Perhaps inside every macroeconomist is a philosopher-king trying to get out?
The most memorable official pronouncement during the financial crisis of 2008 came at a Senate Banking Committee hearing on July 15. There, Treasury Secretary Henry Paulson explained why Congress should give him essentially unlimited authority to purchase debt and equity in Fannie Mae and Freddie Mac, the two government-sponsored enterprises whose activities underpinned the struggling housing market:
If you are used to thinking about the issues, it is very intuitive, that if you have got a squirt gun in your pocket, you may have to take it out. If you have got a bazooka in your pocket and people know you have got it, you may not have to take it out. . . . I just say that by having something that is unspecified, it will increase confidence. And by increasing confidence it will greatly reduce the likelihood it will ever be used.
As it turned out, barely a month after Congress gave him the bazooka he wanted, he was yanking it out of his pocket and firing it. A month after that, the Emergency Economic Stabilization Act of 2008 gave him $700 billion intended for the purchase of “troubled assets” but also available for other uses. Under Paulson’s direction, that money would be directly injected into banks.
Same as the Old Boss
The crisis we face today is very different. Our troubles are caused by a deadly virus forcing us to shut down our economy, rather than any defect in the financial system. Instead of radical uncertainty, we are all too sure that the business shutdown aimed at arresting the spread of COVID-19 will exact a massive economic toll—probably much bigger than anything we have experienced since World War II. One might expect our crisis response to look entirely different.
And yet the Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020 is, in large part, a return to the playbook developed in the last crisis. Its $500 billion Title IV (the “Coronavirus Economic Stabilization Act of 2020”, a title that parallels the 2008 Act) relies heavily on the Treasury Secretary’s judgment to funnel loans to struggling firms, most of it through broad-based Federal Reserve lending facilities. Secretary Steven Mnuchin will be following in the footsteps of his fellow Goldman Sachs alumnus Henry Paulson, with whom he is reportedly in close contact.
To be sure, there is a lot more to the $2 trillion CARES Act than this, much of it befitting the simplicity of our current economic problem. Individuals will receive some $300 billion in cash payments, $260 billion in extra unemployment benefits, and more than $40 billion in interest-free forbearance on student loans. State and local governments (including school districts) will get around $340 billion, and various public services including hospitals around $180 billion.
Then there is the $349 billion Paycheck Protection Program to be administered by the Small Business Administration. Administrator Jovita Carranza’s agency faces an unprecedented administrative challenge in getting money (in the form of loans and loan guarantees) out the door quickly, in an attempt to entice businesses to keep employees on their payrolls for the duration of our lockdown. She will rely on banks with preexisting client relationships, but initially had trouble enlisting their cooperation at an interest rate of 0.5%. Mnuchin, apparently working closely with Carranza, subsequently announced that the rate would be increased to 1%.
Before turning to the Treasury Secretary’s pots of money under CARES, it is worth briefly noting the way he was using his discretion before the law was passed. As the seriousness of the coronavirus outbreak became clear, the Federal Reserve rapidly rebooted many of the liquidity facilities it had created in response to the 2008 financial crisis. Back then, it took years to flesh out its full alphabet-soup menagerie of programs. This time, it brought back its old familiars (PDCF, CPFF, MMLF, TALF, among others) and invented a number of new ones in a matter of weeks—a tour de force of bureaucratic aptitude.
The Fed managed this feat in part thanks to Mnuchin pledging $50 billion from the Exchange Stabilization Fund (ESF) to absorb these programs’ potential losses, thereby relieving the Fed of the credit risk that might legally constrain its ability to act. The ESF was used, with dubious legal justification but excellent practical effect, to bail out the money market industry in 2008. Congress objected and banned a repeat performance—a decision it has reversed in the CARES Act (Section 4015). During emergencies, the ESF can be used to support money markets and, we may infer, just about anything else the Treasury Secretary believes is vital to the economy’s functioning. The ESF (which totaled around $100 billion before the crisis) looks more like a general-purpose slush fund than ever before. If there has been a backlash against its use in that capacity, it has been a very quiet one.
At the Discretion of the Secretary
The money that Congress provided in Title IV of the CARES Act means that the ESF no longer has to play this role since Mnuchin now has $454 billion at his disposal to support the Fed’s facilities as he sees fit. That won’t mean a replay of the firm-specific bailouts that Paulson engineered in September 2008, because the Dodd-Frank Act altered the Fed’s emergency authority (under Section 13(3) of the Federal Reserve Act) to require only “broad-based” facilities available to all similarly situated firms. Still, that leaves the Federal Reserve’s Board of Governors, led by Chairman Jay Powell, to figure out the shape and size of these programs, as well as how much they will leverage the Treasury’s support (apparently 10-to-1). It will be the Fed that administers these programs, cementing the central bank’s position as the nation’s go-to economic defender. Powell, until now known mostly for bearing the brunt of President Trump’s criticism, has accordingly raised his profile somewhat, even giving an interview on NBC’s Today Show, in an attempt to inspire confidence.
Nevertheless, the Treasury Secretary must approve every Fed program under 13(3) and is charged by the CARES Act with the ultimate responsibility for the taxpayers’ money. Mnuchin and Powell apparently have a strong working relationship. Like Paulson and Ben Bernanke before them, they may together become the front line of the federal government’s economic response in 2020.
Economists Amit Seru and Luigi Zingales warn that this Treasury-Fed duo is poised to decimate American capitalism: “if this capital is all deployed by the Fed, and at rates that will surely crowd out private capital, all capital allocation in the U.S. in 2020 will be done by the Federal Reserve System, not by the capital market.” Congress clearly anticipated this possibility and attempted to steer away from it, putting conditions on any firms that receive “direct loans” through the Fed, including restrictions on executive compensation and a ban on stock buybacks and dividends lasting a full year after the loan is repaid. The Treasury Secretary can waive these requirements “upon a determination that such waiver is necessary to protect the interests of the Federal Government” (Section 4003(c)(3)), but this is clearly marked off as an extraordinary possibility by the requirement that the Secretary immediately make himself available to the House Finance and Senate Banking Committees after granting such a waiver. Still, although Mnuchin and Powell seem likely to design their programs so as to avoid crowding out as much as possible, it is remarkable how much is entrusted to their judgment.
Mnuchin’s discretion will be most expansive with the $46 billion provided to him to make direct loans or loan guarantees for specific firms—with $25 billion allocated to passenger airlines, $4 billion to cargo air carriers, and $17 billion for “businesses critical to maintaining national security.” Given how broadly the Trump administration has been willing to define “national security” for the purposes of trade, this last category is effectively open-ended. The one hard constraint that Democrats fought to include is a prohibition on loaning to companies owned by members of the administration or Congress.
Firms that receive such direct support must subject themselves to some exacting conditions—but the nature of these will again be at the Treasury Secretary’s discretion. The loans or guarantees can “contain such covenants, representations, warranties, and requirements (including requirements for audits) as the Secretary determines appropriate.” The interest rate must reflect the prevailing Treasury rate plus an “appropriate” adjustment for risk. Only if “the intended obligation. . . is prudently incurred” can they be eligible; at the same time, the business must be at risk of going under. In all of these cases, Congress has entrusted the operationalization of these requirements to the Treasury Secretary.
All this will leave Secretary Mnuchin as one of the most prolific dispensers of financial assistance in the history of the world. In some ways, it seems like a strange position for someone with no experience in government until 2017. But Mnuchin has been able to earn the trust of both the president (whom he has known for 15 years) and congressional Democrats, including Speaker Nancy Pelosi, who has sought him out as a negotiator. That one amazing photoshoot notwithstanding, his public manner is understated and much less susceptible to caricature than Paulson’s brusque bazooka-bragging. If Congress has decided to put its trust in Mnuchin in this moment of crisis, that may be a conscientious and reasonable choice, but it remains to be seen whether Mnuchin’s use of this immense discretion will fulfill their expectations or surprise them.
Meanwhile, Congress has made some attempts at ex post accountability. Again following the 2008 playbook, the CARES Act will create a Special Inspector General for Pandemic Recovery (Section 4018) and a five-member Bipartisan Congressional Oversight Commission (Section 4020) to carefully oversee the rapid distribution of funds—although Trump’s signing statement has alarmed some who fear that this administration may withhold information from an inspector general. In my book on the responses to the 2008 crisis, I argued that the corresponding bodies overseeing that bailout were frequently obnoxious but ultimately constructive players in preventing against and rooting out abuses.
We are in the early days of this virus-induced economic crisis right now, and so it is far too early to judge the adequacy of the Mnuchin-Powell partnership in meeting our enormous challenges. But it may not be too soon for one observation. Giving leaders extraordinary discretion in times of crisis is nothing new to the American system. Citing examples from Washington, Jackson, and Lincoln to Wilson and FDR, Clinton Rossiter persuasively argued that we (along with other western nations) have a tradition of “constitutional dictatorship.” But Rossiter, who wrote in the wake of World War II, took it for granted that presidents would fill this role.
It is remarkable how little this appears to be the case in either the last crisis when George W. Bush made himself quite scarce in the public eye—perhaps wisely given his abysmal 20-something approval rating at the time—or this one. President Trump continues to be the focal point of a great deal of media coverage (a condition that feels somehow tautological), and Mnuchin and Powell undoubtedly need to retain his support to operate effectively. But it hardly feels like they are his mere subordinates. Instead, we seem to be developing a new tradition of Treasury and Fed dominance in crises.
Given this fact, it is possible that when we look back at the Trump administration’s handling of this economic crisis, we may judge that the President’s most important actions took place years ago when he decided to appoint Mnuchin and Powell. Let us hope those come to seem like prescient choices.