Feds Latest Moves are Good. Theyre Not Enough to Save the Economy.

The central bank says it will do whatever it takes to keep credit flowing. But the government needs to lend directly to businesses and provide cash to workers, fast.

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On Monday morning, the Federal Reserve announced a significant ramp-up of its programs to help offset a particular aspect of the coronavirus impact on the U.S. economy: blockages in the flow of credit to businesses. I expect these measures to help, but they are, by their nature, more of a bank shot than a direct hit on the deep, recessionary effects of millions of Americans staying inside. Nor do they provide direct, immediate cash relief to families that are already facing potentially devastating shortfalls.

Most people think of the Fed in terms of their main interest rate tool, which they raise and lower to slow and speed-up growth. They already fired that weapon, by lowering this rate to about zero earlier this month. But thats not their only weapon, and at this point, its not even their most important one. The other thing they can do is print money and use it to provide credit.

Heres how to think of what they announced Monday in that space: The U.S. economy is a house on fire. The Fed drove up with a fire truck and started hosing off the section of the house that provides credit to business and governments (the federal government is poised to borrow trillions for the stimulus plan under debate as we speak). But that truck doesnt have enough water in it, and instead of sending a bigger truck, they essentially said theyre going to attach their hoses to the ocean.

That is, instead of pledging $700 billion (i.e., a fixed amount) in lending to buy U.S. Treasuries (to support government lending) and mortgage-backed securities (to support mortgage lending) as it did about a week ago, the Fed essentially uncapped such lending and expanded it to other sectors. Instead of saying theyll spend $X on ensuring credit flows, they announced that theyll provide the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions.

Thats Fedspeak for well do whatever it takes to keep credit flowing smoothly.

Will it work? That depends on what do we mean by work. We can look at stock and debt markets to gauge the immediate impact, but for most of us, work means relieving the severe economic stress that families and businesses are starting to face.

When it was first announced, the stock market responded positively, but a few hours later, it was down again. I wouldnt make too much of that. Theres just too much uncertainty and cross-cutting info to know what to make of market signals. On this front, we can safely conclude that the markets are a mess and will likely be relentlessly negative until the initial stage of the crisis is past.

The better metric for gauging the Feds actions are the credit markets themselves. Thus far, theyve reacted positively to the Feds whatever it takes stance. But weve seen this movie before in recent weeks, which is why the Fed judged that it needed to pull out the stops. Im mildly confident that the Feds latest actions will keep credit flowing relatively smoothly, but were in uncharted waters. A lot of this depends on how long containing the virus requires putting the economy in deep freeze.

The problem is that when it comes to directly helping families and even businesses, the Feds tools, even with this massive expansion, are limited for at least two reasons.

First, the bank-shot problem. While the Fed can buy government debt, it cannot lend directly to private businesses, nor can it take on whats called credit risk, meaning that it cant even indirectly lend to risky ventures, of which there are quite a lot right now.

So the Fed can only inject money into the credit system by providing liquidity to lenders under a set of rules that protect it from losses. The U.S. Treasury can and does help here by essentially guaranteeing the Fed that theyll repay the central bank for any of their losses, but this in turn leads to all sorts of complexities. If you follow this sort of thing, you know, for example, that the Fed has dozens of lending facility programs with names like the Term Asset- Backed Securities Lending Facility, where the Fed lends money to investors to buy bundled securities backed by consumer and small-business debt. See what I mean by bank shot?

A more direct approach, one thats current underway in both the U.K. and Denmark, is for the government to directly support businesses. Because its more direct, this approach is far more certain to ensure that we avoid cascading business failures. In fact, Congress is proposing this sort of idea as part of the stimulus, but Senate Republicans have at least initially set it up in a way thats totally unacceptable: with no oversight and no requirements that firms use the money to help maintain their payrolls. Theres a difference between direct support to firms and a slush fund.

The second problem is that credit doesnt put money in the pockets of laid off or furloughed workers. No question, we need to maintain our business sector. We need an economy in place thats capable of bouncing back once we come out of this crisis.

But our first order of support must be helping ill-equipped families get through the crisis, and thats the work of fiscal stimulus. I applaud the fact the Congress is working aggressively on a big stimulus bill, but theyre already behind the fiscal curve. Relief needs to get out the door yesterday.

The Fed is doing all it can to keep credit flowing smoothly, and while its methods are too indirect, they will help. But even if they do succeed, they cant provide direct assistance to those who need it most.

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