Money Stuff: Companies Can Borrow From the Fed Now

The Fed There's a lot going on here, but one thing that is going on here is that now if you are a big investment-grade company you can borrow unsecured from the Federal Reserve for up to four years.[1] That is new! Traditionally the way that central banking's lender-of-last-resort function works is that the central bank lends money to banks, secured by the banks' assets, which most traditionally would be those banks' business loans.[2] Loosely speaking those two approaches ought to get to roughly the same place. In the traditional approach, if the Fed commits to supporting banks by lending freely against good collateral, then the banks will be free to continue lending to businesses. The flow of credit to businesses will continue, intermediated by the banking system, rather than directly from the Fed. And there are obviously good reasons to do it that way. The banks, after all, are in the everyday business of lending to businesses. They have experience in loan underwriting and pricing and due diligence and document negotiation and all the nuts and bolts of giving unsecured loans to companies; they have deep relationships with the companies and know how creditworthy they are and can customize covenants and terms for each company. The Fed has never met any of these companies; the Fed just knows the banks. For the Fed to jump into the business of commercial lending overnight is just weird. But here we are! Weird times. Why? Why would the Fed need to lend directly to businesses, rather than through banks? Surely one part of the answer is that there are concerns that the intermediation through banks might just not work very well these days. In simpler times, a bank that could raise unlimited money from the central bank by pledging its loans could just freely continue to make loans as though everything was normal; the money would flow freely from the central bank, through the banks, to the real business borrowers. But we live in complicated times, and modern banks are large opaque machines with lots of sharp corners on which money can get snagged. The Fed might want to lend banks unlimited amounts of money, but leverage and capital regulation will limit how much money the banks can borrow.[3] The Fed might want the banks to use all that unlimited money to make loans, but liquidity regulation will require them to hoard money. All sorts of risk limits will now be telling bankers to cut back on loans out of prudence.[4] Also a lot of bankers will be working from home, unable to meet with clients for relationship and diligence reasons; the whole thing has just broken down a bit. If the Fed wants money to go to businesses quickly, it might have to bypass the banks and just give the businesses money directly. I suspect that another big part of the answer is that banks have already been so disintermediated from lending markets that the old strategy of "give money to banks who will give it to businesses" can't really work. If you are a big investment-grade company you don't get your financing mainly from bank loans; you get it from selling bonds into the capital markets, to insurance companies and pensions and mutual funds.[5] If those markets freeze up—if people rush to take money out of their mutual funds; if the insurance companies and pensions are panicking—then giving money to banks doesn't do you any good. For the Fed to support actual corporate borrowing in 2020, it needs to go to where (investment-grade) companies borrow, which is the bond market. And so the Fed isn't just doing a "Primary Market Corporate Credit Facility," where it will lend money to companies directly; it is also doing a "Secondary Market Corporate Credit Facility," where it will buy (investment-grade) corporate bonds on the open market. It will even buy shares of corporate bond exchange-traded funds because, as everyone knows by now, the smooth functioning of corporate bond market liquidity involves ETFs. The 19th-century way of getting loans to businesses was by supporting banks; the 21st-century way is by buying shares of bond ETFs. (A related point is that, if lending is largely capital-markets-based, the usual advantages of banks—in due diligence and negotiation and documentation and client relationships—are reduced. If any old mutual fund can price and buy bonds quickly without a longstanding relationship, so, you would think, can the Fed. If corporate bonds trade somewhat liquidly, if ratings are a widely used proxy for creditworthiness and pricing corresponds to ratings, then the market is doing a lot of the Fed's credit-evaluation work for it, so it's easier for it to start a giant corporate lending program from scratch.) By the way, though I started this section saying that big companies can borrow from the Fed now, I should say that all in all these measures feel more like "supporting the capital markets" than like "lending money to businesses to get through this crisis." If you are a big investment-grade company and you have bonds coming due and can't roll them over, rolling them over with the Fed might be an appealing option. But if you are a big investment-grade company and you have salaries coming due and aren't getting any revenue, borrowing from the Fed to pay those salaries might still look like a negative-expected-value decision. The Fed's loans will offer investment-grade companies a bit more flexibility—they will "have interest rates informed by market conditions," which might mean lower-than-market-meltdown rates (or might not), and companies can pay interest in kind for 6 months to preserve cash—but they will not materially change the economic decisions facing those companies, and of course they won't do anything for the non-investment-grade companies that are facing even greater financial pressures. The Fed is offering help to ordinary companies, but not a bailout; for a bailout, those companies will have to rely on Congress. Just some more Fed Like I said, there's a lot going on. From Bloomberg News: The Federal Reserve on Monday announced a massive second wave of initiatives to support a shuttered U.S. economy, including buying an unlimited amount of bonds to keep borrowing costs low and setting up programs to ensure credit flows to corporations and state and local governments. ... The Fed will buy Treasuries and agency mortgage-backed securities "in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy," and will also buy agency commercial mortgage-backed securities, according to a statement. Here are summaries from the Wall Street Journal and the New York Times. Here are the Fed's announcement, and the Open Market Committee's statement. The unlimited quantitative easing is the big headline, and the corporate bond buying is the big novelty (for the U.S.), but there's other stuff too. For instance a Term Asset-Backed Securities Loan Facility, revived from the 2008 crisis, to buy "asset-backed securities (ABS) backed by student loans, auto loans, credit card loans, loans guaranteed by the Small Business Administration (SBA), and certain other assets," and expansions of the Money Market Mutual Fund Liquidity Facility and Commercial Paper Funding Facility. Also: In addition to the steps above, the Federal Reserve expects to announce soon the establishment of a Main Street Business Lending Program to support lending to eligible small-and-medium sized businesses, complementing efforts by the SBA. There are no details yet on the MSBLP, but it does seem like it would be more complicated than the Primary Market Corporate Credit Facility we talked about above. The fact that so much investment-grade lending is done in the capital markets makes it easy for the Fed to support that directly, by just buying corporate bonds. Small businesses do more of their borrowing through banks, and tend not to have the public credit ratings and traded debt that would make it easy for the Fed to lend to them directly. Mortgages, etc. A lot went wrong in 2008, but there is widespread agreement that the heart of it was a "subprime mortgage crisis." People with bad credit and low incomes took out large mortgages against the ever-rising values of their homes, and then they couldn't pay those mortgages, and then a vast financial edifice built on top of those mortgages collapsed and brought a lot of unrelated stuff down with it. There are lots of debates about who was to blame and how it should have been addressed and why that vast edifice was so rickety, but the basic story—a lot of mortgage loans to people who couldn't pay them back—seems pretty straightforward. In 2020, a subprime mortgage crisis is just sort of a trivial side effect of the real crisis, which is that the world economy has stopped to address a deadly pandemic. If businesses stop, people can't work, so they won't have money, so they won't be able to pay their mortgages, so the edifice of subprime mortgage securitization will fall down again. The good news is that subprime mortgage securitization is a lot smaller and less rickety and less central to the financial system than it was in 2008. The bad news is that the reason people can't pay their mortgages is the same reason that they can't pay their rents or their credit-card bills or eat at restaurants or fly on planes or shop for clothes or, generally, buy stuff or pay their bills. The global financial system is no longer disproportionately built on top of subprime mortgages, but it is built on top of economic activity, and economic activity is … bad. Anyway stuff seems bad in the subprime mortgage market. From the Financial Times: A $2.3bn mutual fund sought buyers for more than $1bn of US mortgage bonds on Sunday to cover investor withdrawals after booking heavy losses in the current market turmoil. The AlphaCentric Income Opportunities fund lost more than 30 per cent of its value last week owing to its heavy exposure to home loans to borrowers with lower credit scores. The fund's public filings show that at the end of 2019 — when it still had $4bn in assets — it had invested two-thirds of its portfolio in bonds backed by subprime mortgages.  The mortgage market has come under broad pressure as some investors began to doubt homeowners' ability to repay their loans. Two traders said that the fund's portfolio managers sought offers from potential buyers on a list of more than $1bn of securities to raise cash. ... The statement noted that it was not necessarily trying to sell all the bonds it put up for offer. However, because of the "lack of liquidity in the marketplace" it had put a larger pool of assets up for grabs to see which drew "the most favourable prices".  And from Bloomberg News: The sales included at least $1.25 billion of securities being listed by the AlphaCentric Income Opportunities Fund on Sunday, according to people with knowledge of the sales. It sought buyers for a swath of bonds backed primarily by private-label mortgages as it sought to raise cash, said the people, who asked not to be identified discussing the private offerings. Manny Malbari of Methodical Management, in a note to clients, wrote this weekend: Structured product BWIC volume has exploded over the past two weeks, with three to four times the average weekly volume being put out for bid compared to February (pre-trade pricing sourced from Solve Advisors). Actual trading volume was dwarfed by the amount that was out for bid which translates to an extremely low hit rate when putting out a BWIC and perversely causing larger BWICs to be put out in hopes of executing at the lower hit rate.  If you have to sell some bonds, you put them out for bids (in a "bid wanted in competition," or BWIC). Traditionally, if you need to sell $100 million of bonds, you put $100 million of bonds out for bid and sell them at the best price you can get. When things break down, though, and you need to sell $100 million of bonds, you might have to put more of them out for bids, since you can't be sure that anyone will want to buy any particular bonds at a price you can live with.  Eventually, any time you need to sell any bonds, you might have to start putting all your bonds out for bids to see if anyone will buy any of them. BBBs? One worry that we talk about occasionally is the risk of forced selling of BBB-rated companies that are downgraded to BB. The theory is that there are a lot of investors who are required to own only investment-grade debt, and those investors tend to own a lot of debt with a BBB rating, the lowest investment-grade rating, in part because a lot of investment-grade issuers optimize their capital structures to end up at BBB. If a lot of those just-barely-investment-grade companies were to be downgraded all at once, say because of a recession or a global economic shutdown, then those investors would be forced to dump all those bonds in an ugly fire sale. When I mention this worry people tend to email to explain that it's overblown, that in fact most investment-grade funds have more flexible mandates than that, that they can keep bonds that were investment-grade when they bought them and aren't forced to sell on a downgrade, etc. The financial system is aware of this weird discontinuity—where a one-notch difference in ratings can carry profound consequences—and has systems in place to mitigate it.  On the other hand the Fed is doing a ton to support investment-grade credit and ... not so much to support non-investment-grade credit? Like, if you are a BBB-rated company, you can sell bonds directly to the Fed, and anyone who owns your bonds can also sell them to the Fed, and anyone who owns shares of an ETF that owns your bonds can sell them to the Fed. If you are a BB-rated company, for now, you get none of that. The ratings agencies have a lot more power today than they had last week; now a downgrade can take a company out of eligibility for Fed support. When we last discussed this worry, I suggested that the obvious approach would be for the ratings agencies to take a few months off. I am not convinced that they can add a lot of value these days by telling investors that credit quality has declined—we know!—but they can certainly do some damage by causing forced sales.   NYSE Continuing my occasional series of financial-markets natural experiments from the coronavirus crisis, let's see if all-electronic trading on the New York Stock Exchange affects liquidity: The Securities and Exchange Commission published rule changes on Saturday that allow the New York Stock Exchange  to conduct all-electronic trading.  On Monday, the first day the trading floor will be closed, the NYSE opening at 9:30 a.m. ET should happen immediately for almost all stocks, subject to certain trading bands. Existing circuit breakers that would halt trading briefly should the S&P 500 decline by 7%, 13% and 20% will continue to be in effect. If your theory of NYSE is that its trading all takes place in a data center in New Jersey and that the function of the trading floor on Wall Street is, as I once wrote, "mostly to create a simulacrum of a stock exchange that is legible to humans watching stock-market shows on TV," then I suppose you will expect this to be a non-event. Most stock exchanges are all electronic anyway and it works out fine; why should NYSE be any different? If you think that the humans add a certain sensibility to the otherwise cold and inscrutable world of algorithmic trading, though, I suppose you'll be able to point to the wild volatility of the next few weeks (I'm guessing!) to say, see, with humans it would have been much better. Burr's mind We talked on Friday about the fact that Senator Richard Burr dumped a bunch of stock a few weeks before the market crashed, after hearing classified briefings about the spread of the coronavirus. Burr's defense was that he "relied solely on public news reports to guide my decision regarding the sale of stocks on February 13," specifically "CNBC's daily health and science reporting out of its Asia bureaus at the time." I pointed out that one certainly could have done so. The news about coronavirus was pretty ominous by Feb. 13, and even if you didn't have access to top secret Senate briefings you might have gotten nervous and dumped your hotel stocks. But Burr did have access to those top secret briefings. I don't know what he learned in those briefings, since they were top secret. It's conceivable that they didn't add any information to what Burr learned from television, that the important elements—deadly and highly contagious virus heading inevitably for America—were all public, and Burr just made an astute stock-market call. It's also conceivable that Burr learned a lot about the virus and its spread and the lack of U.S. preparedness for it that made him a lot more nervous than the rest of us. In the first case, he's fine; he had no inside information, so there's no reason not to trade. But what about the second case? Specifically, what if the public information was more than enough to support his selling decision, but he also had private information? What if he woke up one day, watched CNBC, said to himself "this is bad, I should sell all my stocks as soon as I get out of my classified briefing," and then got that classified briefing and it was even worse? Should he be prohibited from selling based on public information, just because he had private information too? I mean I think the answer is clearly yes, he should have been prohibited. (For one thing, you can always find some rationale for trading based on public information, so a rule saying "insider trading is legal if you would have traded anyway without the inside information" will tend to make all insider trading legal; just spend five minutes reading Wall Street research or message boards and you can find some justification for your trades.) And that is absolutely the norm in the financial industry, where traders are considered "tainted" if they are given inside information and generally locked up from trading the stock, even if it's a stock that they trade every day based on public information. Still, at least as a theoretical matter, I guess you could come out the other way.  Anyway here is "Senator Richard Burr and Mixed Motives for Insider Trading," by Andrew Verstein of Wake Forest: Scholars of insider trading will immediately recognize this as a recapitulation of a 30-year old debate known as the "mental causation" debate, the "use/possession" debate, or the "use/awareness debate." It involves the issue of whether a trader with both lawful and unlawful reasons for trading violates the law. Should the law consider just the lawful trading rationales and not the unlawful ones or focus instead on the trader's having proscribed information despite honest and independent reasons for trading? Crypto-utopianism If you are a cryptocurrency enthusiast living in a brutal dictatorship, and you use cryptocurrency as a way to evade the restrictions and bad economic policies of that dictatorship, and one day the brutal dictator comes to you and asks you to design a cryptocurrency for him, do you think that designing that cryptocurrency for him will usher in a new era of freedom and wise economic policies? Or, you know, not? The answer is "not," of course, but I appreciated the naive idealism of Gabriel Jiménez, the designer of Venezuela's Petro cryptocurrency, in this story by Nathaniel Popper and Ana Vanessa Herrero. Mr. Jiménez was just 27, ran a tiny start-up, and had spent years protesting the dictator. Mr. Maduro had not just mismanaged his country into financial crisis — he had detained, tortured and murdered those who challenged his power. But whatever Mr. Jiménez felt about the regime, he felt just as strongly about the potential of cryptocurrency. When the Maduro administration approached him about creating a digital coin, Mr. Jiménez saw an opportunity to change his country from within. If a national cryptocurrency was done right, Mr. Jiménez believed, he could give the government what it wanted — a way to fight hyperinflation — while also stealthily introducing technology that would give Venezuelans a measure of freedom from a government that dictated every detail of daily life. His friends and family warned him that working with the regime could only end badly.  It ended badly.  Things happen WeWork Directors Prepare to Take On SoftBank If It Abandons Deal. Bruised Hedge Funds Ask Clients for Fresh Cash to Buy the Dip. D.E. Shaw Raises $2 Billion for Flagship Composite Hedge Fund. The Worst of the Global Selloff Isn't Here Yet, Banks and Investors Warn. End of heady dealmaking leaves banks fretting over 'turkeys'. Big deals in limbo spell 'arb-ageddon' for hedge funds. Adam Tooze on swap lines. Dire Dollar Shortage Shows Failure to Fix Key Crisis Flaw. People are worried about bond market liquidity. Ruling on Lebanon Debt Insurance Paves Way for $400m Payout. Occidental Nears Settlement With Carl Icahn. U.K. Audit Watchdog Asks Companies to Delay Non-Urgent Reports. Corporate Boards Suffer From an 'Experience Gap' as the Coronavirus Upends Business. Working From Home Means Working Longer Hours for Many. The trillion-dollar platinum coin is back. Nassim Nicholas Taleb is stocking up on weight plates. If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! [1] Technically you can borrow from a special-purpose vehicle seeded with $10 billion of equity from the Treasury's Exchange Stabilization Fund and levered with loans from the Federal Reserve Bank of New York, but I count that as "borrow from the Fed." [2] Though in the modern world they're often tradable securities, including government and agency bonds. [3] Particularly because, in a crisis, you'd expect the value of the banks's assets to go down, reducing their capital from ample levels a few weeks ago to potentially dangerous levels today.  [4] Or, comically, Wells Fargo & Co. might want to make more loans, but can't because it is not allowed to grow its balance sheet due to its history of opening fake accounts. " Wells Fargo has made a pitch to the Federal Reserve to remove an asset cap introduced in the wake of its fake accounts scandal, saying it would allow the US bank to extend support to businesses and customers hit by the economic fallout of the coronavirus pandemic," reports the Financial Times, which seems both correct but also kind of opportunistic. [5] Even "bank loans" are often funded mostly by non-banks, hedge funds and mutual funds and collateralized loan obligations, though that is true mostly for non-investment-grade loans; investment-grade bank loans still seem to come mostly from banks.   Before it's here, it's on the Bloomberg Terminal. Find out more about how the Terminal delivers information and analysis that financial professionals can't find anywhere else. Learn more.   You received this message because you are subscribed to Bloomberg's Money Stuff newsletter. Unsubscribe | Bloomberg.com | Contact Us Bloomberg L.P. 731 Lexington, New York, NY, 10022