Time to take a step back.
Just over a month ago, the U.S. economy looked poised for a solid 2020. Not spectacular, but a lift from 2019. Job growth was holding steady despite earlier fears that the labor supply would run dry as the unemployment rate sank below 4%. Housing markets were on an upswing and both the manufacturing and larger services sectors were on an upswing.
To be sure, we still had economic problems, largely related to inequality, but the broad macroeconomic contours looked solid. And, almost amazingly, there was no obvious bubble in the U.S. economy, no sector that had become relatively outsized as we saw in the last two recessions.
Then the pandemic broadsided the economy. No U.S. firm or employee was to blame. Their decisions had no part in creating the Covid-19 virus. The virus is, rhetorically at least, an act of God.
Nor could any individual or firm reasonably be prepared for a shock of this magnitude. In early March, it was still difficult to imagine that we could shut down the entire U.S. economy as happened elsewhere. No firm’s action could have prepared it for an event where the revenue stream literally entirely dried up overnight. No one runs a business on the assumption that that business won’t be there tomorrow. Such an assumption is ludicrous. You just simply can’t operate if you think the tail risk is in the center of the distribution.
And the pandemic isn’t just tail risk. It is far, far, left hand side tail risk.
It wasn’t the airlines’ fault for doing stock buybacks. It wasn’t the bankers’ fault for making bad or levered loans. Indeed, the banking sector is the only sector that is stress tested for a severe scenario of an 8% drop in GDP. It wasn’t the borrower’s fault for buying a house they couldn’t afford. It wasn’t your fault. It wasn’t my fault.
Look, I understand, in the finance and economics world we are used to a crisis being about us. But, this time it isn’t about us, as least not directly. This was as pure a shock to the national and global economies as one could imagine. One little tiny thing – you can’t even see it! – blew it all up overnight.
Unlike the last two cycles, the shock did not originate in the financial sector and spill over into the real economy. It originated in the real economy and spilled over into the financial sector. Neither is built to accept this level of damage. Just like I can’t blame my iPhone for shattering if I drop it from the roof of a ten-story building, I can’t blame anyone for what is happening in the economy. The phone isn’t made for that, just as the economy isn’t made to not be put to work.
From a macroeconomic perspective, there is no moral imperative to assign blame. There is no moral imperative to root out bad actors. There is no moral imperative to “punish” someone in the pursuit of “creative destruction.” In this situation, there is simply no reason to think that the activities that of 150 million people – our friends and neighbors– were just six weeks ago seriously misaligned.
The only moral imperative is holding together the economy so that those 150 million can resume their lives as quickly as possible. The only moral imperative is working to prevent another 15 million people from losing their jobs.
For the macroeconomy, it’s really not that complicated. Stop looking for someone to blame because there is no one to blame.
Somehow, you knew of course, that this had to circle around to the Federal Reserve. Thursday Federal Reserve Chairman Jerome Powell and his colleagues stepped up their efforts – yet again – to keep credit flowing in the economy. The Fed’s overall objective is blindingly simple: To not let the financial sector seize up and reverberate back into the real economy. To not repeat the mistakes of the Great Depression. To not let another 15 million people lose their jobs. To hold as much of the economy together as possible to let those newly unemployed return to work as quickly as possible.
To accomplish its objective, the Fed has been jumping over roadblocks in credit markets wherever they appear. They have in a matter of weeks rolled out every program and more that former Federal Reserve Chair Ben Bernanke worked years to develop. In this last iteration, they expanded their corporate credit facilities to accept the debt of “fallen angels,” firms that have been downgraded from investment status, and high yield ETFs. Essentially, the Fed is trying to ensure that a firm that was investment grade before the virus and it likely to be investment grade after the virus passes does not fail because they downgraded as a result of the virus. It’s about preventing a liquidity crisis from becoming a solvency crisis.
This has triggered the usual howls from the usual suspects (I won’t link to them, you know who they are and they need no more attention than they already get) complaining that the Fed just needs to let everything burn and if they don’t let everything burn then nothing is real anymore or whatever. It’s not going to happen and it shouldn’t happen. No matter how much you want this to be a story about bad debt or excessive lending or stock buybacks or whatever, it just isn’t about that. It’s about the virus.
I don’t know when, but at some point we will begin to reopen the economy. We will have to learn to live with the virus. We won’t and can’t live in the shadows forever. And when that happens, we will want as much of the pre-virus economy as possible to ramp back up. The Fed (along with fiscal policymakers of course) needs to do everything they can to make that happen. Then it will be the Fed that drops back into the shadows again. Or as Powell said today:
Our emergency measures are reserved for truly rare circumstances, such as those we face today. When the economy is well on its way back to recovery, and private markets and institutions are once again able to perform their vital functions of channeling credit and supporting economic growth, we will put these emergency tools away.
And once the panic has passed, if you think the Fed is going to save you from your bad debt decision, think again. The Fed will once again allow countless firms to fade away just as has happened over past decades. But they will come back again if needed to bail out the economy as a whole because they consequences of not doing so are so severe that you couldn’t possibly expect otherwise.