What the Federal Reserve Is Doing and How It Affects Your Retirement

Most investors know by now that the Federal Reserve has intervened heavily in the US economy over the past several weeks. What they may not realize, however, is just how deep that intervention has become, and how that will affect their retirement.

Much of the mainstream media lauds the Fed’s intervention, seeing it as a guarantor of financial stability. But the Fed’s mandate has never been to keep financial markets stable. The Fed operates in one way: by creating or destroying money. That isn’t a panacea for what ails markets, and the side effects of monetary manipulation can be incredibly destructive.

With trillions of dollars of monetary easing already having taken place, and trillions more on the way, the value and purchasing power of the dollar will be damaged too. So, if you thought cold, hard cash will protect you through the coming crisis, think again. Only tangible assets like gold and silver will help investors make it through the recession or depression in decent shape.

Because it can be hard to keep straight everything the Fed is doing today, we’ve compiled a comprehensive list of the Fed’s actions to keep you informed about what the Fed is doing. With over a dozen interventions so far, it seems like every week brings more and more from the Fed. Without a doubt, the Fed has intervened far more deeply into the economy today than during any crisis in history, and that has profound implications for your investments and your retirement.

1. The Return of ZIRP

Everyone expected the Fed eventually to drop its target federal funds rate to zero, but no one expected the Fed to do it so quickly, nor in the manner that it did. While everyone was waiting for the next Federal Open Market Committee (FOMC) meeting in March, the Fed met in two emergency sessions – first to drop the federal funds rate by 50 basis points, then to drop it again another 100 basis points to zero.

The return of zero interest rate policy (ZIRP) so early in the cycle is worrying for a number of different reasons. For one, the Fed now has no room to maneuver with interest rate policy. With the zero lower bound having already been reached, the only way to go from here is to negative interest rate territory, something which has never been tried in the US.

We know from seeing Japan and Europe try negative interest rates that they don’t work in stimulating the economy. And pushing rates too far into negative territory can even cause economic contraction as money is pulled out of the banking system. So, the Fed has really painted itself into a corner here. If it tries to push interest rates negative, it could have disastrous consequences for the stability of the banking system.

2. Quantitative Easing – Round 4

The Fed has been engaging in quantitative easing since last fall, although it was largely stealth quantitative easing back then. It only officially started its fourth round of quantitative easing after its March 15 announcement that it would purchase at least $700 billion worth of Treasury securities and agency mortgage-backed securities (MBS). Since then, the Fed has far outstripped even that sum, with its balance sheet rising from $4.3 trillion in mid-March to $6.1 trillion today. That’s a $1.8 trillion increase (41%) in only one month.

That amount of quantitative easing is unprecedented, and there’s every indication that the Fed will continue to purchase hundreds of billions, if not trillions, more dollars over the course of the year. Many analysts are expecting the Fed’s balance sheet to rise to over $10 trillion by the end of the year, and even that seems conservative at the current growth rates. It seems that every week brings more and more Fed lending programs, with trillions more dollars of lending that will be created out of thin air.

3. Unprecedented Repo Market Intervention

Markets have shown signs of weakness for months, even before the coronavirus outbreak. Things began to get serious last September, when the Fed saw signs of weakness in overnight repurchase agreement (repo) markets and intervened to ensure that overnight funding markets stay liquid. Since then, the Fed has continued to intervene in overnight repo markets on a regular basis, pledging to provide up to $5.5 trillion in liquidity, a sum greater than the entire economic output of every country except the US and China.

4. Swap Lines With Foreign Central Banks

The Fed has had swap lines in place with foreign central banks since the 2008 financial crisis. In 2013, the Fed formalized its arrangements with the Bank of Canada, Bank of England, Bank of Japan, European Central Bank, and Swiss National Bank. These swap lines enable the central banks to provide each other with quick sources of US dollar or foreign currency liquidity in the event of strains in markets using the dollar or foreign currencies.

But on March 19, the Fed entered into new agreements with the central banks of Australia, Brazil, Denmark, South Korea, Mexico, Norway, New Zealand, and Singapore. These new agreements are US dollar swap lines, allowing the Fed to create dollars out of thin air and lend them against collateral to more foreign central banks whose markets are in need of dollar funding.

5. Dropped Reserve Requirements to Zero

One of the elements of monetary policy that central banks use to influence the amount of money created within the financial system is that of reserve requirements for banks. The current banking system is a fractional reserve system, meaning that banks only keep a fraction of their deposits on hand; the rest are loaned out. Those loaned funds are redeposited, then loaned out again, etc. In this way, a single $100 deposit can become hundreds of dollars of bank deposits, with each dollar in deposits being accepted in the economy as equivalent to $1 in cash. But it’s a very small amount of cash that actually underpins the entire sum of those bank deposits.

This is known in mainstream economics as the money multiplier. If a bank has a reserve requirement of 10%, then it can loan out up to 90% of each deposit. So, if $100 is deposited, $90 is loaned out. That $90 is re-deposited and $81 loaned out, etc. The “multiplier” is 100 divided by the reserve requirement, so that if the reserve requirement is 20%, banks can create up to $500 in deposits for every $100 initially deposited; if the reserve requirement is 10%, banks can created up to $1,000 in deposits; if the reserve requirement is 5%, banks can create up to $2,000, etc.

Normally the Fed sets reserve requirements at anywhere from 0-10%, with only very small banks being allowed to get away with not having any required reserves. But effective March 26, the Federal Reserve lowered reserve requirements to zero for all depository institutions in the US. Using the money multiplier, we divide 100 by zero and get – infinity. Yes, that’s right, US banks can now create unlimited amounts of bank deposits because they don’t have to keep anything on reserve. Wells Fargo, Bank of America, and Citigroup can all create money ad infinitum, with the Fed’s blessing.

6. Primary Market Corporate Credit Facility (PMCCF)

The PMCCF is a new facility that the Fed stood up in order to provide credit to US companies in need of financing. The intent was to provide investment-grade companies with funds by purchasing short-term debt from them rather than having those companies go to the open market, where they might have to pay higher interest rates.

However, not long after the Fed announced the creation of the PMCCF, it expanded eligibility for the facility to companies that had been investment grade before March 22, but were subsequently downgraded to junk status. That allows companies such as Ford to be eligible for the PMCCF, or perhaps other major companies that will be downgraded in the future.

It also means that for the first time ever the Fed will purchase junk bonds rather than highly-rated securities, turning the Fed into somewhat of a “bad bank” which will park billions or trillions of dollars of worthless assets on its balance sheet.

7. Secondary Market Corporate Credit Facility (SMCCF)

The SMCCF is similar to the PMCCF except that it purchases bonds on the secondary market. This allows the Fed to provide funding to holders of bonds whose bond investments may be losing value, allowing them to shore up their balance sheets. It also helps prop up the prices of bonds that otherwise would be losing value.

Just like with the PMCCF, the SMCCF is also now able to purchase junk bonds. With over $10 trillion of corporate debt outstanding, and much of it just one step above junk bond status, there was always a danger that the corporate debt bubble bursting would bring down the economy.

The major fear was that financial institutions, retirement funds, etc., that held debt downgraded to junk status would have to sell those securities in a fire sale, thus potentially freezing bond markets in addition to weakening their own balance sheets. Now holders of downgraded debt can just dump them off on the Fed.

The SMCCF also allows the Fed to purchase shares of exchange-traded funds (ETFs) that intend to provide investors with broad exposure to US corporate bonds, which now includes ETFs that invest in junk bonds.

8. Term Asset-Backed Securities Loan Facility (TALF)

TALF was one of the earliest liquidity facilities established by the Fed during the 2008 financial crisis, and it was one of the first facilities to be reestablished during this most recent crisis. TALF’s purpose is to facilitate the issuance of asset-backed securities (ABS) such as ABS backed by auto loans, student loans, and credit card debt. Between TALF, the PMCCF, and the SMCCF, the Fed is expected to extend up to $850 billion in credit.

9. Money Market Mutual Fund Liquidity Facility (MMLF)

During the 2008 crisis, the Fed created the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) to backstop money market funds after a prominent money market fund collapsed. This time around, the Fed is providing similar support to money market funds through the MMLF, taking in assets such as US Treasury securities and asset-backed commercial paper in exchange for loans. Currently the Fed has funded the MMLF to the tune of $53.8 billion.

10. Commercial Paper Funding Facility (CPFF)

The Fed will be establishing a commercial paper funding facility to ease the issuance of three-month US dollar-denominated commercial paper by US companies. No details have been issued yet about how large this credit facility might get, although it is likely to be eclipsed by other Fed operations.

11. Primary Dealer Credit Facility (PDCF)

The PDCF is another rehashed credit facility from 2008, this time intended to prop up the operations of the Fed’s primary dealers. Primary dealers are the financial institutions that partner with the Fed in its conduct of monetary policy, and that are required to participate in auctions of Treasury securities. They include Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JP Morgan, Morgan Stanley, and Wells Fargo.

Obviously the PDCF is only open to primary dealers. With primary dealers being key to the conduct of Federal Reserve monetary policy operations, the Fed wants to keep them up and running. What’s concerning, however, is that firms this big might be in need of such financial assistance. That doesn’t give anyone much confidence in the strength of the US financial system. Currently the Fed has provided $32.7 billion in loans through the PDCF.

12. FIMA Repo Facility

As if the swap lines with central banks weren’t enough, the Fed has established a repurchase agreement facility for foreign and international monetary authorities (>FIMA Repo Facility). The purpose of the facility is to allow central banks and other monetary authorities who hold US Treasury securities at the New York Fed to exchange those securities for US dollars which they can then provide to financial institutions in their home country. This broadens the number of countries that can come to the Fed for financial assistance.

13. Paycheck Protection Program Liquidity Facility (PPPLF)

One of the cornerstones of the Trump administration’s stimulus response to the coronavirus is the Paycheck Protection Program (PPP), offered through the Small Business Administration (SBA). The PPP is intended to help small businesses weather the coronavirus-related shutdowns by offering up to $350 billion in loans to businesses to cover payroll, mortgage, rent, and utility costs for up to eight weeks.

The PPPLF will lend to financial institutions who originate PPP loans, accepting the PPP loans as collateral. But because the PPP loans are forgivable loans, the Fed might eventually end up being on the hook for the entire $350 billion of the program.

14. Main Street Lending Program

The Fed recently announced a new Main Street Lending Program, offering up to $600 billion in loans to businesses with fewer than 10,000 employees or less than $2.5 billion in revenues. Further details of the program will be forthcoming.

15. Municipal Liquidity Facility

The Fed is also cooperating with the US Treasury in bailing out US municipalities, providing up to $500 billion in support to states, counties, and cities, ostensibly to help smooth over their budget problems as they battle the coronavirus.

What to Expect in the Future

If you’ve made it through all of this without your head spinning, congratulations. By the time you read this article, the Fed may very well have added more credit facilities and pledged trillions more dollars to bailing out the economy. In fact, about the only financial asset the Fed hasn’t pledged to buy is stocks, but that may only be a matter of time. And after that, the Fed might actually begin to buy real assets like real estate, machinery, etc.

For investors who worry about the value of their portfolios, the Fed’s actions have made it clear that markets will not operate without Fed intervention. No longer will the Fed allow markets to fall as market conditions periodically dictate. The Fed will do everything it can to keep that from happening.

What will end up happening, however, is that the professional investors who see the writing on the wall will sell as much of their assets to the Fed as possible, guaranteeing a return and minimizing their losses. The retail investors who believe that the Fed will keep stock markets propped up indefinitely will try to rush back in, thinking everything is perfectly fine and that the Fed will bail them out. They’ll realize – to their detriment – that the Fed won’t be able to protect them.

Losses of 50% or more, like in 2008, won’t be unreasonable to expect in today’s market by the time things are over. And unless you’ve taken steps to safeguard your assets, you could find yourself irrevocably harmed once all is said and done.