The US Fed plays a pivotal role in the global network of US-led finance and dollar hegemony. This role was brought into sharp relief in March, as the stock markets crashed in the wake of the global spread of COVID-19, bringing one of longest stock market booms in recent US history to an end. The US Fed jumped into the fray to avert the collapse: interest rates were slashed, and cash was pumped into the financial system. When that failed to quell the panic, the Fed resorted to extraordinary interventions to keep the global financial system functioning.
Some of these interventions were a reprise of the unconventional measures that had been devised after the collapse of Lehman Brothers in 2008. The financial market collapse in March this year was, however, different from the 2008 crash in the sense that it was triggered by the shock of the global pandemic and not by the speculative excesses of big finance. It could be argued that if the Fed stepped forward to bail out the big banks, it was rescuing them from an external menace, and not their own follies. But the Fed has gone much beyond the unconventional measures it had launched during the crash of 2008. There are two striking dimensions to the current interventions by the Fed that are worth highlighting.
The first is the Fed’s unprecedented entry into the terrain of corporate lending. To understand the significance of this new program, some background will be helpful. The Fed provides a backstop to the banking system by injecting funds into the banking system when needed by buying or lending against safe-assets like US treasuries. After Lehman Brothers collapsed in 2008, the US Fed broke new ground when it broadened the range of financial assets that it would buy or lend against to include securities like mortgage-backed-securities (Perry Mehrling, 2010). These assets were the staple of the new borrowing and lending arrangements that had proliferated in the shadows of traditional banks. When these financial securities had gone into a free-fall with the collapse of the sub-prime mortgage market, the financial mechanisms that been built on the basis of this predatory lending had imploded. The US Fed successfully revived the financial system by signaling its readiness take on these risky assets through its new asset-buying programs.
By extending its safety-net beyond the confines of traditional commercial banks to embrace this security-based shadow financial system, the Fed might have stemmed the free-fall of financial markets. But these interventions also helped bring the security-based financial system out of the shadows into the ambit of the Fed’s safety-net and further consolidated the power and dominance of big finance. The securities-based finance model, that came to dominate finance most spectacularly since the 2000’s, has continued to grow and penetrate different spheres and corners of the global financial landscape. Banking has become more concentrated, with four large banks — Citigroup, JP Morgan Chase, Wells Fargo and Bank of America — dominating the industry after a spate of mergers and acquisitions.
A significant new development in post 2008 period is the emergence of Asset Management Funds that manage financial assets on behalf of the investors as dominant players in the financial markets. With three groups — BlackRock, Vanguard and State Street — controlling the major share of the assets, the sphere of asset management funds is also highly concentrated. The big asset managers have joined the big banks in asserting power and dominance over industry and the corporate sphere. Passive investment funds — that allow investors to follow a strategy of tracking a financial index instead of the traditional strategy of actively picking and choosing winners — have emerged from occupying a small niche to rivalling active funds in scale. Exchange Traded Funds (ETFs) have added a new wrinkle to the passive investment fund universe by allowing investors to trade the shares of these funds throughout the day. With these innovations, a broader range of investors are now able to dip their toes more easily into the markets for corporate bonds and shares. Combined with the prevailing low interest rate environment, these developments fostered a credit bonanza for US corporations. Corporate debt in the US exploded in the decade after the collapse of Lehman to reach $10 trillion in 2019 — about half of US GDP. The corporate analogue of sub-prime mortgage loans, leveraged loans that fund indebted companies with a high risk of default, have nearly doubled in magnitude since 2009. Even before the pandemic hit, the financial system was already fragile, and corporate debt was the weak link in the financial system. In March, as panic spread through the financial markets, it was not just the stock market that collapsed. The market for corporate bonds also sputtered as the bonds of companies like Macy and Heinz were downgraded.
This is the context for the Fed’s unprecedented foray into the market for corporate debt. Not only did the Fed become a partner of the Treasury in lending to large corporations under the Main Street Lending Program, the Fed launched facilities corporate bonds and ETF shares in both the primary and secondary markets. The Fed’s safety net now encompassed risky corporate debt. What is more, the consultancy division BlackRock — the largest and most powerful asset management fund, with a large presence in the corporate bond market — was handed the reins of running the special entity created to buy corporate debt.
The deep nexus between the titans of finance and the US Fed that was evident in the bank-bailouts in 2008 is seen, yet again, in the response to the pandemic. This nexus is embedded in the privileged role of the dollar in the global financial system. This privileged role is brought into sharp relief in moments of crisis when investors rush to stock-pile dollars, the safest of all financial assets. The panic in the financial markets in March had sent investors across the globe scurrying for dollars, a safe-haven in the financial tempest. The Fed stepped into the breach to extend a safety net to protect the mechanisms of dollar funding.
To do this, the Fed extended the special institutional arrangements that had been instituted in response to the global financial crisis of 2008 to keep dollars flowing through the global financial system. These special arrangements — swaplines — allowed select foreign central banks to borrow dollars against their own domestic currencies. Initially instituted as a temporary arrangement, the arrangement with five key central banks —the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank — was given a standing arrangement status in 2013.
Even though the global financial crisis was triggered by the collapse of the US financial system, the crisis helped to further entrench the global dominance of the dollar. In 2019, before the outbreak of COVID-19, the dollar was on one side of 88 percent of foreign exchange transactions, and about half of the outstanding international debt securities and cross-border loans were denominated in dollars. When the global upsurge in demand for dollars threatened to jam the global financial markets in March this year, the Fed lowered the rates and increased the frequency at which foreign central banks could swap their currencies for dollars through these swaplines. The network of swaplines was also widened temporarily to include nine other central banks that had been given access in 2009.
But the US Fed went even further, during the current crisis, in what was the second striking dimension of its extraordinary interventions. In order to reinforce the network of swaplines that had become integral to the mechanisms for managing dollar flows in the global financial system, the Fed created a new arrangement — repo facilities — that, for the first time, allowed central banks outside this select two-tiered network of swaplines to borrow dollars against their holdings of US treasuries.
This new facility can be understood as a response to the changed geography of finance since 2008. European banks have ceded their dominant role in global dollar operations to non-European banks, with Chinese banks in particular expanding their role in overseas dollar lending. The People’s Bank of China, with its huge stockpile of US treasuries, is conspicuously outside the ambit of the Fed’s swaplines. But the tumult in financial markets in March had also seen an unusual sell-off of US treasuries by investors and asset-managers, which triggered a collapse in US treasuries values. The threat to the market for US treasuries was compounded by the sharp reduction of more than $100 billion in the official holdings of US treasuries of foreign central banks kept with the US Fed. Since borrowing against US treasuries (repo transactions) has emerged as a pivotal market channel for acquiring dollars globally, stemming the free-fall in the market for US treasuries was imperative to preserving the mechanisms of global dollar funding.
The launch of the new repo arrangements provided a way for foreign central banks to acquire dollars without selling their holdings of US treasuries. Central bank holdings of US treasuries are in effect a credit line extended to the US. Central banks lend to the US by holding US treasuries. Now they could borrow US dollars —the monetary liability of the US state —by putting up the debt of the US itself as collateral! While this new facility would amplify the credit line that central banks of surplus countries with dollar reserve holdings extend to the US, it adds another tier to the institutional mechanisms that preserve and extend the dollar’s global role. It would not, however, provide access dollar funds to central banks of debtor countries without holdings of US treasuries, which were rendered more vulnerable with the exodus of capital that had ensued with the outbreak.
The Fed has gone much beyond its spectacular rescue of the financial system in 2008. While the toll of the pandemic on lives and livelihoods in the US shows no signs of abating, the financial markets have rallied. The Feds extraordinary interventions have restored the fortunes of finance and reinforced the global dominance of the dollar. If the Fed has been so swift and purposive in rescuing big finance it is because it is deeply enmeshed with big finance. Andrew Haldane, the Chief Economist at the Bank of England, had used the metaphor of the ‘doom-loop’ to describe this relation. The Fed is compelled to rescue big finance in order to pre-empt and limit the destructive domino effect that its speculative excesses would have on the economy. But each bailout promotes further speculation and larger bets, and the need for even more far-reaching interventions when the next crisis hits. The scale and scope of the rescue keeps ratchetting up. Hence the doom-loop. The doom-loop, then, is a reflection of the power of big finance over the state, and of the deep nexus that has been forged between big finance and the Fed. The Fed’s extraordinary interventions in the wake of the pandemic are a testimony to this overwhelming power of finance—big banks and big asset managers — and to the manner in which this power is entrenched within the mechanisms that enshrine the dollar’s global dominance. It is also a signal that doom-loop has been further exacerbated.
About The Author
For more by Ramaa Vasudevan on the role of the Fed in the pandemic, see How big finance is making a killing from the pandemic and COVID-19 and dollar hegemony.
Perry Mehrling (2010). “The New Lombard Street: How the Fed Became the Dealer of Last Resort.” Princeton University Press.
Daniela Gabor (November, 2018). “Why Shadow Banking Is Bigger Than Ever.” Jacobin.
Clara Jeffery, Monika Bauerlein (January, 2010). “How Banks Got Too Big to Fail.” Mother Jones.
Jan Fichtner, Eelke M. Heemskerk and Javier Garcia-Bernardo (April , 2017) “Hidden power of the Big Three? Passive index funds, re-concentration of corporate ownership, and new financial risk.” Cambridge University Press.
Gerald Epstein (December 2019). “The asset management industry in the United States.” ECLAC Series – Financing for Development.
John Gittelsohn (September 2019). “End of Era: Passive Equity Funds Surpass Active in Epic Shift.” BloombergQuint.
David J. Lynch (November 2019). “Corporate debt nears a record $10 trillion, and borrowing binge poses new risks.” The Washington Post.
Joe Rennison and Colby Smith (January 2019). “Debt machine: are risks piling up in leveraged loans?” Financial Times.
Michalis Nikiforos (Janurary 2020). “When two Minsyan processes meet a large shock: the economic implications of the pandemic.” Levy Economics Institute of Bard College – Policy Note.
Joe Rennison (February 2020). “More ‘fallen angels’ could cause big ripples in bond market.” Financial Times.
Gillian Tett (March 2020). “Why the US Federal Reserve turned again to BlackRock for help.” Financial Times.
Ramaa Vasudevan (April 2009). “The Credit Crisis: Is the International Role of the Dollar at Stake?” Monthly Review.
Bank for International Settlements (September 2019). “Triennial Central Bank Survey – Foreign exchange turnover in April 2019 – Monetary and Economic Department.”
Bank for International Settlements (June 2020). “US dollar funding: an international perspective.” Report prepared by a Working Group chaired by Sally Davies (Board of Governors of the Federal Reserve System) and Christopher Kent (Reserve Bank of Australia).
Perry Mehrling (November 2015). “Elasticity and Discipline in the Global Swap Network – Working Paper No. 27.” Institute for New Economic Thinking.
Adam Tooze (March 2020). “This Is the One Thing That Might Save the World From Financial Collapse.” The New York Times.
Tommy Stubbington (March 2020). “US bond market volatility hits highest level since 2009.” Financial Times.
Emily Barrett (April 2020). “Foreign Central Banks Sell $109 Billion of Treasuries in March.” Bloomberg.
OECD (July 2020). “COVID-19 and global capital flows.” OECD Policy Responses to Coronavirus (COVID-19).
Andrew G Haldane and Piergiorgio Alessandri (September 2009). “Banking on the state”.
Original Image Author: APK
Original image Source: Wikipedia
Edited Image Author: Zack, The Money Question
Image Distribution License: Attribution-ShareAlike 3.0