What’s the Fed doing in response to the COVID-19 crisis? What more could it do?
The coronavirus crisis in the United States—and the associated business closures, event cancellations, and work-from-home policies—triggered a deep economic downturn of uncertain duration. The Federal Reserve stepped in with a broad array of actions to limit the economic damage from the pandemic, including up to $2.3 trillion in lending to support households, employers, financial markets, and state and local governments. “We are deploying these lending powers to an unprecedented extent [and] … will continue to use these powers forcefully, proactively, and aggressively until we are confident that we are solidly on the road to recovery,” Jerome Powell, chair of the Federal Reserve Board of Governors, said in April 2020. In that same month, Powell discussed the Fed’s goals during a webinar at the Brookings’ Hutchins Center on Fiscal and Monetary Policy.
What is the Fed doing to support the U.S. economy and financial markets?
Near-Zero Interest Rates
- Federal funds rate: The Fed has cut its target for the federal funds rate, the rate banks pay to borrow from each other overnight, by a total of 1.5 percentage points since March 3, 2020, bringing it down to a range of 0% to 0.25%. The federal funds rate is a benchmark for other short-term rates, and also affects longer-term rates, so this move is aimed at lowering the cost of borrowing on mortgages, auto loans, home equity loans, and other loans, but it will also reduce the interest income paid to savers.
- Forward guidance: Using a tool honed during the Great Recession of 2007-2009, the Fed has offered forward guidance on the future path of its key interest rate, saying that rates will remain low “until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.” This forward guidance on the overnight rate, updated in September 2020 to reflect the Fed’s new monetary policy framework, puts downward pressure on longer-term rates.
Supporting Financial Market Functioning
- Securities purchases (QE): The Fed resumed purchasing massive amounts of securities, a key tool employed during the Great Recession, when the Fed bought trillions of dollars in long-term securities. Treasury and mortgage-backed securities markets became dysfunctional after the outbreak of COVID-19, and the Fed’s actions aimed to restore smooth market functioning so that credit could continue to flow. On March 15, 2020, the Fed said that it would buy at least $500 billion in Treasury securities and $200 billion in government-guaranteed mortgage-backed securities over “the coming months.” Then on March 23, 2020, it made the purchases open-ended, saying it would buy securities “in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions.” Market function subsequently improved, and the Fed tapered its purchases through April and May. On June 10, 2020, however, the Fed said it would stop tapering and would buy at least $80 billion a month in Treasuries and $40 billion in residential and commercial mortgage-backed securities until further notice. Between mid-March and early December of 2020, the Fed’s portfolio of securities held outright grew from $3.9 trillion to $6.6 trillion.
- Lending to securities firms: Through the Primary Dealer Credit Facility (PDCF), a program revived from the global financial crisis, the Fed offered low interest rate (currently 0.25%) loans up to 90 days to 24 large financial institutions known as primary dealers. The dealers provided the Fed with equities and investment grade debt securities, including commercial paper and municipal bonds, as collateral. The goal was to keep the credit markets functioning at a time of stress when institutions and individuals were inclined to avoid risky assets and hoard cash, and dealers could have encountered barriers to financing the rising inventories of securities they accumulated as they made markets. To re-establish the PDCF, the Fed had to obtain the approval of the Treasury Secretary to invoke emergency lending authority under Section 13(3) of the Federal Reserve Act for the first time since the Global Financial Crisis of 2007-2009. On March 8, 2021, the Fed announced that the program will expire on March 31.
- Backstopping money market mutual funds: The Fed also re-launched the crisis-era Money Market Mutual Fund Liquidity Facility (MMLF), which lent to banks against collateral they purchased from prime money market funds, the ones that invest in corporate short-term IOUs known as commercial paper, as well as in Treasury securities. At the outbreak of COVID-19, investors withdrew from money market funds en masse. To meet outflows, these funds sold securities, but disruptions in the financial markets made it difficult to sell, even if the securities were all of high quality and very short maturities. The Fed said that the facility “will assist money market funds in meeting demands for redemptions by households and other investors, enhancing overall market functioning and credit provision to the broader economy.” The Fed invoked Section 13(3) and obtained permission from Treasury, which provided $10 billion from its Exchange Stabilization Fund to cover potential losses. Given limited usage, the MMLF will expire on March 31, 2021.
- Repo operations: The Fed vastly expanded the scope of its repurchase agreement (repo) operations to funnel cash to money markets and is now essentially offering an unlimited amount of money. The repo market is where firms borrow and lend cash and securities short-term, usually overnight. Disruptions in the repo market affect the federal funds rate, the Fed’s primary tool for achieving its price stability and employment mandate. The Fed’s facility makes cash available to the primary dealers in exchange for Treasury and other government-backed securities. Before coronavirus turmoil hit the market, the Fed was offering $100 billion in overnight repo and $20 billion in two-week repo. It has greatly expanded the program—both in the amounts offered and the length of the loans. It is offering $1 trillion in daily overnight repo, $500 billion in one-month repo, and $500 billion in three-month repo. Effective March 18, 2021, the Fed will be offering a limit of $80 billion per day of overnight repo per borrower, up from the previous limit of $30 billion per day for each borrower.
Encouraging Banks to Lend
- Direct lending to banks: The Fed lowered the rate that it charges banks for loans from its discount window by 2 percentage points, from 2.25% to 0.25%, lower than during the Great Recession. These loans are typically overnight—meaning that they are taken out at the end of one day and repaid the following morning—but the Fed has extended the terms to 90 days. Banks pledge a wide variety of collateral (securities, loans, etc.) to the Fed in exchange for cash, so the Fed is not taking on much risk in making these loans. The cash allows banks to keep functioning: depositors can continue to withdraw money, and the banks can make new loans. Banks are sometimes reluctant to borrow from the discount window because they fear that if word leaks out, markets and others will think they are in trouble. To counter this stigma, eight big banks agreed to borrow from the discount window.
- Temporarily relaxing regulatory requirements: The Fed is encouraging banks—both the largest banks and community banks—to dip into their regulatory capital and liquidity buffers, so they can increase lending during the downturn. The reforms instituted after the financial crisis require banks to hold additional loss-absorbing capital to prevent future bailouts. But these capital buffers can be used during a downturn to stimulate lending, and the Fed is encouraging that now, including through a technical change to its TLAC (total loss-absorbing capacity) requirement, which includes capital and long-term debt. (To preserve capital, big banks also are suspending buybacks of their shares.) The Fed also eliminated banks’ reserve requirement—the percent of deposits that banks must hold as reserves to meet cash demand—though this is largely irrelevant because banks currently hold far more than the required reserves. The Fed had been restricting the dividends and share buybacks of bank holding companies throughout the pandemic crisis, but on March 25, 2021, it announced that these restrictions will be lifted on June 30, 2021 for most firms on the basis of stress test results.
Supporting Corporations and Businesses
- Direct lending to major corporate employers: In a significant step beyond its crisis-era programs, which focused mainly on financial market functioning, the Fed on March 23, 2020, established two new facilities to support highly rated U.S. corporations. The Primary Market Corporate Credit Facility (PMCCF) allowed the Fed to lend directly to corporations by buying new bond issuances and providing loans. Borrowers could defer interest and principal payments for at least the first six months so that they had cash to pay employees and suppliers. But during this period, borrowers could not pay dividends or buy back stocks. And, under the new Secondary Market Corporate Credit Facility (SMCCF), the Fed could purchase existing corporate bonds as well as exchange-traded funds investing in investment-grade corporate bonds. These facilities would “allow companies access to credit so that they are better able to maintain business operations and capacity during the period of dislocations related to the pandemic,” the Fed said. Initially supporting $100 billion in new financing, the Fed announced on April 9 that the facilities would backstop up to $750 billion of corporate debt. And, as with previous facilities, the Fed invoked Section 13(3) of the Federal Reserve Act and received permission from the U.S. Treasury, which provided $75 billion from its Exchange Stabilization Fund to cover potential losses. Over the Fed’s objections, Treasury Secretary Steven Mnuchin decided that the final bond and loan purchases for the corporate credit facilities would take place no later than December 31, 2020. The Fed said on June 2, 2021, that it would gradually sell off its $13.7 billion portfolio of corporate bonds.
- Commercial Paper Funding Facility (CPFF): Commercial paper is a $1.2 trillion market in which firms issue unsecured short-term debt to certain money market funds and others, to finance day-to-day operations. Through the CPFF, another reinstated crisis-era program, the Fed bought commercial paper, essentially lending directly to corporations for up to three months at a rate between 1 to 2 percentage points higher than overnight lending rates. “By eliminating much of the risk that eligible issuers will not be able to repay investors by rolling over their maturing commercial paper obligations, this facility should encourage investors to once again engage in term lending in the commercial paper market,” the Fed said. “An improved commercial paper market will enhance the ability of businesses to maintain employment and investment as the nation deals with the coronavirus outbreak.” As with other non-bank lending facilities, the Fed invoked Section 13(3) and received permission from the U.S. Treasury, which put $10 billion into the CPFF to cover any losses. The Commercial Paper Funding Facility is set to lapse on March 31, 2021.
- Supporting loans to small- and mid-sized businesses: The Fed’s Main Street Lending Program, announced on April 9, 2020, and subsequently expanded and broadened to include more potential borrowers, aimed to support businesses too large for the Small Business Administration’s Paycheck Protection Program (PPP) and too small for the Fed’s two corporate credit facilities. Through three programs—the New Loans Facility, Expanded Loans Facility, and the Priority Loans Facility—the Fed would fund up to $600 billion in five-year loans. Businesses with up to 15,000 employees or up to $5 billion in annual revenue can participate. Under the changes announced in June 2020, the Fed lowered the minimum loan size for New Loans and Priority Loans, increased the maximum for all facilities, and extended the repayment period. Lenders retain 5 percent of the loans. As with other facilities, the Fed invoked Section 13(3) and received permission from the U.S. Treasury, which through the CARES Act put $75 billion into the three Main Street Programs to cover losses. Borrowers are subject to restrictions on stock buybacks, dividends, and executive compensation. (See here for additional operational details.) Secretary Mnuchin, again over the Fed’s objections, decided that the Main Street facility would stop taking loan submissions on December 14, 2020, as it was set to make its final purchases by December 31. The Fed also has a Paycheck Protection Program Liquidity Facility that will facilitate loans made under the PPP. Bank lending to small businesses can borrow from the facility using PPP loans as collateral. On March 8, 2021, the Fed extended the PPP Liquidity Facility through June 30, 2021.
- Supporting loans to non-profit institutions: In July 2020, the Fed expanded the Main Street Lending Program to non-profits, including hospitals, schools, and social service organizations that were in sound financial condition before the pandemic. Borrowers needed at least 10 employees and endowments of no more than $3 billion, among other eligibility conditions. The loans were for five years, but payment of principal was deferred for the first two years. As with loans to businesses, lenders retained 5 percent of the loans. This addition to the Main Street program lapsed with the rest of the facility on December 31, 2020.
Supporting Households and Consumers
- The Fed on March 23, 2020 restarted the crisis-era Term Asset-Backed Securities Loan Facility (TALF): Through this facility, the Fed supported lending to households, consumers, and small businesses by lending to holders of asset-backed securities collateralized by new loans. These loans included student loans, auto loans, credit card loans, and loans guaranteed by the SBA. In a step beyond the crisis-era program, the Fed expanded eligible collateral to include existing commercial mortgage-backed securities and newly issued collateralized loan obligations of the highest-quality. Like the programs supporting corporate lending, the Fed said the TALF would initially support up to $100 billion in new credit. To restart it, the Fed invoked Section 13(3) and received permission from the Treasury, and the Treasury allocated $10 billion from the Exchange Stabilization Fund. Without an extension, this facility stopped making purchases on December 31, 2020, at Secretary Mnuchin’s order.
Supporting State and Municipal Borrowing
- Direct lending to state and municipal governments: During the 2007-2009 financial crisis, the Fed resisted backstopping municipal and state borrowing, seeing that as the responsibility of the administration and Congress. But in this crisis, the Fed lent directly to state and local governments through the Municipal Liquidity Facility, which was created on April 9, 2020. The Fed expanded the list of eligible borrowers on April 27 and June 3, 2020. The municipal bond market was under enormous stress in March 2020, and state and municipal governments found it increasingly hard to borrow as they battled COVID-19. The Fed’s facility offered loans to U.S. states, including the District of Columbia, counties with at least 500,000 residents, and cities with at least 250,000 residents. In June 2020, Illinois became the first government entity to tap the facility. Under changes announced in June, the Fed allowed governors in states with cities and counties that don’t meet the population threshold to designate up to two localities to participate. Governors were also able to designate two revenue bond issuers—airports, toll facilities, utilities, public transit—to be eligible. The New York Metropolitan Transportation Authority (MTA) took advantage of this provision in August, borrowing $451 million from the facility. The Fed could lend up to $500 billion to government entities that had investment-grade credit ratings as of April 8, 2020 in exchange for notes tied to future tax revenues with maturities of less than three years. The Fed invoked Section 13(3) with the approval of the U.S. Treasury, which will use the CARES Act to provide $35 billion to cover any potential losses. (See here for additional details.) The Municipal Liquidity Facility stopped purchases on December 31, 2020 when it lost Treasury support, per Secretary Mnuchin’s decision. The New York MTA secured a second loan from the facility on December 10, 2020, borrowing $2.9 billion before lending halted.
- Supporting municipal bond liquidity: The Fed also used two of its credit facilities to backstop munis. It expanded the eligible collateral for the MMLF to include highly rated municipal debt with maturities of up to 12 months, and also included municipal variable-rate demand notes. It also expanded the eligible collateral of the CPFF to include high-quality commercial paper backed by tax-exempt state and municipal securities. These steps allowed banks to funnel cash into the municipal debt market, where stress has been building due to a lack of liquidity.
Cushioning U.S. Money Markets from International Pressures
- International swap lines: Using another tool that was important during the Great Recession, the Fed is making U.S. dollars available to other central banks so they can lend to banks that need them. The Fed gets foreign currencies in exchange, and charges interest on the swaps. Five foreign central banks have permanent swap lines with the Fed. The Fed has cut the rate it charges on those swaps with central banks in Canada, England, the Eurozone, Japan, and Switzerland, and extended the maturity of those swaps. It has also extended temporary swaps to the central banks of Australia, Brazil, Denmark, Korea, Mexico, New Zealand, Norway, Singapore, and Sweden. On December 16, 2020, the Fed extended these temporary swaps until September 30, 2021.
- The Fed also is offering dollars to central banks that don’t have an established swap line through a new repo facility called FIMA (for “foreign and international monetary authorities”): The Fed will make overnight dollar loans to the central banks, taking U.S. Treasury debt as collateral. This facility was extended, along with the temporary swap lines, through September 30, 2021.
Why are the Fed’s actions important?
The steps that have been taken by federal, state, and local officials to mitigate the spread of the virus will limit spending and hurt the incomes of businesses and households, leading to a recession. The Fed is trying to ensure that credit continues to flow to households and businesses during this difficult time and that the financial system doesn’t amplify the shock to the economy. It also wants to do what it can to limit the permanent damage to the economy so that when the pandemic recedes, the economy can grow again, and supply goods and services to meet demand. As our colleague Ben Bernanke, the former Fed chair, said (in so many words) during the Great Recession: We didn’t set out to save Wall Street, but in order to save Main Street, we had to save Wall Street.
In many other countries, most of the credit flows through the banks. In the U.S., a lot flows through the capital markets, so the Fed is trying to keep them functioning as smoothly as possible. As another one of our colleagues, Don Kohn, former Federal Reserve Vice Chair, said:
“The Treasury market in particular is the foundation for trading in many other securities markets in the U.S. and around the world; if it’s disrupted, the functioning of every market will be impaired. The Fed’s purchase of securities is explicitly aimed at improving the functioning of the Treasury and MBS markets, where market liquidity had been well below par in recent days.”
When financial markets are clogged, firms tend to draw on bank lines of credit, and that can lead banks to sell Treasury and other securities or pull back on other loans. The Fed is supplying unlimited liquidity to the banks, so they can meet credit drawdowns and relieve any balance sheet strain.
What more can the Fed do?
The Fed’s powers and tools, as impressive as they are, aren’t sufficient to cope with the economic harm of the COVID-19 crisis. That’s why there has been a big—at least $2 trillion—fiscal response from Congress and the President, in the form of support for businesses and checks to every household. As Powell said when the Fed cut rates nearly to zero, “Monetary policy has a role… [but] we do think fiscal response is critical.”
But the Fed may have a few more moves left.
On the monetary policy front, there’s not a lot left. The Fed could cut interest rates below zero—essentially charging a fee for any bank that puts money on deposit at the Fed. Several other central banks have moved to negative rates, but the Fed has said it probably won’t.
It is also unlikely to buy government debt directly from the government as opposed to buying in the secondary market—a process known as monetizing the debt—as the Bank of England has agreed to do, temporarily.
Still, as Ben Bernanke and Janet Yellen, both former Fed chairs and then our colleagues at the Hutchins Center, outlined in the Financial Times, there is more that the Fed could do. (Yellen has since left Hutchins Center to serve as Treasury Secretary.)
Here are some steps the Fed could take:
- Before Treasury Secretary Mnuchin called for the Fed to end lending programs that were backed by funding from the CARES Act, the central bank had room to expand its lending facilities. The Treasury initially pledged $50 billion from its Exchange Stabilization Fund to protect the Fed from losses. The $2.2 trillion CARES Act provided Treasury with an additional $454 billion that can be used to backstop the Fed’s programs, and the new and expanded programs announced April 9, 2020 used $185 billion of that. However, with the Treasury requesting the Fed return the unused portion of these funds and the expiration of the programs backed by them, it can only continue lending through the subset of its facilities that were not funded by Treasury dollars. Secretary Mnuchin approved the extension of these facilities through March 31, 2021. As of March 31, the Commercial Paper Funding Facility, the Money Market Mutual Fund Liquidity Facility, and the Primary Dealer Credit Facility will lapse, leaving only the PPP Liquidity Facility active. The PPP Facility has been extended through June 30, 2021.
- Restart the Term Auction Facility, an alternative to the discount window. “Many banks were reluctant to borrow at the discount window out of fear that their borrowing would become known and would be erroneously taken as a sign of financial weakness,” the Fed said. Under the TAF, the Fed auctioned 28-day and, later, 84-day loans to U.S. and foreign banks in generally sound condition. “The TAF enabled the Federal Reserve to provide term funds to a broader range of counterparties and against a broader range of collateral than it could through open market operations. As a result, the TAF helped promote the distribution of liquidity when unsecured bank funding markets were under stress. It also provided access to term credit without the stigma that had been associated with use of the discount window.” Discount window borrowing peaked at a little more than $100 billion during the crisis; TAF borrowing at $450 billion.
- Broaden the range of financial firms that can borrow from the PDCF beyond the two dozen firms designated as primary dealers, to include hedge funds and other institutions not currently eligible. The PDCF will close on March 31, 2021.
- Strengthen its forward guidance for maintaining near-zero interest rates and massive securities purchases, either by pledging to continue its extraordinary measures until a specific date or until specific economic or financial conditions are achieved.
- The Fed can go beyond forward guidance on its target for the overnight federal funds rates by deploying another policy tool—yield curve control. Yield curve control caps somewhat longer-maturity yields, such as two-year and three-year yields, at low levels, by committing to buying whatever amounts of Treasury securities are necessary to cap the rate. The Fed last capped yields during and after World War II but hasn’t done so since 1951. More recently, the policy has been used by the Bank of Japan and the Reserve Bank of Australia.
The authors did not receive financial support from any firm or person for this article or from any firm or person with a financial or political interest in this article. They are not currently an officers, directors, or board members of any organization with a financial or political interest in this article. Prior to his consulting work for Brookings, Dave Skidmore was employed by the Board of Governors of the Federal Reserve System.