Putting the Genie Back in the Bottle
By Capital Thinking • Issue #1045 • View online
This weekend’s WSJ essay “How the Fed Averted Economic Disaster” by Nick Timiraos finally brings into public discussion the second question we should all be asking of the Fed.
What happened in the grandest bailout of all time in the covid crisis, and, more importantly, having done it twice, how are we going to avoid massive bailouts becoming the normal state of affairs?
(The first question, of course, is “how did you miss inflation so drastically and when are you going to do something about it?”)
Important questions unasked of the Fed
John H. Cochrane |The Grumpy Economist:
They were offering nearly unlimited cheap debt to keep the wheels of finance turning, and when that didn’t help, the Fed began purchasing massive quantities of government debt outright.
Translation: When dealer banks weren’t buying treasury debt fast enough, the Fed lend the banks money to buy the debt, and quickly bought up the massive amount of debt themselves.
The Fed followed by bailing out money market funds, buying state and local government debt, buying exchange-traded funds that held junk corporate debt, and announcing a do whatever it takes pledge to keep corporate bond prices high.
It worked.
The Fed’s pledges to backstop an array of lending, announced on Monday, March 23, would unleash a torrent of private borrowing based on the mere promise of central bank action—together with a massive assist by Congress, which authorized hundreds of billions of dollars that would cover any losses.
…Carnival Corp. , the world’s largest cruise-line operator. Its business had collapsed as Covid halted cruises world-wide. Within days of the Fed’s announcement, Carnival was able to borrow nearly $6 billion from large institutional investors…If the hardest-hit companies like Carnival, with its fleet of 104 ships docked indefinitely, could raise money in capital markets, who couldn’t?
Let’s be clear who is bailed out here: Creditors. People who lent lots of money to shaky businesses, earned nice high yields in good times, now have the Fed and Treasury bail them out in bad times.
It worked.
Today, nearly two years later, most agree that the Fed’s actions helped to save the economy from going into a pandemic-induced tailspin.
I agree.
A crisis was imminent, a toppling of a vastly over-leveraged house of cards was in the works. As “just in time” supply chains discovered they needed a bit of extra inventory around, just in time debt financing falls apart at the slightest shock, needing a bit of cash inventory and equity buffer.
The Fed’s initial response in 2020 received mostly high marks—a notable contrast with the populist ire that greeted Wall Street bailouts following the 2008 financial crisis. North Carolina Rep. Patrick McHenry, the top Republican on the House Financial Services Committee, gave Mr. Powell an “A-plus for 2020,” he said. “On a one-to-10 scale? It was an 11. He gets the highest, highest marks, and deserves them. The Fed as an institution deserves them.”
I also agree, almost. But
The question now is what will be the long-term costs and implications of that emergency activism—for the Fed, the financial markets and the wider economy.
This is the question. Why did the economy get into a situation once again, so soon, that the Fed had to engineer this massive bailout? What are you going to do to make sure you don’t have to do it again and again?
Pandemics happen. Wars happen. If you’re of that ilk, climate risks happen. Sovereign debt collapses happen. Crises are always unpredicted. If they were predicted, they wouldn’t be crises.
So, dear Fed, well done. The house was on fire, and you sent the entire fire department and put out the fire.
A lot of people made a lot of money, as the federal debt and reserves skyrocketed. And now everyone expects more of the same next time.
Not just the large bank bailouts of 2008; everyone expects that in a downturn you will buy corporate and junk bonds, as many as needed to keep prices from falling and anyone from losing money.
How are you going to put this genie back in the bottle?