The Bailout, the Fed, and the Aftermath

“As we’ve seen in responses to other economic crises, a stark divide is showing up between buoyant sentiments in financial markets and impoverished economic conditions on the ground.”

By Robert Kuttner and cross-posted from The American Prospect.

Sarah Bloom Raskin served as a governor of the Federal Reserve from 2010 to 2014, where she championed the need to protect consumers, rein in financial abuses, and address inequality. She went on to serve as Deputy Treasury Secretary for the remainder of Obama’s second term. Raskin combines progressive values with an astute technical knowledge of both institutions. In a progressive Democratic administration, she would be on a short list to serve either as Treasury Secretary or chair of the Federal Reserve. Before being appointed to the Fed by President Obama, Raskin served as chief financial regulator of the state of Maryland. She is currently a fellow at Duke University working on financial regulation, and has also taught at Stanford and the University of Maryland. Raskin spoke with Prospect Co-Editor Robert Kuttner about issues in the CARES program and the Fed’s bailout of capital markets. This is a lightly edited transcript of their conversation.

Robert Kuttner: What concerns you about the long-term consequences of these emergency measures undertaken by the Federal Reserve and the $2.2 trillion CARES legislation once the crisis is behind us?

Sarah Bloom Raskin: We are in the midst of a massive restructuring of the economy. It might be hard to see because of the pandemic, but the actions taken by the Federal Reserve and by Congress in the CARES Act will have profound consequences for the economic landscape—both in terms of economic concentration and inequality. As we’ve seen in responses to other economic crises, a stark divide is showing up between buoyant sentiments in financial markets and impoverished economic conditions on the ground. That’s never a good formula for inclusive recovery.

The Federal Reserve is going to have a $9 trillion balance sheet, presumably by the end of the year. This is unprecedented. So we have to understand the consequences—first, in terms of this size. Has the Fed itself become a direct market participant? But also in terms of the substance of its holdings. What exactly does the $9 trillion portfolio consist of?

With the Fed’s latest decision to purchase and take as collateral new categories of risky assets—namely less than investment grade—these policies could effect a major transfer of wealth to holders of junk bonds and other risky asset classes. So there’s this initial transfer of wealth, which in extreme could look like a dumping onto the Fed’s balance sheet of risky and unsustainable debt from firms that made poor investment decisions. Are we going to think about paying for these private blunders as a necessary by-product of an otherwise prudent liquidity facility? Or is it some backdoor attempt to saddle the American people with other people’s bad assets? Or is it a new privatized bypass to the bankruptcy code?

And then there’s the question of how this huge acquisition by the Federal Reserve gets unwound. Will it be sold quickly, which could cause new disruption, but at least would indicate that the purchase was an attempt to ease a temporary market dislocation rather than provide a bailout? For assets that are not going to be sold off the Fed’s balance sheet, have they been chosen with some objective criteria related to their long-term ability to revive the economy? Think about oil and gas as an example. If the Fed buys up fossil fuel debt and holds on to it, how much is this debt likely to be worth later when the Fed decides to sell it? And then, will there be oversight over these mechanics, as also seems necessary to assure that the process isn’t corrupted and isn’t simply rewarding the politically connected? To what extent has the Fed become the cover for decisions that properly belong to elected representatives in a properly functioning democracy?

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