Now that things are a bit calmer, I’d like to explain the ways the Fed’s trillion-dollar emergency lending programs are designed to work. 1/14

There are a few different ways the Fed is trying to make it easier for households, businesses, financial firms, & municipalities to borrow. The 1st I’ll cover is most direct: buying debt directly. This is how programs will work for larger companies & for state & local govts. 2/14

Those entities can borrow money by issuing bonds they sell on the open market. The Fed has set up a bunch of different “facilities”–separate legal entities–that will buy short-term business IOUs (commercial paper), longer-term corporate bonds & short-term municipal bonds. 3/14

The Fed will either buy business debt directly from the companies (the primary market) or from other traders (the secondary market), though for now it will only buy debt directly from states and large cities – not from the secondary muni market. 4/14

The point of this is not only to lend to these entities, but also to encourage private lenders (think banks, private equity, etc.) to feel more comfortable participating in those markets because the Fed is there as a backstop. 5/14

Here it’s worth noting that as the central bank, the Fed sits at the center of the financial system, and the way that it generally conducts policy is by working through banks. That’s what makes these programs really unusual – it’s bypassing banks to get credit to people. 6/14

Now, the “Main Street” lending program, which is targeted at smaller businesses, is a bit different. These companies don’t issue bonds, so the Fed is going to buy loans made by banks to them (businesses with fewer than 10,000 employees). 7/14

Technically the Fed is only buying 95% of the loan, so banks will still take on some risk, but the point is to encourage more loans to these companies, essentially making it less expensive for banks to get money out to these companies. 8/14

In these programs, some borrowers might default. But the Fed isn’t set up to take losses, so that’s where most of the $500B in the coronavirus package will go – Treasury helping cover losses from Fed loans. That’s the limiting factor on how much the Fed can lend. 9/14

Another way the Fed is trying to get credit to people is indirect. It’s encouraging banks to make loans and keep rates down by offering to lend the banks cash in exchange for bundled loans (auto loans, credit card loans, student loans, business loans, commercial mortgages). 10/14

As I’ve said: an underappreciated aspect of our economy is the extent to which debt is securitized. Generally, for there to be money that is available to borrow, there needs to be demand for a security containing that loan or bond. The Fed is helping bolster that demand. 11/14

Bailout funds, by the way, don’t need to be used to cover losses from these lending programs because that’s what the collateral is for. 12/14

A variation of this is what the Fed is doing to boost the $350B set aside for the SBA to back small business loans. It’s going to lend to banks and take those “PPP” loans as collateral. Some of those loans will be forgiven by the SBA, and losses will be covered by the SBA. 13/14

These aren’t the only things the Fed is doing, but hopefully it helps you understand a little better what all these multi-trillion-dollar lending programs are about. THE END. 14/14