While Federal Reserve Chairman Jerome Powell finally gave a brief glimpse earlier this week of the Board of Governor’s strong preference to see the Fed’s 13-3 credit facilities extended beyond year-end, US Treasury Secretary Steven Mnuchin has remained non-committal, saying a few days ago he “has not made up his mind yet.”
A few points on our sense of what is driving the 13-3 negotiations led by Chairman Powell and Secretary Mnuchin, and how we think they will play out:
*** First, at the outset, we still expect the current 13-3 facilities will be extended, to at least March 31, and possibly, though less probably, all the facilities could be extended to June 30. We understand that Secretary Mnuchin and Chairman Powell both share the concern the facilities need to be extended, as a “better safe than sorry” prudence measure amid a still uncertain fiscal policy and a raging virus that could mean a difficult first half of next year for the economy despite the promise of a Covid vaccine down the road. A joint Treasury-Board of Governors announcement could come by the first week of December.***
*** But we would also caution that the question is not whether but how the 13-3 facilities will be extended. Unlike the relatively straightforward agreement in September to maintain twelve of the 13-3 facilities until December 31 (the Commercial Paper Funding Facility was extended to March 17), we understand the current negotiations largely revolve around politically sensitive issues of how to “sunset” an extension of the 13-3 facilities, in order to limit or at least more strictly define the terms of future reliance on the Fed’s 13-3 facilities with what is, after all, fiscal policy, and whether future lending remains on the Fed balance sheet. ***
*** And on that front, the Fed’s determination to maintain control of its balance sheet makes for a high stakes navigation by Chairman Powell to a consensus within his own Board of Governors and the broader Federal Open Market Committee, and in finding a path between the competing political agendas on Capitol Hill as well as the diverging interests of the outgoing Trump Administration and the incoming Biden Administration, whose most likely Treasury Secretary, Governor Lael Brainard, will have a vote on any agreement Chairman Powell reaches with outgoing Secretary Mnuchin. ***
The Political Stakes
There are better than even odds that the decision over the fate of the 13-3s could get entangled with the fierce political fights on Capitol Hill over the still stalled supplemental fiscal package and the Continuing Resolution on the FY2021 budget, which must be passed or extended in another CR by midnight December 11.
Barely days after the November 3 elections, the politics over the fate of the Fed’s 13-3 facilities was already being pushed to the forefront on Capitol Hill. On November 5, four Democratic Senators led by Minority Leader Chuck Schumer, and including Massachusetts Senator Elizabeth Warren, wrote a letter to Powell and Mnuchin urging that the 13-3 facilities, in particular the Main Street Lending Facility and the Municipal Lending Facility, be not only extended beyond year-end. but also expanded to be made more broadly available to provide support to an economy weakened by the Covid ravages.
Democrats will argue extended and expanded 13-3 facilities would merely be a “bridge” until the fiscal policies are in place. But the GOP fears, with some justification, that now that they have lost the White House, with the Democrats still controlling the House, and holding a wafer thin majority control of the Senate at best, a Biden Administration may push for an indefinite extension of the existing facilities and, indeed, to further expand on them to create new facilities that would steer the Fed into using its balance sheet to support long favored social and “green economy” fiscal programs.
The letter may have been prompted by remarks earlier the same day by Pennsylvania Republican Senator Pat Toomey, who is likely to be Senate Banking Committee chairman next year. After an oversight review of the facilities, he argued the facilities should be wound down at year-end without a formal Congressional vote.
There is some dispute over whether the wording in the CARE Act that appropriated $454 billion to Treasury to backstop the Fed facilities intended for the funding to go beyond year-end, but in any case, we don’t expect a vote on it by Congress. Our strong sense is that Republicans and Democrats alike, with an eye on the Georgia Senate run-off elections on January 5, will be reluctant to risk an adverse market reaction or dislocation if the backstop facilities are removed, and they would be only too happy to leave the issue to Powell and Mnuchin.
“If someone wants to make the case that we need the government to give money to people or businesses because they’re struggling, by all means you can make that case,” Toomey asserted to reporters which neatly summed up the issue. “But that’s not a Fed exercise.”
The Fed’s Agenda
Toomey’s point is also one that resonates with many Fed officials, including we suspect the Chairman. Most Fed officials fear once the balance sheet is truly opened to support favored fiscal ambitions, it is a Pandora’s Box next to impossible to close.
Months before, at his June post-FOMC meeting presser, Chairman Powell provided a prologue of sorts to Toomey’s caution in what felt liked a prepared remark at his June meeting presser. “I don’t know if that’s part of your question too,” Powell began in shifting to his intended messaging after answering a fairly innocuous question on the 13-3 facilities, “We don’t really want to be part of the decisions that have to be made to manage such a portfolio. So, we’d be looking to have that done either someplace else, a third-party or at the Treasury Department or something. And we’re working on ideas for that.”
Nothing much has been said on that front ever since. But it seems to us that beyond the eventual winding down of the 13-3 facilities once the crisis has truly passed, a majority of Fed officials are aiming to follow through with a more thorough redefining of the lines and limits to the Fed’s monetary responsibilities, with a very limited role, perhaps as Treasury’s fiscal agent, on the use of the balance sheet for fiscal measures.
That, however, is invariably some time away, but in the meantime, we expect Chairman Powell to seek and welcome Democratic support for an extension of the 13-3 facilities until the threat of the Covid pandemic has truly passed. But he is also sympathetic to Republican efforts to limit any future steps by Congress or the Biden Administration to turn to the Fed’s 13-3 facilities, or to expand on them, as a means to tap the Fed’s balance sheet to fund ambitious fiscal spending programs that might otherwise be thwarted on Capitol Hill.
The Balance Sheet As a Primary Monetary Policy Tool
On one final point, Fed officials would all consider the current mix of 13-3 facilities to be a resounding success in calming markets by facilitating the resumption of trading, tightening credit spreads, and encouraging a burst of new spread product issuance, at very little to no cost to the Fed or taxpayers. If it were up to the Fed, they would probably further ease many of the terms and conditions in accessing the credits if the markets should again stress.
But there is also a view among many within the Fed system, and shared by some Committee members, albeit a minority, who believe that in the coming period of low inflation that limits interest rate policy when constrained by the Zero Lower Bound, balance sheet policy will become a primary, if not the primary policy tool, certainly in bolstering the heft of the much relied upon outcome-based forward guidance.
And that, in turn, is where there is an interest in how the little tapped to date Main Street Lending Facility, the Paycheck Protection Program, and to a lesser extent, the Municipal Lending Facility, could come to play a larger role in the transmission of monetary policy directly into the real economy. That thinking has recently gathered some momentum in the wake of skepticism over the efficacy of continuing to rely solely on the various forms of large scale asset purchases and hoping easier financial conditions in the markets translates into higher aggregate demand and business investment spending in the real economy.
If truth be told, we are unsure how strong that sentiment is inside the Board of Governors, whose vote determines the Fed policy position on the use of the 13-3 facilities. But it certainly adds to the complications and careful calculations Chairman Powell must weigh to ensure he has a solid and full Committee consensus on such a politically sensitive policy like using the Fed balance sheet for the “lending not spending” commitments of the 13-3 credit facilities.