By Nick Timiraos 

The Federal Reserve quickly deployed a half-dozen emergency lending programs over the past two weeks to ensure cash keeps coursing through the U.S. financial system. Now, Congress wants it to go much further, approving $454 billion to reload the Fed's own ability to lend.

Washington is relying on the Fed, to an unprecedented degree in peacetime, to preserve business balance sheets after elected officials and private industry have put the economy into the equivalent of a medically induced coma to stop the spread of the coronavirus pandemic.

The economic-rescue legislation President Trump signed on Friday asks the Fed to charge headlong into credit and fiscal policy, by financing businesses, states and cities. These are areas the central bank has normally regarded as matters best left to elected officials in Congress and the White House.

"Congress is the Fed's boss and Congress has mandated them to lend to areas of the economy that they were previously uncomfortable doing," said Julia Coronado, a former Fed economist and founder of economic-advisory firm MacroPolicy Perspectives.

The Fed has essentially unlimited power to lend during a crisis so long as officials consider their loans well-secured. By providing the Treasury Department with a sizable pot of money, Congress has given the central bank more flexibility to ramp up lending because the Treasury will agree to absorb initial losses.

"This is an opportunity to leverage the unlimited balance sheet of the Fed," Sen. Pat Toomey (R., Pa.) told reporters last week. "It's totally unprecedented. We're hoping that it's a mechanism to keep business alive."

The move to entrust the Fed with more responsibility marks an about-face for both Congress and Mr. Trump, who has unsparingly criticized the central bank and the man he picked to lead it, Jerome Powell, for keeping rates too high. Ten years ago, Congress curbed the very emergency-lending authorities lawmakers are now asking the Fed to use, after popular outrage over how the central bank exercised those powers following the failures of Bear Stearns Cos. and American International Group Inc. in 2008.

The Fed's longstanding reluctance to coordinate with fiscal policy dates to an accord with the Treasury Department in 1951. It was reached after the Fed overrode the Truman administration's demands to maintain pegs that had fixed yields on Treasury securities to support the economy during and after World War II.

"There is a long history of coordination between the Fed, the administration, and Congress ending in a bad place," said Claudia Sahm, a former Fed economist now at the Washington Center for Equitable Growth, a liberal think tank. "That shows how severe the situation is."

Mr. Powell, a lawyer who worked in the Treasury Department during the George H.W. Bush administration, has worked diligently during his two years as Fed chairman to meet regularly with scores of lawmakers on both sides of the aisle.

By outsourcing more of the crisis response to the Fed, lawmakers are signaling both a vote of confidence in the central bank while potentially shielding themselves from blame for the difficult decisions that lie ahead, said Mark Spindel, a Washington-based investment manager who co-wrote a book on the Fed's historical relationship with the White House and Congress.

"To Jay's credit, he has worked extensively to forge that connective tissue with Congress, so the individual and the institution are seen as objective; in the best sense, technocratic; and independent of the hyper-partisanship" in Washington, said Mr. Spindel.

The Fed's initial response borrowed from the programs developed by former Fed Chairman Ben Bernanke, who during the 2008 financial crisis broke the seal on lending authorities the Fed hadn't employed since Great Depression.

Having exhausted those off-the-shelf tools, Mr. Powell must now devise new ones, relying on the advice of British journalist Walter Bagehot, author of an 1873 book that central bankers still use as a guide for crisis management.

"The holders of the cash reserve must be ready not only to keep it for their own liabilities, but to advance it most freely for the liabilities of others," Bagehot wrote. "They must lend to merchants, to minor bankers, to 'this man and that man,' whenever the security is good."

The Fed can't lend directly to companies but, with the approval of the Treasury secretary, it can create special facilities that extend credit. The Treasury has already kicked in $10 billion for each of five facilities, including two that will support markets for large firms' debt.

The new Treasury infusions are likely to support another facility the Fed has said it will create to lend to potentially thousands of midsize businesses, likely through the banks that can borrow directly from the Fed -- a massive operational enterprise unlike anything the central bank has done.

The central bank is also looking into ways to prevent higher borrowing costs from exacerbating strains for state and local treasuries.

The real-estate industry, meanwhile, is lobbying the Fed to extend loans to thinly capitalized nonbank mortgage companies that will face distress if loan delinquencies rise. Those firms must pay investors in mortgage bonds even if borrowers fall behind on their payments. Any failure among nonbank mortgage firms could interfere with substantial efforts to keep mortgage rates low.

"Many places in the capital markets, which support borrowing by households and businesses -- I'm talking about mortgages and car loans and things like that -- have just stopped working," said Mr. Powell in a television interview last week.

"So we can step in and replace that lending under our emergency lending powers," Mr. Powell said. "We will do that."

As these facilities are launched, officials are likely to face tricky questions about how much further to intervene in credit markets that remain in rotten shape, especially now that they will have more funds available to take losses. Existing facilities have limited lending to the highest-rated borrowers.

"Given they are constrained by how much protection they're going to get from the Treasury, the fundamental logic of limiting yourself to higher-quality assets but being able to do more is the right trade-off," said Lewis Alexander, chief U.S. economist at Nomura Securities.

"Every step you take into the riskier realm, the less you can do," Mr. Alexander said. "They have to make a choice about that."

Write to Nick Timiraos at nick.timiraos@wsj.com

(END) Dow Jones Newswires

March 29, 2020 12:42 ET (16:42 GMT)

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