Podcast: Extraordinary Actions – The Fed, Treasury and Congress vs. COVID-19

The Federal Reserve, the Department of the Treasury and Congress have undertaken unprecedented actions to buy financial assets, unclog the pipes of the financial system and increase its capacity. Congress has also taken swift action, passing three phases of stimulus packages as of the time of this discussion. In the third and final segment of our series on how COVID-19 is impacting the financial markets, Ken Bentsen, SIFMA President and CEO sits down with Rob Toomey, head of SIFMA’s capital markets practice, and Coryann Stefansson, head of prudential capital and liquidity policy for an overview of the Fed and Treasury’s actions so far, as well as those of the Congress, the market’s response, and what might be ahead.

SIFMA’s team continues to closely monitor the novel coronavirus (COVID-19) and its impact on our industry and the markets; guidance and resources for the industry are available at www.sifma.org/bcp.

Update: Hours after we published this discussion, the Federal Reserve announced programs totaling another $2.3 trillion in loans to support the economy; details are here.


Edited for clarity

Ken Bentsen: Welcome to The SIFMA Podcast. I’m Ken Bentsen, President and CEO of SIFMA. Our team at SIFMA continues to closely monitor the global COVID-19 pandemic and its effect on the industry and the markets. In just a few short weeks, we have seen severe shocks to the economy and capital markets. 

The Federal Reserve, the Department of the Treasury and Congress have undertaken unprecedented actions to buy financial assets, unclog the pipes of the financial system and increase its capacity. Congress has also taken swift action, passing three phases of stimulus packages as of the time of this discussion.

With us today are Rob Toomey, head of our capital markets practice, and Coryann Stefansson, head of prudential capital and liquidity policy. They’re here to give an overview of the Fed and Treasury’s actions so far, as well as those of the Congress, the market’s response, and what might be ahead. Rob and Cory, thank you all for joining us.

Rob, let’s start off with you. When did we start to see pressures in markets begin to manifest?

Rob Toomey: I’m going to take a bit of a historical approach to this to illustrate how fast-moving this is and how quickly it happened and impacted the markets. I’m going to take us back three and a half to four weeks ago, roughly a month ago. You started to see as people and investors started to take down the information on the spread of the virus internationally and as it started to move into the U.S., investors and markets started to show some stresses. Some of those stresses started to show up first in the repo market and the Treasury repo market. You started to see a couple of days in the second week of March or so where the SOFR, which is a rate that follows the repo market, started to spike outside of the Fed Funds range which is very rare for that. It indicated a little stress in that market.

Then as you moved forward, the Treasury market – which is the deepest and most liquid market in the world – started to show some stresses and particularly some illiquidity stresses in the longer dated securities: the 10-year and the 30-year. Certainly, there were illiquid circumstances in the off-the-run sector of the market.

This started to be a concern because also as investors moved more and more into cash or instruments that were very, very close to cash products – usually the short end of the Treasury curve – they started to move out of the longer end of the Treasury curve and that became even more illiquid. That started to build on itself and we’ll talk in a little bit about the policy responses that the Fed and the Treasury implemented that have helped this. But, at this point in time these were the first canaries in the coal mine showing that there were going to be problems, particularly in the fixed income space. It started to spread throughout the corporate securities space. The agency MBS space had some dislocations and illiquid products. One area I do want to focus on is the municipal securities area. It was across the curve – short end municipal securities, longer dated municipal securities, all different credit types – that became some concern and that started building on itself.

When you look at the history over the course of say the mid two weeks in March you saw more and more developing stresses, particularly illiquid conditions, in all the fixed income markets.

Ken: That’s when the Fed in coordination with the Treasury first stepped in to get credit flowing to households and businesses.

Coryann Stefansson: That’s right, Ken. It’s hard to believe, to Rob’s point, that it has only been a month. 

Back on March 3, there was an additional rate cut by the FOMC and a statement of coordination across all central banks reassuring there would be liquidity in the markets. The Fed then did some activity around the discount window: they lowered the rate to 25 basis points, which is actually lower than where it was during the crisis. They also put out a statement in order to encourage people to use the discount window during this period of time. Not from the perspective that it is the “lender of last resort” but rather – and they’ve been working on this for awhile, to eliminate the stigma that going to the discount window is a bad thing – that the Fed is there to be able to bolster liquidity in times when there is broad market concern. They encouraged all the large banks to access that window.

They also put out a statement talking about utilization of intraday credit, to again quell some of the consternation banks have about running a deficit on intraday credit. They also moved the reserve requirements to zero. They also put out a statement talking to organizations saying that they encouraged them to make use of their management buffers and liquidity buffers – both on the capital and on the liquidity parts of their balance sheet.

I think the other thing that they learned from the previous crisis is that they immediately instituted central bank swap lines. They did it with the G-7 first and then expanded it to include a larger group of central banks. Then, even noting there may have been pockets of liquidity across the board or globe, they turned around and instituted a repo facility that permits the pushing of dollars into the global economy. All of those things were pretty quick as well as pretty helpful to deal with liquidity issues.

The other thing that I think is very different from the initial playbook that they used in 2008 is, along with the U.S. Treasury who is providing a backstop to the SPV, they set up the Primary Market Corporate Credit Facility (PMCCF) and Secondary Market Corporate Credit Facility (SMCCF). Both are novel from the Fed’s perspective and will hopefully be able to deliver liquidity to those parts of the larger borrowing market that need some temporary financing while markets are either nervous or where people are still trying to get past the hump of COVID-19.

Ken: It is very interesting because you can see a situation, particularly in the U.S. with the largest markets and particularly the role that credit and equity markets play in funding the real economy. The real economy has effectively downshifted into first gear from fourth gear and what the impact is on economic activity and subsequently on the funding markets the importance of making sure that those markets are operating and that capital and credit is flowing through those markets.

Over the next two weeks, the Fed, again with backstops in many cases from the Treasury, announced more than a dozen different actions to inject liquidity into the marketplace and support the economy including, Cory as you mentioned, near-zero interest rates and valuable forward guidance. 

Rob, maybe you can start in outlining those programs and then followed up by Cory.

Rob: Again taking a bit of a historical approach to this, we start back with the initial dislocation in the repo market and concerns there. The Fed, very quickly once these stresses started to manifest themselves because remember the Fed’s policy rate is the Fed Funds Rate and dislocations in the short term funding market (aka the repo market) can cause or make their target, the Fed Funds Rate, harder to consistently hit. They are concerned about keeping the repo market operating for their policy reasons but also for the economy generally to make sure that credit continues to flow through. They created a backstop for primary dealers to access at the Fed to engage in repo transactions so they could get cash from the Fed. Initially, they instituted a series of overnight operations as well as term two-week operations. Those caps got raised so now essentially the Fed is in the position to make sure that the repo market continues to operate smoothly.

Similarly, what happened in the Treasury market, the Fed started to buy Treasury securities and as they were buying Treasury securities up to $500 billion in Treasuries and $200 billion in agency MBS, that was the initial call. There continued even after that was instituted and that buying had started there continued to be some illiquid stresses in those markets. The Fed essentially took those caps off and said very clearly that we stand in the position to make sure that the Treasury market continues to operate with liquidity and with efficiency. That has continued and they continue to buy treasury securities daily up until today.

Cory mentioned some of this early on. They went back to the playbook from 2008 and have revised a number of programs to get liquidity into the spaces that we discussed earlier. In particular across the fixed income space. 

They have re upped the Primary Dealer Credit Facility (PDCF). This is a primary dealer facility whereby primary dealers can put certain enumerated securities and it is a fairly broad list to the fed to get dollar liquidity.

They relaunched the Term-Asset Backed Securities Loan Facility. This was a way of the Fed supporting lending to households and businesses by lending to holders of asset-backed securities that are usually collateralized by new loans.

They have also relaunched the Money Market Mutual Fund Liquidity Facility (MMLF). This was also from the crisis and it backstops the holdings of certain money market funds.

Finally, another area that I didn’t mention earlier but that was significantly stressed was the commercial paper market. This is another very important short term funding market for both financial firms and non financial firms. It essentially froze; people were not able or companies were not able to access financing in the short term commercial paper market. The Fed announced – and again this is taken from the playbook in 2008 – the commercial paper funding facility (CPFF). Essentially, the Fed will be buying commercial paper directly from issuers up to 3 months and then they’ll let it roll off. This will be important once this fund gets up and running. Some of these programs, especially the CPFF (which is due to start I think April 14), are not up and running yet but once they do get up and running they’ll be providing important liquidity to these markets. 

Ken: Maybe to add just a little context, what the government was dealing with when you think about where the first quarter ended, U.S. equities recorded their worst performance since the financial crisis: the S&P 500 closed down 21%), the Dow Jones 24%, the Nasdaq 15% and the Russell 31%. The CBOE Volatility Index (VIX1) jumped more than three-fold and peaked actually at one point more than five-fold. In addition, throughout this time, as Rob was talking about, the CP market froze up.

In the fixed income space there was tremendous stress – at first in the Treasury market but also in the MBS, CMBS, muni and corporate markets and particularly seeing spreads blown out; when you look in the muni market, where spreads blew out 200 bps in the long end and I believe at one point in the high yield market a four-fold increase – so a tremendous stress. Some of that has come back, right Rob, in response to the programs that have been announced.

Rob: Yes, exactly. I think particularly in the areas that have been targeted by the programs and even in the areas where the programs have not been stood up and are not fully functional yet. I particularly would cite to the corporate programs that Cory mentioned before, the corporate securities programs.

You can largely say that the Treasury market is behaving in a more characteristic way. The liquidity that has been provided both to the repo market which supports the Treasury market and the buying of the Treasury securities has really significantly bought spreads in. There may be some pockets in the off-the-run sector that may be less liquid than they traditionally have been. Generally, the message has been this has improved and stabilized the situation in the Treasury market.

With respect to corporates, they are looking a little better than they were probably in mid-March. I think there is an announcement effect to the Fed announcing they would be in the business of buying the corporates. As I said, that program has not been stood up yet but I would think that market still needs some of that support to keep its liquid conditions.

In a couple of areas within the MBS, within the securitization space, there continue to be some stresses. There is some improvement but there are some products that people would like to see targeted.

The muni market, a couple of the programs that were announced targeted the short end of the muni market and the liquidity issues there have improved significantly. The longer end, while some of the spreads have come in a little bit, there are still some stresses there and we are waiting to see the Fed stand up its muni program to provide support and liquidity to the muni market.

With respect to equities, and Ken gave you some metrics – that is always one of the headlines certainly, around what the equity markets have been doing in terms of numbers and falls and drops – but one thing to cite to, those markets notwithstanding that volumes have increased significantly, they continue to function smoothly and can do so from BCP locations. The floor of the stock exchange is closed; they have moved to full BCP arrangements; they continue to support the secondary market activity in equities. We would like to see how they support IPOs going forward if this lasts much longer but that is a to be determined.

Ken: That’s a good point. There have certainly been some stresses in the equities and options market but given all the volume they have run well particularly with people working from home or remote sites, split shifts. Firms report to us that they have 80-90% people working remotely or working from home. Again, there haven’t been too many IPOs, there certainly have been some high-grade corporate bond issuance, convertible bond deals, very little in the muni market comparatively, but it is a testament to the market structure in the U.S. that it still has been able to operate through this.

Why don’t I switch over to Congressional action and in particular the most recent CARES Act, the $2 trillion fiscal stimulus package adopted by Congress and the Trump Administration that is aimed to help individuals, small businesses as well as larger businesses impacted by the coronavirus or COVID-19. In particular, some of the business-related to municipals and corporate bond markets. As mentioned in an earlier podcast, this is the third stimulus package by Congress.

Cory, how would you describe all these?

Cory: Certainly, I think the U.S. COVID-19 financial stability agenda is comprehensive. The sheer size of it is impressive. In fact, Treasury Secretary Mnuchin calls it “a massive liquidity program.” 

The core of this really is the PPP which is the Paycheck Protection Program that was rolled out or began its rollout last Friday. We are still waiting to see some details as to how the Main Street program would be stood up as well as the mid-sized lending program. All three of those, if you pair that with what is going on in the primary and secondary corporate credit facilities, this is a pretty comprehensive approach.

The Fed obviously partners with the Treasury as being the arm of execution for many of these facilities. They are using Treasury’s backstops, etc. One of the issues is that most of the time when the Fed is trying to lay out or push these programs out to the Street, they rely on the banks in order to intermediate those programs. The banks have been clearly very positive about partnering with the Fed and the U.S. government to lay out what I believe they also believe is a comprehensive and important part of the U.S. response to COVID-19. Given the size of the program, I think there are some concerns and certainly, from our perspective, there are some concerns about the ability of the banking industry to mediate programs of such size. 

At this point, the banking industry is in great shape, it is well capitalized. There are a lot of positives going into this crisis. The thing where I feel there is going to be some concern at some point, if we definitely draw down the full amount of these programs, is from a leverage perspective. The U.S. has a full complement of capital rules. One small subset of that is risk based capital rules that align capital on the riskiness of an asset, which are complemented by a series of leverage ratios that are risk agnostic and really just do a capital over average assets. When I am thinking about where constraints may be it is really in terms of the supplemental leverage ratio (SLR), enhanced SLR and then finally the Tier 1 leverage ratio.

I think the agencies themselves recognize this. Just a week or two ago, probably two weeks ago, the Fed put out a really important acknowledgment of what I am talking about here which is this capacity constraint. They amended on a temporary basis the supplemental leverage ratio at the holding company level which would exclude Federal Reserve deposits and Treasuries on deposit at the Federal Reserve, it removed that from the denominator of the supplemental leverage ratio. This allows some additional capacity for holding companies to support for example their primary broker dealers, etc. One of the things especially as we move into more of a lending program, a lot of that is going to be booked in the bank side of the legal entity. If you think about the bank subsidiary, once you start booking there they are going to be subject to leverage ratio constraints. The other thing that is important to note is that capital ratios apply both at the holding company and at the bank level. I think there might be more to follow potentially as they roll off these programs with regards to how this will all play out from a capacity perspective.

Ken: The Fed as noted has put out a quite impressive package along with the Treasury to support the economy. The programs are historic even in comparison to the 2008 financial crisis. Now we’re seeing them roll them out quite deliberately, seeking to get market feedback and expand where they think they will make the most difference. Rob what’s your take on how these are rolling out.

Rob: I do want to reiterate your comment and Cory’s that these are comprehensive and truly extraordinary. The size of these programs is enormous. I think our members – you have to give credit to the Fed for at least getting them out there and getting them announced quickly. I think that helped calm some of the situations in the market. 

Right now, we’re focused on the programs themselves. I know Cory is going to give a little detail on that, but providing feedback to the Fed and to the Treasury on where those programs can be improved. The Fed certainly has let it be known that they are looking for input. Input specifically on where the gaps are. Where is the next piece of this puzzle? Where did they miss? Where did they obviously miss? Where did they subtly miss? I think that input is important and I give them credit for thinking about it and thinking about perhaps expanding these programs. For example, in the TALF whether or not they should be taking securities from the secondary market. I think these are questions that we and other market participants are raising and certainly the Fed is listening to those comments.

Cory: Yes, Rob. I think it is very difficult in a very short period of time. They’re trying to stand up programs, many of which they have zero previous experience with them. I give them a lot of credit for actually working that quickly to get them together. Their initial FAQs, it is their first attempt and they have been very open about, look you tell us what is the right way for example to engage with the marketplace when I do this type of transaction. This is kind of the minutiae of the market that unless every day you’re a fixed income trader, you’re not going to know necessarily how this all works. You don’t read about it in a book. You tend to know it more because you do it.

To that end, we have been working with our members on two workstreams.

One is to really take a look at all the work, all the term sheets that have been offered as well as anticipating what we believe is going to be in term sheet and give the Fed a number of clarifying questions that will help them to think about what kind of FAQs they should be putting out and how potentially or why potentially those clarifying questions would be important in terms of standing up those facilities.

On the second workstream, that is more after having a good understanding of what the program and the intent is, we are making recommendations that we believe would be helpful to make sure that the liquidity really gets to the dislocated parts of the market. Our members have been great helping to provide that type of information. We’ve already shared our clarifications but are welcoming follow up calls with the Federal Reserve or the Treasury, the local reserve banks that are also implementing on a day to day these programs. We certainly will be looking to have the same kinds of conversations regarding recommendations. We want to be sure the facilities and programs meet their goals of effectiveness. We look at it this way: the market and government are all in this together to get this financial stability agenda rolled out and implemented in a way that reduces the impact to the U.S.

Ken: Rob, there are other areas where we have been engaging our regulators like the SEC, CFTC, IRS and others with respect to technical issues related to market operations and compliance, is that right?

Rob: Yes and you can see we have a letter to the SEC on SEC-related issues on our website. The focus there is on what we would characterize as nuts and bolts issues that have to do with operations settlement, infrastructure and deadlines. Things that have become very, very hard to do in this work from home, BCP environment. By way of an example and you don’t often think of this but we do still have in a limited way physical securities. How are those going to be handled in an environment where 95% of people are working from home? There may be deadlines associated with delivery of those. How can those be eased if at all, again on a temporary basis just while we are in this situation where 90% of people may be working from home. It’s those kinds of things: deadlines, wet signatures, reporting requirement deadlines, things like that. This is a temporary situation, it’s not going to be around for hopefully very long. But in the interim, firms want to do their best to comply. The regulators, I will give them credit certainly, the SEC, the staff at the SEC, the CFTC, FINRA, have certainly been willing to engage in a pretty good dialogue with us and our members around what are the pressure points and where we can be helpful.

Ken: This has become job one or our number one priority at SIFMA working with our members, our Board of Directors, in terms of how we are engaging with our regulators and market participants to continue keeping markets operational, efficient and working through the COVID-19 issue until we get to the other end of it.

Cory and Rob, I want to thank you all for participating with us today. I would remind our listeners to go to www.sifma.org/bcp to see all that we are doing on COVID-19. Please don’t hesitate to reach out to us as well on any issues related to this or any other markets issues that are part of SIFMA’s mandate.

Thank you for listening.

Kenneth E. Bentsen, Jr. is president and CEO of SIFMA, the voice of the nation’s securities industry. Robert Toomey is Managing Director and Associate General Counsel, and heads SIFMA’s capital markets practice. Coryann Stefansson is Managing Director and Head of Prudential Capital & Liquidity Policy.