Cumberland Advisors Market Commentary – Fed Attack Responses

Author: David R. Kotok, Post Date: January 21, 2021

Fed Attack Responses

Fed Attack Responses

We promised we would present responses to our “Attack on the Fed” discussion ( But before we do, we must offer an apology to Senator Pat Toomey, whom we criticized in that commentary for appearing to attempt to limit the Federal Reserve’s emergency lending authority. The back story reveals that Senator Toomey was not, in fact, trying to lessen the central bank’s independence. Media wrongly reported his actions, and markets abruptly reacted to a credit-spread widening based on a misplaced observation reported by the financial press. Toomey wanted a specific change in the Fed’s activities and had to argue it in the midst of a legislative session when time was essential. My criticism of his intentions was wrong. I now believe that he understands the need for an independent central bank. I apologize.

Now here are some reader responses.

Former Philadelphia Fed President Charles Plosser sent these observations. We spoke with him about Toomey and wish to thank him publicly for his input.

“I wanted to share with you a few reactions to some of the issues raised in your piece on the Toomey amendment and the idea of a potential ‘catastrophe.’ Many may disagree with my perspective, but that’s ok. I see the Toomey amendment as a step to protect and preserve the independence of the Fed, even though the Fed itself seems, at times, reluctant to do so.

“First, I am not a lawyer nor one who routinely reads legislation. But, in my simple reading of the Section 1005, it basically says the Fed can make no more loans under the lending programs established in the CARES Act for which the Treasury explicitly provided loans or loan guarantees and that uncommitted funds should be returned to the Treasury. It basically formalizes the terms of what Mnuchin said weeks before. The so-called Powell paragraph basically says the same thing. That is, the amendment doesn’t say anything about general lending under 13(3) except as it pertains to the programs created under the CARES Act. (If I misread it, you can clarify things for me.) This has some relevance and logic to it since those were the programs that were explicitly funded, or backstopped, by Congress under a specific appropriation. Therefore, Congress surely should have a say as to how they evolve.

“It is important to recognize that Congress could have asked the Treasury to set up exactly the same programs back in March and not involve the Fed at all, which would have been my preference and consistent with the appropriate division of monetary and fiscal policy. Blurring the boundaries between monetary and fiscal policy in this manner is the sort of abuse of the central bank’s balance sheet that will undermine Fed independence and fuel adoption of an MMT (so-called modern monetary theory) mentality, if it hasn’t already taken firm control in a large segment of Washington. The prospect of continued large fiscal initiatives will likely see Congress continue to call on the Fed as a source of off-budget fiscal policy, further eroding its independence.

“The second point is about data and evidence. I admit I have not studied the data carefully. My quick look at some of the daily data I had access to on credit spreads shows almost nothing going on from mid-November to Christmas. Indeed, the day Mnuchin announced his decision to end the CARES lending programs of the Fed, there was no detectable response in markets as best I can tell, nor was there anything that appeared abnormal around days when the Toomey bill was proposed. The author indicates the effects were very transitory and spreads rapidly returned to low levels.

“Even if there was some turmoil, I would be very dubious of a dramatic interpretation of such daily movements that quickly disappear. Many things can affect small movements in spreads and interest rates in general, and especially intraday, if that is what happened. Attributing or interpreting small transitory movements can be very tricky. The data on the programs themselves seems consistent with a non-response. None of these programs achieved much scale (except maybe the PPP), and many companies decided to borrow money from traditional banks, in some cases at more favorable rates, or not [to borrow] at all. My intention is not to debate the merits of the individual programs; but as I indicated, the Congress could have, and should have, instructed the Treasury to do exactly the same thing without involving the Fed.

“My third point pertains to the term lender of last resort. The term goes back at least to Henry Thornton in the early 19th century. It was intended to describe what central banks (holders of the specie) should do in the event of a bank run or financial panic. Walter Bagehot later spelled out the idea as lending to solvent banks, against good collateral, at a penalty rate of interest. Surely this is what has long been the meaning of the role central banks have as a lender of last resort. However, for a number of years now, people have expropriated the term to justify Fed lending to rescue even nonfinancial firms to prevent them from failing. This perverts the meaning and allows those who do so to justify interventions by the central bank for entirely different reasons. The crisis this year was not a financial crisis. The Fed did do some things to support the financial system, but the CARES Act programs were traditional fiscal policy actions and should have been done by the Treasury, not by the central bank under the guise of lender of last resort.

“Financial markets have become way too dependent on the Fed. Such dependency means capital markets will cease to provide the correct economic signals for the efficient allocation of capital, which is what we need them to do. Moral hazard distorts incentives as Wall Street becomes more focused on the next ‘backstop’ or intervention by the Fed to limit losses. It is no wonder that the calls from Wall Street for Fed interventions have become more frequent and larger in scale, as the Fed has shown a strong willingness to undertake such interventions. I am afraid that this trend of more frequent and larger interventions will continue – and, by the way, will not be solved by the continued rapid expansion of the balance sheet, which only feeds the problem.

“So my bottom line is that the amendment proposed by Toomey was not a crisis or a near crisis for the Fed or the economy, but a wise step to help the Fed remain independent. There is a crisis facing the Fed and central banking more broadly, but more interventions and backstops are not the solution. More likely they are part of the problem.”

Kotok here again. Charlie Plosser is a dear friend of many years. I must thank him for the time he took to offer these details for all of us to consider and for the time he spent with me on the phone discussing the issues.

Economist Steve Blitz offered this take:

“Congress is using the unused 13.3 money to fund the new CARES Act; without Toomey’s objection the same money would be earmarked to be spent twice.”

Kotok note: Blitz is absolutely correct.

Dave Churchill wrote from Boise,

“David – I think that lack of understanding of the issues is the real problem. I agree that Senator Toomey’s attempt was very ill-advised. But the fact is that most of the news media and many of our national leaders completely misrepresented what was going on. There simply aren’t enough people knowledgeable enough to recognize a real, consequential inaccuracy for what it is, let alone understand what the Fed’s role is and should be. I have six years of college (both BS and MS), and it took me several days to understand the real issue. I nearly fell for the story line coming out of our mainstream press, I am sorry to admit.”

Kotok note: Churchill’s critique of media has merit.

Mark Avallone countered with a different take,

“You may believe Sen Toomey was misguided – and the policy may have been. But he is not running for reelection, so I have to believe he was acting out of principles and his firm beliefs. So while you may be correct, your comments come across as jaded about someone who is at least acting out of conscience, which we don’t see a lot of.”

Kotok note: Avallone doesn’t know if I’m “jaded” or not. But he is arguing that behavior is different if a politician is running for re-election or not. There he makes a sad commentary about our system. I would like to think that Senator Toomey would do the same thing whether or not he seeks reelection.

Fred Feldkamp wrote,

“Your kind words regarding our discussion of the recent Fed power debate are much appreciated.

“Let’s hope the analysis is (a) true and (b) actually works to maintain stability.

“It is SO difficult to keep those ‘with’ market power to refrain from using it in an adverse way. We can only hope ‘this time is different.’”

Paul OBrien, trustee of the Wyoming Retirement System and former deputy CIO of ADIA, wrote,

“David, thanks for the detail on Toomey and the Fed. It’s notable that having a lawyer run the central bank is now an advantage.

“We are in this situation because monetary policy has become fiscal policy: allocating credit to individual firms and localities and in principal picking winners and losers. Sure, this is necessary. But I believe it is a power that should be governed by politicians, not unelected bureaucrats.

“Toomey’s initiative was bad because it was hidden. The Congress should have an open debate on the limits of Fed power – and of course their own responsibilities.”

Kotok note: O’Brien makes a good point about transparency. Had we had it, maybe the market squeeze wouldn’t have happened. But that is a counterfactual, so we’ll never know.

David Blond of QuERI International offered this observation, which he had made previously on LinkedIn,

“How Low Can They Go… Obviously there are new depths.

“I won’t comment on this beyond saying – if there are any of my followers who can find a reason for this other than to spite Biden and the economy and the future, please respond, I’d love to hear why? How low can Republicans go, obviously we have not reached the bottom yet.”

Kotok note: Sad to add that there are Democrats who also go low.

Jeff Harbaugh, president, Jeff Harbaugh & Associates, wrote:

“Okay, I see it’s importantly tactically that we’ve been rescued from the Fed not being able to save us again and again and again.  We’ve dodged a bullet that just keeps getting bigger. I know – no choice, but if you see a way this ends well I’d love to hear it. The middle of a pandemic is not time to start taking our lumps but…. Here’s something I wrote in a whimsical, sarcastic mood a couple of weeks ago.

“Let me see if I’ve got this right.  The Fed has to keep rates low because it’s the only way the government can afford its debt and the benefits it’s promised people.  But they need higher inflation because that’s the only way to manage the debt – reduce it by devaluing it. But at some point, higher inflation will lead to at least higher long term rates, which the Fed needs to avoid.  Meanwhile, something like 90% of the people in this country (maybe I mean 98%) aren’t in a position to buy gold, other commodities, real estate (true, many own houses), to hedge against that inflation and will be hammered by the rising cost of living. But the debt has to go away because as long as it’s this high, getting any meaningful GDP growth is probably impossible. Meanwhile, the Fed has spent all this time failing to get inflation to 2% (who knows why they want to) but are confident that once they get it to accelerate, they can control it. They can’t get it to go up, but are confident they can keep it from going up too much, whatever that means.

“What could go wrong?”

And, finally, retired judge Marc Suffern responded from NY State with a philosophical note in a style that I have witnessed for nearly 60 years, and he contributed our closing quote:

“ ‘Any nation that can survive what we have lately in the way of government, is on the high road to permanent glory.’ – Molly Ivins”

Thank you, Marc.

Lastly, here’s the full wording of Section 1005 of bill H.R. 133, which was inserted by Senator Toomey with the intention of limiting the Federal Reserve’s emergency lending authority to restrict a specific tranche of money authorized under the Cares Act.


Section 4029 of the CARES Act (15 U.S.C. 9063) is amended—

(1) in subsection (a), by striking ‘‘new’’;

(2) in subsection (b)(1), in the matter preceding subparagraph (A), by striking ‘‘, loan guarantee, or other investment’’ and inserting ‘‘or loan guarantee made under paragraph (1), (2), or (3) of section 4003(b)’’; and

(3) by adding at the end the following: ‘‘(c) FEDERAL RESERVE PROGRAMS OR FACILITIES.—

‘‘(1) IN GENERAL.—After December 31, 2020, the Board of Governors of the Federal Reserve System and the Federal Reserve banks shall not make any loan, purchase any obligation, asset, security, or other interest, or make any extension of credit through any program or facility established under section 13(3) of the Federal Reserve Act (12 U.S.C. 343(3)) in which the Secretary made a loan, loan guarantee, or other investment pursuant to section 4003(b)(4), other than a loan submitted, on or before December 14, 2020, to the Main Street Lending Program’s lender portal for the sale of a participation interest in such loan, provided that the Main Street Lending Program purchases a participation interest in such loan on or before January 8, 202 and under the terms and conditions of the Main Street Lending Program as in effect on the date the loan was submitted to the Main Street Lending Program’s lender portal for the sale of a participation interest in such loan.

‘‘(2) NO MODIFICATION.—After December 31, 2020, the Board of Governors of the Federal Reserve System and the Federal Reserve banks—

‘‘(A) shall not modify the terms and conditions of any program or facility established under section 13(3) of the Federal Reserve Act (12 U.S.C. 343(3)) in which the Secretary made a loan, loan guarantee, or other investment pursuant to section 4003(b)(4), including by authorizing transfer of such funds to a new program or facility established under section 13(3) of the Federal Reserve Act (12 U.S.C. 343(3)); and

‘‘(B) may modify or restructure a loan, obligation, asset, security, other interest, or extension of credit made or purchased through any such program or facility provided that—

‘‘(i) the loan, obligation, asset, security, other interest, or extension of credit is an eligible asset or for an eligible business, including an eligible nonprofit organization, each as defined by such program or facility; and

‘‘(ii) the modification or restructuring relates to an eligible asset or single and specific eligible business, including an eligible nonprofit organization, each as defined by such program or facility; and

‘(iii) the modification or restructuring is necessary to minimize costs to taxpayers that could arise from a default on the loan, obligation, asset, security, other interest, or extension of credit.

‘‘(3) USE OF FUNDS.—

‘‘(A) IN GENERAL.—Except as provided in subparagraph (B), the Secretary is permitted to use the fund established under section 5302 of title 31, United States Code, for any purpose permitted under that section.

‘‘(B) EXCEPTION.—The fund established under section 5302 of title 31, United States Code, shall not be available for any program or facility established under section 13(3) of the Federal Reserve Act (12 U.S.C. 343(3)) that is the same as any such program or facility in which the Secretary made an investment pursuant to section 4003(b)(4), except the Term Asset-Backed Securities Loan Facility.’’.

And here’s Section 1006, the single paragraph that was inserted by Fed Chairman Powell.


Except as expressly set forth in paragraphs (1) and (2) of subsection (c) of section 4029 of the CARES Act, as added by this Act, nothing in this Act shall be construed to modify or limit the authority of the Board of Governors of the Federal Reserve System under section 13(3) of the Federal Reserve Act (12 U.S.C. 343(3)) as of the day before the date of enactment of the CARES Act (Public Law 116–136).

Finally, here is a link to the full text of bill H.R. 133:

David R. Kotok
Chairman of the Board & Chief Investment Officer
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