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How Much Is Too Much?

Our team was recently made aware of a Bloomberg opinion article by Jim Bianco discussing the Treasury’s actions and how influential they are being on the Fed. The article published on March 27th was titled The Fed’s Cure Risks Being Worse Than the Disease. The question posed to our team was “Is the Treasury taking over the Fed?” Our response is a very simple “No, the Treasury is NOT taking over the Fed.” In our opinion, there are way too many levers involved and too many people needed to solve the current problem for this to happen. We are apparently in a dire situation and the Fed is taking extreme measures, but we do not believe these extreme measures will continue indefinitely.

Some happenings:

· 30% of mortgages are at risk for default (Source: Moody’s and Bank of America)

· An exorbitant amount of people are out of work or are expected to be out of work shortly as the unemployment rate jumped to 4.4% from 3.5% in February (Source: US Bureau of Labor Statistics)

· As one example: MGM cut 60K of 69K employees in last 3 weeks (Source: CEO Bill Hornbuckle on CNBC)

· In Detroit, the 300 most senior people at ComEd (which runs the electrical grid) are holed up in a local casino hotel in order to keep the lights on, literally. The claim is that they cannot go home for fear of getting ill and the lights in the city of Detroit going out (Source: Motor City CFO during recent earnings call)

· Initial claims for unemployment insurance soared to 6.6 million for the week ending March 28, exceeding the prior week's shocking 3.3 million, and dwarfing the previous high of 695,000 in October 1982 (Source: US Bureau of Labor Statistics)

· The index of consumer sentiment dropped to 89.1 in March—its lowest level since October 2016—from 101 in February. March’s decline in sentiment was the fourth largest in nearly 50 years (Source: University of Michigan)

· The Detroit Three (Ford, GM, and Fiat Chrysler) are extending their factory shutdowns into April (and possibly beyond). They had originally planned on reopening their plants on March 30, but the remaining threat of COVID-19 is forcing the automakers to reconsider (Source: Company Press Releases)

  • During the Great Recession in 2008-09, total job losses were 8.8 million over 25 months versus a total of 10 million initial claims in just the last two weeks (Source: US Bureau of Labor Statistics)

As a result of the above examples, the speed and steepness of the declines we are seeing have, in our opinion, warranted an equally or greater (and we may need more) reaction to mitigate.

A positive example of results:

· In the last 2 weeks of March, approximately $210B of Investment Grade paper was rolled over because the market knew the Fed would help it. Because of this, we didn’t see increased defaults/risks of defaults freeze markets (Source: CreditSights)

These programs are very, very big. The $450B the Treasury will put in an SPV (special purpose vehicle) can be levered 10x, i.e. up to $4.5 trillion. The Fed is not taking over and nationalizing everything because the corporate bond markets are STILL 2.5x that amount AND debt still has a maturity on it (Source: MarketWatch).

Where have we been in the past?

11 years ago the government created 65 separate programs to help the municipal, mortgage, corporate, commercial paper, and dealer markets, and Treasury markets even invested in "shovel ready" construction projects to generate economic activity while financial market stress was worked out and policies put in place to re-start economic activity for Main Street. Since the national economy and many of the specific market sectors are larger today, the programs to support and foster healing /un-freezing are bigger.

Are there risks?

Absolutely. However, we believe the risk of doing nothing is more dire than we have seen in a long, long time. Historically, our nation has looked to its government / financial institutions for counter-cyclical activity to increase when private sector activity decreased. This time around, the problem is a health crisis and the government is fighting with what we see as an imperfect set of tools like interest rates and checks sent directly to citizens. One major goal of these stimulus efforts is to buy time for medical treatments and vaccines as they are being rapidly developed.

We believe the Fed has taken appropriate action and may continue to take more going forward. The idea here is to save the economy at all costs and not something more philosophical. We agree the cost will be large, but the US economy itself is extremely large with an estimated total wealth of $100 trillion (Source: US Federal Reserve; Brookings Institute). We must keep the economy moving because millions of people's lives depend on it.

To sum up, we view the current actions being taken by US fiscal and monetary authorities as an essential step during these extremely drastic times—the political and ideological debates can and should come down the road, but do not have a place in the current crisis. The focus now should be on fixing the problem, and we believe this is what the authorities are rightly trying to do.

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