Thursday, April 30, 2020

Ready to reopen?

I've been on the "reopen fast but smart" bandwagon for weeks. The reopening is coming. Are we ready? I'm afraid not. I remain on the "plan ahead" bandwagon, which means not lots of ideas from bloggers but lots of implemented plans of action for local public health bureacracies. Two items in today's news.

Coronavirus Testing Capacity Is Going Unused
Many commercial and academic laboratories in the U.S. are processing coronavirus diagnostic tests far below their capacity, leaving tools crucial to slowing the virus’s spread unused.
Lab executives and public-health officials say that in some cases, the labs are getting far fewer orders for tests than they could conduct. 
For weeks, everyone has been saying "test test test," and bemoaning the lack of testing capacity. Well, now we have testing capacity. What's going wrong? Well, our public health officials don't have (and did not, in the last month, develop) concrete ready to implement testing protocols in place. You still get a test if you ask for one, which mainly is if you think you have symptoms and can get through the guidelines that still restrict testing. These guidelines are not developed with public health in mind.

Testing meant, for example, widespread random testing, or at least testing of volunteers, so we could find out where the virus is. Just how many people  in Palo Alto have the virus, right now? With 1000 roughly random tests we could find out. Nobody is doing that.

We remain, I think, sorely lacking in the public health infrastructure that must take over from blanket shutdowns. California just issued a revised list of what businesses can open. Apparently that's all we know how to do.

Food plants turned out to be a super spreader. ( Kris Maher, Jacob Bunge and Alexandra Berzon in WSJ)  The larger point here: About 40% of the economy is still open as "essential." Well, as we get ready to reopen safely the rest of the economy, one would think that the "essential" parts would be rapidly implementing the open with distance protocols that the rest will follow. No. It's pretty much business as usual. The same cropped up in the Amazon and Instacard delivery strikes.

If the "essential" businesses are still not operating with reasonable protocols, just how can the rest reopen?

It's not zero. I read with pleasure the quite sensible list of actions that our county required of the local hardware store, including posting said list on the front window where I could see compliance. (Waiting with the dog while my wife bought TP.) But one would expect the essential part of the economy to be really zooming along with safety protocols if the 'inessential' part is ready to reopen.

That does not mean reopen. The economic carnage is everywhere, and people will not stand to watch their livelihoods disappear, while virus trackers in many counties remain with stable small numbers. But watch out for the second wave.

We Still Don’t Know How the Coronavirus Is Killing Us is a great essay by David Wallace-Wells. While we're spending $2 trillion or more, and printing $5 trillion or more, it is really striking that our government is  not spending massive amounts on research, including just collecting data. Sure, bottlenecks and waste abound here too, but the amount just not known is striking.

For example, I attended a great presentation by Stanford's Jay Bhattachrya on his random sample testing in Santa Clara County, which found a surprisingly large number of asymptomatic cases. Yes, I've read the controversy. Some other day. But, in a $2 trillion dollar budget why are lonely heroes like Jay doing random testing on a shoestring?

Wednesday, April 29, 2020

The fire in Treasurys

Just where was the fire that caused the Federal Reserve to buy $1.3 trillion of treasury debt in a month -- financing all treasury sales and then some? I've been puzzling about this question in a few posts, most recently here. Commenter "unknown" impolitely but usefully points me to a nice paper by Andreas Schrimpf, Hyun Song Shin and Vladyslav Sushko that explains some market mechanics. I am still not persuaded that these gyrations motivate or justify the Fed buying these or more trillions of debt, but there is an interesting story here.

Treasury yields

Their first graph shows stock prices and bond yields. As risk and risk aversion rose, as they always do in bad times, stock prices fell and bond prices rose, with yields falling.

Trouble starts on  9 March when "the market experienced a snapback in yields" Look hard at the graph. The blue line rises a bit while the red line continues to fall.

OK, but still -- is it a disaster that the US treasury, that had been borrowing happily at 1.8% in January, must borrow at 0.8-1.2% in March? Is it such a disaster that the Fed must buy all new issues of debt?

"Arbitrage" redux

What caused the "snapback?" here is where the paper gets interesting. Basically a bunch of hedge funds replayed an age-old strategy and got caught. Plus ça change. They bought treasury bonds and simultaneously sold them in futures markets. Since treasury bonds are great collateral they can lever up a small price difference to make a lot with little investment.

But even arbitrage opportunities are not risk free.** Prices that are slightly off can get further off before they eventually converge. And then the hedge funds need to post margin, which they don't have. So, they follow the mother of all financial fallacies -- risk management that consists of selling  positions on the way down, trying to synthesize a put option with a stop loss order. But selling to who? Everyone else is doing the same thing, markets get illiquid in times of stress (no, they've never done that before), so the price difference widens even more.

Tuesday, April 28, 2020

University finances

Colleges and universities are being badly hit by the Covid-19 virus. The spring and summer were pretty bad.  If, as likely, it extends into the fall things will be much worse. The tragedy of all this, for large private colleges, is that our administrations apparently learned nothing from 2009, and set themselves up for exactly the same (if not worse) financial crisis.

The exposure

It's hard to think of a business model more susceptible to pandemics. Students come to universities from all over the country, and all over the world. Many US colleges are highly dependent on full-tuition revenue from overseas, especially China. College education was a big export industry for the US, which travel and visa restrictions are likely to kill.

Many state schools depend on people paying full tuition from out of state. Lots of people are not likely to want to pay for online classes, and they certainly don't want to pay more quarters of room and board while living at home in another state. (This might be good for some flexible state schools or community colleges that can let people pick up some transferable credits).

Classes are really not the problem.  Undergraduates barely go to classes anyway, and, as reviewed in previous super-spreader posts, we have not seen classrooms as a site of such events. It seems like if people don't talk loudly, they don't spread the virus. The main problem is that the college experience in most of the US centers on a loosely supervised alcohol-fueled bacchanalia. As Stanford's president put it delicately in a recent email to faculty and staff,
A key challenge is the highly communal nature of our undergraduate living, dining and learning settings, which are not conducive to the physical distancing that has been a key means of controlling the pandemic...
How to spread Covid-19? Nursing home. Aircraft Carrier. Cruise Ship. Jail. College dorm or fraternity. 

Saturday, April 25, 2020

Economics of lockdowns video

Cato took some comments I made in a recent event and produced it into a nice short video, 8 minute overview of where I am, or was last week, on the economics of lockdowns.  I clearly need to work on the visuals.

Friday, April 24, 2020

Heckman Haiku

Jim Heckman's interview with Gonazlo Schwartz at the Archbridge Institute is making the rounds of economists. I admire it for how much the interviewer and Heckman pack in so little space, so pithy, well expressed, and so happy to trounce on today's pieties. (As blog readers will have noticed, short does not come easily to me.) It's hard to summarize a Haiku -- go read the whole thing. But I'll try.
Gonzalo Schwarz: Many commentators have said that it is not possible to achieve the American Dream any more in the United States. Do you think the American Dream is alive and well?
Dr. James Heckman: Ask any immigrant. They are grateful for the chances that America has given them. Many came with nothing. They live in decent neighborhoods and their families have better lives than they could have before coming here. Their children go to college and integrate into American society. The progress of African Americans over the past century is staggering. Many have shaken off the legacies of poverty and discrimination....
Social mobility:
G: ...what do you think are the main barriers to income or social mobility?...
H: The main barriers to developing effective policies for income and social mobility is fear of honest engagement in the changes in the American family and the consequences it has wrought. It is politically incorrect to express the truth and go to the source of problems.... Powerful censorship is at play across the entire society....The family is the source of life and growth. Families build values, encourage (or discourage) their children in school and out. Families — far more than schools — create or inhibit life opportunities. A huge body of evidence shows the powerful role of families in shaping the lives of their children. Dysfunctional families produce dysfunctional children. Schools can only partially compensate for the damage done to the children by dysfunctional families.
He is right on the fact, how blissfully it is ignored by those wishing more "policies" to address inequality and other social programs, and censorship against those who say it.

On "current academic and policy discussion on income mobility and inequality, "

Ban parties not business

A while ago, I started getting messages that my computer was running out of memory. I put off doing anything about it -- cleaning up a decade's worth of files did not sound like a fun task. But eventually I took a look, sorted files by size, and came to a lovely discovery. There were a few large files -- some video attachment to an email someone sent me three years ago, stuff like that. After I deleted 10 or 20 of these, all of a sudden there was lots of space! The rest of my computer remains a Marie Kondo nightmare.

Every distribution has fat tails. And if you need to do something about it, spend all your time on the tail events and don't bother with the small stuff.

That lesson, of course applies to stopping the spread of the corona virus. Stopping the negligible possibility that a hiker passes it to another hiker out on a (now closed) trail in the Santa Cruz mountains is beyond pointless. Stopping the tiny probability that a worker passes it to another worker in a thoughtfully structured high value business is equally pointless, and vastly more costly.

What do we know about the fat tail? Not as much as we should. Jonathan Kay's lovely Quillette essay on super spreader events covers a lot. (HT Marginal Revolution).

Jonathan points out that our scientists still  don't reallhy  know whether Covid-19 is spread primarily by large "ballistic" droplets, small persistent aerosol droplets, or contact with surfaces where droplets have landed. They don't know what kind of activities lead to spread.  He investigated super spreader events to try to figure out. Jonathan put together all the information he could find on known Covid-19 super spreader events. He found 54, with details on 38. A bit more  data collection and research effort on this crucial question would seem worthwhile.

I have a different goal -- what are the activities that we can reduce with greatest effect on the disease, and least economic cost, and within the everyday more apparent limitations of our political and government apparatus?

Like others (see Arnold Kling for example) I'm starting to despair of a way out. We will not have a  vaccine for a long time, and kill the economy till the vaccine comes is not an option. Bend the curve, followed by vigorous test,  trace and isolate would be possible, but I doubt the US, has the institutional capacity or political will for trace and isolate once we eventually get test to work. I cannot imagine our authorities imposing life in Wuhan (another MR HT).  Paul Romer has articulately advocated a big push for widespread testing, notably by relaxing regulations (university labs not allowed to conduct tests, for example). Paul notes correctly that it's worth spending hundreds of billions of dollars on testing to save trillions of dollars of economic and fiscal damage. If we could test everyone every day, and get most of the positives to stay home, the virus would quickly peter out. But I'm dubious our government is capable of even this. Let it rip, argue many others, and wait for herd immunity. But I don't think our governments can do that either, as Boris Johnson found out.

Our governments can, however, come up with lists of banned activities. So let those lists have just a little more common sense. Let the lists of banned activities 1) focus on the tail of super spreader events 2) consider the economic damage vs. public health benefit.

The bottom line I get from Jonathan: It looks like the biggest transmission danger is large droplets exchanged by people talking loudly in large gatherings, in closed quarters, and where many different people interact. Yes, it may be transmitted in other ways, but this is the fat tail, and start with the fat tail. The even greater news: practically no GDP is lost if you ban the super spreading activities on his list.

However the rhetoric needs to change. Right now the calls are for "relax social distancing." This is exactly wrong. Keep social distancing, but relax economic prohibitions. The challenge is that our regulatory state finds it much easier to shut down business -- at tremendous economic cost -- than birthday parties.

Epidemiologists know about fat tails   “20% of the individuals within any given population are thought to contribute at least 80% to the transmission potential” of previous infectious diseases.
Also from here (again HT Marginal Revolution)
We identified only a single outbreak in an outdoor environment, which involved two cases. Conclusions: All identified outbreaks of three or more cases occurred in an indoor environment, which confirms that sharing indoor space is a major SARS-CoV-2 infection risk.
An added observation: Fat tails of superspreader events helps to explain why the virus seems to spread quickly in some places and not in others. 2,4, 8, 16, 32, 64, actually takes a while to get to 10,000. 2, 124, 256 from an early super spread event gets you there much faster.

Jonathan's events: 
Many of the early SSEs, in fact, centered on weddings, birthday parties, and other events.
The joy of life, but nearly zero GDP.

Thursday, April 23, 2020

Treasury Liquidity

So just what was the "disruption" in the Treasury market that so spooked the Fed, that now the Fed is buying more than the Treasury is selling?

A commenter on my last post on corporate bonds points to Treasury Market Liquidity during the COVID-19 Crisis by Michael Fleming and Francisco Ruela at the NY Fed, April 17 .

Michael and Francisco nicely show us the facts. They make no editorial comment at all, except perhaps in the figure titles, so my questions about just how big a problem this is are not directed at them.

Bid-ask spreads widened, to financial crisis levels (when the Fed did not, by the way, intervene.) The plot is hard to read in the far right end in order to compare to 2008. (Suggestion to the authors: focus on the last three months so we can see what was happening, not on the comparison to 2008.) As far as I can make it out, the 5 year spread widened form 0.25 /32 to about 0.4 /32; the 10 year from 0.5 to 1.0 and the 30-year from 1 to 5.

If I read the caption correctly, each of these numbers is 1/32 of one percent of par, 0.03%, so the 5 year spread went from 0.008% to 0.012% and even the 30 year went from 0.03% to 0.16%.

The "order book depth, measured as the average quantity of securities available for sale or purchase at the best bid and offer prices" (my emphasis) declined. There is usually a lot more for sale if you're willing to pay more.

The difficulty of trading includes not just the bid ask spread, but a guesstimate of how much you will depress prices if you sell $100 million in a huge hurry. This price impact went up. But, it is measured as "slope coefficients from ...regressions of one-minute price changes on one-minute net order flow." How bad is it to wait a whole minute to sell $100 million? Also, most traders use fairly complex strategies to minimize price impact. And there is lots to complain about in this measure of price impact. (I prefer autocorrelation measures -- how much did the price bounce back.)

And the absolute value looks to a layperson remarkably small. 7/32 = 0.22%, two tenths of a percent, on the 5 year bond. OK, 0.75% on a 30 year bond which is almost real money. But 30 year bonds are pretty volatile anyway as we'll see in a moment.

Price volatility jumped, especially (actually almost entirely)  for the 30 year bond. The 30 year bond was experiencing 70% annualized volatility, which is 4.4% per day. That puts some of these spread and price impact measures into context. They are orders of magnitude smaller than the daily price volatility.

This is not unique to the Treasury market.  Stock price volatility went through the roof too by the way. Here's the VIX, peaking at 80. The Fed has not yet seen fit to buy stocks, and let us hope it does not do so.

Throughout all these numbers, the steady march from 1, 5, 10, to 30 year bonds is instructive. Longer bonds are more volatile always. "Liquidity" is usually confined to the shorter maturities.

Trading volume was high too. Again you have to squint to see it.
... daily trading volume in the market overall reached a record high for the week ending March 4, averaging over $1 trillion, roughly twice its post-crisis average
What does it all add up to? 

A trillion dollars a week is a lot of buying and selling. What's "disruptive" or dysfunctional about that? This isn't Costco, whose trading volume in toilet paper went to zero after it sold out.

To me, there is a sense of utterly normal in all of this. Supply curves slope up, of everything, including "liquidity."

Obviously, we hit a period of huge uncertainty, divergence of opinion, and liquidity needs. The fundamental, rational, normal, functional, whatever you want to call it, price will be quite volatile, as was the stock price. The fundamental, rational, normal, whatever you want to call it desire to trade will rise as well.

So how does a market react when there is a large increase in the volatility of prices and demand for trading. Well, supply curves slope up -- that demand is accommodated but at a higher price.

Dealers who buy and have to hold securities in inventory for a day or two are more exposed to risk when prices are more volatile, so they buy less other things constant. Bid ask spreads and price impact rise to give them a higher profit, commensurate with that risk. In a time of volatility, there is more asymmetric information, so dealers charge a higher bid-ask spread. This may sound like less of a problem for Treasuries, but there is short term information about future order flows and future Federal reserve actions and even interest rates given the huge macro uncertainty. And the price volatility may be both a sign of trading demand and an inducement to it. If you can spot the direction, there is a lot more money to be made.

Supply and demand. If trading volume goes up while spreads and price impact are rising, the shock is to the demand for trading. If trading volume went down while spreads and price impact rose, the shock is to the supply of trading services. This event sure looks like a shock to demand, accommodated pretty well by dealers. (I wrote a paper a long time ago called "stocks as money," documenting a similar case of demand for trading)

Where is the evidence that something is wrong with supply, that there is also a shift in the supply curve?

Michael and Francisco wryly note the same point:

High trading volume amid high illiquidity is common in the Treasury market, and was also observed during the market turmoil around the near-failure of Long-Term Capital Management (see this paper) and during the 2007-09 financial crisis (see this paper). Periods of high uncertainty are associated with high volatility and illiquidity but also high trading demand. 
Not surprisingly, volatility caused market makers to widen their bid-ask spreads and post less depth at any given price, and the price impact of trades to increase, illustrating the well-known relationship between volatility and liquidity. 
So just where is the fire here? Where is the screaming hole in financial markets that justifies the Fed buying $1.3 trillion treasury securities in a month?

Even if "intermediation" were the problem, why is buying up the whole supply the answer, not both buying and selling, to reduce bid-ask spreads?

The Fed announced:
To support the smooth functioning of markets for Treasury securities and agency mortgage-backed securities that are central to the flow of credit to households and businesses, over coming months the Committee will increase its holdings of Treasury securities by at least $500 billion and its holdings of agency mortgage-backed securities by at least $200 billion.
How does buying it all up promote the "smooth functioning" of markets?  Is there anything more than
"because of (big financial gobbledygook which you wouldn't understand anyway so it doesn't matter if it makes any sense) we're going to buy a trillion dollars of treasurys?"

Finally, if absolute liquidity in Treasury markets is so important, if the ability to transact at 0.01% or less loss, in minutes, is a crucial social problem, then why not talk about some fundamental reforms to those markets?
As described in this post, roughly half of Treasury securities trading occurs through interdealer brokers (IDBs), in which dealers and other professional traders transact with one another, and roughly half between dealers and clients. Our focus is on the IDB market, and on the electronic IDB market in particular, which accounts for about 87 percent of IDB trading. 
Wider trading would make a lot of sense. Federal debt is carved up into 250 different securities or more. As I argued here, if you want them liquid, rearranging federal debt to only a few securities would make each one more liquid. If "balance sheet space," i.e. inadequate equity financing and regulatory risk-taking constraints, are stopping those with expertise in market making from making more markets, why in heaven's name after 12 years of Dodd-Frank act, capital requirements, essays on equity-financed banking, Volker rule and the rest, don't broker dealers have enough equity capital to let them trade through the covid-19 virus on top of a new cholera pandemic and a war? "Constrained balance sheets" are not a fact of nature, they are the product of 12 years of regulatory failure.

 There is a tendency throughout economics to write, "here is my policy," then "here are the problems that motivate my policy." But if you look at the problems, a lot of other policies would solve them better. Economics is too often answers in search of questions.

So, bottom line, I'm still looking for evidence. I'm willing to give the Fed the benefit of the doubt. All the people I know at the Fed are smart and well-intentioned looking at a lot more data than I am. Just what is it that motivates buying a trillion dollars of treasury debt, and more trillions to come?

Wednesday, April 22, 2020

GoodFellows: Cold War 2

The latest GoodFellows, on just how much we need to ramp up Cold War 2 against China.

Since it was two against one, and I didn't get a response in, I'll add one unfair late hit. In discussing Huawei, and whether Chinese state planning would allow them "economic dominance" in the next decades, my colleagues jumped to the charge that Huawei equipment would include nasty backdoors that the Chinese government would use to spy on us.

I think here they confused "economic competition" with security competition. The topic was whether state planning could give a nation "economic domination" of anything important. The reply that we need to worry about security implications does not answer the question.

The charge I think has also been overstated. Huawei has every interest to assure people its equipment does not have back doors, and my impression is they convinced the UK pretty well on that. Moreover, the US government is explicit in its desire that Apple and other US companies give the NSA back doors. I would welcome more knowledgeable commentary on this issue before next week.

Bond liquidity

When the Fed stepped in, were corporate bonds "illiquid," the market "dysfunctional," or were the prices just low, as they should be in advance of a Great Recession with larger bankruptcy risk? Did the Fed "liquefy" the market, "intermediate," grease the wheels, or is it just buying, and propping up prices so that bondholders can dump bonds on the Fed before things get really bad?

I asked for evidence on bond market liquidity in my last post on the topic, "Bailout redux," and Pierre-Olivier Weill passed on a paper he has recently written with Mahyar Kargar, Benjamin Lester, David Lindsay, Shuo Liu, and Diego Zúñiga, Corporate Bond Liquidity During the COVID-19 Crisis.

Here is their estimate of roundtrip trading costs -- if you buy and then sell, how much do you lose in bid ask spread. Feb 19 is the stock market peak.  March 18 is the day after the Fed announced it would lend money to broker-dealers and take bonds such as these as collateral. March 23 the Fed announced it would buy corporate bonds on the secondary market, and buy directly from companies issuing new corporate bonds.

We were prepared

A lovely compilation from Judge Glock. Some excerpts
six months before the current outbreak, Congress passed the Pandemic and All-Hazards Preparedness and Advancing Innovation Act of 2019, which offered funds and planning authority for just such a crisis as we now face.[2] This act was a reauthorization and an extension of half a dozen similar acts passed over the previous two decades, which acts were themselves extended in countless congressional spending bills, all of which resulted in countless plans....
Pervasive Pandemic Preparedness Planning
After the avian influenza scare of 2005, Congress did the thing it does best, demand that somebody else come up with a plan. With the help of some of the best known names is Congress, Congress passed the Pandemic Preparedness and Response Act in December of the following year.[3] The act ordered the administration to convene a Pandemic Influenza Preparedness Policy Coordinating Committee, with most of the Cabinet in attendance, to write a plan for a biological catastrophe.[4] The result was, first, a White House Homeland Security Council National Strategy for Pandemic Influenza, followed the next year by National Strategy for Pandemic Influenza Implementation Plan. The latter plan contained 233 pages of nebulous suggestions, such as recommending that, in a crisis, the government should be “providing anticipatory guidance and dispelling unrealistic expectations about the delivery of health and medical care.”[5] These general plans in turn birthed numerous individual departments plan, such as the Department of Defense Implementation Plan for Pandemic Influenza.[6] To supplement these federal plans, the Preparedness Act, and its subsequent iterations, also mandated that states create their own Pandemic Preparedness Plans, which have to be submitted regularly to the Centers for Disease Control and Prevention for approval. These plans total thousands of pages.[7]

Mitigating moral hazard -- unemployment edition

As Kurt Huffman, restaurant owner, writes vividly in the WSJ, concerns that unemployment insurance paying more than wages might induce people to stay home even when jobs are available  are not just scare stories told by heartless free-market economists.
 ...we realized that we needed to hire back some of our staff to help with the demand. That proved harder than we expected.
We started making the calls last week, just as our furloughed employees began receiving weekly Federal Pandemic Unemployment Compensation checks of $600 under the Cares Act. When we asked our employees to come back, almost all said, “No thanks.” If they return to work, they’ll have to take a pay cut.
This has had the perverse effect of making it impossible for us to hire enough people even for our limited takeout and delivery business at a time of rapidly rising will persist at least until July 31, when the unemployment bonus expires. ...
The Trump administration is talking about setting a timeline for when the country can “open for business.” For my business, Congress has already locked down that date. We plan to open our dining rooms on Aug. 1, once the government stops paying people $15 an hour, on top of standard unemployment compensation, to stay home.
Hint to Mr. Huffman: I would not bet too much that this deadline is not extended.

Lars Ljungqvist and Tom Sargent long ago pondered the question why Sweden, with an apparently quite generous unemployment insurance program had so much less unemployment than, say, France. The answer, as I recall, is that Sweden had a bit of stick with the carrot: if you got offered a job, you had to take it or lose unemployment insurance.

It's in Ljungqvist, Lars and Thomas J. Sargent. ”How Sweden’s Unemployment Became More Like Europe’s” in Reforming the Welfare State: Recovery and Beyond in Sweden, eds., Richard B. Freeman, Birgitta Swedenborg and Robert Topel. Chicago: University of Chicago Press, 2010, one of many great papers Lars and Tom wrote on unemployment insurance.  I don't have a link to an online version.  p. 191:
"The Swedish government was exceptional among European countries in intervening in workers' search processes by monitoring them to make sure they accepted job offers that the government deemed to be acceptable. "
A similar idea might make sense to get the US going again. Our unemployment insurance has been extended from those fired to those furloughed. Surely if your employer says "we need you back now," the extra Federal unemployment insurance that pushes wages above replacement for furloughed workers can cease.

Tuesday, April 21, 2020


Peter Wallison has a worthy OpEd in the WSJ, "Forbearance." Continuing my earlier thoughts on the financial response here and here, I don't think he goes far enough.

Let me tell a little story. Andy runs a restaurant. To run the restaurant, and live, he has a mortgage, he rents the restaurant space, and he borrowed money to buy to buy the equipment. Bob is retired. While he was working he lent Andy the money to buy the house and the restaurant equipment, and he owns the building. He lives off the income from these investments.

The virus comes and Andy has no income. He has enough savings to buy food for a while, and other current expenses. But he can't pay rent, mortgage, and debt payments. This is the central problem our government faces right now.

One answer: The federal government prints money and lends it to Andy so he can keep paying Bob. You can see a major problem here. Andy has no income. Eventually the restaurant may reopen, but then from the same profit stream Andy has to keep paying Bob and also pay back the loan that kept things going in the lockdown. Hmm.

Monday, April 20, 2020

Tidbits of wisdom

From my Hoover colleague Niall Ferguson
It is not just that Trump bungled his response to the crisis (though he certainly did). Much more troubling is the realisation that the parts of the federal government that are responsible for handling a crisis like this – supposedly, the genuine experts — bungled it too. 
The United States Department of Health and Human Services is a mansion with many houses, but the ones that were charged with pandemic preparedness appear to have failed abjectly: not only the Centers for Disease Control and Prevention, but also the Food and Drug Administration and the Public Health Service, as well as the National Disaster Medical System. 

Kocherlakota on moral hazard

I found a kindred spirit. Narayana Kocherlakota, ex president of the Minneapolis Fed, shares my concerns over the current lending and bailout spree, in particular propping up the prices of corporate bonds.
In its last financial stability report of 2019, the Fed highlighted how many nonfinancial corporations were making use of highly risky debt. The report pointed out that “a number of contacts expressed concern that a U.S. recession would expose highly leveraged sectors … concerns related to nonfinancial corporate debt were cited most frequently, with a focus on the growth in leveraged loans, private credit, and triple-B-rated bonds.” 
The financial stability report, of course, made no mention of pandemics or social distancing. It didn't need to — the risk to the financial system and the economy is posed by any recessionary shock. The coronavirus just happened to be the first one that come along.

Bailout redux

The greatest financial bailout of all time is underway. It’s 2008 on steroids. Yet where is the outrage? The silence is deafening. Remember the Tea Party and occupy Wall Street? “Never again” they said in 2008. Now everyone just wants the Fed to print more money, faster. (Well, there are some free market economists left. But we're a small voice!)

Maybe the Fed is right that if any bondholder loses money, if bond prices fall, if companies reorganize in bankruptcy, the financial system and the economy will implode. I am not here today to criticize that judgement. But if so, we must ask ourselves how we got to this situation, again, so soon. Once is an expedient. Twice is a habit.  It is clear that going forward any serious shock will be met by bailouts, and the Fed printing reserves to buy vast quantities of any fixed-income asset whose price starts to fall.

Why does the Fed feel the need to jump in? Because once again America is loaded up with debt, because bankruptcy is messy, and because the Fed fears that debt holders losing money will stop the financial system from providing, well, more debt.

This crisis is a huge wealth shock. The income lost during shutdown is simply gone. The question is, who is going to take that loss? Borrowing to keep paying bills, the current solution, posits  that future profits will soak up today's losses. We'll see about that. The CARES act puts future taxpayers squarely on the hook to pay today's bills. But where do those bills go? To creditors -- property owners, bond holders, and so forth. If we're looking around for pots of wealth to absorb today's losses, why are bondholders not chipping in? The biggest wealth transfer in history is underway, from tomorrow's taxpayers to today's bondholders, on the theory that if they lose money the economy falls apart?

OK, but why did America load up with debt again, apparently all "systemically important?" Could the expectation of a bailout any time there is an economy wide shock happens have had something to do with it? Will we do anything when this is over to stop companies from once again loading up with debt -- especially short term debt -- and forcing the Fed's hand again?

Meantime, anyone who hoarded some savings in the hope of profiting from fire sales, in the hope of providing liquidity to "distressed markets" has once again been revealed as a chump. Will we do anything to encourage them? Will lots of debt, private gain, taxpayers take the losses,  be the perpetual character of our financial system.

"You can't worry about moral hazard in a crisis," they said, and they didn't. At least last time there was some recognition of moral hazard, and a promise to clean up the moral hazard with reform. Will there be any such effort this time? Is anyone even thinking about the enormous moral hazard we are creating with these precedents? Will  the financial system perpetually a four-year-old on a bicycle, a parent running closely behind with one hand on the seat? Will the "Powell put" on fixed income grow ever larger? Or will we, this time, finally cure the financial system so it can survive the next shock?

A bailout 

Small but symbolic: The federal government just bailed out the airlines -- or more precisely airline stockholders, bondholders, unions, airplane leaseholders and other creditors who would lose in bankruptcy.
 "big airlines will receive 70% of the money as grants—which won’t be paid back—and 30% as loans. The cash comes with strings attached: Airlines must give the government warrants amounting to 10% of a given loan’s value that can be swapped for stocks; they cannot lay off staff until September; and they face restrictions on dividends, buybacks and executive compensation."
Oh, and as the article makes clear, this only gets us maybe through the summer. Anyone want to take a bet that planes are full again by September?

The big banks got bailed out in 2008 — or more precisely, the stockholders, bondholders and creditors of the big banks got bailed out.  Never again, they said. Again.

Now, one can make a case that big banks are “systemic,” that if their bondholders lose money the financial system collapses. Just how are airline bondholders “systemic?” What calamity falls if airline bondholders don’t get paid in full?  Just why is a swift pre-packaged bankruptcy not the right answer for airlines? This seems like a great time to renegotiate airplane and gate leases, union contracts (some require the airlines to keep flying empty planes!) fixed-price fuel contracts and more.

If taxpayers have to give airlines cash grants don't we get some reassurance this doesn't have to happen again? Even I would say, no more debt financing. You can see the instinct in "restrictions on dividends, buybacks and executive compensation." Democrats in Congress wanted "stakeholder" board seats, carbon reporting, and more. Why not go full Dodd-Frank on them? Detailed regulation of their financial affairs, stress tests to make sure they can survive the next time? Like banks, the existing airlines might not end up minding so much a return to the 1970s status as regulated utilities. Or, more likely, like GM, we just forget about it, let them load up on debt again, and pretend there won't be a 2030 bailout?

The Fed's big artillery

The real action is at the Fed. The Fed is buying commercial paper, corporate bonds, municipal bonds. The Fed is explicitly propping up asset prices. The Fed is also lending directly to companies. The current guesstimate is $4 trillion, with $2 trillion already accomplished. More is coming.

It started "small" On March 17, the Fed bailed out money market fund investors, buying the “illiquid” assets of those funds so that the funds could continue to pay out dollar for dollar.  Recall that in 2008, the Fed and Treasury bailed out money market fund investors, buying assets to stop a run on money-market funds' promise that you can always cash out at $1. Never again, they said. Fixed dollar promises must be backed by Treasuries, other funds must let asset values float. Again.

On March 17 the Fed also announced it will buy commercial paper.  “Directly from eligible companies.” Yes, the Fed prints reserves to lend directly to companies that can issue A1/P1 commercial paper.
"By eliminating much of the risk that eligible issuers will not be able to repay investors by rolling over their maturing commercial paper obligations, this facility should encourage investors to once again engage in term lending in the commercial paper market. " 
Why are companies borrowing long term by rolling over commercial paper? Didn't we learn anything about rolling over short term debt in 2008? Are we going to follow up by putting a stop to that? Why don't companies have more equity financing, on which they can just stop paying dividends?

"Investors" you say, it's not all the Fed. Read carefully. "By eliminating much of the risk..." The Fed props up prices, and removes risk. Then private investors will come in. The markets won't ride that bike without the Fed's hand on the saddle, apparently. Why do we bother to have private markets?

On March 17 the Fed started to lend again to primary dealers. These are the traders, much maligned by the Volcker rule.
The PDCF will offer overnight and term funding with maturities up to 90 days...Credit extended to primary dealers under this facility may be collateralized by a broad range of investment grade debt securities, including commercial paper and municipal bonds, and a broad range of equity securities. 
Let's translate. You're the trading desk at, say Goldman Sachs. You want to buy stocks, as you think people are dumping in a hurry. Great, that's what traders are supposed to do: "provide liquidity." But, sadly, you're in the habit of of funding trading activity by borrowing money, short term. And you can't do that right now. So the Fed will now lend you the money to buy stocks, and will take the stocks as collateral! It's almost as if the Fed is buying stocks -- except you get the gains, and if you go under, the Fed gets the stocks! (A friend in the securities industry say nobody is bothering to investigate and price high grade corporates. The Fed is setting the prices.)

Again, the Fed is between a rock and hard place. Yes "balance sheets are constrained." Trading firms don't have enough equity to take on additional risk. The natural buyers at asset fire sales are constrained out of the market. Bail the Fed feels it must. But this is exactly what happened when the Fed first lent to broker/dealers in 2008! Why in the world are we in this position, 12 years after that crisis?

On March 20, the Fed expanded into state and municipal markets. The mechanism is the same: Fed lends to a financial institution, which buys the assets, and then gives the Fed the assets as collateral for the loan. Once again the point is  "enhance the liquidity and functioning of crucial state and municipal money markets."

On March 23, the Fed rolled out real artillery. Ominously, Treasury markets appeared "illiquid," so the Fed has stepped in buying $1.3 trillion in the first month -- more than the Treasury issued.  The Fed is funding Treasury borrowing with newly printed reserves.  The Fed now buys mortgage backed securities.

And now.. corporate bonds. This is well past 2008.
the Primary Market Corporate Credit Facility (PMCCF) for new bond and loan issuance and the Secondary Market Corporate Credit Facility (SMCCF) to provide liquidity for outstanding corporate bonds.
Translation: The Fed will buy new corporate bonds, thus directly lending to corporations. And it will buy  outstanding bonds.

Why would it do that? Well, to "provide liquidity." This is a word that ought to set off BS detectors. Yes, there is such a thing as an "illiquid" market. There is also such a thing as a market whose prices are dropping like a stone. Sell all you want but at 50 cents on the dollar. "I wish I had sold at yesterday's prices" is not illiquidity. You have to pay people a lot to take risk right now. Which is it? Hard to tell. There are ways to tell, of course. For example, illiquid markets have negative price autocorrelation -- a low price today bounces back. I am not aware of the Fed having applied this or any other test. (Research topic suggestion.)

Again, I don't want to criticize, but there sure is a danger of propping up prices under the guise of "illiquidity." The Fed's view that if the Fed takes all risk off the table "liquidity" will reappear is also pretty close to taking risk off the table so prices will rise.

The Fed is already buying new bonds from companies to finance their new expenditures. Propping up prices of existing bonds is a way to let old bondholders cash out at high prices, now before the deluge. Just why can't old bondholders even take mark-to-market losses?

And, if corporate bondholders need to be bailed out in this way, are we going to do anything about it going forward? Do you get to buy junk bonds, high interest municipal debt, and the Fed will let you out if anything bad happens?

Wrap up

OK, I haven't even gotten through March and the Fed is just getting going. Let's wrap up.

The Fed has felt the need to take over essentially all new lending in the economy. The Fed is also propping up most fixed-income prices. The Fed is deliberately removing risk from holding these assets.

Once again, I will be told, "this isn't the time to think about moral hazard." But having done this twice, the first time with huge protest, the second time as if it is perfectly normal, this is the pattern, and the moral hazard is there. The economy will load up on debt, especially short term debt. People will not keep stashes of savings around to provide liquidity or jump on buying opportunities. And the need for bailouts will be larger in the next crisis.

"But the Fed made money in 2008" you may retort. And it has a half chance of making money again. If the recession wraps up in September and these "loans" get paid back, it will do nicely. If the recession goes on a year and all these "loans" go sour, it will not look so pretty.

Yes, in 2008 the Fed and treasury successfully operated the world's largest hedge fund, printing money to buy low-price assets. But is this really the function of the Federal Reserve? Do we want it driving private hedge funds out of the liquidity provision business, by its ability to print rather than borrow money, and by the off-balance-sheet put that the US taxpayer will in the end take losses if this massively leveraged portfolio doesn't work out?

Where is the outrage? Where are the financial economists? Where is the reform plan so we don't do this again? At a minimum, can we say tha  the government could stop subsidizing debt, via tax deduction and regulatory preference for "safe" (ha!) debt as an asset?

Hello out there? In 2008, everyone was writing financial crisis papers. Now everyone is playing amateur epidemiologist.

Finance colleagues, you have a bigger crisis and intervention to study, and a deeper set of regulatory conundrums. Is everyone just too scared of sounding critical of the Fed? Get to work!

The Fed and Treasury's actions are telling us we are on the verge of financial apocalypse. Let's wake up and look at what's coming, especially if it doesn't all get better by September.

Some links 

This post continues from Financial Pandemic.

I had planned a longer post on the details of many of these programs, but this is long enough.

A great explanation by Robert McCauley in FT. Section heads include  1) Acting as a lender of last resort to securities firms, 2) acting as a lender of last resort to investment funds, 3) acting as a securities dealer of last resort, 4) acting as a securities underwriter of last resort and finally 5) acting as a securities buyer of last resort.

A simple tweet storm by Victoria Guida

Via the indefatigable Torsten Slok,

Financial Policy During the COVID-19 Crisis MIT opeds on financial affairs

A great list of policy trackers.

Financing Firms in Hibernation During the COVID-19 Pandemic

The Yale Financial Stability Tracker and especially the Finance Response Tracker are very useful list of what's going on.

Fed Intervention in the To-Be-Announced Market for Mortgage-Backed Securities
by Bruce Mizrach and Christopher J. Neely is a very nice description of what's going on there

The United States as a Global Financial Intermediary and Insurer by Alexander Monge-Naranjo. More contingent liabilities waiting for Uncle Sam bailouts.

A data set of international fiscal responses

Subways and virus

The Subways Seeded the Massive Coronavirus Epidemic in New York City is an intriguing and delightfully written article by Jeff Harris

New York City’s multitentacled subway system was a major disseminator – if not the principal transmission vehicle – of coronavirus infection during the initial takeoff of the massive epidemic that became evident throughout the city during March 2020. The near shutoff of subway ridership in Manhattan – down by over 90 percent at the end of March – correlates strongly with the substantial increase in the doubling time of new cases in this borough. Maps of subway station turnstile entries, superimposed upon zip code-level maps of reported coronavirus incidence, are strongly consistent with subway-facilitated disease propagation. Local train lines appear to have a higher propensity to transmit infection than express lines. Reciprocal seeding of infection appears to be the best explanation for the emergence of a single hotspot in Midtown West in Manhattan. Bus hubs may have served as secondary transmission routes out to the periphery of the city

Later in the article

The Metropolitan Transit Authority’s decision to cut back its train service to accommodate the reduced demand may have indeed helped to shore up the agency’s financial position, but it most likely accelerated the spread of coronavirus throughout the city. That’s because the resulting reduction in train service tended to maintain passenger density, the key factor driving viral propagation (Goldbaum and Cook 2020). How ironic it is that, from the public health perspective, the optimal policy would have been to double – maybe even triple – the frequency of train service. The agency’s decision to convert multiple express lines into local service only enhanced the risk of contagion (Goldbaum 2020). How ironic it is that the preferred policy would have been to run even more express lines. We have not seen any public data on the incremental cost of the agency’s decision to begin to disinfect subway cars twice daily. Still, it is natural to inquire why the cars weren’t disinfected every time they emptied out of passengers at both ends of the line.
Why not continually? There are a lot of unemployed people being paid by the government. Why not send a cleaning crew of 10 to continually wipe down each train, monitor mask use, and social distance protocols?

London apparently made a similar blunder.

Comment: I've been harping for a while on the fat-tailed distribution of activities. Shut down the super-spreading activities. Shut down dangerous activities not specific businesses. Consider lost income.

But how do you shut down the subways in New York City? How do you run subways in a vaguely safe way? If the virus lasts, getting around NY is going to be a mess for a long time.

Negative oil prices

A fun tidbit sent to me by a good friend in the money management industry.

NYM WTI Crude oil is negative $37.73. They pay you to take it. The catch: you need an oil tanker and a place to park it. It went down from $-11.42 in the 10 minutes we were emailing about it.


From an email correspondent:
Exchanges are very careful to match approved warehouse space with the production capacity of the region surrounding the delivery point.
Warehousemen can do extremely well under conditions of surplus supply.  Where are the warehousemen?
I would expect that EPA regulations on constructing tank storage and pipelines have hampered the response time in developing storage capacity.
The latter I can believe. China can build a hospital in 10 days, but zoning permitting and many other regulations would make it impossible to build an oil storage tank in a mere 2 months in the US.

Where is the US strategic petroleum reserve?

Friday, April 17, 2020

Good fellows and grumpy podcast

Niall Ferguson, H.R. McMaster and I did another "good fellows" discussion here

And the latest Grumpy Economist podcast

To readers having trouble,  you did figure out to click the link above, not the picture, right? I haven't figured out how to launch the podcast directly from this blog. You have to go to the link on the hoover website. Thanks for your persistence.

Thursday, April 16, 2020

Weisbach advice

Mike Weisbach is writing an excellent book of advice, A Field Guide to Economics: A Young Scholar’s Introduction to Research, Publishing, and Professional Development. As a good scholar he is circulating the manuscript. It's really half advice and half a meditation on how the profession works and how it should work.

There is a lot of good advice, and a lot of good questions. I'll highlight a few things I disagree with, but don't take that as criticism of the project, rather an invitation to read and think about the issues yourself.

Real time labor market survey

Alex Blick and Adam Blandin are putting together a real-time labor market survey.
Labor market statistics for the United States are collected once a month and published with a three week delay. .... Currently, the most recent statistics refer to the week of March 8- 14; new statistics will not be available until May 8...
This project aims to provide data on labor market conditions every other week, and to publish results the same week, thereby reducing the information lag. We do so via an online labor market survey of a sample representative of the US working age population. Our core survey closely follows the CPS, which allows us to construct estimates consistent with theirs.
The first wave of our survey covers the week of March 29-April 4. Our findings reveal un- precedented changes in the US labor market since the most recent CPS data were collected:
1. The employment rate decreased from 72.7% to 60.7%, implying 24 million jobs lost.
2. The unemployment rate increased from 4.5% to 20.2%.
3. Hours worked per working age adult declined 25% from the second week of March.  Half of this decline is due to lower hours per employed as opposed to lower employment.
4. Over 60% of work hours were from home, compared with roughly 10% in 2017-2018.
5. Those who still have their jobs are working fewer hours; 21% report a decline in earnings.
6. Declines were most pronounced for workers who were female, older, and less educated. 

Bottom line, even worse than you thought. Well, if we shut down the economy, we shut down the economy.

Ready to reopen?

Are we ready to reopen? No but not for the usual reason.

Once we have testing we can reopen, says conventional wisdom. I doubt that. Who is going to give these tests, and what are they going to do with the information? 

Maybe maybe maybe if we had a free test, with instant results, that every American (and person flying in on a plane) could take every day; if almost all Americans were actually willing to take said test; and if people were universally willing to quarantine themselves upon its results, the test might help. But even that's a pipe dream. 

We won't have a vaccine, applied to the entire world's population, for a long time. "Herd immunity" seems unlikely. It's not even clear that exposure to COVID-19 confers immunity. (I've been looking for any study of how often people who had it once get it again. Let me know if you see one.) The whole point has been to bend the curve so that the vast majority don't get it. 

So, we will have through summer and fall, a pretty susceptible population and a virus ready to break out any chance it gets to. 

The point of "testing" and "reopening" is to have a system whereby public health interventions take the place of draconian economic shutdown to keep the reproduction rate under one. 

Public health does not mean just lots of tests. It means using the tests to identify small outbreaks and keep them from getting big. And that requires a tooled up, effective, nimble, local, public health bureaucracy. And a bureaucracy that steps on a lot of toes. 

Suppose your neighbor gets one of these tests and is positive. What gets done about that? First of all, under HIPPAA, his or her test result is nobody else's business, not even local government. Who forces him or her to self-quarantine? Who forces them to get the test if they know forced quarantine is coming? 

In Asia, apps tell you who got tested and the result. You can judge if you had contact. Or state  surveillance tells you that tracking your cell phone and theirs the authorities know you had dinner together last week and you're being isolated now. We, properly, have big laws against all of this! Are we willing to do this? How fast? Will we faintly have the capacity to do it? In a month? 

Maybe after weeks of wrangling, local public health officials (which local public health officials?) can use the information to decree there has been a positive test on your block and impose a quarantine on the whole block. The heck with that, say you, proud American. Like me, you've been strenuously distancing for a month, so you know you haven't got it from the neighbor, you're off to the newly opened park for a jog. Obviously, such edicts will have to be enforced, against a restless and resentful populace. Can you really see cops cordoning off apartment houses, blocks, towns, controlling who goes in and out? Do we even have cops to do it? And the method to figure out who goes where?

"Testing" and "tracing" are popular. Do most Americans (and our 10 million undocumented residents!) really want to tell someone from the government every person they've met in the last two weeks? Knowing the government is likely to quarantine them and ask more questions?  Or let them track your phone? Or carry your phone the minute you know they're tracking it? 

Birthday parties are just as bad as bars. Are we going to allow health authorities to monitor our cellphones and bust up birthday parties? 

A key part of public health is to isolate known areas. Are Americans going to put up with travel bans?  Are there any public authorities with the competence to put in place data-driven nuanced travel bans? Again, for the vast majority of people, the travel ban will be a senseless annoyance. 

We will need a robust public health response, to keep a small number of cases from ballooning, and allow the economy to open. We will need the response we should have had in January. "Testing" is one of many inputs to that response. But "testing" is not the response itself. An effective public health response needs a detailed, competent bureaucracy, temporary relief from thousands of privacy regulations -- and swift assurance that those privacies are reinstated when it's over -- and enforcement in order to something useful with the tests. I doubt Americans will put up with the enforcement. I doubt our government has the capacity to put them to that test. I hope I'm wrong as the alternative is waves of lockdown.  

MR Admiration

24 hours of Marginal Revolution:

April 16 1:23 PM Covid-19 Fast Grants update

April 16 12:15 PM. The vital daily links, including
2. An alternating lockdown strategy.
3. Vox on the Watney Stapp Mercatus mask plan.
4. Derek Lowe on vaccine prospects.
5. Will coronavirus change the proper CPI bundle?
6. “This paper argues that daily ‘universal random testing’, as recently proposed by Paul Romer, is not likely to be an effective tool for reducing the spread of Covid-19... Link here.
7. Why is Detroit worse than Baltimore?  And is there also a Brazilian heterogeneity? (limited information, however)
8. JPMorgan reopening plan, involves building herd immunity among the young. ...
9. How well did Italy do lowering R0 through lockdown?  [Very important -- models predict much swifter end than were are seeing]
11. Ongoing chart of Covid-19 deaths in Sweden, also accounting for reporting delays.
12. Who is this helping? (NYT): “Amazon said Wednesday that it would temporarily halt its operations in France after a court ruled the company had failed to adequately protect warehouse workers against the threat of the coronavirus and that it must restrict deliveries to only food, hygiene and medical products until it addressed the issue.” 
April 16 7:28 AM When Will The Riots Begin? Protests against lockdowns have begun. Crucial.

April 16 7:26 AM PPE Shortages and the Failure to Increase Prices. Vital. Anti-price gouging rules are inhibiting supply. An interesting new mechanism: usually people won't pay for stuff until it's delivered. But if you have to ramp up production 10x, you don't have working capital to buy supplies. higher prices provide working capital. There is a rising supply curve everywhere.

April 16 2:59 AM (!) One reason why food intended for restaurants is not reallocated to supermarkets We've been puzzling about that here. Why are farmers throwing away food? At our dinner table the answer was obvious -- some regulation is getting in the way. But which one? Food labeling is an obvious one. You can't just sell, you know, food, in a food store. "I’ll say it again: America’s regulatory state is failing us."

April 16 12:22 AM Supply curves slope up round 1. Why you get more tests if you agree to pay higher prices. (As I've written a few times, ponder that we are spending a trillion dollars a month on stimulus yet worrying about "price gouging" and haggling over $40 tests and $1 face masks.)

I can't keep up! I can barely read this fast.

Tuesday, April 14, 2020

Financial pandemic

The headlines are on the disease, the shutdown, and the hoped-for safe reopening. It's time to pay some attention to the financial side of the current situation, and the Federal Reserve's immense reaction to it.

Disclaimer: do not read in this post criticism of the Fed. Maybe the world would have ended if they had done things differently. But it is important for us who study such things to understand what they did, what beneficial and adverse consequences there are, and how the system might be set up better in  the future.

Big picture: We face an extremely severe economic downturn, of unknown duration -- it could be a V,  U, or L. If it is not a V shaped in months, there will be a wave of bankruptcies from personal to corporate, and huge losses all over the financial system. Well, earn returns in good times and take losses in bad times, you may say, and I do, more often than the Fed does, but for now this is simply a fact.

Our government's basic economic plan to confront this situation is simple: The Federal Reserve will print money to pay every bill, and guarantee every debt, for the duration. And, to a somewhat lesser approximation, to ensure that no fixed-income investor loses money. 

I reiterate, the point of this post is not to criticize. If you are reading economics blogs, you like me probably have a nice work-from-home job that still pays some money. This is not what's going on. From a combination of voluntary and imposed social distancing, the economy is collapsing. As I detailed in an earlier post  20 million people, more than 1 in 10 US workers, lost their jobs in the first month of this shutdown. That's more than the entire 2008 recession. In 3 weeks. 1/3 of US apartment renters didn't pay April rent. Run that up through the financial system. Most guesses say that companies have one to three months of cash on hand, and then fail. We'll look at signs of financial collapse in a bit, that the Fed reacted to. If you want to know why the Fed hit the panic button, it's because every alarm went off.

Pay every bill? Yes, pretty much. This is not "stimulus." It is get-through-it-us. People who lost jobs and businesses that have no income can't pay their bills. When people run out of cash they stop paying rent, mortgages, utilities, and consumer debts. In turn the people who lent them money are in trouble. Businesses with zero income can't pay debts (just why debts are so large is a good question to keep track of), employees, rent, mortgages, utilities. When they stop, paying they go through bankruptcy and their creditors get in to trouble. If you want to stop a financial crisis, you have to pay all the bills, not just some extra spending cash.

And that's pretty much the plan. There will be unemployment insurance, with 100% replacement of wages, for people who lose jobs, so they can pay rent, mortgages, utilities, and consumer debts. The Small Business Administration will make forgivable loans to businesses. Bailout plans are in place to make sure industrial companies like Arlines do not file for bankruptcy. (Much of this money is stuck in snafu, but that's the plan if not the execution.) And, where the big money is, the Fed is propping up corporate bond, municipal bond, treasury, money market funds, and other markets. I'll survey the programs below, this is big picture for now.

Printed money? Yes. Start with the Treasury. The Treasury wants to spend $2 trillion in the first stimulus bill. Where is that money coming from? In normal times, that would mean selling $2 trillion of treasury bond and bills. But who has $2 trillion of extra income lying around that they want to use to buy treasury debt right now? Yes, the new treasury debt has to come from a new flow of savings. Well, you can argue if that's there or not, but you don't have to. The Fed is buying more debt than the Treasury is selling. 

When the Fed buys Treasury debt, it prints up new money, and gives it to the holder of the Treasury debt. (I will say "printing money" as that is clearer. The Fed actually creates new reserves, accounts banks have at the Fed, by flip of an electronic switch. Banks can convert reserves to cash and back at will.)  On net, if the Treasury borrows and spends the money, and the Fed buys the Treasury debt, the government as a whole has printed up new money to spend. That's what's going on now. 

From the March 4 and April 8 Fed H.1 data, we learn that the Fed held $2,502 billion and $3,634 billion Treasury securities on those dates, an increase of $1,132 billion.  From the Treasury debt to the minute page, we learn that debt held by the public (including the Fed) rose from $17,469 billion to $18,231 billion -- a (huge) rise of $762 billion. $9 trillion at an annual rate. The Fed bought all the Treasury debt, printing new money to do it, and then some. On net, the government financed the entire $762 billion by printing new money and printed up another $370 billion to buy back that much existing treasury debt. 

The UK is abandoning pretenses. Bank of England to directly finance UK government’s extra spending writes the FT. Rather than have the government sell to the market, and then the bank buy it, the bank will now print money for the government to spend, and the government will print treasury debt to give to the bank in return.

(Who cares you may ask? The US Fed is not legally allowed to buy from the Treasury. The Treasury must sell in private markets to establish the interest rate, i.e. the price of the debt. If not, there is an inevitable temptation to say that markets are "impaired" or "illiquid" requiring too high rates, and thus the Fed buys at artificially low rates and high prices. The laws against inflationary finance are pretty thoughtful.)

The new lending programs are explicitly financed by the Fed printing up new money to do so.

The Fed and Treasury are teaming up to provide trillions to lend money to businesses and banks, and to buy assets including  money market funds, corporate bonds, municipal bonds, mortgages,

Now where do these trillions come from? Answer, in short, the Fed simply prints them up. It prints up the new money, and gives it to a business or bank or uses it to buy assets. 

A bit longer explanation 

In normal times, the Fed creates money (reserves) by buying Treasury bills. It has an asset -- the Treasury -- and a liability -- the money. The money is backed by Treasurys, a good principle of non-inflationary policy. That's the simple version of which  the Fed just did a trillion. 

When the Fed lends money to a bank or a company, the Fed likewise prints up money, gives it to a company, and counts the company's promise to pay back the loan as the corresponding asset. You can see the danger. The Fed is supposed to make only safe loans, to guard against inflationary finance, and to keep the Fed politically independent. Printing money to hand gifts to well connected firms and politically powerful interest groups is dynamite, and an independent agency will not stay independent long if it does so. 

For this reason the Fed and Treasury work together. The Treasury agrees to take the first tranche of losses, so the Fed can say this is a safe loan. Jay Powell was, as usual, clear on this. 
I would stress that these are lending powers, not spending powers. The Fed is not authorized to grant money to particular beneficiaries. The Fed can only make secured loans to solvent entities with the expectation that the loans will be fully repaid
What happens if the loans are not paid back? Well, in the first 5 to 10%, the Treasury takes the loss.  But right now, the Treasury gets its money from the Fed. So it really comes back to printed money anyway. If losses are so severe that the Fed loses a lot of money, the Treasury will have to recapitalize the Fed with a gift of Treasury bills. 

So, if the loans are not paid back, one way or another, we end up with that much more outstanding Treasury debt, either owned by the Fed and money outstanding, or owned by people. 

But this Fed vs treasury business, while important inside baseball for Fed independence and a bunch of issues on how the plumbing works, is really beside the point. The Fed and Treasury right now are, together, printing up trillions of dollars -- $4 -$6 trillion is the current guesstimate, which assumes a short sharp recession -- and handing them out. Most of it is "loans" which the Fed and Treasury hope to recoup. Then they can reduce the amount of money left outstanding. 

Is this really lending? 

As Jay Powell emphasized, the current vision is that most of the current support is lending, not spending. The Treasury kicks in something like $400 billion which really is spending, the anticipated loan losses (companies that don't survive) and forgiveness (programs that promise to forgive the loan if the company meets employment or other goals). The Fed lends $4 trillion on top of that, and gets its money back. The government as a whole has only spent $400 billion when its over, and the new debt (money) is soaked up again by repayment. 

But is this really lending or just spending?  Well, in the short run it's lending, but if the recession lasts more than a few months it will turn in to spending.

Companies have no income but must pay rent, debts, (interest on their corporate bonds and bank loans used to purchase now idle plant and equipment), utilities, skeleton staff, etc. Local governments are in a similar bind. They borrow to cover this cost. What's wrong with that? 

Well, borrowing usually corresponds to a productive asset, to an increase in value. If a bakery borrows to buy an oven, the bakery will make more bread, and use the additional profits on the extra bread to pay off the loan. If it doesn't work out, the oven is a real asset, collateral that the bank can sell to get some of its money back. A city borrowing to build a highway gets more tax revenue from greater activity to pay off the loan. 

But there is no economic value to these loans. These are consumption loans, stay-afloat loans, preserve-the-business loans. They are loans against future profits, but not additional future profits. They are a transfer of the franchise value of the firm to the lender. 

So, first, the firm clearly at some point is better off shutting down than promising its entire profit stream to a lender just for the right to reopen someday. Second, the government, already inclined to forgive, say, student debt, has every reason to forgive these "loans" as well. The business "loans" explicitly promise forgiveness if the government keeps workers on board. When we are in a sluggish recovery, and businesses are saying "well, I would hire more people, but we have all this extra debt because we took Fed loans to keep our employees fed while we were shut down," let's see just how tough the government is going to be on repayment. 

So, in a matter of months, these loans turn to gifts. The $4 trillion Fed lending package winds up as $4 trillion permanently added to Treasury debt. 

Does this mean inflation? 

You would think that, if the Fed and Treasury are going to print up something like $1 trillion a month of money to pay everyone's bills and prop up markets for the duration, we would be heading for inflation, soon. 

No, or at least not immediately. Reserves pay interest. Reserves are just another form of Treasury debt. (Reserves that pay interest is one of the best innovations of recent decades, and Kudos to Ben Bernanke and everyone else involved.) 

So why does it matter? Couldn't the Treasury just print up Treasury bills, sell them for reserves, hand out the reserves, collect loans in due time and retire the Treasurys? In the short run it does matter, which should send a few shivers up our spine. Apparently the Treasury had a hard time finding willing buyers. So printing up the reserves directly made a difference. So, the Fed ends up with a loan "asset" on its balance sheet against reserves, rather than the Treasury with that loan as an asset on its balance sheet against Treasury bills. Conveniently, also, reserves though equivalent to Treasury debt are not counted in the debt limit along with many other contingent liabilities. 

In the long run it does not matter. The Fed and Treasury print up reserves, lend it to Joe's Laundry; Joe pays his mortgage; the mortgage company pays its investors. If those investors are happy sitting on reserves (bank accounts backed 1:1 with reserves on the margin), it sits. If they are not, which would be the beginning of the inflationary process, the Fed can just raise the interest rate on reserves until they are, really really transforming reserves to Treasury debt. Or the Fed can give them some of its stock of Treasurys and so on up the reserves. 

With abundant interest-paying reserves, reserves and Treasury debt are almost exactly the same thing, and in roughly functional markets, what matters is their total supply, not reserves alone. Inflation is a danger, but from the total quantity of government debt, not its split between reserves and  bills. Inflation comes basically if the US hits a debt crisis. 

(That is, so long as the Fed pays market interest on reserves, and lets the market basically have as much or as few reserves as it wants. If the Fed, and Treasury, start worrying about interest costs of the debt, and do not pay interest on reserves and do not allow people to convert to Treasurys, then inflation comes sooner. )

But we're looking for sure at raising US debt from $22 trillion to $27 trillion, likely hitting 150% of GDP if this is a short and swift recession. It could be much larger if the recession goes on a year or more. Is there a demand for that much more treasury debt in the long run? Is there a flow of that much new saving that people are willing to park with Uncle Sam? How much more can markets take? So the chance of a global sovereign debt crisis and inflation is not zero -- but not centrally from the fact that it's currently financed by printing money. I'll come back to this issue in detail later. 


First, how long can this go on?

As you can see, the viability of this whole plan depends on a short recession. The Fed is printing up something like $1 trillion per month. If the recession ends up being L shaped, those numbers will ramp up as reservoirs of private cash dry up. A few large company bailouts, a few more "dysfunctional" markets turn to the Fed to buy everything, and so on. The  IMF wants  $1.2 trillion to bail out emerging market economies. After 3 weeks. That will get worse. State and local governments, already facing pension crises, are gong to be toast when sales and income tax receipts collapse. Bear Stearns, Fannie and Freddy, AIG...

Where is the limit? Perhaps the peasants with pitchforks, remarkably absent so far, will revolt. Perhaps the willingness to hold interest-bearing reserves or US Treasury debt will find its limit after $10 trillion. Or $20 trillion.

At some point, people who bought risky, high return debt, and earned nice returns on the way up, will have to bear some of the genuine economic losses. There is no magic. Government debt is paid back by taxes. (If you think that law has been repealed by MMT or r<g, I'll disabuse you of that in an upcoming post.) Trillions will be spent. Either taxpayers pay it, or creditors pay it. 

Second, isn't there a bit of moral hazard here? Now, you may say, nobody asks about moral hazard in a foxhole. But at some point we have to address the moral hazard. Half of these interventions were things done in 2008, and we said no, never again, we'll pass a mountain of regulations to control moral hazard. Remember "no more bailouts?" Especially money market funds? And here were are, one week into it and airlines are too big to fail and money market funds need the Fed to stop from breaking the buck. At a minimum we can look at what the Fed has done, remark on how the post 2008 controls on moral hazard failed, and at least think about how we might avoid being in exactly the same  pickle in 2032.  We can also once again Monday morning quarterback and suggest how things might be done in a way to diminish the moral hazard. At least we can get a better playbook for next time.

I will look at both these issues in detail in upcoming blog posts.