Two Congressional Wrongs Don’t Make a Right

Kathryn Judge

Congress has ended the experiment of having the Federal Reserve provide a financial backstop directly to companies, nonprofits, and municipalities. When Congress tasked the Fed with providing this backstop back in March, it may well have been a mistake. But the programs are finally up and running, and the economic crisis is far from over. Prohibiting the Fed from continuing these programs at this stage magnifies – rather than rectifies – the initial error.

The Fed has long provided emergency liquidity to banks during periods of systemic distress. In 2008, the Fed expanded its emergency lending to also reach nonbank financial intermediaries that now play a critical role in providing credit and financial services to the real economy. In the CARES Act, Congress asked the Fed to go even further.

In March, Congress allocated $454 billion that the Fed and Treasury were to deploy in the form of loans totaling up to ten times that amount. Rather than just making sure that the financial system was functioning well – the Fed’s traditional role – Congress asked the Fed to facilitate the flow of funds directly to the companies, nonprofits, and municipalities that are the real economy. At the time, I was skeptical that this was the best way to provide needed support.

In the intervening months, the results have been decidedly mixed. Confirming one of my initial concerns, it was far easier for the Fed to restart the bond market than it was for the Fed to funnel support to smaller companies, nonprofits and municipalities. The result was an intervention that benefited the large and powerful far more than the entities really in need.

Further confirming my initial fears, the logistical challenge of having the Fed provide funding directly to the real economy slowed implementation. For large companies, this didn’t matter. As soon as the Fed announced its intention to provide support, bond markets recovered quickly. This was great news for large companies with access to public debt markets. But smaller companies don’t have the ability to issue debt directly to the public. To get financing to these companies, the Fed had to find a way to work with bank or other financial intermediaries. This was new territory for the Fed, resulting in significant delays. And even after the Fed launched these new programs, uptake was limited.

The reasons that the Fed’s Main Street and municipal facilities have had limited usage remain contested. Some see this as a sign that the Fed was never going to be able to provide support directly to the real economy. Others believe that these facilities could have been quite helpful if the terms were more generous, and the bar to access was not so high. The latter view is premised on the assumption that the money allocated by Congress should have been available to absorb potential losses, enabling far more lending while still protecting the Fed from any meaningful credit risk.

The change in administration was poised to be the ideal shock to determine which side was right. All of the facilities are finally operational, and demand is slowly increasing, so the logistical frictions that delayed implementation should largely be in the rearview mirror. Moreover, the new administration’s nominee for Treasury Secretary, Janet Yellen, may well have been more ready to authorize the types of risk taking and terms that many see as critical to making the programs work. Precisely for this reason, this is the wrong time to end the experiment.

If the skeptics are right, the failure of the programs to flourish even under a new Treasury Secretary would have made it clear that policymakers need a different tool to mitigate the impact of an economic shock on smaller companies, nonprofits and municipalities. And, if those who think these programs might work are right, allowing these programs to persist could have the beneficial effect of hastening the economic recovery.

Economic and financial shocks seem to be increasingly common. In 2020, it was a pandemic. Next time, it may be a natural disaster or something else entirely. The government needs a better toolkit for softening the impact of these shocks on the companies and other entities that constitute the backbone of the economy. Abandoning the current path prematurely denies future policymakers critical information about whether the Fed can be an instrument for providing this vital support. Regardless of whether it was a wise path in March, abandoning it now is the wrong call.