’ll be returning to this series until mid-May. The big theme of this set of announcements is expanding already announced programs. The big expansions this time around came in the Municipal Liquidity Facility and the Main Street Lending Program. The MLF’s expansion was clearly a big net positive, though some problems remain. The MSLP expansion is more mixed and brings up pointed climate change concerns in a sharp matter. The other expansion that’s happened is over Federal Reserve transparency. That is a hard-won public good, especially in the middle of crises. We need to fundamentally restructure the Fed’s relationship to FOIA. In the midst of all this, the problem remains the same- the economy has lost a huge amount of income and no one is replacing it at a remotely adequately scale to prevent depression.