Latest / Monetary Policy Explained with Fexingo: Central Banks, Money Supply, and Interest Rates / How Central Banks Use Credit Easing to Target Specific Markets
Transcript
- Lucas: Let's talk about credit easing. It's one of those central bank tools that sounds like a jargon sandwich—'targeted asset purchases in private credit markets'—but it really matters because it's how central banks reach beyond government bonds to unstick specific lending channels. Luna: So it's not just buying Treasuries. They're buying corporate bonds, or even ETFs? That feels like a different game from the standard QE playbook. Lucas: Exactly. And the canonical example is what the Federal Reserve did in 2020. In March of that year, the corporate bond market was freezing up. Investment-grade companies that had been able to borrow at, say, one and a half percent just days earlier suddenly couldn't issue bonds at all. The bid-ask spreads on some bond ETFs blew out to levels that signaled panic. Luna: Right, I remember that. The market for new issuance basically shut. Even solid companies like Boeing were scrambling for liquidity. Lucas: So the Fed launched two facilities. One was the Secondary Market Corporate Credit Facility, or SMCCF—that bought existing corporate bonds and bond ETFs in the secondary market. The other was the Primary Market Corporate Credit Facility, the PMCCF, which could lend directly to companies and even buy bonds at issuance. Luna: And this wasn't quantitative easing in the usual sense, right? Because QE typically targets government bonds and agency mortgage-backed securities to lower long-term rates broadly. This was much more targeted. Lucas: That's the distinction. Credit easing is about the composition of the central bank's balance sheet, not just the size. The Fed was explicitly trying to repair functioning in a specific market. They even bought shares of bond ETFs—like the iShares iBoxx Investment Grade Corporate Bond ETF, ticker l q d—which was a first. They'd never bought individual corporate bonds or ETFs before. Luna: That must have raised some eyebrows. I mean, buying an ETF means the Fed is indirectly owning hundreds of different companies' debt. How do you avoid picking winners and losers? Lucas: The Fed tried to be market-neutral. They used a broad market index approach—buying a diversified basket of bonds that matched the composition of the broad investment-grade and high-yield markets. They also capped their ownership at something like ten percent of any individual issuer's bonds. But Lina Khan and others argued that even that participation distorts prices and basically backstops the entire asset class. Luna: And did it work? The conventional wisdom is that it calmed markets almost immediately. But what about the longer-term side effects? Lucas: On impact, it worked fast. The announcement alone on March 23, 2020, sent the S&P 500 up about nine percent that day, and corporate bond spreads tightened significantly. New issuance reopened within weeks. The Fed bought about fourteen billion dollars in corporate bonds and ETFs in total—tiny compared to the nearly seven hundred billion in Treasuries and MBS they bought in the same period. But the signal was enormous. Luna: So the actual purchases were small, but the commitment changed behavior. That's the classic central bank 'credible promise' play. Lucas: Precisely. Now, the big criticism is moral hazard. If investors know the Fed will step in and buy corporate bonds whenever spreads blow out, they might take on more leverage than they otherwise would. The Fed's own internal research later found that the facilities did reduce credit risk premiums, but it's hard to disentangle that from all the other interventions happening at the same time. Luna: And there's the fiscal policy overlap question. When a central bank buys corporate bonds, it's effectively channeling credit to specific sectors. Some people argue that's a decision better left to elected officials. Lucas: That's the tension. The Fed's mandate is maximum employment and price stability, not industrial policy. But in a crisis, if the credit channel is broken, the theory is that you have to fix it to achieve your mandate. The question is where you draw the line. After 2020, the Fed kept the facilities on standby for a while but eventually let them expire. They haven't used them again—yet. Luna: Speaking of having the resources to keep doing this work—I know we usually don't do this, but I've heard from a few listeners who appreciate that we keep the show ad-free and independent. Lucas: Yeah, that's actually a good point. A small number of listeners chip in through Buy Me a Coffee—buy me a coffee dot com slash fexingo—and that support is exactly what lets us keep making these episodes without any sponsor interruptions. It's not a big ask, just a quiet nod to the people who help us stay on the air. Luna: Exactly. We're grateful for that. And it means we can keep diving into niche topics like credit easing without worrying about ad read constraints. Lucas: So back to the mechanics—one other thing worth noting is that the Fed's credit easing in 2020 also included purchases of high-yield bonds, which were previously considered too risky for central bank balance sheets. That was a major threshold crossing. Luna: Right, the 'fallen angels'—companies that were investment grade before the pandemic but got downgraded. The SMCCF was allowed to buy bonds that had been investment grade at the time of purchase, even if they were downgraded later. That was a clever way to avoid stigma. Lucas: And they also bought a small amount of high-yield ETFs from the start. The message was: we're not just backstopping the safest names, we're backstopping the market's ability to price risk at all. Luna: Other central banks have done similar things. The European Central Bank had its Corporate Sector Purchase Programme, which bought corporate bonds directly. And the Bank of Japan has been buying ETFs for years, including stock ETFs, which is even deeper into private assets. Lucas: The Bank of Japan is the extreme case. They've been buying Japanese equity ETFs since 2010, and at one point they owned a significant share of the entire Japanese stock market through those purchases. That blurs the line between monetary policy and state ownership. But credit easing as the Fed practiced it was more surgical—aimed at restoring market functioning, not permanently altering ownership structures. Luna: So if we look ahead, what's the likelihood the Fed uses credit easing again in a future downturn? Has the precedent made it more likely? Lucas: I think the precedent makes it available, but the politics have shifted. In 2020, there was bipartisan support for extraordinary measures. Now, there's more skepticism about central bank power, especially from Republicans who criticized the Fed's corporate bond buying as 'bailing out big business.' So the next time, you might see more conditions attached, or a requirement for Treasury approval—the 2020 facilities already had equity from the Treasury via the CARES Act. But the tool is in the toolkit. Whether it gets used depends on how severe the next credit freeze is. Luna: And whether the Fed can design it to avoid the perception of picking winners. That's the real challenge. Lucas: Exactly. The technical design matters, but the legitimacy question might matter more. Credit easing works as long as the public trusts that the central bank is acting in the broad interest, not propping up favored firms.