By Pam Martens and Russ Martens: May 27, 2020 ~
On May 13 the House Financial Services’ Subcommittee on Consumer Protection and Financial Institutions held a virtual roundtable with federal regulators. One of the regulators in attendance was the Vice Chair for Supervision at the Federal Reserve, Randal Quarles.
At the very end of what evolved into a roundtable beset with static and inaudible passages, it was Utah Congressman Ben McAdams’ turn to ask questions. McAdams’ voice was sharp and crisp. He politely said he had a question about the corporate bond buying program that the Fed was launching (for the first time in its 107-year history). The exchange went as follows:
McAdams: “Do you anticipate holding these investments through the life of the purchased bond or do you anticipate selling them at a date TBD [to be determined]?
Quarles: “Our intention is to buy and hold.”
That answer from Quarles effectively means that the Fed plans to keep its corporate bond buying program alive for at least half a decade. Here’s how we know that.
The Fed has two corporate bond buying programs: the Primary Market Corporate Credit Facility (PMCCF) and the Secondary Market Corporate Credit Facility (SMCCF). The Fed has released detailed descriptions (called Term Sheets) for both programs. The PMCCF Term Sheet indicates that the bonds it will be buying will “have a maturity of four years or less.” The Term Sheet for the SMCCF states that the bonds it will buy will “have a remaining maturity of 5 years or less.” Since the Fed plans to “buy and hold,” the program will have to be alive for at least five years until the last of its bonds mature. But here’s why the program could become much longer than that.
The combined programs will start out to buy up $750 billion in bonds by September 30 of this year. Both programs say the Fed can extend that purchase period. If it’s extended out a year, then we have a six-year program; if it’s extended out two years, then we have a seven-year program, and so forth.
Additionally, corporate bonds pay interest, typically every six months. What is the Fed going to do with that income? In the case of its other bond buying programs for Treasury securities and Mortgage-Backed Securities (MBS), the Fed uses the interest income and maturing principal to buy more of the same bonds. There’s every reason to believe it will do the same with the corporate bond buying program. If the Fed is using the interest income to perpetually buy more four- and five-year bonds, we’re looking at the potential for an infinite time frame.
The MBS also started out to be a short-lived program during the last financial crisis. It launched on January 5, 2009. It’s still alive today 11 years later with $1.86 trillion on the Fed’s balance sheet in Mortgage-Backed Securities.
The first leg of the Fed’s corporate bond buying began on May 12, with the SMCCF buying up Exchange Traded Funds (ETFs) holding both investment grade and junk bonds. In just an 8-day period, the Fed’s balance sheet showed that it was holding $1.8 billion in bond ETFs.
The CARES Act stimulus bill allocated $454 billion of taxpayers’ money to be used as “loss absorbing capital” to eat the first 10 to 25 percent of losses in the Fed’s rapidly growing list of bailout facilities. The Fed will use $50 billion of that for the PMCCF and $25 billion for the SMCCF – at least for starters. Those programs will be leveraged by an approximate factor of 10 to 1 by the Fed to create a $750 billion corporate bond buying program, buying corporate bonds outright as well as ETFs holding corporate bonds.
The Fed has outsourced both programs to the New York Fed which has, in turn, outsourced both programs to BlackRock, a large purveyor of investment grade and junk bond ETFs. BlackRock will be allowed to buy up its own ETFs in proportion to its share of the market. (See related articles below.)