The Federal Reserve is redefining central banking.

By Nick Timiraos and Jon Hilsenrath

Wall Street Journal, May 27,2020

Ratchel Casas

Summary

The question of who gets the money, what criteria to use when selecting on who to lend money and the risk associated has been there for the past decade in the central bank. Due to the corona virus pandemic, the federal bank reserve is expanding in its performance by issuing more public debt. The central bank has created new bond and loan programs that will enable the general public borrow loans therefore expanding the Federal Reserve. The expansion of the Federal Reserve is associated with risks such as the some of the plans to expand wont, some politicians will take advantage of the programs and benefit themselves and there will be public discontent about the bonds and loans being issued.

This move is aimed at easing the lending restrictions so as to increase the amount of money lent out to institutions and circulating in the economy. This will mitigate the risk of a failing and crumbling economy as well as help citizens access credit more easily as well. This means that there will be more money in circulation and the interest rates will not necessarily increase due to external factors. However, there has been debate on the risks associated with the FRB issuing out additional credit to the market. Political advantage whereby politicians might benefit themselves with the money meant to boast the economy is one such risk that is envisaged in the article.

Association to specific chapter material and concepts

Chapter Two – The Impact of Government Policy and Regulation on the Financial-Services Industry

2.2 Banking Regulation

Concept from the textbook

Federal Reserve System

• Supervises and regularly examines all state-chartered member banks and bank holding companies operating in the United States and acts as the “umbrella supervisor” for financial holding companies (FHCs) that are now allowed to combine banking, insurance, and securities activities under common ownership.

• Imposes reserve requirements on deposits (Regulation D).

• Must approve all applications of member banks to merge, establish branches, or exercise trust powers.

• Charters and supervises international banking corporations operating in the United States and U.S. bank activities overseas.

Reasons for choosing this article

This article is relevant with the current world facing the corona virus pandemic that has affected most financial institutions. The Federal Reserve System has enabled various financial sector to be able to lend money to the public in spite of the pandemic. The central bank is looking forward t expanding its portfolio an action that will be twice the size reached in the year 2007 financial crisis. Issuing of bonds and loans is one way that the central bank uses to stabilize the markets and the economy hence reserves play an important role.

Important points or lessons learned

This read inspires the concept that financial structures and regulations are not rigid but rather flexible especially in the wake of external factors. Covid-19 has led to some form of crisis in the economy and financial industry and therefore redefining the central banking concept is a counter measure to reduce the impact of the pandemic

Copy of the article

The Federal Reserve is redefining central banking.

By lending widely to businesses, states and cities in its effort to insulate the U.S. economy from the coronavirus pandemic, it is breaking century-old taboos about who gets money from the central bank in a crisis, on what terms, and what risks it will take about getting that money back. And with large-scale purchases of U.S. Treasury securities, the Federal Reserve is stretching the boundaries for what a central bank will do to finance soaring federal debt—actions that move it deeper into political decisions it usually tries to avoid.

Fed leaders don’t like doing any of this. They believe they have no better alternative. “None of us has the luxury of choosing our challenges; fate and history provide them for us,” Fed Chairman Jerome Powell said in a speech this month. “Our job is to meet the tests we are presented. ”Economists project the central bank’s portfolio of bonds, loans and new programs will swell to between $8 trillion and $11 trillion from less than $4 trillion last year. In that range, the portfolio would be twice the size reached after the 2007-09 financial crisis and nearly half the value of U.S. annual economic output. It would make its role in the economy far greater than during the Great Depression or World War II, according to Wall Street Journal calculations. The portfolio had reached $6.57 trillion by April 22. “The Fed is being sent on a mission to places it has never been before,” says Adam Tooze, a Columbia University history professor who writes about financial crisis and war. Due to the financial and economic shocks caused by the virus, he says, central-bank officials “are being sucked into a series of entanglements that they cannot control and that they normally will not touch with a long pole, but this time felt they had to go in, and go in hard.”

Uncharted Territory

The Fed’s portfolio of bonds, loans and new programs will swell to $8 trillion–$11 trillion, economists estimate. Figures are as of year end, except final two. First 2020 assets figure is as April 22. Final 2020 estimate is based on WSJ Survey of Economists’ GDP forecast and the midpoint of analysts’ balance-sheet estimate, $9.5 trillion.

Sources: Federal Reserve Bank of St. Louis, FRED and Fraser databases (assets); Commerce Department (GDP)

Many government policy makers, including past Fed critics, support its actions this time, though political calculations could change quickly. “This should be considered a very freakish Black Swan event, not anything that would be revisited under ordinary circumstances,” says Sen. Pat Toomey (R., Pa.), who criticized the Fed after the last crisis for enabling large federal budget deficits. Last month, he helped advance the $2.2 trillion economic-rescue legislation in Congress that puts the Fed at the center of the government’s economic-rescue efforts.

Among risks the Fed is taking: that some programs won’t work, that officials won’t be able to unwind them, that politicians will grow accustomed to directing the central bank to fix problems its tools aren’t designed to solve, and that public discontent about the central bank’s choices will erode its authority over time. This last risk is prominent because the Fed’s tools are better suited to helping large firms that borrow in capital markets than small ones that don’t.

“Capitalism without bankruptcy is like Catholicism without hell,” Howard Marks, director of investment fund Oaktree Capital Management LP, said in a letter to shareholders this month, writing that “Markets work best when participants have a healthy fear of loss.” Mr. Marks in a later interview said he didn’t want to imply Mr. Powell’s actions were wrong: “The fact that something can have negative, unintended consequences, doesn’t mean it’s a mistake.” Mr. Powell defines the government’s task from a different moral perspective. “People are undertaking these sacrifices for the common good,” he said in his speech. “We need to make them whole to the extent we have the ability.”‘The Treasury is using the Fed as its arm,’ says a former CBO director, ‘because the Fed is better at setting up these facilities and getting the money out.’

After cutting interest rates to near zero in mid-March, the Fed began a torrent of bond-buying programs to stabilize markets. Between March 16 and April 16, it bought Treasury and mortgage securities at a pace of nearly $79 billion a day. By comparison, it bought about $85 billion a month between 2012 and 2014. Fed purchases help the government inexpensively finance its debt, which is soaring as the Treasury sends checks directly to households and spends more on unemployment insurance. The central bank is preparing a second wave, programs in partnership with the Treasury to get loans directly to companies and state and local governments. Congress has armed the Treasury with $454 billion to work in cooperation with the central bank for the effort.The Fed will lend as much as 10 times the amount Congress appropriated, with the Treasury taking the first losses on loans that go bad. The Treasury has so far committed around 40% of those funds to some of nine different programs, leaving room to expand them or deploy others. Congress called upon the Fed in part because it developed capabilities to intervene during the 2008 banking crisis and is positioned like few other institutions to move fast. It also entered the crisis outside a partisan fray marked by distrust between congressional Democrats and the Trump administration, lawmakers and analysts say.