Wednesday, October 8, 2008

Fed Will Lend Directly to Corporations

Oh Mama, can this really be the end...
-Bob Dylan

Back in February we posted "Doom and Gloom: What Can the Federal Reserve Do? Part II" which quoted from a 2005 paper by the Federal Reserve:
We left part I at the "Money Rain" section of the Fed paper Monetary Policy When the Nominal Short-Term Interest Rate is Zero.
The paper's conclusions are worth an extended exerpt.
9 Conclusion
...When the nominal Treasury bill rate is at zero, the Federal Reserve could attempt to provide a stimulus to aggregate demand through effects in addition to those from increases in the monetary base. The Federal Reserve could purchase assets other than Treasury bills, such as U.S. Treasury bonds or foreign government debt. Even if these assets are perfect substitutes for U.S. Treasury bills, purchases of them could have a stronger stimulative impact than purchases of Treasury bills because of signalling effects."

...A similar effect is present if the Federal Reserve were to write options in an attempt to communicate its desired path for the Treasury bill rate.

But with discount window loans whether in the form of advances or discounts the Federal Reserve can accept as collateral (and therefore make liquid" for a depository) a wide variety of assets that the Federal Reserve cannot purchase. A potentially serious limitation on such loans is that it has apparently been the intent of Congress that the Federal Reserve not take onto its balance sheet the credit-risk of the collateral: The Federal Reserve could turn to the depository for full payment of the loan.

The Federal Reserve can bypass depositories and lend directly to individuals, partnerships, and corporations (IPCs). However, the Federal Reserve must and there to be "unusual and exigent" conditions and the IPC receiving the loan must be unable to secure credit from other banking institutions. It seems the intent of Congress was that the Federal Reserve should make such loans only to credit-worthy IPCs. With the Federal Reserve not taking credit risk onto its balance sheet, private- sector loan markets would still incorporate all credit risk into any new loans to households and businesses|preventing any decline in credit-spreads, which may be elevated should the economy be at the zero bound and should the economy be weak. Nonetheless, loans by the Federal Reserve to depositories and to IPCs could provide some liquidity for the credit instruments used as collateral and thereby could lower liquidity premiums. Even if these restrictions on accepting private-sector credit risk were surmounted, or relaxed by an act of Congress, direct involvement by the Federal Reserve in the credit allocation process would raise a number of difficult issues...

That post went on to look at another paper, this one from the Dallas Fed:
...The goods & services solution
Why not have the Fed just conduct an open market purchase of real goods and services? Even more so than exchange rate intervention, this strategy would represent a direct stimulus to aggregate demand. As posed, though, the strategy has a major drawback: it violates the Federal Reserve Act. The Fed isn’t authorized to purchase goods and services, apart from those needed for the operation of the Federal Reserve System. The strategy can be implemented, however, by coordination with fiscal policy-makers. The Federal government, for example, could purchase goods and services and finance the purchases with new debt, which the Fed in turn would buy–in technical terminology, the Fed would ‘monetize’ the resulting debt.

...What if the assets in the “not allowed” column were “allowed”, though? This point is not moot, since aggressive use of the discount window–under certain emergency provisions in the Federal Reserve Act–can allow the Fed to sidestep, to some extent, the restrictions which apply to open market operations.
Even if the legal constraints were not present, however, it’s not necessarily desirable to have the Fed acting in markets for corporate debt or mortgages. Whatever benefits there might be from such actions would have to be weighed against the cost of putting the Fed in the business of allocating private sector credit–a task for which the Fed has no particular expertise, and which would likely subject the Fed to unwelcome political pressures.

Interesting, no?

The post ended with a Bernanke speech detailing more options. So no, this isn't the end, but God help us all if it gets to the "stuffing bottles with currency and hiding them in played out gold mines" option.
From the Wall Street Journal:
Fed to Lend Directly to Companies for First Time Since Great Depression, Hints at a Rate Cut; Stocks Fall as Dow Hits 5-Year Low

The Federal Reserve said it will bypass ailing banks and lend directly to American corporations for the first time since the Great Depression, and it hinted strongly at further interest-rate cuts -- a cocktail of unconventional and conventional remedies for an economy whose prognosis is deteriorating rapidly.

The historic and potentially risky move of lending to nonfinancial corporations, the latest in a string of extraordinary steps taken by the Fed over the past month, carries the government deeper into the role of propping up private markets. Investors remain unconvinced any of it will work....

CH-47 Chinook Helicopter

Some of our posts on Fed policy options:
Depression risk might force U.S. to buy assets

Doom and Gloom: What Can the Federal Reserve Do?

The Federal Reserve's "Extraordinary Actions"

"Stupidity Got Us Into This Mess and Stupidity Will Get Us Out!"
-Homer J. Simpson
Quoted in The Wisdom of Homer

Who Are Those Guys?
-Butch Cassidy
Butch Cassidy and the Sundance Kid
Monday, March 24, 2008
Fed May Buy Mortgages Next, Treasury Investors Bet

"I don't want it, why do you think I sold it to you"
-overheard when one trader tried to D.K. (don't know) a trade with another.
Friday, July 11, 2008
Federal Reserve: Send in the Helecopters, No GSE Left Behind (FNM; FRE)

American Taxpayer on the Hook for $1 Trillion of Banks Non-, Mis- and Malfeasance. Plus: Music to Hunt Bankers By
It appears there will be a decade long wealth transfer from savers to bankers. To reliquify the big banks balance sheets, the powers that be will let the banks borrow cheap from the Fed or at artificially low shorter term rates, then turn around and lend at higher rates to the Treasury. There is probably a carbon trading angle here too*. You just watch....
Bernanke Violates Federal Reserve Act Section 23A

Fed Widens Collateral, Banks Set Up $70 Billion Fund

Federal Reserve Accepting EQUITIES as Collateral