The Federal Reserve Bank of New York posted a new "Liberty Street Economics" blog entitled, "Expanding the Toolkit: Facilities Established to Respond to the COVID-19 Pandemic," which gives a spirited defense of the Fed's actions during the March coronavirus crisis. Written by Anna Kovner and Antoine Martin, the piece explains, "The Federal Reserve's response to the coronavirus pandemic has been unprecedented in its size and scope. In a matter of months, the Fed has, among other things, cut the federal funds rate to the zero lower bound, purchased a large amount of Treasury securities and agency mortgage backed securities (MBS) and, together with the U.S. Treasury, introduced several lending facilities. Some of these facilities are very similar to ones introduced during the 2007-09 financial crisis while others are completely new. In this post, we argue that the new facilities, while unprecedented, are a natural extension of the Fed's toolkit, as they operate through similar economic mechanisms to prevent self-reinforcing bad outcomes. We also explain why these new facilities are particularly useful as part of the response to the pandemic, which is an economic shock very different from a financial crisis."
It continues, "The distinction between new and old facilities loosely maps to a commonly used description of facilities as 'liquidity' or 'credit' facilities. Liquidity facilities include the Primary Dealer Credit Facility (PDCF), the Commercial Paper Funding Facility (CPFF), and the Money Market Mutual Fund Liquidity Facility (MMLF). These facilities support financial intermediaries, such as primary dealers and money market funds, or money markets, such as the commercial paper market. In addition, they provide short-term support, generally less than one year. "Credit" facilities include the Municipal Liquidity Facility, the Main Street Lending Program, the Primary and Secondary Market Corporate Credit Facilities (PMCCF and SMCCF), the Term Asset‐Backed Securities Loan Facility (TALF) (introduced during the 2007-09 crisis) and the Paycheck Protection Program Liquidity Facility (PPPLF). They support corporations, states, and municipalities more directly and the terms of the loans are longer. All these facilities were established under Section 13(3) of the Federal Reserve Act, with approval of the Treasury Secretary."
Kovner and Martin write, "Liquidity provision by the central bank can break the vicious cycle that makes panics self-fulfilling. For example, in a bank run, if a bank can borrow from the central bank to repay its depositors, it will not have to sell its assets at a loss. This means that the bank will have enough resources to repay the depositors that are not withdrawing immediately, which reduces or eliminates the incentive to do so. This is an example of multiple equilibria -- a situation with multiple outcomes. By acting according to Walter Bagehot's advice to the Bank of England to lend freely and vigorously against good collateral, the Fed can prevent or mitigate run dynamics."
They explain, "In the 2007-09 financial crisis, the liquidity facilities were established to help prevent run dynamics in financial markets, just as the Fed has done through the discount window for banks since its founding, thus avoiding the bad equilibrium that could follow from inefficient fire sales of assets. Many of these facilities have been reinstated to respond to the severe market dislocations and run risks that emerged in response to the coronavirus pandemic."
The blog also says, "It is important to recognize that the coronavirus pandemic is of a different nature than the 2007-09 financial crisis. That crisis was primarily a financial shock that amplified what may have otherwise been a reasonably small macroeconomic shock. By contrast, the pandemic is primarily a large macroeconomic shock arising from measures taken to contain it. The shock to the economy created by the pandemic has created unusually high uncertainty about the possible macroeconomic outcomes.... [T]he Fed had to adapt its tools to address this new problem. The multiple equilibria argument does not mean that these facilities are a free lunch -- costlessly leading the U.S. economy to the better outcomes. Interventions could raise concerns, particularly about moral hazard, as we discuss in a later post (publishing Thursday)."
The article adds, "A central bank's toolkit must adapt to the circumstances it faces. The Fed has established a number of facilities, in partnership with the Treasury and at the direction of the Congress. These facilities play a similar role to that played by the facilities introduced during the 2007-09 financial crisis, helping to prevent self-reinforcing bad outcomes. The "credit" facilities are particularly helpful to respond to the macroeconomic shock created by the uncertainty associated with the coronavirus pandemic. Of course, the facilities are only one aspect of the official sector's response to the pandemic."
In other news, Fitch Ratings published, "Local Government Investment Pools: 2Q20." The dashboard explains, "Cumulative assets for the Fitch Liquidity LGIP Index and the Fitch Short-Term LGIP Index reached another new high of $349 billion at the end of 2Q20, an increase of $27 billion QoQ and $56 billion YoY. Similar to 1Q20, asset flows for both indices during the second quarter were again on par with their observed historical cyclical patterns (+10% QoQ for the Fitch Liquidity LGIP Index and +4% QoQ for the Fitch Short-Term LGIP Index). Thus far, the economic downturn caused by the coronavirus has not had a visible impact on asset levels for most LGIPs, particularly as assets typically grow during the second quarter due to tax payment deadlines. However, lower sales, income, and other taxes, along with reduced state support for local municipalities, will lead to smaller future inflows into LGIPs relative to prior expectations."
It continues, "The Fitch Liquidity LGIP Index and the Fitch Short-Term LGIP Index ended the quarter with average net yields of 0.34% (a drop of roughly 70bps from March) and 1.15% (down 53bps from March), respectively. These downward trends for LGIP yields should continue as the Fed's interest rate policy is expected to remain in the zero-bound territory for a prolonged period. LGIP managers extended their interest rate exposures out slightly during the quarter, with the weighted average maturity of the Fitch Liquidity LGIP Index increasing to 44 days (+2 days) and the duration of the Fitch Short-Term LGIP Index ticking up slightly higher to 1.28 years (up from 1.27 at the end of 1Q20)."
Fitch adds, "Given the elevated uncertainty surrounding the economy and future revenues and expenditures of local governments, LGIP managers have actively shifted more of their portfolios to higher quality asset classes this year. The shift in allocation becomes more apparent when comparing positioning to the prior year. In the Fitch Liquidity LGIP Index specifically, exposure to U.S. Treasury debt increased to approximately 20%of the index as of June 2020 from 11% as of June 2019. On the other hand, combined exposure to corporates (commercial paper and corporate bonds) dropped to 24% of the index from 33% last June." (See also, Fitch Assigns First-Time 'AAAf'/'S1' Ratings to the Sarasota County Investment Pool.")
Finally, Crane Data published its latest Weekly Money Fund Portfolio Holdings statistics Tuesday, which track a shifting subset of our monthly Portfolio Holdings collection. The most recent cut (with data as of September 18) includes Holdings information from 70 money funds (down 8 from a week ago), which represent $1.987 trillion (down from $2.322 trillion) of the $4.867 trillion (40.8%) in total money fund assets tracked by Crane Data. (Note that our Weekly MFPH are e-mail only and aren't available on the website. For our latest monthly Holdings, see our September 11 News, "Sept. MF Portfolio Holdings: Repo Jumps; Agencies, CP, CDs Decline.")
Our latest Weekly MFPH Composition summary again shows Government assets dominating the holdings list with Treasury totaling $1.038 trillion (down from $1.255 trillion a week ago), or 52.2%, Repurchase Agreements (Repo) totaling $460.1 billion (down from $526.8 billion a week ago), or 23.2% and Government Agency securities totaling $290.7 billion (down from $329.3 billion), or 14.6%. Certificates of Deposit (CDs) totaled $71.0 billion (down from $73.5 billion), or 3.6%, and Commercial Paper (CP) totaled $64.3 billion (down from $69.4 billion), or 3.2%. The Other category accounted for $33.7 billion or 1.7%, while VRDNs accounted for $29.1 billion, or 1.5%.
The Ten Largest Issuers in our Weekly Holdings product include: the US Treasury with $1.038 trillion (52.3% of total holdings), Federal Home Loan Bank with $160.6B (8.1%), Fixed Income Clearing Corp with $57.9B (2.9%), BNP Paribas with $57.8B (2.9%), Federal Farm Credit Bank with $53.2B (2.7%), Federal National Mortgage Association with $47.1B (2.4%), RBC with $34.0B (1.7%), JP Morgan with $32.0B (1.6%), Credit Agricole with $29.8B (1.5%) and Mitsubishi UFJ Financial Group Inc with $28.2B (1.4%).
The Ten Largest Funds tracked in our latest Weekly include: JP Morgan US Govt MM ($176.6B), Fidelity Inv MM: Govt Port ($156.8B), Wells Fargo Govt MM ($154.3B), BlackRock Lq FedFund ($143.0B), JP Morgan 100% US Treas MMkt ($105.3B), BlackRock Lq T-Fund ($94.3B), Morgan Stanley Inst Liq Govt ($92.5B), Dreyfus Govt Cash Mgmt ($89.1B), JP Morgan Prime MM ($83.6B) and First American Govt Oblg ($73.5B). (Let us know if you'd like to see our latest domestic U.S. and/or "offshore" Weekly Portfolio Holdings collection and summary, or our Bond Fund Portfolio Holdings data series.)
