It's a Bank’s World: The Fed’s COVID-19 Response Explained

Life has come to a halt with the onset of COVID-19 in the United States. Months of quarantining and we are just peering out of our ‘Safer at Home’ shelters — for those of us who are lucky enough to have one. Yet the imminent second lockdown seems to loom overhead as hospitalizations continue to rise, and is perhaps only days away. The government is alarmed, not by the rising deaths, but rather by the ongoing loss of economic activity. Their beloved GDP is shrinking right before their eyes. So how has the government responded to this economic crisis? The saner ones who have not opted for reopening the economy and letting the economically downtrodden head to their graves have pursued policies to keep the economy afloat. Today I seek to break down this response of the government.

To begin our exploration it is necessary to familiarize ourselves with the tools the government, particularly the Federal Reserve, has at hand. There are two methods of economic control by our government: fiscal and monetary. Fiscal involves the tax system and the active spending of the government in what is called expansionary policy. Monetary policy involves several mechanisms of controlling the money supply in the country, including:

  • Open market transactions: transactions of securities (short-term bonds) that takes or puts money in the hands of banks

  • The reserve requirement: the rate at which banks must must keep money on hand, limiting or promoting lending (generally around 10%)

  • The discount rate: the interest rate which the Fed charges on its loans, expected to correlate that of the commercial banks

Through the aforementioned methods, the government can influence the economy and maintain growth, or so the hope is. 

It must be noted that these do not take into account bailouts, a newly eminent economic policy through which the government refloats bankrupt companies and insolvent banks, or what some economists call “socialism for the top.” Though the Fed is too embarrassed to admit that this controversial action has been added to its list of mechanisms, after the 2008 crisis it seems to be an important one. Now we wait to see if a new round of bailouts will make the public responsible for the misdemeanor of the corporations once again, but until then we must revisit the currently acknowledged tools of the government.

In March of this year, the Federal Reserve dropped a bombshell decision, they came out guns blazing, every single one of them, and all at once. What I mean to say is the Fed pulled all three levers of monetary policy in March of this year.

  • They announced the purchase of at least $700 billion of Treasuries and mortgages, a continuation of quantitative easing that began in 2008 without any foreseeable end. Though it has now edged towards trillions since March put in the hands of the banks ($2.06 Trillion in 5 weeks)

  • They lowered the reserve requirement ratio to 0%, meaning the banks can lend infinitely without any guarantee of solvency, essentially eliminating any regulation of their lending

  • They dropped the interest rates to 0% overnight, allowing for banks to borrow without penalty

So how goes fiscal policy you ask? The government gave each qualifying American a measly $1,200 check while the other trillions (together totaling $2.7 Trillion thus far) went to programs distributed through (Guess who!) the banks. Programs like the Payroll Protection Program put money in the hands of the banks to distribute to small businesses to keep their employees employed and on payroll, but instead 4% of the loans accounted for 43% of the dollars (not-so-small small businesses, huh?). It should be no surprise that these corporations are the biggest customers of big banks and let's not forget, the ones who make up their portfolios in the forms of securities. Let’s expand on that.

With the economy at a virtual stand still, banks are not clueless to the gravity of the situation. They are not lending money to the average American or business owner, and this goes for both the financial and regulatory freedom they have received from monetary and fiscal policy. They are putting their money into the financial system, into securities and large corporations. Don’t be shocked that the stock market edges higher and higher as the nation hovers between 10-15% unemployment, sure to rise even higher after the Payroll Protection Program expires. The banks and the wealthy fuel the success of the financial economy while the real economy and the hoi polloi wallow in unemployment and nonexistent savings.

However, that is just the beginning of the fun for the banks. We must not forget to address the atomic bomb that the Federal Reserve dropped - the dazzling 0% reserve requirement, the nuclear weapon of monetary policy. This rate was once 20% for the first 50 years of Federal Reserve history and has been worn down to only 10% in the Fed’s relatively recent history. That was until March 15th. This new move means the banks could theoretically continue to lend ad infinitum. And who is the preferred loan recipient of the banks? The corporations. In a new era of infinite liquidity, this should scare us, perhaps more than a pandemic that we could simply end within months with face coverings (… Alas). 

In a report on the March 15th announcement by the Fed, Pam and Russ Martens of Wall Street on Parade reported, “One brave reporter on the Fed’s press conference…, which was held by telephone, asked exactly how eliminating reserves was going to help businesses and consumers. Howard Schneider of Reuters [asked], … ‘Did you get explicit agreements from [the banks] that this will go to customer finance and not something else?’ Powell made it clear that the Fed had not gotten any contractual guarantees from the banks.”

Now, we must remind ourselves, we never fixed the problem of 2008. The massive looming debt and irresponsibility of the banks has only increased since then. The situation is, in fact, very bizarre. Think of it like this: you give your child an allowance to buy school lunches for the year and they spend it on candy, so you again give your child the lunch money without even a slap on the wrist (this is the bailout). Then a week later you hand them your whole wallet to watch over! Mind you, a wallet with endless reserves. The Fed only assumes the appearance of having control over the economy, but in reality, virtually all of their policies put money in the hand of banks, the same ones who turned our economy belly up in 2008.

With a looming crisis and an endless cycle of debt, we have given banks the limitless credit card and asked them to refloat the economy and save the average American from poverty. If we are to respond realistically and adequately, it is high time we rethink economic policy itself. Or maybe, some more radical economists like Yanis Varoufakis would suggest, perhaps it is time to eliminate commercial banks altogether. Regardless, we await the next surge of the pandemic much like we await the next move of the unscrupulous government as it continues its fiscal hemorrhage and eyes the final unflipped switch: ‘Bailout.’

Written by Katia Arami, Undergraduate Economics and International Development Student


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