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The Mnuchin-Powell Dream Team Faces Its Biggest Test

Brian Chappatta
·7 min read

(Bloomberg Opinion) -- Throughout the U.S. coronavirus crisis, investors have viewed Federal Reserve Chair Jerome Powell and Treasury Secretary Steven Mnuchin as steady leaders who are capable of steering the world’s largest economy through uncharted waters. They have appeared together before Congress to give updates on their joint emergency lending programs, which helped restore smooth functioning to corporate-bond and municipal-debt markets. Even when elected officials in both parties dragged their feet on another round of fiscal aid, traders could seemingly rest easy knowing that the Mnuchin-Powell duo would remain above politics and keep markets and the economy on the right track.

That was before last week’s U.S. elections, which showed Joe Biden winning the presidency while Republicans appear likely to retain control of the Senate. Now it seems Democrats and Republicans are jockeying for power, and Mnuchin risks being thrown into the fray as well, given that his time as Treasury Secretary is presumably drawing to a close.

The most pressing issue on the table is whether to extend some or all of the Fed’s emergency lending programs, which are set to expire on Dec. 31. The Municipal Liquidity Facility, for instance, which offers a backstop to state and local governments, will only accept notices of interest for loans at least 30 days before year-end, according to a central bank statement last month. So as it stands, three weeks from now, no state or city will be able to turn to the Fed to issue bonds at a known interest rate if Covid-19 outbreaks threaten their residents and economies.

This simply doesn’t align with the Fed’s long-stated reasoning behind providing these lending facilities. Powell described it like this during a speech in May:

“The Fed takes actions such as these only in extraordinary circumstances, like those we face today. For example, our authority to extend credit directly to private nonfinancial businesses and state and local governments exists only in ‘unusual and exigent circumstances’ and with the consent of the Secretary of the Treasury. When this crisis is behind us, we will put these emergency tools away.”

The Covid-19 pandemic is in no way behind America at this point, and there’s little reason to believe that’ll change in the next two months. The seven-day average of new U.S. cases is at a record, according to Johns Hopkins University data. According to Covid Tracking Project data, current hospitalizations related to Covid-19 are rising in 49 states or territories in the U.S., with about half of those reaching their highest level since the start of the pandemic. Even with this week’s optimistic news about a potential vaccine, Biden cautioned about a “dark winter” and some hard months ahead.

In this context, extending the Fed’s facilities should be a no-brainer. The central bank just held a meeting last week, publishing a statement that reiterated “the path of the economy will depend significantly on the course of the virus.” Well, Covid-19 outbreaks are now just as bad as they were during the financial market turbulence in March and April. So, what’s the holdup? Why did Powell punt when asked about extending the programs, saying “we’ve had a lot of things to work our way through,” even though the central bank made no change to any policy stance?

It sounds awfully political. Here’s The Wall Street Journal’s Nick Timiraos:

Democrats, looking ahead to President-elect Joe Biden’s inauguration in January, see the programs as a potential tool to deliver more aid if Congress doesn’t act, while some Republicans are worried about relying on central bank lending powers as a substitute for congressional spending decisions.

The tussle could open a divide between the Fed and the Treasury Department, which have mostly collaborated smoothly over providing emergency support after the coronavirus pandemic convulsed Wall Street. The Treasury launched the programs with the central bank in March and April after that turmoil threatened to freeze the flow of credit to small businesses, large companies, cities and states.

With markets in much better shape and the economy improving, the Treasury is facing pressure from some Republican lawmakers and some within the Trump administration to wind the programs down.

Failure to at least extend the Municipal Liquidity Facility and the Main Street Lending Program would be a permanent stain on the legacy of the Fed and Treasury as bulwarks during this crisis. For one thing, neither of these direct lending initiatives has received much take-up: Only Illinois and the Metropolitan Transportation Authority have placed bonds with the MLF, while the central bank has made fewer than 400 loans to small- and medium-sized businesses since the Main Street program got up and running in July. Yet they each cater to particularly hard-hit constituencies that may yet find themselves strapped for cash in the next few months.

The Treasury’s hesitancy to keep the facilities operational was clear even before the election. A report released last month from the Congressional Oversight Commission included questions to department officials about whether they thought the MLF should be extended beyond Dec. 31. The answer: At this time, no.

But even then, there were still political undertones. Just consider the difference between the two Democratic appointees on the commission, representatives Donna Shalala and Bharat Ramamurti, and that of Republican Senator Pat Toomey.

Here’s Shalala and Ramamurti’s 11th question out of 12:

Does the Treasury Department believe that the Municipal Liquidity Facility should be extended beyond its current expiration date of December 31, 2020?

Contrast that with Toomey’s only question:

Given the municipal bond market’s significant recovery since March, does the Treasury Department believe it is still necessary for the Federal Government to intervene in the municipal bond market?

The phrasing is not subtle. Toomey, who stands to head the Senate Banking Committee if Republicans control the Senate, wants the Fed to put its emergency tools away because he somehow sees a little-used backstop as “intervening” in markets. What’s more, according to reporting from Jeanna Smialek and Alan Rappeport at the New York Times, Toomey has been arguing that the Fed and Treasury don’t even have the legal authority to extend the programs past 2020 without congressional approval. That’s far from a certainty, however, and neither Mnuchin nor Powell has made remarks that suggest any calendar constraint. Democratic senators have said the law is clear that the Fed and Treasury have the power to keep the facilities operational.

Then, of course, there’s the scorched-earth possibility from the Times report: “Mr. Trump could also block a reauthorization by pressuring Mr. Mnuchin, leaving Mr. Biden with fewer economic stimulus tools at his disposal.”

Put it all together, and this is the biggest test yet of whether the largely technocratic Mnuchin-Powell dream team can withstand outside political pressure. Even with stock markets near record highs and junk-bond yields at record lows, there are any number of signs that things aren’t as cheery beneath the surface.

Some of the most troubled U.S. companies are racing to the bond market to stockpile cash to tide them over for the coming months. New Jersey, fresh off a downgrade from S&P Global Ratings, is planning to sell $4 billion of “emergency bonds” via the public market next week, though it could yet use the Fed’s facility instead. A recent survey from Goldman Sachs Group Inc. found that more than half of small business owners have stopped paying themselves, 42% have laid off workers or cut their pay and 33% have used personal savings to stay afloat.

The Fed’s programs are obviously not a cure-all for these strains. It’s fair to say the central bank doesn’t necessarily need to buy junk-bond exchange-traded funds anymore, nor bonds from Apple Inc. But prematurely taking away a last resort for local governments and small businesses lacks any sort of sound reasoning. If Powell and Mnuchin let political crosscurrents impede their hard-fought efforts to get the economy through the Covid-19 pandemic, it’s only America that loses in the end.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.

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