COVID-19 bailouts: No time for Treasury secrecy

During the 2008 Great Financial Crisis (GFC), former Federal Reserve Chairman Paul Volcker expressed his unease about the Federal Reserve’s sweeping new powers, saying the role was “neither natural nor comfortable for a central bank.”

Here we are 12 years later, and the Fed, backed by the U.S. Treasury and Congress, seems quite comfortable with its even bigger arsenal of emergency powers, including more than a dozen emergency lending facilities to supplement quantitative easing, swap lines, repo operations and standard monetary policy tools.

Traditional systemic risk protections have been thrown out the window. The size and complexity of the new COVID bailout dwarfs our previous experiences with proper bailout checks and balances. With vast bailout sums already out the door, we need to play urgent catch-up to safeguard the integrity of our economic system and keep our financial overseers accountable. As Cornell University law professor Saule Omarova put it, we don’t want to see “whatever it takes” morph into “anything goes.”

The question in the minds of many market participants is whether it will be possible to monitor, track and enforce proper bailout execution and maintain public trust.

Bailout Integrity To-Do List

Admittedly, while oversight is hard, identifying where the oversight needs to be focused is easy. First, the Federal Reserve, the Small Business Administration and the Treasury need to ensure transparency regarding loan recipients, type and the amount of fiscal support received under CARES programs and Fed facilities.

Next, there needs to be the prompt empanelment of the congressional oversight committees and CARES oversight councils charged with bailout monitoring. By extension, the oversight committees will need access to additional resources and personnel to pursue the “hot spots” they identify. Finally, and perhaps most importantly, there needs to be a mechanism for prompt enforcement of violations by those distributing, administering or receiving assistance under CARES programs or Fed facilities.

Systemic Risk Lessons Learned During GFC – A Good Plan Ignored?

As the last financial disruption began to wane, the popular phrase “Never let a good crisis go to waste” was ringing in the ears of policy reformers. The new mantra was that taxpayer funded bailouts of the financial ecosystem should never again be permitted.

Recognizing these new sensitivities and limits, the Dodd-Frank Act (DFA) did its best to rebuild the systemic war chest. It took a range of systemic risk mitigation steps including: Strengthening bank capital requirements, enhancing stress rules and establishing the Orderly Liquidation Authority (OLA) and “living will” plans. It implemented the Volcker Rule to limit proprietary trading by banks and brought over-the-counter derivatives under a new regulatory framework. Dodd-Frank also introduced a range of liquidity risk-management protocols into the investment management space.

Notably, the financial services industry has spent the past decade fighting these reforms tooth and nail. The fight over the Volker Rule, which limited propriety trading by banks, was legendary. 

It was believed that in combination, these steps would soften any future blow. And, importantly, it was thought that these initiatives would restore accountability and transparency to the marketplace, instead of having the Federal Reserve and U.S. Treasury planning on the fly and picking economic winners and losers.

Unfortunately, the GFC playbook has been completely overwhelmed and over-ridden during the COVID shutdown. All the planning and systemic resiliency steps designed for a GFC-like economic crisis seem largely for naught, and we are squarely back in unknown and unchecked territory.

COVID-Style Bailouts

If nothing else, the GFC taught us that rapid action is imperative to prevent illiquidity from becoming insolvency. The Federal Reserve has quickly moved from being the lender of last resort for banks to what many feel is a lender of last resort to the entire U.S. economy. In a little over a decade, global economies have experienced two profound economic shocks, both of which have required a “whatever it takes” policy response. The latest COVID version includes nearly $500B from the U.S. Treasury to invest in Fed facilities and expands the Fed’s emergency lending authority under Section 13(3) of the Federal Reserve Act.

Relying on this little-tested provision, the Fed seems to have carte blanche to ensure systemic solvency wherever it sees the need. Between Congress and the Federal Reserve, the government has committed more than $6 trillion to sustain the U.S. economy, an astounding price tag that surpasses all economic stimulus funding since the Great Depression. This expanded authority raises myriad red flags, including regarding the Fed’s ability to create, track and enforce the rules on where the unprecedented fiscal and monetary support lands.

Accountability and Oversight

With the money spigot already flowing, the need for robust oversight is urgent. The SBA has approved more than $510 billion in PPP loans to date. But last week Treasury Secretary Steve Mnuchin stated that the administration will not disclose recipient names and loan information despite clear public expectation of transparency into how their taxpayer money is spent. This contradicts the disclosure terms of the PPP loan application, which explicitly states that such information will be “automatically released” and is subject to FOIA. Eleven news organizations have sued to obtain the records, as congressional outrage is becoming increasingly bipartisan.

The oversight protections and details of the numerous other Fed credit facilities are similarly vague and evolving. Questions abound regarding regulatory compliance oversight and conflicts management by the Fed. As an example, the third-party management agreements in the corporate bond area provide the third-party administrators with broad discretion but fail to adequately define conflicts of interest, ethical wall policies or the penalties for breaching these guidelines. 

Perhaps most concerning is the fact that oversight committees and councils intended to help ensure compliance and integrity are barely off the ground. Two months into the launch of CARES, the Congressional Oversight Commission has no chair, no subpoena power, nor the authority to oversee the PPP program.

Three inspector general members of the Pandemic Response Accountability Committee (PRAC), including the chair, were fired or replaced. And it wasn’t until this month that the Senate approved a special inspector general for the Pandemic Recovery. To underscore the dire gap in oversight, out of the four CARES-designated oversight committees, only the House Select Subcommittee on the Coronavirus Crisis is near fully operational and poised to provide independent oversight.

No Shortcuts on Bail-Out Integrity

It is important in this moment to be honest about what is happening. Systemic protection parameters and prohibitions put in place post GFC are being overridden in the name of economic emergency. The only check and balance left on institutions and activities surrounding these massive fiscal outflows is full transparency and accountability to elected congressional leaders and the public.

This is no moment for experimental or ad hoc oversight of those with unelected power.

Kurt Schacht is advocacy director at the CFA Institute and a member of the Systemic Risk Council. Karina Karakulova, policy director at the CFA Institute, contributed to this article.