WASHINGTON — By all accounts, the Federal Reserve’s assertive response to the coronavirus pandemic earlier this year helped contain the damage to the U.S. economy. But the limits of the Fed's powers will likely become more apparent in 2021, experts say.
The central bank's initial action came on March 3, in the face of rising pressure on the markets due to COVID-19 outbreak, when the Fed made its first emergency interest rate cut since the 2008 financial crisis.
Before the month ended, the Fed
“The American economy was definitely cruising along, 100 miles an hour on the interstate, and then hit a wall, and the car got totally obliterated, and the Fed, Congress and the administration acted as the airbag,” said Keith Noreika, a partner at Simpson Thacher and former acting comptroller of the currency. “They did a masterful job, I think, of deploying that cushion.”
But with the book on 2020 all but closed, the Fed's tools appear to be exhausted just as the economy is again threatened by the largest wave of COVID-19 cases yet and ensuing small-business closures. Many of the economic closures have become permanent, forcing thousands out of work.
“I think we’re done at the Fed,” said Travis Norton, counsel at Brownstein Hyatt Farber Schreck and a former general counsel at the House Financial Services Committee. "The Fed’s authorities and abilities here are pretty limited going forward.”
Fed Chair Jerome Powell has said as much, calling the case for fiscal policy “very strong” at a Dec. 16 news conference.
“With the expiration of unemployment benefits, some of the unemployment benefits, the expiration of eviction moratoriums, with the virus spreading the way it is, there is a need for households and businesses to have fiscal support,” he said.
And although the Fed does have a role to play, Powell acknowledged, experts say that the Fed’s main responsibility is to grease markets, while its ability to backstop the areas of the economy that most need support is constrained.
Calls from the Fed and others for Congress to pick up more of the slack in responding to economic hardships were answered in the
Notable successes, some failures
The Fed has won ample applause for its earliest actions in the pandemic. Staff were said to have worked around the clock to stand up crucial programs, such as the Money Market Mutual Fund Liquidity Facility, which the agency announced close to midnight on March 18 in response to hemorrhaging short-term funding markets.
“All of the programs that launched early in March — the liquidity facilities and the aggressive drop in the rates — all of that tended to be very effective and act as an immediate injection,” said Brad Rustin, a partner at Nelson Mullins and chair of the firm’s financial regulatory and fintech team. “I think that anything that was fast did well.”
The central bank created a whole slate of emergency lending facilities as authorized under Section 13(3) of the Federal Reserve Act, some of which were backed with funding from the Coronavirus Aid, Relief and Economic Security Act that passed in the spring.
“I think the Fed shined as a professional, highly competent agency with lots of talented and dedicated staff that were able to step up and do the work that needed to be done at the time,” said David Portilla, a partner at Debevoise & Plimpton and a former Treasury official.
Unlike during the 2008 financial crisis, the Fed was required to get the Treasury Department to sign off on the creation of any emergency lending facilities. Observers say that requirement created a unique relationship between the Fed and Treasury that provided confidence to investors.
“The Fed and the Treasury worked pretty closely together and to act quickly in order to foster economic conditions that basically bought biomedical science some time to come up with a real solution,” said Keith McCutcheon, senior vice president and treasurer at the $4.9 billion-asset Bryn Mawr Trust in Pennsylvania.
Norton called it “a historic degree of cooperation” between Treasury and the Fed that enabled Powell and Treasury Secretary Steven Mnuchin to create new facilities to respond to a crisis that originated outside of the financial system.
“Many of the 13(3) programs were unprecedented,” he said. “Some of them were reruns of programs that we saw in ‘08 and ‘09, but certainly the Main Street Lending Program in its different iterations, including for nonprofit organizations, was completely new ground for the Federal Reserve.”
The Fed’s asset purchases of Treasury securities and mortgage-backed securities, which the central bank is still continuing to buy, also helped buoy yields on 10-year Treasury and lower mortgage rates, enabling the housing market to be a source of strength for the still-crippled economy.
“Unlike 10 years ago, which was a housing issue, housing has been the huge beneficiary of all this,” McCutcheon said.
But not all of the Fed’s efforts have been successful. Two of the biggest disappointments in its response, lawmakers and industry observers argue, were the Municipal Liquidity Facility that aimed to assist state and local governments and the Main Street Lending Program, which offered loans to midsize businesses.
The Municipal Liquidity Facility was tapped by just the state of Illinois and New York’s Metropolitan Transportation Authority, and the Main Street program purchased just $10 billion in loans, a far cry from the $600 billion allocated for the program.
“Anything that tended to take a while to underwrite tended to be a problem, whereas in terms of your liquidity facilities for known-quantity financial institutions, all of that tended to work very effectively,” Rustin said.
The Fed was ultimately limited in its ability to absorb material losses, constraining the types of businesses and entities that it could lend to. Powell and Mnuchin
That was particularly true for commercial real estate borrowers and others that obtain financing from capital markets, rather than banks, Norton said.
“The Fed and Treasury never got around to figuring out how to do asset-based lending to midsize borrowers, and that had a great impact on industries that almost by their very nature have to resort to asset-based lending,” he said.
Congress tried to address smaller businesses and working families through the Paycheck Protection Program, which offered forgivable loans to companies with less than 500 employees, and expanded unemployment insurance. Yet that relief came with limits. New loans under the PPP were suspended when the program established in the CARES Act expired in August. The latest $900 billion stimulus package will reboot the small-business lending program.
Some argue that the government's relief efforts have resulted mainly in
“We've created a lot of liquidity on Wall Street. We've kept the bond markets working; we've kept the Treasury markets working,” said Rustin. “But the time bombs in 2021 are right below that, meaning groups of businesses that were too big for the [Paycheck Protection Program], but not big enough to really have corporate credit, investment-grade securities bonds that really would have been picked up in the liquidity up top.”
Looking ahead
Although lawmakers and outside experts alike have floated ideas for improving some of the Fed’s programs like the Main Street Lending Program to make them more attractive, the MSLP along with several other programs funded with CARES Act appropriations, were set to expire at the end of 2020.
Plus, the Fed won’t be able to restart those programs under President-elect Joe Biden thanks to a compromise in the newest congressional stimulus package that prevents the Fed from being able to reopen identical facilities.
Without those options, the Fed is left with a limited toolkit to support the sectors of the economy hit hardest by the pandemic, and it remains to be seen what other emergency lending facilities, if any, it would be able to start up after the Biden administration takes over.
“I think that the Fed’s response this year to the COVID pandemic will largely be remembered as having been cabined in by the political branch, or by the political forces emanating from the Treasury Department,” Norton said.
Powell himself said that the best thing the Fed can do for smaller businesses and middle- and lower-class workers is to facilitate a solid economic recovery.
“The main thing that [small and medium-sized] companies need is a robust recovery — a strong, robust recovery,” Powell said Dec. 16. “We contribute to that through highly accommodative monetary policy [and] through accommodated financial conditions that are supporting economic activity.”
The Fed will also be responsible for ensuring that the banking system remains well capitalized. The agency will have to make a decision in early 2021 whether to loosen its restrictions on bank dividend payments and share repurchases.
“As I think about it, the Fed’s main role in terms of supporting the recovery will be to continue with the accommodative monetary policy that they're pursuing at the moment and also making sure that the financial system and the banking sector stays healthy and strong,” said Portilla. “I have to imagine that's pretty far up on their agenda.”
And the Fed will have to decide when to ease off some of its measures meant to stem the economic effects of COVID-19, like its asset purchases, Rustin said. There will inevitably be some market shock when the Fed winds those down, he said.
“The question is, can you actually walk this stuff back? Can you stop buying bonds? Can you stop buying Treasuries? Can you stop buying mortgage-backed securities?” he said. “Powell has consistently said we've got to stop, but I don't know that you can without creating a market force that's going to significantly hurt midsized small businesses, small businesses and consumers.”
But from this point forward, it’s Congress that’s responsible for driving the economic recovery and not the Fed, Norton said.
Powell "used the tools that he was given in a way that was responsible to the Fed's dual mandate and mission,” Norton said. “I think that he also acknowledged very plainly and transparently the limits of the Fed's ability, frankly to, I think in his view, make up for what Congress was not doing.”
