The rapid spread of Covid-19 and massive change in behavior required to curb it have transformed the trajectory of the world’s economy. Just a few short weeks ago, the United States was basking in the longest period of sustained economic growth on record. The country now faces what could be the steepest decline in economic activity in its history. The long-term health of the country and the economy remain fluid and will be determined in part by how policymakers respond. The Federal Reserve quickly recognized the unprecedented nature of the threat and has intervened aggressively to stem the pain this crisis will inflict on the long-term health of the real economy. Congress should now authorize the Fed’s most creative interventions and give the Fed explicit, albeit time limited, authority to go even further.
The Fed has been at the forefront of the government’s efforts to soften the tremendous economic blow of Covid-19. There is no way to avoid much of the suffering to come. Public health officials are rightfully driving policy and behavior. Their message is clear: To reduce the human suffering from Covid-19, we need to flatten the curve. That means spending a lot more time at home and virtually none in shared spaces. That means empty restaurants, empty factories, empty classrooms, empty hotels, empty offices… and only a fraction of that activity can shift to the virtual worlds everyone is now being asked to inhabit. Although this may be necessary for public health, the economic consequences are devastating.
The Fed was quick to respond. Consistent with its mandate to promote full employment and its obligations to promote systemic stability, the Fed pulled out every known tool. It rapidly slashed interest rates to near zero. It ramped up the dollar liquidity swap lines relied on heavily during the 2008 financial crisis to funnel dollars to and through central banks around the world. It reinstated many of the special credit facilities it had used to stem the 2008 financial crisis, including one to support money market mutual funds and another to funnel liquidity to primary dealers, and it provided a broad list of eligible collateral. It has also gone on a buying spree, and—in an unprecedented move—committed to effectively unlimited quantitative easing, meaning it will buy up as many Treasuries and government agency mortgage-backed securities as it needs to in order to keep those markets functioning well.
But there’s more. The Fed has also implemented two programs to effectively buy up corporate debt, including secondary debt already trading and new issuances that it stands ready to buy directly from large, creditworthy corporations. It also announced its intention to launch a new Main Street Business Lending Program to encourage lending to small and midsized companies. And, as important as any of the individual programs, the Fed signaled a willingness to continue to act creatively and aggressively to address the growing threats. The press release to announce the new set of programs opened: ‘The Federal Reserve is committed to using its full range of tools to support households, businesses, and the US economy overall in this challenging time.’
The Federal Reserve has not been acting unilaterally. The expanded credit facilities have all been created under Section 13(3) of the Federal Reserve Act, which allows the Fed, in ‘unusual and exigent circumstances’ to extend collateralized loans to nonbanks, just as it normally provides to banks via the discount window. After questions about the Fed’s use of that authority during the 2008 crisis, Congress modified Section 13(3) to require the US Treasury secretary, in addition to five members of the Federal Reserve Board, to approve any facility. The Treasury Department has further agreed to fund an equity stake in the special entity vehicles through which a number of the new facilities will be run. Although not statutorily required, this signals the Treasury’s willingness to share in the losses given the credit risk that these programs may entail.
The blessing of the administration conveyed through the Treasury Department’s actions is important. The Fed’s most recent interventions could expose the Fed to meaningful credit risk. Technically, it is extending collateralized loans, not buying risky assets. But the way the Fed makes these interventions look like loans is by creating new entities that will do nothing but buy up qualifying assets, such as corporate debt, that the Fed is not authorized to buy. With the exception of the very narrow slice of equity being provided by the Treasury Department, these newly created entities will be funded entirely by the Fed, which means the Fed also bears the downside risk if those loans aren’t paid in accordance with their terms. Looking ahead, that possibility cannot be discounted even for creditworthy firms. The mix of interventions also has important allocational effects, which is why decisions about the types of assets that can be used as collateral have been followed so closely. The two new debt facilities, for example, inevitably confer a disproportionate benefit on large, otherwise healthy companies, as they are the only companies positioned to issue the investment grade debt that the Fed has authorized the new programs to acquire.
None of this means that these programs are inappropriate. Exceptional times call for exceptional measures. Moreover, the Fed’s ability to use special purpose vehicles to creatively deploy its authority under Section 13(3) was on full display during the last crisis and was something Congress understood well when it modified other aspects of Section 13(3) in the Dodd-Frank Act.
The issue at stake is not just the lawfulness of the Fed’s actions, but also how best to preserve the long-term independence of the Federal Reserve. The Fed also acted creatively and aggressively in 2008. Those actions likely helped make the recession that followed less searing than it would otherwise have been. Nonetheless, as the dust settled and the ramifications became clearer, politicians from both sides of the aisle went after the Fed. There was a movement afoot not only to scale back its emergency-era authority, but to also scale back its independence with respect to monetary policy or even to do away with the Fed entirely. Although the Fed survived and retained its independence, the threat was real and would have cost the country dearly.
The same thing could happen again. No one yet knows how the Covid-19 pandemic will play out, and the Fed has little control over its evolution. Depending on how bad things get and how long the bad times last, a lot of companies and other borrowers may not be able to pay their debts when due, no matter how healthy they were before this calamity hit. A public that is mired in a wave of unemployment and foreclosures may not take kindly to seeing just how much money the Fed injected into certain parts of the economy, regardless of the systemic rationale underlying those actions.
Issues of accountability also come into play. At the broadest levels, the balance of powers scheme built into the US Constitution gives Congress the power of the purse. Although the reality has long deviated from that ideal, the ideal remains important. Congress is made up of elected officials from all 50 states. Those officials both reflect the views of their constituents when making law and act as mouthpieces for new laws, explaining to their constituents what is happening in DC and why. The further the Fed moves from merely printing massive sums of money—something it should be able to do—to directing where that money goes, the more important is Congress’ role.
The good news is that there is a solution. Congress can authorize what the Fed has done already and give it even broader authority to deal with this particular emergency. That authority could be either time limited (a few years), or it could be capped by reference to efforts to contain the fallout associated with Covid-19. As with the far more pressing fiscal stimulus package, the aim should be speed over perfection. Ensuring that the Treasury secretary continues to authorize any new facility could provide some ex ante check on the Fed’s authority. Congress could also impose other mechanisms for promoting accountability without excessively limiting the Fed’s flexibility through ex post mechanisms, such as delayed reporting and other requirements.
An additional benefit of having Congress bless the Fed’s action and to focus on ex post accountability is that it could stop any opportunistic denials of legal authority later in this crisis. Among the most fateful and controversial decisions the Fed made—in discussions with Treasury—during the 2008 crisis was to allow Lehman Brothers to fail. Then-Federal Reserve Chairman Ben Bernanke defended the action as driven by a lack of legal authority. Others have vigorously contested this explanation. Nonetheless, the plausibility of that defense—which arises from the vagueness of the limitations on the Fed’s authority as applied in times of crisis—has prevented a robust debate about whether that was a good policy decision. That mistake should not be repeated and very well could be if Congress does not intervene to clarify the Fed’s authority to take the type of exceptional actions that this exceptional moment calls for.
This post first appeared on the Columbia Law School Blue Sky blog here.
Kathryn Judge is the Harvey J. Goldschmid Professor of Law at Columbia Law School.