How the Fed Opened Pandora’s Box

Pandora’s box of 2020

When disaster struck again, this time caused by a virus, the Fed took sweeping action even more quickly — and more expansively — than it did during the global financial crisis.

The Treasury market was melting down, so the central bank bought government debt in previously unheard-of sums. Then the market where corporations issue bonds to raise money was looking wobbly, so within weeks the central bank established emergency lending programs to fix it. Next came rescues for midsize businesses and, finally, for municipal bonds.

The emergency buying programs were set up alongside the Treasury, per a legal requirement, and Congress provided a layer of security funding to cover any losses: $454 billion. That gave the programs an element of democratic buy-in. But the Fed’s ability to take those dollars from Congress and supplement them with its own limitless balance sheet meant that America could pledge vastly more relief to the financial system — the Fed could have lent trillions of dollars to flailing borrowers.

The sheer scope of that promise meant that markets calmed and little lending was required.

“It think it was the Fed at its best,” said Richard Clarida, who was vice chair of the Fed at the time and is now a professor at Columbia University. “It was an unusual circumstance, and being able to move boldly and with principle and design served the country well.”

Yet between the Fed’s huge bond purchases — which made it easier for the whole government to borrow — and the backstops the central bank provided to key financial markets, it also became clear just how far the central bank’s powers could reach.

Article source: https://www.nytimes.com/2023/02/25/business/economy/federal-reserve-powe.html