Earlier this week, I called on the Fed quickly to use its emergency-liquidity powers to bolster household and small-business financial resilience. This isn’t another discount window for banks; it’s what I would call a Family Financial Facility to provide short-term, low-cost consumer loans from regulated lenders accessing collateralized borrowings from the Federal Reserve at this time of unprecedented stress. The reason for a Family Financial Facility is simple even though financial markets are extraordinarily complex: in this crisis, financial-market illiquidity isn’t the result of financial-market peculation as in 2008; now, market stress is the result of contagion risk as workplace, supply-chain, and geopolitical disruptions threaten the ability of hundreds of millions of consumers and businesses handling their debt just a week ago now to honor their obligations. Emergency liquidity is meant to prevent illiquidity from erupting into insolvency and the Fed is the only powerhouse for emergency liquidity. If it doesn’t act soon, it will be too late.
After my proposal on Wednesday, I’ve received many questions about how this Fed intervention would work, why this isn’t instead the responsibility of fiscal policy-makers, and what it would do for whom. Let me take each of these in turn.
Reflecting the fundamental central-bank liquidity mission, the Federal Reserve has several windows through which it can pour funds. None of these has ever been used directly for families and small businesses, but they can now be quickly and effectively deployed to do so.
The most relevant window comes via Sections 13(3) and 13(13) of the Federal Reserve Act. Each allows the Federal Reserve System to provide collateralized liquidity to financial institutions, businesses and even individuals on varying terms and, with regard to the most expansive authority, under emergency circumstances following approval by the Secretary of the Treasury. Congress rolled back the Fed’s virtually limitless emergency-liquidity powers in the Dodd-Frank Act, but the Fed’s implementing rules are still almost wide-open.
Founded on this legal authority, the fastest way to speed emergency liquidity to COVID-19’s economic victims is to use 13(3) powers to create liquidity facilities open to all federally-regulated consumer-finance lenders for the sole purpose of providing short-term, low-cost funds to prevent delinquency, default, or other financial hardships for individuals, families, and small businesses that can readily demonstrate COVID-inflicted financial distress. In very short, banks or other lenders governed by effective consumer protections would draw funds from the Fed, protecting the central bank with collateral and then lending the funds forward to customers struggling with credit-card bills, short-term loans, mortgages, student loans, rent, or other liquidity challenges. These loans would have to be on risk-mitigating – not profit-reinforcing — terms, replacing existing loans with more affordable terms or providing new short-term financing.
Importantly, the Family Financial Facility isn’t a substitute for forbearance. As I noted last week, that’s also essential – many millions of American live paycheck to paycheck. They can’t handle a blown tire without distress, let alone weeks without pay. But forbearance is costly, many lenders are outside the reach of federal regulation, and deferring a loan still won’t pay the rent.
Setting up this window, establishing its rules, and properly setting the requisite penalty rate for lenders accessing the window isn’t easy, but this crisis isn’t a small matter. None of these complexities is large enough to stop quick action on an effective emergency-liquidity window if Fed leadership pushes over-punctilious lawyers out of the way and mandates the rapid action the emergency demands.
Why isn’t this fiscal policy from which the Fed should avert its gaze? Simply put, the U.S. central bank is established not just to set interest rates – good luck on that – but also to provide emergency liquidity. Historically, it did so only for banks, but it threw that history out the window in 2008. Then, it intervened across financial markets because the great financial crisis was a financial-market debacle. Now, it must do so for households and small businesses and, indirectly, for the lenders at risk to them. The COVID-19 crisis is no longer just a supply-chain or biomedical crisis, but also a new-order liquidity emergency outside the immediate reach of the usual recipients of central-bank largesse.
Finally, what good would the Family Financial Facility do? For the first time, it would be a federal window for average Americans, using the vast resources of the Fed and the retail financial system to speed aid across the economy much as doctors and hospitals are seeking to rush out a COVID cure. No one, least of all no big bank, would be bailed out by this facility – it’s premised on loans, loans that restore ability to repay to the greatest extent possible after life returns to the normalcy we all took for granted just two weeks ago.