The Fed Should Never Lend to Anyone Other Than Banks
(Bloomberg Opinion) -- This morning, the Federal Reserve announced two entirely novel interventions in the corporate debt market: the Primary Market Corporate Credit Facility (PMCCF) and the Secondary Market Corporate Credit Facility (SMCCF). If used appropriately, the latter is a smart and defensible use of central bank power to stabilize liquidity conditions in a key financial market. The former is an indefensible attempt by the Fed and the administration to sidestep Congress.
Consider where we are. The spreads on corporate bonds have widened markedly in the past few weeks. Like all movements in yields, this one has two sources. First, corporate bonds have gotten less liquid: Buyers have rising concerns that, if they needed cash, they wouldn't be able to resell the bonds quickly without taking a big loss. Second, corporate bonds have gotten riskier: buyers are increasingly worried that corporations won't have the cash flow to repay their debts.
This liquidity problem is one that the Fed can and should fix. The Fed never needs to worry about reselling any asset. So it can use its ability to print money to tell corporate buyers: look, we’ll always be here to buy your assets. This can eliminate any fear on the part of corporate bond buyers that they won’t be able to resell their assets quickly. As a result, corporations will be able to borrow at a lower interest rate.
The risk problem is entirely different. Given the challenges in the economy posed by the coronavirus and the appropriate public-health response, corporations face a great deal of risk. It makes sense, because of that risk, that their bonds should trade at a lower price and higher yield. The Fed has no special epidemiological powers or knowledge that will allow it to eliminate or even understand this risk.
What are the policy implications of this analysis?
First, the Fed can and should fix any liquidity problem in these critical markets by intervening in the secondary market. The SMCCF is the right vehicle for this job.
Second, the Fed shouldn't get in the business of lending directly to corporations through a vehicle like the PMCCF. Because the Fed is fixing the liquidity problems through the SMCCF, its direct loans are simply a way to assume default risk without receiving a compensatory return. This is simply a direct taxpayer subsidy to corporate shareholders.
Right now, there is a debate in Congress about the shape of a fiscal stimulus package. The administration clearly believes that corporate subsidies are desirable. Its Democratic opponents are much less convinced. By setting up the PMCCF, the Fed is using its independence to decide this important and necessary debate in favor of the White House. Congress would be doing the Fed a favor by eliminating its ability to make direct loans to nonfinancial corporations.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Narayana Kocherlakota is a Bloomberg Opinion columnist. He is a professor of economics at the University of Rochester and was president of the Federal Reserve Bank of Minneapolis from 2009 to 2015.
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