Federal Reserve Board Chairman Jerome Powell listened to 73-year-old President Donald Trump slashing the Federal Funds Rate to zero in response to economic fallout from the coronavirus AKA SARS CoV-2 or Covid-19. Powell took the step two days before the Federal Open Market Committee [FOMC] was due to meet at it regular time March 17-18. Powell’s aggressive action mirrors his predecessor former Fed Chairman Ben S. Bernanke who slashed rates to zero Dec. 16, 2008 in response to the worst financial collapse since the Great Depression. Powell’s decision to slash rates to zero undermines his approach in 2018 when he hiked rates three times, ultimately slashing 50 basis points March 3 seeing storm clouds ahead. Slashing 1% today, Powell stares at more than storm clouds, he’s looking a recession in 2020 unless Covid-19 subsides and the economy bounces back.
Trump’s worst nightmare started Dec. 31, 2019, the day China admitted it was dealing with a deadly infectious disease crisis. Little did anyone know then that it was most likely hatched in a bioweapons laboratory connected to China’s Wuhan-based Institute of Virology. While there’s no proof yet that the virus was bio-engineered in China’s laboratory, there’s growing proof that it leaked due to lax bio-security from the lab. Whether it leaked from an infected lab worker or infected laboratory animals sold into Wuhan’s commercial food chain is anyone’s guess. What’s known for sure is that the deadly CoV-2 virus sprang from Wuhan, most likely China’s virology laboratory. Whatever its origins, the world faces a growing pandemic shutting down major businesses and industries, causing the global economic dislocation prompting Powell to act aggressively.
Powell not only slashed the Federal Funds Rate to zero, he’s starting a fourth round of quantitative easing AKA QE-4, where the Fed buys $700 billion worth of treasuries or government-owned mortgage-backed securities. Bernanke’s QE-1, QE-2, and QE-3, kept liquidity in the banking system at a time when the system ran out of cash. While a liquidity crisis hasn’t happened yet, Powell’s trying to get a head of the curve that’s looking like a repeat of 2008. If Covid-19 persists longer than a few weeks, it could cause catastrophic damage to U.S. businesses, unable to stay solvent, especially in transportation and hospitality industries. “The actions we have announced today will help American families and businesses, and indeed, our entire economy weather this difficult period and will foster more vigorous return to normal once the disruptions from the coronavirus abate,” Powell said.
Fed’s actions don’t directly help families, they help the nation’s largest financial institutions borrow money for nearly nothing. Even cutting the Prime Interest Rate, commercial banks won’t slash interest rates to ordinary borrowers, especially those with revolving credit. Banks continue, despite borrowing the money for next-to-nothing, charge customers exorbitant interest rates. Average credit card borrowing rate are around 20%, not the zero percent banks borrow from the Fed. Powell’s kidding himself that his move help families. They’re designed to help give stimulus to Wall Street so the stock market doesn’t collapse. All indications point to another major sell-off tomorrow, despite Powell promising the world. Powell understands the limits of the Fed to reverse economic fallout from Covid-19.
Powell expects to start buying treasures or federally-owned mortgage-backed securities as early as tomorrow, looking to add some $700 billion to the Fed’s balance sheet. Slashing the Federal Funds rate allows Congress to borrow more national debt, paying back the Fed at historically low rates. If rates went up with today’s national debt, the government would go under in short order. Given the size of the national debt, about $23.3 trillion, it’s going to be impossible for the Fed to raise rates for the foreseeable future. “The Committee [FOMC] expects to maintain this target range until it is confident that the economy has weathered recent event and is on track to achieve its maximum employment and price stability goals,” Powell said. No one at the Fed knows how long the Covid-19 crisis will paralyze the economy. But the longer it goes, the more damage it causes.
Coming to rescue the battered U.S. economy, Powell hopes to stave off some of the inevitable damage to business, industry and private citizens from the coronavirus. Slashing the Federal Funds Rate to zero will drop a full one percent on the Prime Interest Rate, the rate banks charge their preferred lending customers. How that impacts variable or fixed rates on revolving lines of credit is anyone’s guess. Banks generally don’t pass on the savings to revolving lines of credit. Mortgage interest rates actually increased as the Federal Funds Rate began to drop last week. Adding $1 trillion to temporary banking reserves in New York assures that major banks don’t run out of cash. Fed also suspended banking reserve requirements, allowing banks to make loans without much in reserves. While that sounds good for a crisis, it’s a bad long-term policy that could stretch banks too thin in the future.
