Treasury Secretary Steven Mnuchin has a favorite talking point: With the Federal Reserve’s help, the government will turn a $500 billion spending package working its way through Congress into a $4 trillion booster shot for the United States economy.
How, you might ask, does that figure?
The answer lies in the central bank’s emergency lending authorities, given to it by the Federal Reserve Act. When the Fed declares that circumstances are unusual and exigent, and Treasury signs off, it can set up special programs that essentially buy debt from — or extend loans to — businesses large and small.
The Fed could simply print the money to back that lending, but it avoids taking on credit risk, so it asks for Treasury funding to insure against losses. But those taxpayer dollars can be leveraged: Because the Fed expects most borrowers to pay back, it does not need one-for-one support. As a result, a mere $10 billion from Treasury can prop up $100 billion in Fed lending. And voilà — the $454 billion Congress dedicated to Fed programs in the aid bill can be multiplied many times. A separate $46 billion in the package will go to specific industries.
This is how the mechanics work and who might get the money:
What’s in the bill?
Congress allotted at least $454 billion to the Treasury specifically to support Fed programs. It attached a few strings — for instance, companies that get direct loans backed by Treasury funding could be prevented from paying out dividends or buying back shares. Mr. Mnuchin is also required to push the Fed to set up specific programs, including one that would help medium-sized businesses.
Another $46 billion in the legislation will go to specific industries, including airlines. The Fed won’t be involved in that set of loans.
Who gets it?
The Treasury and the Fed will work together to decide how the $454 billion should be deployed. The central bank designs and runs the programs, but Treasury consults on the broad-brush outline and must sign off on any plan.
The Fed has already announced a number of emergency lending programs in recent weeks, including one that supports corporate debt issuers and another meant to keep money flowing in the market for short-term business loans. It has said it will establish a “Main Street” lending facility for small businesses, though details on what that will look like are scant.
The Fed is also indirectly helping the market for local debt through one facility, and some economists have speculated that it could go further by actually buying state and local bonds in an emergency measure. The legislation instructs Mr. Mnuchin to push for a program that supports state and local borrowing, something lawmakers have long clamored for.
The Treasury fund used to back those efforts contains just $94 billion, so congressionally-approved money would pave the way for serious scaling up.
Depending on how much the money is leveraged — which in turn depends on the credit risk of the programs it supports — it could result in trillions of temporary support for companies and local governments. Mr. Mnuchin has repeatedly estimated the injection at about $4 trillion. (It could be bigger now: When he made that estimate, the congressional allotment was $425 billion.)
That seems like a lot of money.
It is worth noting that this setup will not necessarily pump $3.5 trillion of monopoly money into the economy permanently.
When it makes a loan, the Fed temporarily sends fresh dollars out into the financial system. But that loan must be paid back with interest, sucking the funds back out. When the Fed buys bonds using its emergency powers, it takes an asset out of the system in exchange for central bank cash.
“When it comes due, cash essentially has to be taken out of the private banking system and given back to the Fed,” said Matthew Luzzetti, chief United States economist at Deutsche Bank.
That said, money can be hard to fully snuff out once it is created. The Fed swelled its asset holdings significantly during and after the 2008 financial crisis. It struggled to shrink them again, leaving outstanding reserves — central bank deposits that it had used to buy bonds — permanently higher.
Why can’t the Fed go it alone?
The Fed is legally prohibited from lending to bankrupt companies, and it avoids lending to risky businesses without backup. That’s partly because it is afraid of losing money on loans and facing political repercussions, lawyers who study the matter say.
That may seem silly. The Fed is no ordinary bank: It creates money at the touch of a digital button. If it is not paid back, it will not go out of business. But if it took a significant loss, it would mean that the central bank had tried to prop up failing companies rather than simply striving to improve market functioning amid a temporary cash crunch. Keeping the gears of commerce chugging is the Fed’s job. Picking winners and losers is not.
“Losses look really, really bad,” Kathryn Judge, a professor at Columbia Law School, said in an email. “Most people are comfortable with the Fed providing liquidity, even a lot of it, to keep markets functioning.”
If the Fed does take on a risk but Treasury backs at least the first round of losses, it means the elected government is agreeing to the plan. That puts a veneer of accountability on the whole enterprise, giving unelected central bankers some cover.
Is it a bailout?
While the $46 billion in Treasury-determined funding will go to specific industries, the Fed-tied money is likely to be used more broadly.
So far, the Fed’s emergency programs benefit wide groups: The Fed is buying high-grade corporate bonds, for instance, because such debt had become hard to issue or renew, threatening to choke off funding to a broad range of companies.
The goal is to keep critical markets functioning through the coronavirus crisis.
“The government has stepped into the breach in a dramatic way, and has made Treasury the Federal Reserve’s deputy,” said Peter Conti-Brown, a Fed historian at the Wharton School of the University of Pennsylvania. “The Federal Reserve has become your friendly neighborhood loan officer.”
Tell me the nerdy details.
Since you asked. When we say that the Fed “essentially” buys debt and makes loans with its emergency lending programs, it’s because the way many of the operations are structured is a bit complicated.
Legally, the Fed is not allowed to buy debt that is not backed by the government. To achieve a degree of separation, it sets up a special purpose vehicle and then lends into it — which is why all of these programs are called “emergency lending.” The vehicle then snaps up bonds or makes loans to the private sector.
It’s also worth noting that it is a big deal in the wonky world of central banking that Congress is poised to explicitly give the Fed so much backup.
“I know of no other time that a legislature has delegated to a central bank such far-reaching authority to allocate credit,” Ms. Judge wrote in an email.