Federal Reserve Bank Vastly Expands Measures to Aid Economy; Announces Unlimited Quantitative Easing
Earlier this week the Federal Reserve expanded on the measures that it had announced a week ago to address the rapidly evolving situation in the financial markets. Below is a summary of the main steps:
- The Fed has pledged an unlimited amount of quantitative easing (QE) or asset purchases. Those efforts are focused on the Treasury bond, mortgage-backed securities markets and commercial mortgage-backed securities.
- Implication: These new efforts will help keep the Treasury and mortgage market liquid for consumers looking to refinance and commercial builders hoping to stay afloat.
- The Fed will start buying corporate bonds with ratings of at least BBB/Baa3. That is just above the investment grade level and includes the largest share of corporate bonds. The loans are four years or less and prohibit firms from using the funds for stock buybacks or dividends. They exclude businesses that are getting direct assistance from Congress.
- Implication: This will be of particular help to the shale industry which is under certain strain given its more than $300 billion in BBB-rated debt; oil prices have dropped below break-even for the U.S. industry and are expected to stay there for some time (as much as a year), depending on the size and length of the demand shock tied to COVID-19 combined with the price war now underway between Russia and Saudi Arabia; both countries would like to see our shale industry idled.
- The Fed will provide liquidity for outstanding corporate bonds including those in exchange traded funds (ETF). These loans go up to five years in duration and exclude businesses that are getting direct assistance from Congress; again, no stock buybacks or dividends during the length of the loan.
- Implication: Again, a first for the Fed, as it has never ventured into the ETF market, suggestive of the “whatever it takes” stance adopted this time around.
- The Fed resurrected a crisis-era facility from 2008-09 that allows it to extend three-year loans to businesses. Collateral accepted to back these loans includes car loans, student loans, credit cards and small business loans.
- Implication: This is designed to ease the upfront crunch on cash flow with easier terms for borrowers.
- The Fed will support money markets including municipal bonds. This is to narrow credit spreads and are 12-months in duration. The Fed will support three-month commercial paper including municipalities. Foreign banks operating in the U.S. can participate.
- Implication: This will make it easier for state and local governments, who are on the front line battling COVID-19, to fund their operations; The mounting costs of this crisis to state and local governments are risking massive cuts to government budgets. This could accelerate layoffs and cut critical services.
- The Fed is planning to launch a direct-lending program to consumers and small and medium-sized businesses. This will be done via its regional bank network, where loans can be better assessed and expedited.
- Implication: By reaching out to consumers and lenders directly, the Fed is expanding its role from being the “lender of last resort” to being, in a sense, a “lender of first resort.” Again, a first for the Fed.
The bulk of these actions are designed to stay in place until September 30 and are in addition to actions the Fed has already taken, which include cutting short-term interest rates to zero, eliminating reserve requirements to get banks to lend more aggressively and regulatory changes that encourage lenders to go easier on affected borrowers. The Fed is encouraging lenders to work with borrowers to waive late fees, defer payments and restructure loans without fees to help get borrowers through the cash crunch. The Fed has started to provide liquidity for money market funds, which are critical to the funding of the short-term commercial paper market. Helping ease the flow of funds should help the transmission mechanism to the real economy and reduce the adverse impact of the current forced idling of businesses and workers. The Fed’s moves are even more crucial since activity on the fiscal relief front seems stalled at this time.
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