Cumberland Advisors Market Commentary – Not As It Seems

Author: Robert Eisenbeis, Ph.D., Post Date: December 1, 2020
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On November 19, Treasury Secretary Mnuchin sent a letter to the Federal Reserve Board requesting a 90-day extension of several Fed programs to provide liquidity to financial markets, including the Commercial Paper Funding Facility, the Primary Dealer Credit Facility, the Money Market Liquidity Facility, and the Paycheck Protection Liquidity Facility.

Cumberland Advisors Market Commentary - Not As It Seems (Eisenbeis)

Those programs were backstopped by contributions from the Exchange Stabilization Fund and in some instances were continuations of programs put in place during the 2007–2008 recession.  On Monday, November 30 the Board extended those programs through March 31, 2021. In addition, Mnuchin also requested the return of unused funds provided as loss protection for programs initiated under the CARES Act, which are scheduled to expire at the end of December. These programs include the Primary Market Corporate Credit Facility, the Secondary Market Corporate Credit Facility, the Municipal Liquidity Facility, the Main Street Lending Program, and the Term Asset-Backed Securities Loan Facility.

In his letter, Mnuchin stated that he had authorized $195 billion of the potential $454 billion Congress had appropriated for those facilities, but far less than he had authorized had actually been committed. Indeed, the Treasury has provided loss-absorbing capital investments consisting of a combination of deposits and nonmarketable Treasury securities. The Fed data in its H.4.1 reports do not break out the equity investments by cash and Treasury holdings, but the combined total is $101.8 billion for the five programs that the Fed considers as falling under the CARES Act. There is some question about how the Fed is accounting for these programs and which ones fall under the CARES Act funding (see Congressional Research Service, “Treasury and Federal Reserve Financial Assistance in Title IV of the CARES Act,” P.L. 116–136, August 5, 2020). But the key point is that, compared with either the provisions of the act or the amount that Treasury has authorized under the CARES Act, the actual funding has been much less; and the programs themselves, as enacted, are very small. All five of the above-listed programs combined have only $24.3 billion outstanding, with a low of zero for the Commercial Paper Funding Facility and a high of $13.8 billion for the Corporate Credit Facility.

Given that CARES Act Section 4029 terminates the authority to make new loans under the program on December 31, 2020, the main reason Secretary Mnuchin would be requesting the return of excess or unused funds from the Fed is that there are plans underway to have Congress reappropriate the $454 billion in funds for some other purpose before the end of the year. With the year-end closing of the CARES Act, the expiration of the extra unemployment benefits that were extended to millions of the unemployed, and concern about a resurgence of virus cases, the case can be made for reappropriating those funds for a different use, especially since they would not change the deficit. However, so far there has been no mention of proposed programs from either Congress or the administration that could serve as a basis for compromise. There have been claims that the Fed objects to the return of the funds, and there is the assertion that return of those funds would force incoming Treasury Secretary Yellen to go back to Congress to ask for more appropriations. But things are not as they may seem, for at least two reasons.

    1. – Since the programs will expire on December 31, 2020, and the new administration doesn’t take office until January 20, 2021, any new programs would require new appropriations. Only existing programs would continue in place if spending were authorized and completed in 2020. So, the argument that reclaiming the funds would limit the incoming administration’s options is a stretch. Of course, the lame-duck Congress could pass an authorization for funds, but as of now the two sides seem deadlocked. The most likely prospect is some extension of unemployment benefits as Congress attempts to avoid a government shutdown by December 11.
    2. – What happens to the loans granted by the Fed if the Treasury’s equity contribution is returned? The loans will continue to exist and be managed by the Fed. The loans will not be extinguished or pulled back. However, the Fed, and not the Treasury, will now be in a first lost position. As Greenlaw, Hamilton, Hooper, and Mishkin (“Crunch Time: Fiscal Crises and the Role of Monetary Policy,” NBER Working Paper 19297, August 2013) point out, if the Fed’s income is less than its expenses – due to losses, for example – then the Fed could either write down its capital or, using a 2011 change in its accounting rules, book the loss into what is called a deferred asset account (or negative asset account) and stop paying remittances to the Treasury until the loss is extinguished by future income. Even if income were to exceed expenses, any recognized loss would be an expense and would thus reduce the Fed’s net income and, again, reduce remittances to the Treasury. Either way, the loss is ultimately born by the Treasury.

The bottom line is that neither the Fed nor incoming Treasury Secretary Yellen will be unduly hampered by current Treasury Secretary Mnuchin’s request for return of unused funds. The key is what happens to those funds between now and the end of the year and what, if any, compromises the Congress can or will make to address the facts that we have more than 12 million unemployed, increasing claims for unemployment insurance, and the threat of a government shutdown.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
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