Mnuchin’s Partnership With Powell Blurs Lines Between Fed and Treasury
Mnuchin’s Partnership With Powell Blurs Lines Between Fed and Treasury
(Bloomberg) -- Treasury Secretary Steven Mnuchin has forged a crisis partnership with Federal Reserve Chairman Jerome Powell, giving the central bank a bigger role in U.S. fiscal policy and blurring the lines between the agencies as they unleash $4.5 trillion in stimulus to combat the coronavirus.
Mnuchin and Fed Chairman Jerome Powell work together on the coronavirus rescue “round the clock,” according to the Treasury secretary. Already, the 106-year-old central bank is lending directly to main street businesses for the first time since the Great Depression.
Some analysts and former government officials see an erosion of the Fed’s traditional independence from politicians in the White House and Congress, as well as a central bank straying from monetary policy -- the supply of dollars -- into tax-and-spend fiscal policy. The risk is that “fiscal dominance” of the Fed could raise inflation or create currency and banking crises down the road, said Mark Sobel, who was a civil servant at Treasury for more than 40 years.
“This crisis is blurring the boundaries between fiscal and monetary policy,” he said.
Other governments and central banks also have clouded the lines. For instance, the Bank of Japan has been a key player in Prime Minister Shinzo Abe’s plan to reflate the economy with a mix of monetary stimulus and fiscal spending. It now holds 43% of the national debt, which is the world’s largest.
In the U.S., Mnuchin negotiated with Republican and Democratic congressional leaders to craft the $2.2 trillion virus-relief package Trump signed last month. He and House Speaker Nancy Pelosi worked to find common ground, and as the bill came together, both spoke with Powell by phone about issues including what Congress should do for the economy.
At the same time, Mnuchin was signing off on about half-a-dozen Fed actions to address the sudden economic collapse from the virus. He says there have been days when he’s spoken to Powell 30 times.
Mnuchin helped set the stage for a greater role by the central bank in the way he proposed crafting the stimulus and then in shaping the Fed’s role in backing small business loans.
One of the main relief measures in the stimulus is a $349 billion loan program for small businesses. Mnuchin worked with the central bank to create a secondary market for the loans after aggressive lobbying by community banks the weekend after the program launched April 3.
Doubling Balance Sheet
Now, instead of Americans buying war bonds to fight the coronavirus, it’s the Fed slurping up debt. The central bank’s work with Treasury is seen doubling its current $6.08 trillion balance sheet, which was already at a record high. Meanwhile President Donald Trump and Pelosi have said the next phase of virus-related stimulus spending should include $2 trillion in infrastructure development.
Congress, which has already made unprecedented demands of the Fed to cope with the pandemic, could insist it add an infrastructure program to its balance sheet.
The collaboration between Mnuchin and Powell echoes what unfolded during the 2008 financial crisis between then Treasury Secretary Hank Paulson and then Fed chairman Ben Bernanke.
But the last time the Fed and Treasury coordinated so closely was after the U.S. sold war bonds to finance World War II, Sobel said. The Treasury Department pressured the Fed to keep interest rates high to safeguard the value of that debt, contributing to 21% inflation by 1951. The conflict led to the two agencies signing the Treasury-Federal Reserve Accord of 1951, in which they vowed to “minimize monetization of the public debt.”
They now find themselves heading toward breaking that promise.
That would lead to what former Fed official Stanley Fischer calls “the most extreme case” of central bank and government coordination: “pure monetary financing of government debt.” Now at the BlackRock Investment Institute, Fischer and his colleagues have highlighted risks of monetary and fiscal authorities merging to deal with the next crisis but concluded that cooperation would be necessary.
“What if Congress says: We’ll do another $2 trillion stimulus and the Fed needs to buy up those Treasuries?” Sobel asked. He is now U.S. chairman for the Official Monetary and Financial Institutions Forum.
Job Losses
The Fed is at the front lines trying to save the economy because monetary policy can be adjusted faster in crisis than fiscal policy, which depends on negotiations between two polarized political parties.
The coronavirus outbreak has pushed the U.S. into a dramatic economic downturn. Nearly 17 million Americans lost their jobs in the last three weeks, a pace twice as fast as during the Great Recession a decade ago. Mnuchin, Fed officials and big Wall Street banks say the worst-case scenario is 20% or more unemployment.
Mnuchin says the stimulus he helped steer to passage last month will last about 10 weeks during a virus-induced economic shutdown.
The Fed’s unprecedented steps to support the law’s programs include creating a secondary market for $349 billion in small business loans. The central bank also is backing a “main street” lending program for medium-sized businesses, as well as funding the purchase of some types of junk-related bonds, collateralized loan obligations and commercial mortgage-backed securities.
The Fed’s measures are backstopped by $454 billion that Congress last month added to the Treasury’s Exchange Stabilization Fund.
“The Fed should have no such qualms in this moment to use its emergency authority, but it’s an incredibly uncomfortable spot for it to be in,” said Peter Conti-Brown, a Fed historian and an assistant professor at The Wharton School. “This is fiscal policy, this is using the central bank’s emergency authority that has long pre-existed to fix dysfunctional markets in a part of the fiscal policy that has nothing to do with the Fed -- like the Small Business Administration program.”
Mnuchin and Congress have made the SBA program -- which offers loan forgiveness if businesses retain workers -- the centerpiece to the economic rescue package. Mnuchin worked with the Fed to create a facility to help speed the flow of federal funds to small companies through the Treasury Department’s coronavirus stimulus package.
The Fed will take loans off the books of small banks so they can originate new ones under the Paycheck Protection Program.
Expanding Role
The Fed’s involvement wasn’t required under the law that created the program. Small banks lobbied Mnuchin earlier this month for a secondary market to smooth the process. The job fell to the Fed because it already has connections to banks across America, enabling it to more easily execute the lending facility.
And the central bank’s role may expand. Congress and the White House are debating the details of a plan to add $250 billion to the SBA program.
Mnuchin and Powell aren’t done with their blitz to help the economy survive the coronavirus shutdown. The Fed has so far used roughly 40% of the seed money that Congress has provided.
They are undertaking “very, very intense cooperation,” said Nathan Sheets, who worked at the Fed and later the Treasury Department during the Obama administration. “There are risks that the definition of central bank independence might be a little bit different than when we got into this crisis.”
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