(NYTIMES) – By the middle of March 2020, a sense of anxiety pervaded the US Federal Reserve. The fast-unfolding coronavirus pandemic was rippling through global markets in dangerous ways.
Trading in Treasuries – the government securities that are considered among the safest assets in the world, and the bedrock of the entire bond market – had become disjointed as panicked investors tried to sell everything they owned to raise cash. The Treasury market had never broken down so badly, even in the depths of the 2008 financial crisis. The Fed called an emergency meeting on March 15.
Ms Lorie Logan, who oversees the Federal Reserve Bank of New York’s asset portfolio, called for a virtual conference with regional bank presidents. Washington-based governors were arrayed in a socially distanced ring around the Fed Board’s mahogany table.
Ms Logan delivered a blunt assessment: While the Fed had been buying government-backed bonds the week before to soothe the volatile Treasury market, market contacts said it hadn’t been enough.
To fix things, the Fed might need to buy much more. And fast. It was a clear signal that the 2020 meltdown echoed the 2008 crisis in seriousness and complexity. Where the housing crisis and ensuing crash took years to unfold, the coronavirus panic had struck in weeks.
How it started
Financial markets began to wobble on Feb 21 last year, when the Italian authorities announced localised lockdowns. At first, the sell-off in risky investments was normal – a rational “flight to safety” while the global economic outlook was rapidly darkening.
Stocks plummeted, demand for many corporate bonds disappeared, and people poured into super-secure investments, like US Treasury bonds.
On March 3, as market jitters intensified, the Fed cut interest rates to about 1 per cent – its first emergency move since the 2008 financial crisis. Some analysts chided the Fed for overreacting, and others asked an obvious question: What could the Fed realistically do in the face of a public health threat?
“We do recognise that a rate cut will not reduce the rate of infection, it won’t fix a broken supply chain,” chairman Jerome Powell said at a news conference, explaining that the Fed was doing what it could to keep credit cheap and available.
But the health disaster was quickly metastasising into a market crisis.
Lockdowns in Italy deepened during the second week of March, and oil prices plummeted as a price war raged, sending tremors across stock, currency and commodity markets. Then, something weird started to happen: Instead of snapping up Treasury bonds, arguably the world’s safest investment, investors began trying to sell them.
The yield on 10-year Treasury debt – which usually drops when investors seek safe harbour – started to rise on March 10, suggesting investors didn’t want safe assets. They wanted cold, hard cash, and they were trying to sell anything and everything to get it.
How it worsened
The Fed began to roll out measure after measure in a bid to soothe conditions, first offering huge temporary infusions of cash to banks, then accelerating plans to buy Treasury bonds as that market swung out of whack.
But by March 13, government bond markets were just one of many problems. Investors had been pulling cash from prime money market mutual funds, where they park it to earn a slightly higher return, for days.
But those outflows began to accelerate, prompting the funds themselves to pull back sharply from short-term corporate debt markets as they raced to return money to investors. Banks that serve as market conduits were less willing than usual to buy and hold new securities, even just temporarily. That made it harder to sell everything, be it a company bond or Treasury debt. The Fed’s announcement after its March 15 emergency meeting – that it would slash rates and buy bonds in the most critical markets – was an attempt to get things under control.
But Mr Powell worried that the fix would fall short as short- and long-term debt of all kinds became hard to sell. He approached Mr Andreas Lehnert, director of the Fed’s financial stability division, and asked him to prepare emergency lending programmes, which the central bank had used in 2008 to serve as a support system to unravelling markets.
Mr Lehnert communicated with Fed staff via instant messenger and video chats – in-person meetings were already restricted – and worked late into the night to get the paperwork ready.
How they fixed it
The next weekend, March 21 and 22, was a frenzy. Officials dialled into calls from home, completing still-secret programme outlines and negotiating with then Treasury Secretary Steven Mnuchin’s team to establish a layer of insurance to protect the efforts against credit losses.
After a tormented 48-hour hustle, the Fed sent out a mammoth news release on Monday morning. Headlines hit newswires at 8am, well before American markets opened. The Fed promised to buy an unlimited amount of Treasury debt and to purchase commercial mortgage-backed securities – efforts to save the most central markets.
The announcement also pushed the US central bank into uncharted territory. The Fed was established in 1913 to serve as a lender of last resort to troubled banks. On March 23, it pledged to funnel help far beyond that financial core. The Fed said it would buy corporate debt and help to get loans to midsize businesses for the first time ever.
It finally worked. The dash for cash turned around starting that day. The Fed, along with the Treasury, most likely saved the nation from a crippling financial crisis that would have made it harder for businesses to survive, rebound and rehire. Many of the programmes have since ended or are scheduled to do so, and markets are functioning fine. But there’s no guarantee that the calm will prove permanent.
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