The Federal Reserve announced Wednesday that it will begin winding down a program that purchased tens of billions of dollars of corporate assets to shore up the economy during the pandemic.
In a statement, the central bank said the facility was crucial to businesses during the depth of the recession. But as the economy rapidly recovers, the time to start winding it down has begun.
The program "proved vital in restoring market functioning last year, supporting the availability of credit for large employers, and bolstering employment through the Covid-19 pandemic," the Fed said.
The Fed currently holds $13.7 billion worth of corporate assets, including more than $5 billion of corporate bonds and another $8.5 billion worth of exchange-traded funds.
That's a huge amount of money to unwind, so the Fed said it would sell off those assets over time to keep markets functioning properly and to reduce any resulting shock to the system.
Fed's Balance Sheet
The Fed's balance sheet is $7.9 trillion. Somehow we are supposed to believe that a measly $27.2 billion in corporate bond and ETF purchases "saved the economy".
The Fed said the program was "vital in restoring market functioning" an absurdity in an of itself.
CNN then translated the Fed's statement into an even more ridiculous "program that saved the economy."
Illegal Corporate Bond Purchases
It's important to note the Fed's tiptoe waltz into the corporate bond program was illegal. John Hussman explained the illegality in Fundamentally Unsound.
The Fed is using Congressionally-approved crisis funds to buy corporate bonds from investors in order to boost valuations and protect bondholders from losses, with neither sufficient collateral nor evidence of inability to secure bank credit (both of which are legally required). Worse, the Fed is also creating base money to “leverage” these purchases.
The Fed has announced the intention to “leverage” the funds approved by Congress with additional money creation, in an amount ranging between 3-10 times what Congress actually allocated, in order to buy unsecured corporate bonds from private investors. Aside from the violations of law involved here, and the shift of private risk onto the public balance sheet, it’s important to understand is that the financial effect is to amplify speculation and the issuance of low-grade debt.
What's Going On?
- A $27.2 billion purchase certainly did not save the economy.
- The total purchase was so small it may have done nothing at all except this key thing: The Fed just usurped authority it never had then bragged about the success of the program.
- CNN further hyped what the Fed did as not only a success, but one that allegedly saved the economy.
- The next time the Fed acts it may not be a small size and it may not even be limited to corporate bond ETFs but virtually anything the Fed wants to do.
One Toe Too Much
It's not the size, it's the idea. The Fed got its foot into another illegal door and was praised for it.
This is similar in nature to The Psychology of QE is Far More Important Than the Amount of It
This time however, the key idea is not the amount but what the Fed may do next time.
You likely know the answer but there's more to the setup than a simple yes.
Addendum From Hussman
As a practical matter, it’s possible to scrape enough grey areas out of the legislative wording of the CARES Act to argue that the Fed’s purchases of corporate bonds were allowed by 4003(b)(4)(B), but even that strained argument holds only for purchases financed directly by funds provided by the Treasury, and where those Treasury funds themselves could be interpreted as the 13(3) “collateral.” It’s a major red flag that the Fed counted the unsecured bonds as collateral as well, and that it booked them at cost rather than market value, because that’s like claiming that any unbacked IOU scribbled on a napkin can be treated as its own collateral.
In any case, the use of additional Fed “leverage” would have been patently illegal, and it seems that the Fed understood this because leverage (i.e. creating base money to buy unbacked corporate bonds beyond the amount of funding approved and provided by Congress) was never used, as far as I can tell. In addition to $8.5 billion in corporate bond ETFs, the Fed’s “secondary market corporate credit facility” holds about $5 billion in individual bonds.
As of 11/24/20, the largest holdings were, in order: AT&T, Volkswagen Group of America Finance, Toyota Motor Credit, Daimler Finance North America, Verizon, Apple, Comcast, and BMW US Capital. Over 74% of the dollar value in the top 4 holdings represented bonds issued by wholly-owned subsidiaries of foreign companies. This is what one gets when one places the Federal Reserve in charge of allocating funds on behalf of the American public. We can do better.
The above snip is from the tail end of Hussman's December 2020 post Hypervaluation and the Option Value of Cash