As the coronavirus scare accelerates, one critical question takes precedence after the over-arching dilemma of diagnosing, containing, and curing COVID-19: how to prevent an economic fever from putting national economies into the ICU. Bagehot’s hallowed dictum tells us that central banks should support only illiquid, not insolvent, banks. A like-kind rule should govern economies under acute stress, stipulating that financial policy should intervene or allow financial institutions to forbear only for as long as it takes companies or families suffering supply-chain or operational interruptions to recover. Bailing out markets or companies that can’t recover prolongs macroeconomic pain and suffering, with fiscal – not financial – policy the right way to resolve a pandemic’s structural macroeconomic consequences.
Given the magnitude of financial-market losses, pressure is growing on the Fed not just to drop short-term rates, but even to do so before the next FOMC meeting in March. However, saving the market won’t save the world. A quarter point or even more might well buoy equity markets, but so emphatic a Powell put only reinforces the Fed’s role as the equity market’s savior, driving the Fed still deeper into an ultra-low rate hole from which it can’t extricate itself no matter the long-term damage to growth and economic equality.
Even worse, a rate drop won’t work. The Fed’s huge, unconventional intervention in 2008 worked – at least for a while – because the great financial crisis was, well, financial. The coronavirus crisis, should one come, is a biomedical event with contagion risk (how apt the phrase) for supply chains and overall productivity. All the Fed could really do to make a difference in the economy is to buy a whole lot of copper or book thousands of hotel rooms. That’s a new form of helicopter money, but not one that should be dropped no matter how great the crisis. The Fed’s remit is and should be limited to financial markets; sovereign powers should take charge of sovereign risk.
That’s not to say that there’s nothing the Fed and other financial-policy makers can do to prevent a pandemic from turning into an economic panic. U.S. regulators already have a play-book that they should and I think surely will reopen. In it, financial institutions are told to forbear with troubled borrowers, at least up to Bagehot’s point. After 9/11, the FRB and OCC told banks to make “prudent” credit available as need to borrowers through new loans or adjusted terms and conditions. These high-level statements are intended to and generally do stay supervisory hands – and a good thing too. Interestingly, the FDIC on 9/11 didn’t join the OCC and FRB. Instead, it issued an October statement telling its banks that they could count efforts to help 9/11 victims towards CRA goals. This time around, the FDIC should join inter-agency statements akin to those in natural disasters and government shut-downs to make it clear that cutting off borrowers’ noses is not needed to save a bank’s face from an examiner’s wrath.
However, it’s also noteworthy that the 9/11 statements and many that followed told banks to forbear only when prospects for repayment are probable. A company with no hope of recovery following a supply-chain interruption will be no better for forbearance and its bank will only be all the weaker. Been there, done that not just in the 1980s’ S&L crisis that gave U.S. regulators a strong aversion to forbearance, but also in the EU. There, almost a decade of forbearance for borrowers with no ability to repay had created billions of debt at “zombie” borrowers and years of economic stagnation, fragile banks, and political unrest.
The last pandemic remedy – operational protections – are the easiest to go down. These were first established in a 2007 statement from the Federal Financial Institutions Examination Council. Many banks may well have forgotten about them, but resilience has nonetheless been reinforced by more recent operational resilience standards and the disciplines demanded by resolution planning. Reuters yesterday reported that banks and other large financial institutions are already closeted with regulators working through issues such as how now to handle operational dislocations akin to those that threatened the markets in 2012 after Hurricane Sandy. Physical-presence standards will surely be waived and the OCC will do what it now usually does in disasters, clarifying that national banks need not open after three days when doing so is dangerous.
More will come. Despite all this operational-resilience planning, there’s an important difference between 9/11 and COVID-19: the shocks for which banks know how to plan are shocks to physical facilities and infrastructure. In a pandemic, buildings stand tall and the lights stay on – it’s the people who are hurt. It’s thus time to update the 2007 pandemic guidance – indeed, it’s quickly becoming past time.