The Lender of Last Resort

There is a high stakes political fight looming over whether to extend the emergency loan programs put in place this past Spring by the Federal Reserve and the Treasury Department, in response to the economic fallout from the coronavirus pandemic. While it appears that the Fed might be amenable to continuing the lending programs beyond their December 31st deadline, Treasury Secretary Steven Mnuchin is feeling pressure from Republicans to allow the programs to expire.

The interesting twist here is that it is the Democrats who are pushing for an extension of the loan programs. Unable to achieve another round of economic stimulus, a large comprehensive package that fully addresses social and economic needs, Democrats now appear to believe that the Federal Reserve’s loan program would be an adequate substitute. And amazingly, it is the Republicans who want extension of the Fed programs to be off the table, with some even admonishing Congress for not stepping up. Ordinarily it is the Republicans who support fiscal austerity and Fed policy only to shore up the financial markets, and the Democrats who prefer deficit spending in tough times. What we are seeing now is practically the opposite!

Now it appears to be the Democrats in favor of “trickle down” economics, the idea that the sweet deals given to the fat cats indirectly help the middle class by generating production and employment. The outdated idea continues to be used to rationalize the propping up of financial markets even while the economy nosedives. Policy adherence to the fraudulent trickle-down vision has a major hand in the monstrous increase in U.S. inequality. To give you an idea how bad it has gotten, upper income Americans have over past 40 years increased their share of national wealth from 60 to 79 percent, while the middle income share has dropped from 32 to 17 percent, and that of the lower income group from 7 to 4 percent.

Even though Americans did finally see a massive attempt at a fiscal stimulus earlier in the year, it was clearly insufficient. And what is more, it appears to have been a one-off. If the Federal Reserve balance sheet is anything to go by, it appears that “trickle-down economics” is here to stay.

Source, Wall Street Journal, April 27, 2020.

Assets in the Fed’s balance sheet grow as it extends more loans or buys bad assets as it did during the financial crisis. The Fed’s assets as a percentage of GDP spiked during the financial crisis to about 25 percent (see Figure), a level not even reached during World War II. Yet not even a decade later the number is expected to double to almost 50 percent of GDP! Such a degree of intervention by the Fed is surely unprecedented and clearly signals the fragility of the financial system.

Fed and Treasury officials have hyped the recent Fed loan programs as a major success in stemming the financial collapse of 2020. With Fed assurances that it would buy up to $750 billion in corporate securities, companies again began borrowing freely. But the fact is that over the past few decades such borrowing has increasingly financed speculative ventures rather than tangible investments that could directly benefit the economy. The recent spike in Covid-19 cases and continued economic misery calls for serious policy intervention. Meanwhile, the Democrats want to preserve what appears to be not much more than a corporate gravy train while the Republicans don’t even want to do that. Aggressive direct stimulus appears no longer to be on anyone’s radar.