University of Washington Economic Effects of The COVID 19 Pandemic Paper Based on the materials in this module, describe three (3) activities that the Fede

University of Washington Economic Effects of The COVID 19 Pandemic Paper Based on the materials in this module, describe three (3) activities that the Federal Reserve Bank has recently engaged to address the economic effects of the Covid-19 pandemic. Describe the specific goal of each activity and the mechanism of how the activity works.Your response should be at least 5 paragraphs and use correct spelling and grammar.Two articles I put on a word doc down below. WSJ Opinion Article
The High Cost of Low Interest Rates
Irresponsible policy from the Federal Reserve made the coronavirus crisis worse than it had
to be.
By James Grant
April 1, 2020 6:38 pm ET [Click here (Links to an external site.) for online article]
——-It took a viral invasion to unmask the weakness of American finance. Distortion in the cost
of credit is the not-so-remote cause of the raging fires at which the Federal Reserve
continues to train its gushing liquidity hoses.
But the firemen are also the arsonists. It was the Fed’s suppression of borrowing costs, and its
predictable willingness to cut short Wall Street’s occasional selling squalls, that compromised
the U.S. economy’s financial integrity.
The coronavirus pandemic would have called forth a dramatic response from the central
bank in any case. Not even the most conservatively financed economy could long endure an
official order to cease and desist commercial activity. But frail corporate balance sheets and
overextended markets go far to explain the immensity of the interventions.
Perhaps never before has corporate America carried more low-grade debt in relation to its
earning power than it does today. And rarely have equity valuations topped the ones quoted
only weeks ago.
“John Bull can stand many things, but he can’t stand 2%,” said Walter Bagehot, the
Victorian-era editor of the Economist, concerning the negative side effects of a rock-bottom
cost of capital. Needing income, investors will take imprudent risks to get it. And if 2%
invites trouble, zero percent almost demands it.
Interest rates are the critical prices that measure investment risk and set the present value of
estimated future cash flows. The lower the rates, other things being equal, the higher the
prices of stocks, bonds and real estate—and the greater the risk of holding those richly priced
assets.
In 2010 the Federal Reserve set out to lift market prices through a rate-suppression program
called quantitative easing. Chairman Ben Bernanke was forthright about his intentions.
“Easier financial conditions will promote economic growth,” he wrote at the time. Lower
interest rates would make housing more affordable and business investment more desirable.
Higher stock prices would “boost consumer wealth and help increase confidence, which can
also spur spending.” The Fed commandeered investment values into the government’s
service. It seeded bull markets in the public interest.
But investment valuations don’t exist to serve a public-policy agenda. Their purpose is to
allocate capital. Distort those values and you waste not only money but also time—human
heartbeats.
Illustration: David Gothard
Like a shark, credit must keep moving. Loans fall due and must be repaid or rolled over (or,
in extremis, defaulted on). When the economy stops, as the world’s has effectively done,
lenders are likely to demand the cash that not every borrower can produce.
To resolve the devastating panic of 1825, the Bank of England rendered “every assistance in
our power,” as a director of the bank testified, “and we were not upon some occasions over
nice.”
In a still more radical vein, the Fed has set about buying (or supporting the purchase of)
commercial paper, residential mortgage-backed securities, Treasurys, investment-grade
corporate bonds, commercial mortgage-backed securities and asset-backed securities. It has
abolished bank reserve requirements. Through a new direct-lending program, the Fed has
become a kind of commercial bank.
If not for the buildup of the financial excesses of the past 10 years, fewer such monetary
kitchen sinks would likely have had to be deployed. No pandemic explains the central bank’s
massive infusions into the so-called repo market that followed this past September’s
unscripted spike in borrowing costs. For still obscure reasons, a banking system that
apparently is more than adequately capitalized was unable to meet a sudden demand for
funds on behalf of the dealers who warehouse immense portfolios of government debt.
The superabundance of Treasury securities is the spoor of America’s trillion-dollar boom-
time deficits. Persistently low interest rates have facilitated that borrowing, as they have the
growth of private-equity investing (ordinarily with lots of leverage), the rise of profitless
startups, the raft of corporate share repurchases, and the unnatural solvency of loss-making
companies that have funded themselves in the Fed’s most obliging debt markets.
For savers in general, and the managers of public pension funds in particular, lawn-level
interest rates confer no similar gains. On the contrary: To earn $50,000 in annual interest at a
5% government bond yield requires $1 million of capital; to earn the same income at a 1%
yield demands $5 million of capital. To try to circumvent that forbidding arithmetic,
income-famished investors buy stocks, junk bonds, real estate, what have you. It worked as
long as the bubble inflated.
In a bubble, performance is the name of the investment game. Over the past 10 years,
skeptics of our debt-financed prosperity have had to fall in line. To keep up with the Joneses,
fiduciaries have sought an edge in lower-quality assets. Managers of investment-grade bond
portfolios dabbled in junk bonds. Junk-bond investors slummed it in lower-rated junk or in
the kind of bank debt that is senior in name but structured without the once-standard
protective legal fine print.
Investing at positive nominal yields, Americans are still comparatively lucky. The holders of
some $10.9 trillion of yen-, euro- and Swiss franc-denominated bonds are paying for the
privilege of lending. “Investors seeking safety were prepared to face a guaranteed loss when
holding the debt to maturity,” was how the Financial Times last summer tried to explain the
nearly inexplicable.
Negative nominal bond yields are a 4,000-year first, according to Sidney Homer’s “A History
of Interest Rates,” republished for a fourth edition with co-author Richard Sylla in 2005.
Topsy-turvy investment-grade bond markets aren’t without precedent, but the extent of the
upheaval today is startling. If adversity is the test of the quality of a senior security, as oldtime doctrine held, segments of today’s corporate bonds and tradable bank loans have already
flunked. On March 20, according to S&P Global Market Intelligence, the volume of such
loans quoted below 80 cents on the dollar topped the peak distress level of 2008. While the
panic subsequently abated, many supposedly senior corporate claims are proving to be fairweather investments, not so different from common equity.
Deceived by ultralow interest rates, Americans borrow and lend in the kind of false economy
that candidate Donald Trump properly condemned in 2016. Covid-19 will sooner or later
beat a retreat. For the sake of honest prices and true values, it would be well if the central
bankers did the same.
Coronavirus Crisis Legacy: Mountains of Debt
The government and the private sector are going deeper in the hole to survive the economic
shutdown, which could be a drag on recovery if it spurs a period of thrift
by Jon Hilsenrath
April 9, 2020 11:54 am ET
—–The full impact of the coronavirus pandemic may take years to play out. But one outcome is
already clear: Government, businesses and some households will be loaded with mountains
of additional debt (Links to an external site.).
The federal government budget deficit is on track to reach a record $3.6 trillion in the fiscal
year ending Sept. 30, and $2.4 trillion the year after that, according to Goldman Sachs
estimates. Businesses are drawing down bank credit lines (Links to an external site.) and
tapping bond markets. Preliminary signs are emerging that some households are turning to
credit (Links to an external site.) for funds, too.
The debt surge is set to shape how governments and the private sector function long after the
virus is tamed. Among other things, it could be a weight on the expansion that follows.
Many economists believe low interest rates will help the nation manage the soaring debt
load. At the same time, they say high levels of private sector debt could lead to a period of
thrift, slowing the recovery if businesses and individuals try to rebuild their savings by
holding back on investment and spending.
“People and firms and government are facing a negative shock, and the classic textbook
prescription for a temporary shock is to do some borrowing to smooth that out,” says Alan
Taylor, an economist and historian at the University of California, Davis, who has studied
the economic effects of pandemics going back to the Black Death of the 14th century.
Borrowing now amounts to a transfer of economic activity from the future to the present.
The payback comes later. “You do have something to worry about in terms of the recovery
path,” Mr. Taylor said.
Past crises and buildups in U.S. government debt led to changes in the tax code and sharp
fluctuations in inflation. In the private sector, debt loads could become a dividing line
between firms that fail and those that emerge more dominant in their industries.
Because states generally run balanced budgets to avoid large debt, they are likely to dip into
rainy day funds in the weeks ahead and could turn quickly to cost cutting to keep their
budgets in line in a downturn, squeezing the economy.
Moody’s Analytics sees $90 billion to $125 billion of such cuts or tax increases coming and
says the hits will be unevenly spread around the country. New York, Michigan, West
Virginia, Louisiana, Missouri, Wyoming and North Dakota are especially vulnerable, it said.
The Federal Reserve, the nation’s central bank, will play the critical role of navigating the
nation through the rising tides of debt. It sways the cost of debt service, whether inflation
emerges and whether banks and other financial institutions can bear the burden of lending
that the nation demands.
So far the Fed is getting high marks from President Trump and many economists and
investors for moving quickly to make credit widely available, though it faces challenges and
uncertainties deciding how far to extend itself and when and how to pull back. On Thursday,
it announced more programs to support $2.3 trillion in lending (Links to an external site.).
During and after the 2007-09 financial crisis, the Fed expanded its own portfolio of securities
and other holdings from less than $800 billion to $4.5 trillion. The Fed unwound some of
that as the expansion took hold. Now, in the initial stages of the coronavirus crisis, it has
stretched its holdings from $3.8 trillion last September to $5.8 trillion as of April 1, and is on
track to increase them by trillions more in the months ahead.
“Had the Fed not come in these past few weeks, we would have had a combination of the
Great Depression and the 2008 financial crisis,” said Mohamed El-Erian, chief economic
adviser at Allianz, the Munich-based financial firm.
The U.S. government currently has $17.9 trillion in debt held by private investors and other
governments—the amount it has borrowed from others to fund its annual budget deficits.
That works out to 89% of U.S. gross domestic product, the highest since 1947. Before the
coronavirus crisis, debt and deficits were pushed higher by ramped up government spending
on military and other programs and tax cuts enacted in 2017.
Government borrowing will soar in the months ahead due to the $2 trillion economic rescue
program, higher spending on programs like unemployment insurance and an expected fall in
tax revenues amid lower incomes and corporate profits.
Mr. Trump is pushing for an additional Washington stimulus program focused on
infrastructure spending. House Speaker Nancy Pelosi said another round of stimulus could
exceed $1 trillion. That could include an expansion of small business loans and grants by
another $250 billion.
Past crises accompanied by swelling government debt led to dramatic changes in the
government’s role in economic life. Alexander Hamilton, the nation’s first Treasury
Secretary, consolidated state debts at the federal level after the Revolutionary War, one of
the nation’s first steps toward centralizing power. The vast expansion of lending from
Washington today could further increase its sway over the economy.
Abraham Lincoln’s Revenue Act of 1861 imposed import taxes and a 3% tax on high incomes
to fund the Civil War effort. An income tax created in 1913 was expanded to finance World
War I. The Treasury Department started tax withholding during World War II, when the tax
rate for high income households surged over 90%.
Mr. Trump has likened the virus crisis to another war.
“After the dust settles in the U.S. there will be arguments over who should pay for all of this
spending and absorb the burdens of the debts, which will be political arguments,” said Ray
Dalio, founder of Bridgewater Associates, the large hedge fund company.
Many economists believe that for now the U.S. can manage the surge in government
borrowing, in part because the Fed is likely to buy a lot of the debt itself.
The U.S. Treasury funds government deficits by issuing Treasury bonds. In normal times the
Fed isn’t a player in the Treasury market, but after the 2007-09 financial crisis it started
buying government bonds itself. Its “quantitative easing” program was meant to hold down
interest rates to help the recovery by reducing the supply of Treasury securities in public
hands.
With the Fed’s abrupt restart of bond buying, government debt held by the public actually
went down in March, according to Louis Crandall, an economist at Wall Street bond broker
TP ICAP. He sees the Fed’s overall portfolio reaching $10 trillion by year-end.
In theory, large scale purchases of government bonds by the Fed should cause inflation,
because it involves pumping money into the financial system in exchange for the securities.
That money eventually finds its way to households whose purchases drive consumer prices
higher.
Such price spikes did occur after World War I and World War II, and the U.S. could head for
such a repeat.
But inflation didn’t budge during or after the Fed’s purchases in the 2007-09 crisis. Despite
warnings by critics that the moves would destroy the purchasing power of dollars, inflation
has remained below the Fed’s 2% target for most of a decade. Interest rates also stayed low.
Japan, the world’s third-largest economy, offers additional evidence that inflation might not
surge. Japanese government debt is even larger than U.S. government debt, at two-times
GDP. The Bank of Japan (Links to an external site.) has been buying Japanese government
bonds for years, but inflation there has been subdued throughout.
Many economists see a repeat of those patterns now. With inflation and interest rates
expected to remain low, they see reason for the central bank and federal government to
respond aggressively to lift the economy, even if it drives government budget deficits higher.
“The much greater danger on the part of governments is that they may choose to underrespond rather than over-respond, based on a notion of fiscal rectitude that’s carried over
from a generation or two ago,” said David Wilcox, the Fed’s former chief economist.
As long as the economic growth rate returns to a level higher than the interest rate,
government debt is manageable, some economists argue.
As in Japan, the Fed was fighting deflationary headwinds before the health crisis, stemming
from an aging population that sapped consumption, and increased saving that tamped down
inflation.
The pandemic might amplify these trends. Mr. Taylor, the University of California economic
historian, said interest rates tended to remain low for years after past pandemics as businesses
and households saved to rebuild lost wealth.
Government debt has risen sharply since the 2007-09 crisis…
Households pared back their mortgage debt after the 2007-09 crisis, slowing the recovery
while they rebuilt their savings. Individual borrowing shows signs of rising now as some
households look for funds to ride out the economic storm.
Better.com, an online lender, says it has seen a 500% increase so far this year in applications
by households for mortgage refinancing that involves taking cash out of the equity held in
homes. Fed data show a modest pickup in household borrowing from bank home equity lines
in March after an extended decline following the 2007-09 crisis.
Student debt has become a heavier burden for households, and since 2007 it has tripled to
$1.5 trillion, with large exposures among young individuals, according to Fed data.
“We were talking about, when this is over, we want to downsize, maybe move into a
townhome, being way more conservative in terms of major purchases and spending and start
building savings,” Heather Schmiege, 41 years old, said of a conversation she recently had
with her husband.
Both have student loans, in addition to a mortgage and two car payments. The Tallahassee
couple makes enough with two jobs to cover the bills with a bit left over, but the crisis and
recent Florida hurricanes have made them wary of risk.
Congress, concerned that delinquencies could rise if unemployment skyrockets—as
happened after the last economic downturn—granted a reprieve for student-loan borrowers
as part of the recent economic-rescue package.
The law will allow most of the 43 million Americans with federal student loans to suspend
their monthly payments, interest free, for six months. Since the federal government is the
nation’s primary student lender, the program effectively shifts the student debt fallout from
the crisis to Washington.
Households in recent years have taken on more auto and student loan debt, while mortgage
debt, which was cut back after the 2007-09 crisis, has grown slowly…
Business debt was high and rising before the crisis, as firms took advantage of low interest
rates and steady growth. Now debt is increasing as firms scramble for funds to keep
themselves running while profits evaporate.
Issuance of investment grade corporate bonds reached $194 billion in March, $138 billion
more than the month before, according to Dealogic.
The boom in bond issues contrasts with the 2007-09 crisis, when credit dried up. In the
month after Lehman Brothers collapsed in September, 2008, for example, investment grade
bond issuance fell 72%, according to Moody’s Corp.
Businesses are also tapping bank credit lines. In the weeks between March 11 and March 25,
bank commercial industrial loans rose $365 billion, according to Fed data.
Mark Kiesel, chief investment officer of Pimco, the large bond investment firm, said he
expects many companies to respond to all of this borrowing by investing modestly after the
crisis ends and paring back dividends and share buybacks. “Priority number one is going to
be to pay down debt,” he said. “We are not expecting a V-shaped recovery. We are expecting
a U-shaped recovery.”
Debt is already proving to be a dividing line for firms racing to adjust to the crisis, and a
crucial factor in a competition of survival of the fittest. Companies that came into the crisis
highly indebted will have a harder time continuing. That line is especially stark in the
energy sector, which is being pummeled by falling oil prices. Many U.S. oil drillers face
pressure to meet hefty debt obligations they took out from banks and bondholders to make
America into the world’s largest oil and gas producer. One of them, Whiting Petroleum
Corp., filed for bankruptcy protection in late March.
“People will want to get into bankruptcy quickly in order to beat the rush,” said Buddy
Clark, a partner and co-chair of energy practice group at Haynes & Boone.
Occidental Petroleum Corp. took on tens of billions in debt to buy Anadarko Petroleum
Corp. last year, leaving its c…
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