By Jonnelle Marte and Howard Schneider
(Reuters) – Analysts and economists increasingly expect the Federal Reserve to roll out measures beyond interest rate cuts and bond purchases to ensure financial markets keep operating smoothly and banks have ample liquidity during the coronavirus outbreak.
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The Fed, which delivered an emergency rate cut last week and is expected to lower them more when it meets next week, has already taken steps to ensure liquidity in the banking system by substantially increasing the support it provides to overnight lending markets. [nL1N2B41X9]
But the central bank has an array of other emergency lending facilities and other tools it used during the 2007-2009 financial crisis that it could turn to if needed to keep credit markets from freezing up during times of stress.
“The playbook story in these events is that the Fed would always be a provider of liquidity as needed,” said Nellie Liang, a senior fellow in economic studies at the Brookings Institution and former director of the Division of Financial Stability at the Federal Reserve Board.
Some steps the Fed can take on its own under existing authority, while others might require partnering with the Treasury Department or expanded authority from Congress.
But here is a look at some of the tools that could be adjusted or revived to support markets if credit conditions worsen significantly:
** Discount window
The Fed’s lending tool of last resort is rarely used because banks are worried that borrowing from the window could make them appear weak. But policymakers could start by reminding banks that “the discount window is open, please use it,” said Liang. Fed officials could also make the credit more attractive by lowering the rate they charge or extending the length of the loans offered from one day to 30 days or 90 days.
** Term Auction Facility (TAF)
The Fed rolled out the TAF in 2007 as a way to offer loans to banks that were too hesitant to turn to the discount window. The TAF lacked some of the stigma associated with the discount window because of the way the loans were issued. Financial firms had to bid for the funding, which meant that the rate they paid would be viewed as being determined by the market, and not as a penalty rate.
The money also was not disbursed until three days later, suggesting that the banks who borrowed in that way were not in immediate need of cash.
“It is a signal that you are not desperate,” said Liang. The Fed closed the facility in March 2010.
** Commercial paper funding facility (CPFF)
In the financial crisis, establishing the CPFF was the closest the Fed came to making direct loans to non-financial businesses.
The commercial paper market is a key source of short-term funding for a range of businesses. When it froze up in 2008, the Fed created the CPFF to help reopen that market by purchasing high-rated, asset-backed commercial paper at three-month maturities. The facility was closed in 2010.
Some measures of potential stress have appeared in this market. The spread on borrowing rates between the highest-rated non-financial borrowers and the next tier below them has widened notably this month. It is now the widest in nearly two years.
It is too early to say if the current stress will grow to an extent that allows the Fed to reopen such a facility under the “unusual and exigent circumstances” section of the Federal Reserve Act, which allows it to lend to businesses and individuals.
** Central bank liquidity swaps
The Fed has standing agreements with five other major foreign central banks – the Bank of Canada, European Central Bank, Bank of England, Bank of Japan and Swiss National Bank – that allows them to provide dollars to their financial institutions during times of stress. These were converted from temporary to standing arrangements in 2011.
The Fed could roll out more agreements with other central banks not currently party to the standing agreements to increase access to dollars if needed.
** What else?
The central bank could create new tools more tailored to today’s market, said Kathy Bostjancic, chief U.S. financial economist at Oxford Economics. “Many of these were created for the specific issues that were plaguing the financial system back then,” said Bostjancic.
“What it shows is the Fed can be innovative.”
(Reporting by Jonnelle Marte and Howard Schneider; Editing by Dan Burns and Andrea Ricci)
