MNI EXCLUSIVE: Yellen Raises Hope For Stronger Fed Backstops

The looming appointment of ex-Federal Reserve Chair Janet Yellen to Treasury secretary raises the chances of a coordinated effort with the Fed to boost the economy even if Congress resists major new fiscal stimulus, ex-officials tell MNI.

Not only could Yellen revive emergency lending programs put to rest by outgoing Secretary Steven Mnuchin, she could create new ones or revamp existing facilities, sources say. A joint announcement with Fed Chair Jay Powell about an intent to create these facilities could be made soon after President-elect Joe Biden's swearing in and would likely have a big market impact.

"I expect the Municipal Lending Facility to be restarted and I expect Fed and the Treasury to work in concert to make it more effective in a targeted way," Claudia Sahm, a former Fed board economist, said in an interview.

"If I were Jay Powell today, I would be working right now on creating new programs," Stephen Cecchetti, a former New York Fed official and the former chief economist at the Bank for International Settlements, told MNI. "I would look at what can I do on my own, what do I need Treasury approval for and what do I need Treasury indemnification for."

Yellen's top priority will be helping the White House reach an agreement with Congress over another sufficiently sized relief package, sources said. If that consensus does not happen, then Treasury and the Fed will be more aggressive on credit policy.

MORE APPETITE FOR LENDING

"If it looks like Congress is unlikely to provide what is considered adequate direct fiscal support, there may be more of an appetite to push on the terms of some of the lending programs. But what is seen as adequate will depend on the evolving views on the economic outlook, and on the effect on credit markets of recent good news on the vaccine front," former Richmond Fed adviser John Weinberg told MNI.

While sources say the expiry of USD429 billion in loss-absorbing capital provided by Treasury as a backstop to the Fed programs is unfortunate, they add it's not an impediment to the programs' revival. Like in 2008, Treasury may be able to provide new backstops through indemnification against losses.

Yellen and the Fed could also rely on roughly USD80 billion in the Exchange Stabilization Fund to underpin loans to stressed credit markets.

Yellen's leadership at Treasury would create opportunities to fix programs where uptake has been slim, either by overhauling their terms or creating new facilities. She has endorsed a funding-for-lending scheme subsidizing new loans for banks by lending on preferential terms through the Fed's discount window. Such a program could target small- and medium-sized businesses or corporate bonds.

CHANGING THE TERMS

Sources said if the Municipal and Main Street lending programs are to see more effective usage, their terms would need to be substantially changed, while the corporate credit program only needs to be reinstated.

The 13(3) facilities "could be revived in the future but they were programs that had some criticism around them. I'm not sure that a new Treasury Secretary will want to go back" to exactly the same programs, St. Louis Fed President James Bullard told reporters Tuesday in response to a question from MNI.

"If we did get into a period of substantial financial stress in the future, the Treasury would have the option to look at programs like this once again."

It's difficult to know just where Fed and Treasury might focus their attention -- it will all depend which market, if any, shows signs of strain.

For Cecchetti, now a professor at Brandeis International Business School, the size and importance of the corporate credit facility makes it a likely candidate given that facility probably had the biggest "announcement" effect in terms of a tightening of spreads. The market also has the most risk of another disruption should the economy go south, he said.

DANGER ISN'T OVER

"Given that it is effective now, you wouldn't want to remove it until you're sure it wouldn't have an impact, and that seems to me to be when we're done with all the pandemic stuff, at least another year away," Cecchetti said.

Mnuchin's decision to shutter the 13(3) emergency lending facilities for corporate and municipal bonds, as well as its Main Street Lending Facility, took many ex-officials by surprise last week, since they believed the backstop has played an important role in soothing markets.

"The danger period isn't over yet -- the pandemic is still worsening -- so the backstops should remain in place until you are highly confident that they are no longer necessary," William Dudley, ex-president of the New York Fed, told MNI.

The Fed itself issued an unusual statement following the Treasury's decision, saying it would have preferred to have kept the facilities in place.