RE: Stop the Federal Reserve from “Leveraging” CARES Funds to Buy Corporate Bonds from Investors

Dear Esteemed Members of Congress:

We, the undersigned citizens of the United States, petition you to exercise the oversight authority of Congress to investigate and prevent the illegal abuse of public funds by the Federal Reserve. These actions violate existing law, bypass Congressional spending authority, shift the risk of corporate losses from private investors to the public - in an amount that is ten times what was intended by Congress, amplify financial speculation, widen income disparities, and provide neither direct benefit nor the assurance of indirect benefit to U.S. companies, their employees, or the U.S. economy.

Put simply, nothing in the Federal Reserve Act nor the CARES Act allows the Fed to buy unbacked corporate securities from investors by creating money - in amounts that vastly exceed CARES funds budgeted by Congress and allocated by Treasury. Nor may the Fed create money to make loans or to acquire corporate securities, without also taking enough collateral to fully prevent losses to the public.

Legal Background:

Congress provides $500 billion of public funds in Section 4003 of the CARES Act “to provide liquidity to eligible businesses, States and municipalities related to losses incurred as a result of coronavirus.” Specific uses of these funds may include programs or facilities established by the Federal Reserve to lend directly to businesses, States and municipalities; to purchase their obligations in the secondary markets; and to make loans or advances secured by collateral. 

“For the avoidance of doubt,” CARES Section 4003(c)(3)(B) also requires these programs and facilities to obey the provisions of Section 13(3) of the Federal Reserve Act, “including requirements relating to loan collateralization, taxpayer protection, and borrower solvency.”

Because Congress is the only branch of government with spending authority under the U.S. Constitution, the Federal Reserve Act is carefully written to prevent actions by the Federal Reserve that would amount to fiscal policy. So, for example, Section 14 requires bonds purchased by the Federal Reserve to be “fully guaranteed as to principal and interest” by the U.S. government, a U.S. government agency, or a foreign government. Likewise, Section 13(2) prohibits the Fed from making loans for the purpose of carrying financial securities, “except bonds and notes of the government of the United States.” The emergency lending powers of the Federal Reserve in Section 13(3) also impose collateral requirements “that the security for emergency loans is sufficient to protect taxpayers from losses.”

All of these provisions have a consistent intent: to ensure that Federal Reserve actions, including security purchases and emergency loans, do not risk potential losses to the public. If this were not true, the transactions that produced the loss would amount to a grant or expense of public funds by the Fed without Congressional authority. Under the Federal Reserve Act, every dollar created by the Fed must be backed by either gold, a security that is government guaranteed as to principal and interest, or a pledge of collateral sufficient to avoid public loss. Creating dollars without such backing is akin to counterfeiting. 

Yet the Federal Reserve has chosen to violate both the provisions of 13(3) and the provisions of CARES 4003(c)(3)(B) by creating a “Secondary Market Corporate Credit Facility” (SMCCF) for the specific purpose of carrying corporate bonds, including junk bonds at elevated risk of default, without requiring any collateral except the bonds themselves. Moreover, the Fed has announced plans to “leverage” CARES funds provided by Congress by as much as ten-to-one in order to engage in purchases of corporate bonds from private investors. The Federal Reserve does this by literally creating money beyond the amount allocated by Congress.

These “secondary market” purchases are not even loans to corporations. Rather, the Fed is purchasing existing corporate securities from private investors, using public funds in an amount as much as ten times what was allocated by Congress. These purchases shift the risk of these securities onto the public. Rather than requiring collateral “sufficient to protect taxpayers from losses,” the Federal Reserve is essentially asserting that the bonds are their own collateral.

Each dollar spent by the U.S. government is a grant of purchasing power to the individual that receives it. While Congress is vested with the authority to make spending decisions, the Federal Reserve is not. By “leveraging” CARES funds to purchase corporate bonds, without requiring collateral sufficient to prevent public losses, the Federal Reserve has established itself as a spending authority independent of Congress.

Economic Effect:

It is not simply the illegality of Federal Reserve policy that concerns us, but also potential economic and financial damage and inequity that may result. Specifically, we view the actions of the Federal Reserve as contributing to the following risks:

The Federal Reserve’s intent to illegally “leverage” public funds to buy existing corporate bonds from individuals, corporations, and hedge funds exacerbates already profound wealth disparities. 

Emphatically, these funds do not go to the companies that issued the bonds. When the Fed buys bonds on the “secondary” market, the funds go to the investors that previously held those already-issued bonds. While the actions of the Federal Reserve have helped to drive bond prices to record highs, they do little to provide funds to companies that are suffering economic hardship, except to inspire a general belief among investors that the Fed will prevent or absorb their losses.

The current policy both depresses interest rates and convinces investors that the Federal Reserve will provide a public backstop against losses. As a result, the Fed encourages excessive borrowing while also encouraging investors to extend their risk-taking. This is precisely the same behavior that fueled the 2005-2007 mortgage bubble and subsequent global financial crisis, which ultimately collapsed at the cost of millions of jobs and years of economic difficulty.

The current policy misallocates capital and stifles productivity. Projects that are only worth initiating at near-zero interest rates are also projects that are likely to generate near-zero returns. The main projects that are encouraged are those involving financial speculation, where interest is the primary cost of doing business and high levels of borrowing are required. As capital flows to speculative and unproductive projects, economic growth and innovation are suppressed.

The ultimate result of the current Federal Reserve policy is to shift risk onto the public, without sufficient collateral to avoid loss, with ten times the exposure to corporate default risk that Congress intended when it provided funds through the CARES Act. Meanwhile, there is no assurance that the funds used to buy existing bonds from investors will be used for the benefit of those companies, their employees, or even the U.S. economy. 

For these reasons, we request:

A.   That the Federal Reserve be expressly prohibited from “leveraging” public funds provided by the U.S. Treasury under Section 4003 of the CARES Act;

B.   That the Federal Reserve shall be expressly prohibited from illegally treating uncollateralized corporate securities as if they were their own collateral, and;

C.   That even the use of CARES funds provided to the Federal Reserve by the U.S. Treasury shall conform to the requirements of Section 4003(c)(3)(B), “including requirements relating to loan collateralization, taxpayer protection, and borrower solvency.”

We recognize that amid the current epidemic, Congressional support for the U.S. economy is critical. While we believe that it is essential to support basic family incomes, employment, incentives for productive investment, and properly structured programs that benefit those who have suffered actual economic losses, we do not believe that shifting corporate risk from private investors to the public by illegally “leveraging” Congressionally-approved funds is an effective or appropriate means to that end.

Thank you,

Jonathan Ferry, John P. Hussman (co-authors), and the undersigned citizens of the United States