Extraordinary Measures the Federal Reserve Can Enact to Help Main Street

extraordinary measures fed reserve can enact covid

By PrimeRevenue • Published March 26, 2020 • 5 minute read

The Federal Reserve has extraordinary powers to support the economy in times of stress, such as those we find ourselves in now. It’s already taken action to reduce interest rates and to push liquidity into the financial markets with limited economic impact so far. Consequently, in order to really help the US economy, we would argue that now is the time for the Federal Reserve to use the full power of its authority to directly support commerce in the United States.

Many pundits and experts have pointed out the differences between the last U.S. financial crisis and now. The former was a crisis within the banking industry and traditional Federal Reserve actions could therefore help to resolve the crisis. What we’re facing today is more of a crisis of Main Street as opposed to Wall Street. Near-zero interest rates and injections of capital into the banking system – drastic (albeit conventional) measures in any other financial crisis – are unlikely to provide sufficient, immediate support for the Main Street economy.

Given the unprecedented circumstances of the COVID-19 pandemic, even more extraordinary action needs to be taken. The impact of reducing the interest rates on credit cards, mortgages and car loans will not have enough of an immediate or direct impact on economic activity to be meaningful in the short run. Nor will quantitative easing. This is where the Federal Reserve injects capital into the financial system through the purchase of financial instruments such as government securities and mortgage backed securities in order to provide extra liquidity to banks, which can then lend more. Similar to interest rate cuts, any beneficial economic impact is likely to be delayed or insufficient to keep commerce (and the economy) moving.

Certain Extraordinary Measures from the Fed Could Deliver Swift Aid to Main Street

The good news is the Federal Reserve is already undertaking some extraordinary measures – namely actions to support large commercial enterprises (as well as banks). This includes the Federal Reserve purchasing short-term corporate debt obligations (known as “commercial paper”) from commercial/industrial enterprises to help them maintain appropriate financial liquidity. The Federal Reserve has also said it will support money market mutual funds in an effort to keep these markets active.

But, while these actions will be helpful for large enterprises, they do little for the small and mid-size businesses that are the backbone of the U.S. economy. These companies are not public and many are too small to have access to bond or commercial paper markets. While they may ultimately benefit from the support provided to larger enterprises through the effect of trickle-down economics, relief may not come quickly enough.

So, what other extraordinary, fast-acting measures should be considered? One is to have Federal Reserve banks step in and purchase drafts – which is the payment instrument issued by a payer to a payee (similar to an IOU). Section 13(2) of the Federal Reserve Act grants Federal Reserve Banks the authority to discount notes, drafts and bills of exchange arising out of actual commercial transactions. This includes drafts issued for commercial purposes. The Board of Governors of the Federal Reserve System have the right to determine or define the character of the paper thus eligible for discount. These powers grant an extraordinary authority to the Federal Reserve and provides Federal Reserve banks with the ability to inject financial lubrication directly into the inner workings of commerce within the U.S. economy.

One byproduct of this measure would be increasing the effectiveness and security of supply chain finance. Supply chain finance programs, like those run by PrimeRevenue, create drafts as defined in the Federal Reserve Act to facilitate supply chain finance transactions (note: not every supply chain finance program creates drafts – some are based on the purchase of accounts receivables). Using PrimeRevenue’s supply chain finance platform, large creditworthy enterprises are able to create electronic time drafts for the payment of their suppliers, which can then be discounted for early payment to those suppliers based on the obligor’s high credit rating. The Federal Reserve banks could therefore step in and purchase these drafts from our participating banks in a secondary market in order to provide additional liquidity to these corporate supply chains, in turn easing commerce and keeping the economy moving. In times of unprecedented economic stress, this may be the only source of financing and liquidity available to many U.S. small and mid-size businesses that supply corporate giants.

It also gets in front of the issue of finite bank credit capacity and potentially higher financing costs as market turbulence unfolds. While we are not seeing capacity issues among PrimeRevenue’s participating banks that currently purchase drafts, Federal Reserve involvement in the market will assure interest rates remain low and the market remains liquid. In addition, as authorized in the Federal Reserve Act, Federal Reserve banks could choose to purchase drafts directly off of the PrimeRevenue platform, thus providing potentially billions of dollars in stimulus directly into the Main Street economy and opening up supply chain finance to areas of Main Street not traditionally served by commercial lenders and banks. Furthermore, this would give all funders participating in supply chain finance access to additional channels of liquidity.

Will the Federal Reserve Step Up to the Plate?

We have every reason to believe they will – including the fact that variations of the measures above have been already been enacted in other parts of the world. Governments in various Asian countries are stepping in to facilitate trade finance in order to support their local economies. Furthermore, the Asian Development Bank is setting up lines of credit specifically to support supply chain finance programs. In these volatile times, we suggest the Federal Reserve has an obligation to do likewise. Main Street needs help now – yesterday, really – and that will require bold action from all of us.