Money, Banking and Financial Markets

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Posts tagged PDCF
The Fed Goes to War: Part 3

For the second time this century, the Federal Reserve is a crisis manager. In this role, policymakers can lend to solvent but illiquid intermediaries (as the lender of last resort). They can backstop financial markets (as a market maker of last resort). And, when all else fails, they can take the place of dysfunctional private-sector intermediaries.

During the first financial crisis of the 21st century, the Fed’s response shifted from one role to the next as the crisis intensified. Yet, even compared to that massive crisis response, the Fed’s recent moves are breathtaking—in speed, scale and scope.

Indeed, with its most recent announcements on April 9, the Federal Reserve is committed to an unprecedented course of action to ensure the flow of credit to virtually every part of the economy. In carrying out its obligations under the newly enacted CARES Act, the Fed is effectively transforming itself into a state bank that allocates credit to the nonfinancial sectors of the economy.

Yet, picking winners and losers is not a sustainable assignment for independent technocrats. It is a role for fiscal authorities, not central bankers. Instead of using the Fed as an off-balance sheet vehicle for the federal government, we hope that Congress will shift these CARES Act obligations from the Federal Reserve to the Treasury, where they belong….

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Steve Cecchetti and Kim SchoenholtzCARES Act, Coronavirus, COVID-19, Crisis management, Crisis mitigation, Federal Resere balance sheet, Lender of Last resort, Balance sheet, Market maker of last resort, Commercial Paper Funding Facility, CPFF, Primary Dealer Credit Facility, PDCF, Money Market Mutual Fund Liquidity Facility, MMLF, Primary Market Corporate Credit Facility, PMCCF, Secondary Market Corporate Credit Facility, SMCCF, Term Asset-Backed Securities Loan Facility, TALF, Municipal Liquidity Facility, MLF, Main Street New Loan Facility, MSNLF, Main Street Expanded Loan Facility, MSELF, Paycheck Protection Program Lending Facility, PPPLF
The Fed Goes to War: Part 1

Over the past two weeks, the Federal Reserve has resurrected many of the policy tools that took many months to develop during the Great Financial Crisis of 2007-09 and several years to refine during the post-crisis recovery. The Fed was then learning through trial and error how to serve as an effective lender of last resort (see Tucker) and how to deploy the “new monetary policy tools” that are now part of central banks’ standard weaponry.

The good news is that the Fed’s crisis management muscles remain strong. The bad news is that the challenges of the Corona War are unprecedented. Success will require extraordinary creativity and flexibility from every part of the government. As in any war, the central bank needs to find additional ways to support the government’s efforts to steady the economy. A key challenge is to do so in a manner that allows for a smooth return to “peacetime” policy practices when the war is past.

In this post, we review the rationale for reintroducing the resurrected policy tools, distinguishing between those intended to restore market function or substitute for private intermediation, and those meant to alter financial conditions to support aggregate demand….

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Steve Cecchetti and Kim SchoenholtzLender of last resort, LOLR, Expired monetary policy tools, New monetary policy tools, Coronavirus, COVID-19, Federal Reserve Act, FRA Section 13(3), Quantitative easing, QE, Targeted asset purchases, TAP, VIX, Volatility, Commercial paper, CPFF, Primary dealer, PDCF, Money market mutual fund, MMMF, MMLF, Central bank independence, Helicopter money, Fiscal dominance
Ten Years After Bear

Ten years ago this week, the run on Bear Stearns kicked off the second of three phases of the Great Financial Crisis (GFC) of 2007-2009. In an earlier post, we argued that the crisis began in earnest on August 9, 2007, when BNP Paribas suspended redemptions from three mutual funds invested in U.S. subprime mortgage debt. In that first phase of the crisis, the financial strains reflected a scramble for liquidity combined with doubts about the capital adequacy of a widening circle of intermediaries.

In responding to the run on Bear, the Federal Reserve transformed itself into a modern version of Bagehot’s lender of last resort (LOLR) directed at managing a pure liquidity crisis (see, for example, Madigan). Consequently, in the second phase of the GFC—in the period between Bear’s March 14 rescue and the September 15 failure of Lehman—the persistence of financial strains was, in our view, primarily an emerging solvency crisis. In the third phase, following Lehman’s collapse, the focus necessarily turned to recapitalization of the financial system—far beyond the role (or authority) of any LOLR.

In this post, we trace the evolution of the Federal Reserve during the period between Paribas and Bear, as it became a Bagehot LOLR. This sets the stage for a future analysis of the solvency issues that threatened to convert the GFC into another Great Depression.

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Steve Cecchetti and Kim SchoenholtzLender of last resort, LOLR, Bagehot, Bagehot's dictum, Solvency, Illiquidity, Collateral, Banks, Nonbanks, Great Financial Crisis, GFC, Great Depression, BNP Paribas, Bear Stearns, Lehman, Discount lending, Stigma, Eurodollars, Global Dollar system, Primary dealers, Securities dealer, Continental Illinois, CME, October 1987 stock crash, LTCM, Fire sale, Common exposure, Panic of 1907, LIBOR, OIS, Liquidity risk, Counterparty risk, Term Auction Facility, Dollar swap lines, Maiden Lane entity, Federal Reserve Act, FRA Section 13(3), Emergency lending authority, PDCF, TSLF, Resolution, Adverse selection