MNI EXCLUSIVE: Fed May Never Exit 'Emergency' Policies

By Pedro Nicolaci da Costa

     WASHINGTON (MNI) - The Federal Reserve's unprecedented interventions in

financial markets, including purchases of corporate and municipal debt, may

prove impossible to fully unwind, fueling moral hazard and even unproductive

risk-taking from firms that might otherwise be insolvent, ex-Fed insiders told

MNI.

     Jeffrey Lacker, the hawkish former head of the Richmond Fed, said he was

not convinced by Fed officials' stated rationale for intervening so deeply and

so quickly in financial markets: liquidity issues in the Treasury market.

     "I don't understand when the Fed says it's intervening to ensure smooth

functioning of markets," Lacker told MNI. "It looks like the Fed is intervening

to lower borrowing costs."

     The Fed cut official rates to zero over two unscheduled meetings in early

March. It also announced limitless bond buys and a range of credit easing

programs targeted at specific sectors.

     Many of those facilities were revived after first being launched during the

Great Recession, while others are brand new.

     "These programs seem even less transitory," Lacker said. "The Fed's

response has been far broader than I would have expected."

     Lacker is especially worried about the Fed's forays into new corners of the

credit markets, including pledges to buy corporate and municipal bonds.

     "The precedent it sets both among economic actors and among politicians and

the political system is going to affect the Fed for decades -- and be cited

every recession," he said.

     The New York Fed launched its secondary market corporate bond purchase

program Tuesday, buying exchange-traded funds linked to the market. It said

primary market buying would begin in "the near future."

     --BLURRED LINES 

     Fed officials are well aware of the risks associated with their emergency

programs, but most believe the threat of a prolonged downturn that morphs into a

possible depression are much greater given the magnitude of the economic hit

from Covid-19-related shutdowns.

     And the central bank's consensus view, unmoved by the financial crisis of

2008, is that monetary policy is best suited to "mop up" after bubbles pop

rather than preventing them ahead of time.

     The Fed also feels shielded from any potential political scrutiny resulting

from these programs, in part because the Treasury has ponied up some USD454

billion in equity to fund the emergency lending.

     But skeptics say this confuses things further.

     Joseph Haslag, who spent 12 years as a Dallas Fed research economist, fears

the blurring of monetary and fiscal lines will have damaging long-run

repercussions.

     "The Fed's current stance is a treatment aimed at maintaining balance

sheets for companies affected by the mitigation policies. This seems more like a

Treasury issue than a Fed issue," he told MNI.

     "The agency issue notwithstanding, I think the moral hazard problem could

be quantitatively important the longer the policy is drawn out," he said.

     --BAIL OUTS

     That's because "some insolvent companies are going to be bailed out by this

debt-purchase program," Haslag said. 

     Just as Fed bailouts of the banking sector led to excess risk-taking in

finance, implicit backing for corporations could lead to similar patterns but on

a much broader scale across the economy.

     "If owners expect the policy will continue for a few months then it will

become like an insurance program," he said. "As with the financial institutions,

nonfinancial institutions that are virtually insolvent could begin taking on

risky projects conditioned on the belief that the central bank will continue

purchasing their debt."

--MNI Washington Bureau; +1 202 371 2121; email: pedro.dacosta@marketnews.com

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