By Rob McDonough
As the Great Financial Crisis (GFC) of 2007-2008 began unfolding, the Federal Reserve initiated several programs intended to mitigate the economic deterioration that was originally rooted in a deterioration in the mortgage credit markets but which had rapidly expanded across the entire global economy. Many of the actions undertaken by the Fed were unprecedented and, in some instances, received almost immediate criticism from politicians and market participants alike.
Fed Initiatives During the GFC
Under the guidance of then Chairman Ben Bernanke, the various operational arms of the Federal Reserve Board and the 12 regional Federal Reserve Banks began executing on four major initiatives. The first was a series of interest rate cuts implemented by aggressive monetary policy. The Fed began reducing interest rates starting in September 2007 through June 2008 in reaction to an economy that, as former Fed Chairman Alan Greenspan famously said, was exhibiting signs of “irrational exuberance.” In spite of this move, the US economy began an extended contraction, and by December 2008 the Fed Funds rate had in reaction been lowered essentially to the zero boundary.
The second initiative was providing financial support to distressed banks and other financial institutions. This was sometimes referred to as the Alphabet Soup Program due to the substantial number of acronyms describing the specific programs. Most of these programs and their ultimate cost in dollars are summarized below:
- Troubled Asset Relief Program (TARP)
- $245 billion was committed in programs to stabilize banking institutions, including the designation of Goldman Sachs and Morgan Stanley as bank holding companies, which gave them access to the Discount Window.
- $27 billion was committed through programs to restart credit markets.
- $80 billion was committed to stabilize the US auto industry.
- $68 billion to stabilize American International Group (AIG)
- $46 billion to help individuals and families avoid foreclosure
- Term Auction Facility (TAF) – term collateralized discount window loans to depository institutions in generally sound financial condition ($493 billion)
- Liquidity swaps with foreign central banks ($586 billion)
- Term Securities Lending Facility (TSLF) – loaned liquid Treasury securities to primary dealers for one month in exchange for eligible collateral consisting of other, less liquid securities ($236 billion)
- Primary Dealer Credit Facility (PDCF) – overnight loan facility for primary dealers, similar to the discount window for depository institutions ($130 billion)
- Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) – loaned money to banks and BHCs so they could finance purchases of commercial paper that money market mutual funds needed to sell ($152 billion)
- Commercial Paper Funding Facility (CPFF) – three-month loans used to purchase newly issued, highly rated, US dollar-denominated, unsecured, and asset-backed commercial paper ($350 billion)
- Term Asset-Backed Securities Loan Facility (TALF) – loans up to five years to any US company that owned eligible ABS collateral ($48 billion)
The third initiative was commonly called quantitative easing (QE) but was referred to by the Fed as the Large-Scale Asset Purchase program. This involved the purchase of longer-term US Treasury securities and federal agency guaranteed mortgage-backed securities (MBS). This was an attempt to lower the long end of the yield curve to match the declines at the short end of the curve caused by the Fed’s reduction of the Fed Funds rate.
The fourth initiative was “forward guidance” on the Fed’s future rate policy, which involved sending a clear message to individuals and businesses that rates would be held at or near zero for a long time. The Fed repeatedly stated that they would constrain rates at these levels as long as unemployment stayed over 6.5 percent and inflation did not exceed 2.0-2.5%. This helped to set expectations that rates would stay “lower for longer.”
Over time, most of these actions were later understood to have been both appropriate and beneficial, although some observers remain critical of what they view as overreach by the Fed during the GFC.
Fast Forward to 2020 – Déjà Vu All Over Again?
Although markets were relatively stable throughout February 2020, the increasing spread of the coronavirus created pressure on governments and monetary authorities to craft a global response to the impending crisis. Federal Reserve Chairman Jerome Powell held a previously unscheduled conference on Sunday, March 15 to announce several steps that would be taken by the Fed in response to the unfolding crisis. The initial impact of this announcement was a precipitous drop in global equities markets the following Monday. The Dow Industrial Index fell almost 3,000 points, the worst point drop since the 1987 Black Monday market crash.
While it is too early to determine whether or not the Fed’s actions will be successful in mitigating the negative impact of the virus on financial markets and the economy in general, it’s worth noting the steps that are being taken, many of which mirror specific actions and programs that the Fed also implemented during the GFC. It could be argued that certain elements of the policies were implemented more quickly and with less market disruption in this crisis scenario because of the Fed’s experience with similar programs during the GFC. As of now the Fed’s responses to the coronavirus crisis can be described as falling into three major categories: monetary and interest rate policy, lending and liquidity programs, and regulatory relief.
Monetary/Interest Rate Policy
The Federal Open Market Committee (FOMC), the Fed’s monetary policy arm, had been reluctant to lower the Fed Funds rate since a series of rate increases beginning in late 2015 that were intended to mitigate concerns of rising inflation, primarily due to upward pressure on wages. Concerns stemming from signs of an impending global slowdown eventually caused the Fed to lower the rate from 2.25% to 2.00% in August 2019, with additional cuts in September and October. However, the impact of the spread of the coronavirus exacerbated these concerns and the Fed, in an attempt to get in front of the issue, decreased the Fed Funds rate 50 bps on March 3.
Despite this move, economic conditions continued to worsen, and Chairman Powell’s hastily convened press conference on March 15 announced a new series of measures. In addition to lowering the target range for the Fed Funds rate to 0.00 to 0.25%, the Fed also elected to reinstate the Large Scale Asset Purchase program by announcing their intention to immediately buy $80 billion in US Treasury and Agency MBS, with no limit to the purchases that could be undertaken if needed to backstop the economy.
In a departure from their 2008 policy, the Federal Reserve Bank of New York’s Open Markets Trading Desk also announced that it would begin purchasing commercial mortgage-backed securities (CMBS) for the first time, although for the time being these purchases will be limited to CMBS that are guaranteed by Fannie Mae and Freddie Mac (so-called “Agency CMBS”).
The Fed announced that it would encourage the use of the discount window by lowering the rate on that facility to 0.25%. In a move intended to eliminate the stigma commonly associated with borrowing from the window, the largest and most systemically important financial institutions (SIFIs) were “encouraged” by the Fed to obtain credit from the facility. Eight of the country’s largest banks soon complied, borrowing over $50 billion on March 16.
The Fed also coordinated with several foreign central banks to lower the pricing on USD-denominated liquidity swaps by 25 basis points. This was intended to create additional liquidity in the USD after some very volatile swings in exchange rates during March. This was in addition to a new temporary Foreign and International Monetary Authority (FIMA) repo facility that will allow foreign banks to exchange Treasuries for USD in collateralized repo transactions. This should increase the availability of USD without requiring the outright sale of securities in a volatile market.
Concurrently, the Fed announced that they would reinstate the TALF and the PDCF as well as several new programs:
- Commercial Paper Funding Facility (CPFF) – a new facility that will buy commercial paper (CP) at favorable rates from issuers who might have difficulty selling the paper on the open market.
- Money Market Mutual Fund Liquidity Facility (MMLF) – a facility offering collateralized loans to large banks who buy assets from money market mutual funds. The MMLF is being administered by the Federal Reserve Bank of Boston, where a number of large money market mutual funds are headquartered. The list of acceptable collateral was expanded to include high-quality municipal debt and bank CDs.
- Primary Market Corporate Credit Facility (PMCCF) and the Secondary Market Corporate Credit Facility (SMCCF) to support credit to large employers. The Treasury will provide $30 billion in equity to these facilities.
In addition, the Fed announced a new initiative called the Main Street Business Lending Program that is intended to provide direct support to small and medium-sized businesses. This program will be implemented in parallel with a number of Small Business Administration (SBA) programs, which include the Economic Injury Disaster Loan (EIDL) and Paycheck Protection Program (PPP) initiatives.
The Fed announced that a number of steps that would allow commercial banks to use portions of their regulatory capital reserves to lend to households and businesses impacted by coronavirus. These actions would essentially allow banks to operate with substantially lower levels of capital than is generally required to be considered well or adequately capitalized under the Prompt Corrective Actions (PCA) standards. One such move was the relaxation of requirements to maintain the supplementary leverage ratio (SLR), a capital reserve intended to ensure that banking institutions with more than $250 million in total assets hold sufficient capital in economic downturns. The Fed specifically noted that any additional capital released under these more relaxed standards could not be used for share repurchases.
The Fed also reduced reserve requirements to zero for all but the largest banking organizations, incrementally increasing the amount of lendable funds available in the banking system. The total loss absorbing capacity (TLAC) requirements of the largest globally active banking organizations were temporarily relaxed to supplement other regulatory efforts to encourage banks to lend actively during the coronavirus crisis.
Non-critical examination requirements of smaller banks will be temporarily relaxed. The Fed will pivot from a reliance on onsite examinations to offsite surveillance activities. The largest and most complex banking organizations are still required to submit their capital plans under the CCAR requirements by April 6, although most of these institutions have substantially completed this process for the 2020 reporting period.
The Fed is permitting banking organizations with less than $5 billion in total assets to submit financial statements up to 30 days after existing filing deadlines to reduce overall regulatory burden, if the banks contact their primary regulator in advance.
The banking regulatory agencies have released an interim final rule concerning the calculation of “current expected credit loss” (CECL). This would extend the implementation of this potentially costly accounting standard over an additional two years.
The Federal Reserve is clearly leveraging the experience they gained and the tools that they developed during the GFC to address the economic distress that the global economy is currently facing. The rapid onset of the coronavirus crisis has forced the Fed to react even more quickly than during the previous downturn. Additional tools have been made available, many of which are intended to address some of the perceived inadequacies of the Fed’s prior actions during the GFC, which included a focus on the well-being of large complex “Wall Street” firms at the expense of smaller “main street” concerns. While it is premature to gauge whether or not these efforts will be successful, it is clear that the Fed is willing and able to go well beyond their traditional dual mandate of full employment and price stability to support the US economy during the unprecedented economic distress associated with the onslaught of the coronavirus.