The Fed's Cure Risks Being Worse Than the Disease

The Fed took unprecedented action to meet an unprecedented crisis. Is it dangerous? Photographer: Olivier Douliery/Bloomberg

The economic debate of the day centers on whether the cure of an economic shutdown is worse than the disease of the virus. Similarly, we need to ask if the cure of the Federal Reserve getting so deeply into corporate bonds, asset-backed securities, commercial paper, and exchange-traded funds is worse than the disease seizing financial markets. It may be.

In just these past few weeks, the Fed has cut rates by 150 basis points to near zero and run through its entire 2008 crisis handbook. That wasn’t enough to calm markets, though — so the central bank also announced $1 trillion a day in repurchase agreements and unlimited quantitative easing, which includes a hard-to-understand $625 billion of bond buying a week going forward. At this rate, the Fed will own two-thirds of the Treasury market in a year.

But it’s the alphabet soup of new programs that deserve special consideration, as they could have profound long-term consequences for the functioning of the Fed and the allocation of capital in financial markets. Specifically, these are:

• CPFF (Commercial Paper Funding Facility) — buying commercial paper from the issuer.
  
• PMCCF (Primary Market Corporate Credit Facility) — buying corporate bonds from the issuer.
  
• TALF (Term Asset-Backed Securities Loan Facility) — funding backstop for asset-backed securities.
  
• SMCCF (Secondary Market Corporate Credit Facility) — buying corporate bonds and bond ETFs in the secondary market.
  
• MSBLP (Main Street Business Lending Program) — Details are to come, but it will lend to eligible small and medium-size businesses, complementing efforts by the Small Business Association.

To put it bluntly, the Fed isn’t allowed to do any of this. The central bank is only allowed to purchase or lend against securities that have government guarantee. This includes Treasury securities, agency mortgage-backed securities and the debt issued by Fannie Mae and Freddie Mac. An argument can be made that can also include municipal securities, but nothing in the laundry list above.

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Source: Jim Bianco | Bloomberg