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What Happens When a Policy "Bazooka" Fails?

03/19/2020 9:07 am EST

Focus: STOCKS

Mike Larson

Editor, Weiss' Safe Money Report & Under-the-Radar Stocks

The Federal Reserve has thrown the kitchen sink, so to speak and this sell-off, but hasn’t been able to turn the tide, writes Mike Larson.

During the Great Financial Crisis, before it completed broke in September with the implosion of Lehman Bros., then-Treasury Secretary Henry Paulson made a stunning declaration in July 2008.

Speaking before Congress as the government-backed mortgage giants Fannie Mae and Freddie Mac were on the verge of failing, he said not to worry. The Treasury Department had a plan, a weapon it was ready to fire to backstop them, and he said that would reassure the markets:

“If you’ve got a bazooka, and people know you’ve got it, you may not have to take it out.”

But nothing could have been further from the truth. Less than two months later, the mortgage agencies came under even more pressure – and the government was forced to bail them out. The backstop “Bazooka” ultimately totaled $187 billion.

The good news is that the moves took Fannie and Freddie off the board as victims of financial turmoil. Along with other steps taken by monetary and fiscal authorities, it helped stabilize markets, at least temporarily.

But what happens when a policymaker fires his or her “bazooka” — and it fails? If dramatic policy action is implemented, but markets keep falling apart anyway? It’s an incredibly concerning scenario – and one we may be on the verge of facing.

Think about it. On Sunday evening, March 15, the Federal Reserve fired what it considered to be a massive bazooka. After an unscheduled meeting, the Fed ...

  • Slashed its benchmark federal funds rate target by 100 basis points – or one full percentage point – to a new range of 0% to 0.25% (the low it maintained for seven years as a result of credit crisis).
  • Cut the discount rate, an emergency rate at which banks can borrow directly from the Fed, by 150 basis points to a lower level than it hit during the 2008 Great Financial Crisis.
  • Reduced the level of reserves banks are required to keep on hand, a move designed to encourage more lending. And ...
  • Re-launched “Quantitative Easing (QE)”, saying it would buy $500 billion of U.S. Treasuries and $200 billion of Mortgage Backed Securities (MBS) to stabilize the bond market.

But none of it worked to calm investor jitters. After rallying briefly, S&P 500 futures plunged to the down 5% limit. Then since stocks couldn’t manage a bounce, trading was halted again after the regular morning session began. The Dow Jones Industrial Average ultimately plunged almost 13%, the second-worst one-day decline after the Black Monday crash in 1987.

After additional market fires broke out this week, the Fed brought out even more artillery. It re-launched the so-called Commercial Paper Funding Facility (CPFF) it first introduced in the 2007-2009 crisis. The program is designed to make it easier for corporations to access short-term funding to cover near-term liquidity demands in the commercial paper market.

Then late Tuesday, it re-introduced another program called the Primary Dealer Credit Facility (PDCF). That allows 24 large financial institutions authorized to transact with the Fed to obtain short-term funding in exchange for posting collateral. That collateral can include anything from Mortgaged Backed Securities (MBS) and corporate debt securities to equities.

And of course, the Trump administration and legislators in Congress are promising an enormous amount of fiscal aid. Multi-billion-dollar bailouts for airlines. Thousand-dollar checks sent to all Americans. Cheap loans for struggling businesses. A little bit of everything is on the table here – and the price tag could come to $1 trillion or more.

All of that managed to push stocks up for a day. Yet early this morning, S&P 500 futures locked limit down again. In other words, even the enormous policy bazookas being deployed to fight the virus threat and stabilize markets aren’t working, or at least not as well as I’m sure policymakers hoped.

That speaks to a couple of things: 1) The very real, very acute, very severe economic threat posed by the virus plus the government and business reactions to it, and  2) The underlying vulnerability and fragility of the credit markets, plus the wild overvaluation in many asset markets, that existed before the virus struck.

I have faith that we will ultimately get through this crisis as a nation. We’ve faced enormous threats of all kinds in the past and endured. But as an investor, you need to continue to stay focused on capital preservation, liquidity, and safety in this turbulent time.

That more-defensive, “Safe Money” philosophy has been a cornerstone of my market approach since the first quarter of 2018, when cracks in the market’s façade first appeared. And it is even more important now, when volatility is soaring, asset markets are plunging, and the outlook is incredibly uncertain.

When might the tide change? When will it be a better time to get more aggressive with bargain hunting? I can’t say for sure.

But I will be monitoring both the incoming data and how markets behave when they reach a few key levels. Specifically, I’ll be watching whether we sink to around 18,000 on the Dow, 2,100 on the S&P 500, and 5,100 on the Nasdaq, and whether the averages find more solid footing in those support zones. Stay safe.

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