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The Fed Fights The Virus

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UNIDENTIFIED PERSON: This is PLANET MONEY from NPR.

ROBERT SMITH, HOST:

Hello and welcome to PLANET MONEY. I'm Robert Smith.

JACOB GOLDSTEIN, HOST:

I'm Jacob Goldstein. Robert, I should say it's 12:50 p.m. Eastern Time on Monday. We are in Prospect Park, Brooklyn, about midway between our apartments, where we're both working today.

SMITH: We are 6 feet apart. And we are today recording an emergency episode of PLANET MONEY - and there may be a lot of these in the future - an emergency episode because over the last few days, the Federal Reserve of the United States of America has done some extraordinary things - extraordinary, important things that we really need to break down and talk about.

GOLDSTEIN: So today on the show, we're going to say what those things are, talk about why the Fed did them, what it could mean for the economy and if there's anything else left for the Fed to do. Is the whole park - are we in the one part of the park that's the most under the planes?

SMITH: It's funny, I never noticed how many planes went over.

GOLDSTEIN: I've noticed it sort of, but...

SMITH: It's every three minutes. If you lay on the grass - sometimes I'll lay on grass...

GOLDSTEIN: Yeah. Yeah.

SMITH: ...And you just watch them go over.

GOLDSTEIN: Yeah.

SMITH: I just have to take a moment to say how strange this is. Jacob hasn't shaved in days, and he's dressed in leggings.

GOLDSTEIN: For a jog - we can just say for a jog. I'm going to go keep a safe space and keep healthy.

SMITH: So you can make fun of me. I have....

GOLDSTEIN: Do you want to tell the world that you have the mask - the face mask?

SMITH: I have a mask just in case I go into a crowded space - and some gloves and a lot of Kleenex. So we should talk first about the Federal Reserve and the purpose of the Federal Reserve - and stay with me here because over the last six, seven, eight years, we've gotten used to a certain thing that the Federal Reserve does.

GOLDSTEIN: Lowered interest rates.

SMITH: Lowered interest rates, but it's doing it for...

GOLDSTEIN: Raised interest rates.

SMITH: It's doing it to prevent a recession, to get people spending.

GOLDSTEIN: Right. This is the main thing in normal times that we think of when we think of the Fed, right? They raise interest rates when they think the economy is overheating and they want everybody to chill out. And then, when they're worried that the economy is slowing down, they lower interest rates to encourage people to borrow money and spend and hire and build.

SMITH: And, in fact, last night, in a surprise emergency decision, the Fed did lower interest rates to zero - the lower bound is what they call it. Some places have lower interest rates, negative interest rates, but not in the United States of America. We went down to zero.

GOLDSTEIN: And this is the headline. It's sort of a big deal. It seems reasonable that they did it. But, you know, I was talking to somebody this morning, and they were like, look, it's not like a little bit lower interest rates, people are going to be like, oh, great. I'm going to go, you know, start eating out again. Like, nobody's going to do anything right now, no matter what the interest rate is.

So to me, the really interesting thing that has been going on with the Fed over the last few days is not the interest rate thing that we always hear about, right? There is this second thing that the Fed does.

SMITH: In fact, what the Fed was originally designed to do a hundred years ago...

GOLDSTEIN: And that is try and prevent a financial crisis, right? So we're at this moment right now where there is this economic crisis happening around the world. And importantly, unlike the financial crisis it didn't start, obviously, in the financial system - it started with the virus - but there is this fear that because the economy is cratering right now, today and next week...

SMITH: And so quickly, so quickly...

GOLDSTEIN: ...That we could have a financial crisis that could make things even worse. And the Fed clearly, with most of these moves, is trying to prevent that.

SMITH: Because as bad as things seem right, now if money stops flowing, if banks and financial institutions stop trusting each other, that is far, far worse.

GOLDSTEIN: So the fundamental problem right now - like, the immediate, short-term problem, in terms of finance, is basically everybody wants money. So in normal times, there are some people who want to lend and some people who want to borrow, right? And banks kind of sit in the middle, borrowing from some, lending to others.

Now, nobody wants to lend. Everybody just wants their money back. And when everybody wants their money back at once, what you need is for the central bank to be the one to be like, OK, we'll lend. We will lend into this panic, basically.

SMITH: And to send a signal that, listen, there is enough money in the world. In fact, we print it ourselves. We make our money, so be afraid of a lot of things, but do not be afraid of how much money there is in the system.

GOLDSTEIN: Yes. So the so the Fed is acting - the term of art here is lender of last resort. Nobody else wants to lend, the Fed is going to lend to everybody in hopes that everybody else is going to keep lending. And so, as we talk through everything else the Fed has done in the last few days, it all comes back to that.

So everybody is asking for their money back. And one weird place we saw this, well, last week, was actually in the market for Treasurys - U.S. Treasurys, government bonds, the safest asset in the world.

SMITH: And, in fact, the asset that sort of makes the world go round. Everyone around the world uses U.S. Treasurys as this safe, risk-free asset when they're doing deals.

GOLDSTEIN: And so this strange thing happened last week which was, as people were selling off stocks, people were also selling off Treasurys, which never happens - right? - because when people are selling off stocks, everybody is like, I want something safe. I'm going to go buy Treasurys. And yet, last week that wasn't happening. And what people think was happening then was, there are lots of people who, you know, before things got crazy, had borrowed money and bought Treasurys. And now at this moment, when everybody on the planet's like, I want my money back, I want my money back, those people were selling their Treasurys and paying back their debts.

SMITH: So they were essentially unwinding positions, they say. They were trying to figure out, where can I get money anywhere?

GOLDSTEIN: Unloading Treasurys.

SMITH: And we also noticed that gold went down too, which is another...

GOLDSTEIN: Weird.

SMITH: ...Weird thing.

GOLDSTEIN: Presumably because people had borrowed money and bought gold, and now they had to pay the money back and sell the gold.

SMITH: So this was the situation. It didn't really make normal news headlines, but people inside the financial system were very worried.

GOLDSTEIN: So the Fed sees this happening and, as lender of last resort, it sees this market that's essential to the whole world acting funny at a time when lots of bad things are happening in the world. The Fed says, OK. If you have Treasurys and you want money, you just give us your Treasurys for a month, and we'll give you money.

SMITH: You may have seen this headline last week. The headline was, Federal Reserve injects - they always use the term injects - Federal Reserve injects 1.5 trillion - with a T - $1.5 trillion (laughter) into the economy. But what did what did that actually mean? They were not printing $1.5 trillion dollars and handing it to anyone.

GOLDSTEIN: What it meant was they said, you basically give us your treasury bonds for a month. And we'll give you cash for a month. And at the end of the month, either pay us back with interest - and if you don't, we'll just keep the treasury bond and sell it and get our money back. And they're offering to do that for $1.5 trillion in total. Although, I should say, the first sale started, I think, on Friday - a few days ago. And it was under subscribed. It was - they - I think they offered to do 500 billion. And what people actually wanted was much less than that.

SMITH: So a tiny recap - people were worried they didn't have enough cash. The Federal Reserve said, listen, if you need cash, we have up to $1.5 trillion worth of it in order to lend this money to you if you need it. Do not panic. Did it work?

GOLDSTEIN: I mean, define work, right? Clearly, it wasn't enough. I don't think they thought it would be enough. It wasn't like, oh, now all the financial problems are solved because we're lending money into the repo market against Treasurys. So yesterday, Sunday, they did a lot more.

SMITH: So yesterday - let's go to yesterday, then. Yesterday was an emergency sort of meeting decision by the Fed. It came around 5:00 in the afternoon. And there was just - all of a sudden, the Fed said, our interest rate target is now 0%. We are lowering it all the way. And everyone sort of thought they were going to do it. And they did it before, I will note, before the stock markets opened in Asia, just in case...

GOLDSTEIN: Classic.

SMITH: ...That could help things out a little bit.

GOLDSTEIN: Classic crisis move. Yeah. But they also did a bunch of other lender of last resort stuff, right? So there was this whole chunk of things they did where, like, the subtext is just, like, please, please, banks, keep lending. They...

SMITH: You have your phone out. You...

GOLDSTEIN: I got my phone out, I got my list. I got the list now.

SMITH: Let's do it. Let's do it.

GOLDSTEIN: OK. So...

SMITH: Let's go down the list.

GOLDSTEIN: So there's this category I have called Other Lending Things - lowered rate on discount window, capital liquidity buffers and reserves.

SMITH: Oh, this is going to be a great hour.

(LAUGHTER)

GOLDSTEIN: Hello, and welcome to planet - no. All of those are just ways to get banks to keep lending. So the discount window...

SMITH: OK.

GOLDSTEIN: ...Is just a way that banks can borrow from the Fed against lots of assets. They normally don't borrow from there because it becomes public. And if they borrow from there, everybody's like, oh, bank, you're in trouble, you borrowed from the discount window. So there's this weird catch-22. And the Fed is like, no, please, please borrow.

SMITH: They did beg. They did beg a little bit because normally, banks would borrow and lend from each other because it's just easier.

GOLDSTEIN: That's right.

SMITH: And it's pretty cheap. But in this particular case, they're like, listen, just in case there's any problems, come to us. We will give you the money that you need - sorry, lend you the money that you need.

GOLDSTEIN: (Laugher). Yes, lend against assets. Like, it's - yes, lend you the money. So they did that. They had this other statement that was like, don't worry too much about all those big safety buffers we've been making you maintain.

SMITH: Wait. Now I'm worried about the safety buffer.

GOLDSTEIN: Well, but the point of the safety buffers is so that banks can keep lending now, right? Both - like, the idea is, you know, after the crisis, they forced banks to have a lot more money, to fund themselves more with their own money, with capital.

SMITH: And, in fact, they did these things called stress tests - just sort of simulations of something like this...

GOLDSTEIN: Yes.

SMITH: ...To make sure that they would not go under. And before this crisis started, people said the banks were in pretty good shape here the United States of America.

GOLDSTEIN: They're in way better shape than they were in 2008.

SMITH: OK.

GOLDSTEIN: So again, the Fed had this whole statement yesterday that was like, banks have great capital and liquidity buffers. Use those, lend money. And they also said the same thing about reserves, which is just the money the banks have at the Fed. And the banks have a ton of reserves. And they're like, don't worry about reserves, just please, for the love of God, banks, keep lending.

SMITH: So that helps out banks here in the United States. But they also did something to help out banks around the world because everything is interconnected here.

GOLDSTEIN: Yes. Well, so banks all around the world borrow and lend in dollars.

SMITH: Which is great for us.

GOLDSTEIN: Yes. The dollar is the, basically, the reserve currency of the whole world.

SMITH: Makes banks go around, yes.

GOLDSTEIN: And everybody does business in dollars. But banks outside of the U.S. don't - can't just come to the discount window, don't have all these ways of getting dollars that U.S. banks have. So yesterday, the Fed announced this set of agreements with all of these central banks around the world - the European Central Bank and the Bank of Canada and the Bank of Japan and maybe the Bank of Switzerland - I don't know all, the big ones, certainly, which is basically saying - they're called swap lines.

And it basically says, we will essentially trade dollars for all of those countries' currencies to get dollars out into all of those other countries because this same fundamental problem of everybody wants their money back right now - nobody wants to lend. Everybody's like, give me my money back. Give me my money back. This is a global problem. And it's a global problem in dollars. And the Fed is the only institution that can solve it.

SMITH: Because if I'm in another country and I have a pile of dollars, at this point, I would not lend them out to anybody.

GOLDSTEIN: You would not...

SMITH: I would be like, I don't know if I can get more. What the Fed is saying is, yes, you can get more. You can get as much as you want.

GOLDSTEIN: Exactly right.

SMITH: So you've just described several ways in which a - some employee of the Federal Reserve is sitting there hitting zero on the computer...

GOLDSTEIN: So many zeros...

SMITH: ...Just sending millions...

GOLDSTEIN: Send it all...

SMITH: ...Billions, trillions...

GOLDSTEIN: Please...

SMITH: ...Sending it out.

GOLDSTEIN: ...Begging banks.

SMITH: All right. But there was one other big thing that happened yesterday, which is a form of quantitative easing. You've heard of this? QE. The Fed said that they would buy bonds. What exactly are they doing?

GOLDSTEIN: So they are buying relatively long-term bonds, so Treasury bonds - that's U.S. government debt - and of mortgage bonds that are backed by the U.S. government - very safe, all very safe debt. And the interesting thing to me about this is the following. So look sort of classic quantitative easing - QE - the point of it is to lower interest rates - long-term interest rates. It's, again, to get people to borrow and spend.

And, like, that may happen here, but you know what? It doesn't really matter right now. There's this huge economic catastrophe. Like, people are not going to borrow and spend much more because of the lower interest rates. The reason they seem to be doing it this time is not to lower interest rates, but, again, just to get money out and to be a promised a buyer of Treasurys and of these mortgage bonds because these - as we talked about earlier in the show, with the repo stuff and the Treasurys, the market for Treasurys needs to work. It's this very important very, safe asset. And everybody needs to know, if I have a Treasury bond, I can sell it whenever I want to.

SMITH: Because there are people out there in the financial system who are not banks officially and can't do some of these bank things we've talked about, but still have Treasurys. So anyone who has them, this is a benefit for them.

GOLDSTEIN: Yeah. There is a guaranteed buyer for Treasury bonds. So this bedrock piece of the financial system needs to keep working. And that's really what this quantitative easing is about - not lowering the rates, but making sure the treasury market - like, maybe the most important financial market in the world, even though we hear so much more about the stock market - keeps working. Right? This - actually, this idea is an old idea. It goes back to the 1800s. Somebody figured it out, basically.

This guy Walter Bagehot, who was an editor of The Economist magazine, in the 18 - I don't know, like, 80-ish, plus or minus - sort of saw this financial crisis in England. He was like, wait. There are these moments when everybody wants money. When everybody just wants their money back and nobody wants to lend. And that is a messed-up situation that is not good for anybody. And the only way to solve it is to have the central bank come in and say, we will lend. We will buy your asset. We will buy that Treasury bond. It's safe we're not going to lose money on it. Everybody's just panicking and screwing themselves. We will prevent a panic from occurring. And that's what the Fed is trying to do now.

SMITH: It seems like the Fed has done everything in its arsenal - threw the kitchen sink at this problem. After the break we'll talk about, is there anything left that the Fed can do next? I hope the break is just planes going overhead.

GOLDSTEIN: Yeah, the planes are still flying. The planes are still flying. I don't know if there's anybody on them, but they keep going overhead.

(SOUNDBITE OF MUSIC)

SMITH: Is there anything else left that the Fed can do?

GOLDSTEIN: So it's talking to somebody this morning about this, and he mentioned one intriguing possibility - not that he thought they should do it now, or even that he thought they would do it, but that they have the legal right - the Fed, if it wants, can lend money to normal businesses. The Fed could lend money to restaurants, to, you know, dry cleaners, to airlines.

SMITH: Is that a new power? Did that come in after the financial crisis?

GOLDSTEIN: You know, I think it got modified. I frankly don't know the details. But the thing - so in the financial crisis they did this emergency lending to AIG.

SMITH: Yes.

GOLDSTEIN: And people got mad about that. And the new rule basically says, you can't just do it for one company. That's like too - we don't like that. But you can set up like a facility. You could be like a bank that makes loans against - you know, and they have to be collateralized. They have to be, you know, they have to be safe loans, basically. So that's one.

SMITH: That would be amazing. And, I mean...

GOLDSTEIN: That would be very dramatic.

SMITH: Yeah. And the level of assets that they could lend against - I mean, that's huge.

GOLDSTEIN: Sure. I mean, that's far off, right? That doesn't seem like it's about to happen. I mean, the one other thing - and it's maybe repetitive to say, but I don't want to not say it in the show - is, like, the Fed is just this one little piece, right? Like, if the Fed can prevent a financial crisis, that's good, obviously.

But, like, the rest of the government - Congress and the president need to spend more money, are going to need to spend lots more money to keep the real economy from collapsing. Like, it's collapsing right now. And the Fed is just not supposed, to not equipped to - it's not even right to think that the Fed is supposed to save it, right? So it's like, the Fed is in this one important corner, but like, the rest of the government has to do a tremendous amount more to save the economy.

(SOUNDBITE OF MUSIC)

SMITH: We're going to try and do more episodes as things rapidly change in the economy and with the Fed. And if you have anything that you want us to explain, please write in. We're planetmoney@npr.org. Or you can find us on Instagram and Facebook, Twitter - @planetmoney.

GOLDSTEIN: Thanks to Joe Gagnon of the Peterson Institute and Nellie Liang at Brookings, both of them formerly at the Federal Reserve. They helped me think through this stuff. Our producer, standing next to us and keeping us a safe distance apart, is Nick Fountain.

SMITH: Our editor is Bryant Urstadt. And our senior producer is Alex Goldmark.

GOLDSTEIN: I'm Jacob Goldstein.

SMITH: And I'm Robert Smith. This is NPR. Thanks for listening.

(SOUNDBITE OF MUSIC)

SMITH: Hey, everyone, just a quick update. It is now after 4:00 p.m., and the stock markets just closed. It is too soon to see the effects of the Fed moves on the entire financial system, but we can say this - it did not reassure the stock market. The S&P 500 fell 12% today - that's its biggest drop during this crisis. And it's the worst day in the markets since October of 1987, known as Black Monday.

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