Given the extreme turbulence in the financial sector sparked by the global COVID-19 pandemic, the Federal Reserve has taken extreme measures to keep the economy afloat. People all over social media are holding it up as proof of how much could be spent on projects like social programs that increase the welfare of common people. So is the Federal Reserve truly spending trillions of dollars?
The answer is a resounding no. These are effectively very short-term loans, many of which are recouped literally the very next day. The intention is not to help banks cover losses or to — as some assume — stabilize stock prices. Instead, it is to prevent a liquidity crisis. Many of the day-to-day transactions banks do require plain ole cash. However, much of the banking system’s wealth is tied up in assets such as bonds, stocks, and other financial instruments that generate a return in a way cash simply cannot.
During an economic crisis, such as the one we are now in, the value of these assets plummets, and finding buyers for them can be tricky. Additionally, in most cases, it is in the financial interest of not just the bank, but those collecting interest from the bank through deposits, to hold onto these assets until their value recovers. This makes it difficult for banks in times like these to manage their assets — not because they are broke, but because they can’t fluidly change between liquid and illiquid assets in their portfolio with ease.
Numerous armchair pundits on social media have made cynical remarks claiming the government will be lenient with these loans or have no real expectation to repay — this could not be further from the truth. These loans have extremely stringent terms. They are fully collateralized with an equivalent amount of the illiquid assets the bank is unable to sell. Most often, this is treasury bonds. If the loan is not repaid, the Federal Reserve recoups the entire value of the loan through this collateral. Much of the trillions of dollars loaned out is already repaid — and even recirculated again back out in new repo operation loans.
Many ask why the Federal Reserve does not use these powers to enact social programs that would help ordinary folks, and the unfortunate reality is they are legally barred from doing so. They are able to autonomously manage the money supply and provide financial assistance to banks — they are a reserve bank after all — but operating outside of those bounds requires Congressional approval. The roadblock there isn’t the Federal Reserve, it’s the GOP-controlled Senate.
Given how, in many regards, the economic system is designed to protect and benefit the highly wealthy, the rampant cynicism is not surprising. But it is important to understand the reality of what is happening to provide useful political commentary. Telling people what they want to hear, when it is not based in reality, does not help accomplish desired political goals — and can even wind up counter-productive.
Robust social programs that ensure everyone has a comfortable, stable existence not just through crises, but in good times as well, are a worthy and important cause — and one I personally have long passionately pursued. However, this requires informed, sound strategies and not wishful thinking based on deep misunderstandings of how the government functions. I encourage those who share my aspirations for such a world to direct their justified anger at the failures of the system in productive places.