Over Fed Objections, Lending Programs Will Expire. Here's What Happens Next.

By Nick Timiraos

Treasury Secretary Steven Mnuchin and the Federal Reserve exposed a rare public rift last month when Mr. Mnuchin declined to extend several emergency lending programs put in place to repair credit markets convulsed by the coronavirus pandemic in March.

His decision to allow the programs to expire on Dec. 31 also intensified a partisan divide over the lending programs, which both parties supported as part of the $2 trillion stimulus package known as the Cares Act approved in March.

Sen. Pat Toomey (R., Pa.) said he was concerned about how a Democratic administration might change the programs while Democrats accused Mr. Mnuchin of sabotaging efforts to rehabilitate the economy and denying the Biden administration a useful economic-recovery tool.

Mr. Mnuchin may not get the last word on the matter. The Biden administration could have enough legal flexibility to restart the programs next year, according to legal analysts. These issues could receive a public airing when Mr. Mnuchin and Fed Chairman Jerome Powell testify over two days of congressional hearings beginning Tuesday.

Here's a look at the issues:

What are the emergency lending programs and how do they work?

The Federal Reserve Act allows the central bank to extend such loans by citing "unusual and exigent" circumstances. They sometimes are referred to as "13(3) loans," after the relevant section of the act.

The Fed faced blowback for how it used these loans to rescue failing financial institutions in 2008. In 2010, Congress required the Treasury secretary to approve any new emergency loan programs in the future. The Fed also collaborates with the Treasury because the central bank doesn't believe it is legally allowed to sustain capital losses on such programs.

How many emergency loan programs are there?

The Fed and Treasury launched nine loan programs in March and April. The Treasury agreed to provide money to cover loan losses in seven of them, initially using a special purse called the Exchange Stabilization Fund, created by Congress in 1934 to stabilize the value of the dollar.

At first, the lending programs this spring backed money-market mutual funds and critical funding markets on Wall Street.

A subsequent round of programs were made larger with money from the Cares Act and covered markets for corporate debt, short-term municipal securities and consumer and other debt that is packaged and bundled into securities. The Fed also said it would purchase loans made to small and midsize businesses that weren't able to benefit from these other programs, called the Main Street Lending Program.

Which programs are ending at the end of the year?

This second group of programs will end after Dec. 31.

In the Cares Act, Congress agreed to turbocharge the Fed's lending by providing $454 billion to the Treasury to cover losses, allowing the Fed to make riskier loans. Mr. Mnuchin declined to renew five lending facilities with Treasury funds made available through the act.

In April, Mr. Mnuchin approved $195 billion, or around $3 for every $7 Congress provided, for the five different lending programs -- for corporate credit, municipal debt, asset-backed securities, and the Main Street Lending Program. Those programs had purchased around $25 billion in assets through Nov. 25. Currently, they have around $102.5 billion of Treasury capital behind them to cover losses.

Why is the Treasury ending the programs?

Mr. Mnuchin says the programs are no longer needed because markets have healed. Second, he says he lacks the authority to extend the programs because he believes the Cares Act doesn't allow for them to continue. Third, Mr. Mnuchin says the money would be better spent on other relief measures for which Congress can't agree on funding.

In his Nov. 19 letter, Mr. Mnuchin asked the Fed to return all of the money that has been committed to the programs except for $25 billion, an amount equal to the sum of assets the Fed has purchased in the lending programs.

What does the Fed say? Does the central bank have to give the money back?

The Fed says that even though most of the lending programs have seen little demand because market conditions have improved substantially, the programs are providing an important source of security should conditions worsen amid rising virus cases.

In a Nov. 20 letter, Mr. Powell said he would return unspent funds. The Fed isn't legally required to do so but acting against Mr. Mnuchin's wishes would likely have provoked a political fight the Fed would prefer to avoid.

Can the next Treasury secretary restart the programs?

Yes. Establishing any emergency lending program simply requires a vote of at least five governors of the Federal Reserve Board and the approval of the Treasury secretary. President-elect Joe Biden is set to nominate former Fed Chairwoman Janet Yellen as Treasury secretary. If confirmed, Ms. Yellen could restart the programs. They would have a small amount of funding to cover losses.

Many of these programs were effective at convincing the markets the Fed could do whatever it takes because of the substantial Treasury funding made available through the Cares Act.

Can these programs be restarted using the Cares Act money?

Possibly. That will be up to how the next Treasury secretary and the department's lawyers interpret the Cares Act.

Mr. Mnuchin says the answer is no. Moreover, the Treasury says it will move the unused Cares Act funds into the general fund, an account beyond the reach of the Treasury secretary. The Cares Act says these funds can't be moved until 2026.

The Cares Act says the Treasury can't make investments in new Fed lending programs after Dec. 31, but it does say that the Treasury can use any remaining funds to modify existing investments beyond that date.

The lending programs themselves won't close. After all, Mr. Mnuchin is leaving $25 billion with them to cover losses. Whether a new Treasury secretary and a new Treasury general counsel would agree that the Fed facilities could be extended and given more funding is an open question, said Scott Alvarez, who was the Fed's general counsel from 2004 to 2017. "There is a pretty decent legal argument there" that they can, he said.

"A new Treasury could say that it can modify the existing investments in the Fed facilities," said Mr. Alvarez. "If the Treasury agrees to modify the existing investments after Dec. 31, it could reinvest some of the Cares Act money in the facilities."

The ultimate answer could be a political one more than a legal one. With Senate Republicans likely to object to reopening the programs, a new administration and the Fed would have to weigh the costs of any political fight versus the benefits of restarting the programs.

Any decision by Ms. Yellen to restart the lending programs "would more than poison the well with this administration," said Mr. Toomey on Monday. He said Congress provided tremendous discretion to the Fed and Treasury to engage in lending and he believes Congress never intended for the programs to extend beyond 2020.

If the Fed and Treasury restarted the lending programs next year, "it could be a very, very long time before a future Congress decides we ought to give any new discretion to a Treasury-Fed combination," Mr. Toomey said.

Write to Nick Timiraos at [e-mail]

(END) Dow Jones Newswires

12-01-20 0544ET