The stock market crashed in March, wiping out a large part of the gains from one of the longest market booms in US history. Since then, about 40 million jobs have been lost in the country — losses that dwarf the worst months following the great financial crisis of 2008.
But in a remarkable twist, just as the pandemic was battering the lives and livelihoods of working people, the stock market has rallied. In April, it recovered about one-third of its losses in what has been its best month since the 1987 crash.
The Federal Reserve has played a pivotal role in the revival of financial markets. The Fed’s swift and extraordinary intervention in response to the pandemic is even more remarkable when we contrast it with the faltering, fumbling response of the US state to the humanitarian and public health crisis.
How is it that the Fed could act in such a far-reaching way to protect the financial system, when the response of the state on other fronts was so fatally ambivalent?
Pulling the Levers
To grasp the Federal Reserve’s distinctive role in this gathering storm, we need to understand the deep ties that weld the Fed and private finance together. Finance is not just the fuel for the engines of accumulation: it is also an expression of social relations and power.
It is hard to confine private finance to a productive role in the economy, since the quest for returns continually spurs risk-taking and speculation. When the inevitable crash comes, it upends the whole economy. The Fed holds the levers that can be pulled to prevent the financial system from running aground.
The doom loop is a useful metaphor that captures this pivotal axis between the Fed and private finance. Whenever the speculative excesses and myopia of private finance bring the system to a juddering halt, a rescue of private finance becomes imperative to ensuring the survival of the entire regime of accumulation. But if the terms of this rescue allow private finance to carry on as before, financial fragility builds up again and the speculative bets become even larger. As a consequence, the Fed has to ratchet up its support further still, since the fallout would also be much more pervasive.
If the Fed acted to ensure that the speculative, risk-taking impulses were kept in check, the inexorable growth of this doom loop could, in theory, be curtailed. But the doom loop is embedded in the growing power of finance, and the entanglement of the Fed with its obligatory intervention. And so the Fed’s regulatory reach fails to keep pace with finance as it mutates in form, constantly seeking higher returns by venturing ever further into risky, unregulated territory.
We saw this doom loop in action during the Fed’s heroic rescue of the financial system in 2008 followed by the embattled, stalled efforts to tighten regulation after the markets recovered. The same process is being played out today. But the landscape has changed since the last time the Fed was at the center of a financial storm.
In early March, we felt the first tremors of the crisis as stock markets and oil prices plummeted. However, there was a more freakish ripple effect in the market for US Treasury bonds. Normally, when the stock market bubble bursts, there is a stampede toward safe, easily traded assets like US Treasuries causing the value of those assets to rise.
But this time, a dash for cash triggered a huge sell-off of assets, which resulted in investors off-loading safer US Treasuries because they were easier to trade. This led to a sharp fall in their prices. There was an unusual collapse of both the stock market and the market for bonds.
This peculiar market behavior reflects a thirst for cash — specifically the US dollar — as the escalating panic drove investors toward safe havens. This thirst was global, since the dollar is the anchor of the world financial system. So when the market for US Treasuries jammed up, the dollar soared in value — a symptom of panic.
The Fed stepped in to quell that panic and get dollar flows moving again. It slashed interest rates to zero, and on March 16 poured cash into the financial system with an emergency purchase of about $700 billion of Treasuries.
Emergency Tool Kit
When these early interventions did nothing to calm the roiling financial markets, the Fed pulled out the emergency tool kit that was devised after the collapse of Lehman Brothers in 2008. Created specifically for this purpose, separate new facilities were employed to start buying up a wider range of assets and open a spigot of lending to avert financial free fall.
These include a facility to buy US Treasuries, and three others developed to prop up the markets for more liquid short-term assets like commercial paper, money market mutual funds, and the market for a range of assets backed up by credit card, student, and auto loans. By directly buying or lending against the collateral of assets that are becoming toxic in the market, the Fed is helping to provide a backstop, putting a floor under the crashing prices so that the jammed credit machinery can get moving again.
These interventions, while extraordinary, were essentially a reprise of the unconventional monetary arsenal the Fed had deployed during the 2008–9 crisis. At that time, the implosion of the market for subprime mortgages set off the crisis. There was a vast financial machinery based on these predatory loans through the shadow banking system.
Traditional banking is based on loans and deposits, and operates under the Fed’s regulatory ambit. The shadow banking system, in contrast, involves lending through the slicing up and repackaging of illiquid loans and risky assets — such as subprime mortgage loans — via a process of securitization and borrowing on short-term money markets. This shadow banking network draws cash from pension funds and money market institutions that are flush with funds thanks to high-net-worth individuals and corporate cash pools seeking safety, and uses it to fund the activity of investors with a high appetite for risk and yield.
The collapse of the subprime market brought this house of cards crashing down. The Fed was at the center of the storm. By launching a massive program of buying and lending against a wide range of assets, including the toxic assets that had triggered the meltdown, the Fed absorbed the risk and market panic onto its balance sheet.
These unconventional monetary policies might have helped avert another Great Depression, but they did not address the growing fault lines that have been exposed by the crisis. The proliferation of the shadow banking system is rooted in structural transformations that were set in motion in the 1980s, which exacerbated inequality and the concentration of wealth. As a result of this changing balance of class forces, a narrow corporate elite captured a rising share of revenues while working-class incomes were squeezed. The growing power of Wall Street drove this structural transformation.
When the Fed bailed out the banks to prevent a systemic collapse in 2008–9, it merely consolidated the power of finance. Four big banks — Citibank, Bank of America, JPMorgan Chase, and Goldman Sachs — emerged from the financial turmoil to dominate an even more highly concentrated banking sector.
A New Crisis
More than a decade later, the trigger for the latest financial meltdown was not the excesses of private finance but the global rampage of COVID-19. Once again, the Fed has been at the front line, battling to manage the implosion and restart the machinery of credit. This time, the scale and scope of its interventions have gone well beyond measures taken in 2008. The Fed has added more than $2 trillion to its balance sheet since March 16, increasing its total size to $6.7 trillion by the beginning of May (nearly one-third of the US GDP).
In a highly significant new foray, the Fed has entered the terrain of corporate lending, which has historically been off-limits. About $450 billion of the initial funds allocated under the $2.2 trillion CARES package has been earmarked for the US Treasury to inject capital into the Federal Reserve so that it can set up separate offshoots to provide loans and guarantees for businesses and buy corporate debt.
Each dollar in the hands of the Fed can be used to support ten times that amount in debt: that means the $450 billion could be leveraged to supply over $4 trillion, or about one-fifth of US GDP, in support for business. The capital injection by the US Treasury would provide a cushion for the risk that the Fed takes on from private finance.
The partnership between the Fed and the Treasury is blurring the line that separates fiscal and monetary policy. It also throws into sharp relief the Fed’s role as the channel through which the risks of financial fragility will be absorbed by working households.
A Wall Street Consensus
There are two prongs to this corporate bailout. The first is the Main Street Lending Program that is intended to support midsize businesses — those with up to 10,000 employees and less than $2.5 billion in revenue — by buying 95 percent of the value of bank loans. The aim is to prop up loans of between $1 million and $25 million, amounting to a total of $600 billion across the banking system.
While the bailout plan has yet to specify the exact terms and conditions of the loans, it does acknowledge the need to prevent firms from using the funds for dividend payouts, share buybacks, or CEO compensation; and the requisite for a commitment to preserve the jobs and salaries of their workers. However, the authorities have already relaxed the eligibility criteria for these loans, which allows for riskier companies to be included, and watered down the pledge to maintain employment, so that a “good faith” effort to do so, successful or not, will suffice.
In a far-reaching new initiative, the Fed has set up two new facilities to buy up to $750 billion of newly issued corporate and secondary market bonds, including exchange-traded fund (ETF) shares. With this measure, the Fed has ushered in a new era of central bank policy by intervening directly in the buying and selling of corporate debt.
By April, the Fed had extended the scope of these facilities to include not just the lowest rung of investment-grade bonds, but even the riskiest junk bonds. In 2008–9, the Fed stepped beyond its traditional role as a backstop to the financial system to embrace the world of shadow banking. Now it is going further still to support the flailing market for corporate debt.
This momentous shift explicitly recognizes that even nonfinancial corporations in the United States are deeply embedded in financial accumulation channels. It also reflects the power of finance manifested in the pervasive control that big banks and asset managers exercise over nonfinancial corporations.
The significance of this move becomes clearer when we see it in the context of profound changes that have been underway in the sphere of finance since the 2008 crisis. Some of the new regulations that were put in place afterward, under the Basel III standards and the Dodd-Frank Act, have imposed a heavier burden on the big banks, which have to maintain larger reserves and keep high-quality liquid assets on their books. But finance has a way of seeking out loopholes to breach regulatory frameworks.
The post-crisis financial terrain was characterized by the growing power and sway of asset-management funds, ushering in what some observers have dubbed the age of asset management. Asset managers control financial assets on behalf of investors. Unlike banks, they do not hold deposits or engage in trading on their own behalf.
As “agents” of the investors, the asset managers don’t keep the risks that accompany their investment strategies on their own books. They have, therefore, been able to claim exemption from the new rules that require banks to maintain capital and cash buffers. Asset management seized the opportunity to prosper in the new environment after 2008, and by 2019, asset-management funds had swollen to about $74 trillion globally.
The Big Three
The sphere of asset management is also highly concentrated. Three groups, referred to as the Big Three — BlackRock, Vanguard, and State Street — control the major share of the assets. These groups oversaw about $13 trillion in 2019, and have captured an increasing share of funds flowing into the sector. They have ownership stakes in big banks like Citibank, Bank of America, and JPMorgan Chase.
BlackRock, Vanguard, and State Street hold about one-fifth of shares in the top 500 companies on the US stock exchange, and they rank among the top shareholders in most of these corporations. These funds also have significant stakes in Big Tech, airlines, hospitals, and pharmacies. Common ownership and concentration of holdings among the Big Three means that they can determine who is on the executive board of companies and shape company policies on everything from executive pay to strategies for dealing with environmental goals.
The influence that finance now exerts over industry and the corporate sphere goes beyond the power exercised by big banks through shareholdings and interlocking directorship. Asset managers have penetrated the web of controls and, in so doing, recast the rules and conventions of corporate governance. This can take place either through private meetings with executive board members, or more indirectly by using their influence over management practices and objectives.
Evolving from their position as scrappy outsiders, the leading asset managers have now come to occupy a place in the inner sanctum of financial power.
Too Big to Regulate
The asset groups showed their clout by successfully campaigning to avoid the “too big to fail” label and its accompanying regulatory burden, in spite of their pervasive role in the financial markets. BlackRock’s aggressive initiatives — a mix of lobbying, campaign contributions, and networking — were key to this success. BlackRock became the world’s largest asset manager after its acquisition of Barclays Global Investors in 2009. By the end of last year, it had become a $7.4 trillion behemoth, having trebled in size over the previous decade. BlackRock has also forged deep connections to Washington’s political class, following in the footsteps of banks like Goldman Sachs.
By dodging the rules and regulations that banks have to follow, the big asset managers have clawed their way to dominance. Investors have turned away from active investment strategies where the asset managers try to beat the market by picking winners and losers, and opt instead for passive strategies that track a cluster of bonds or equities, usually through a financial index like the S&P 500. Passive funds, sold on the promise that risks and fees will be lower, have gone from occupying a small niche of the asset-management sphere before the 2008 crisis to account for more than half of that sphere by 2019.
Passive asset managers may not follow the cutthroat, myopic approach of private equity and hedge funds, but their industry-wide stakes have reshaped the contours of global finance. By concentrating control over investment portfolios in just a few hands, they have greatly increased the likely fallout from any disruption to markets. The strategies of these managers are therefore not immune to the inherent instability of finance.
Potential sources of instability include the size and scale of their operations, the herding effect of their approach to investment, the ease with which panic can spread across markets, and the risk that the machinery will jam if investors pull their money out. The Financial Stability Oversight Council (FSOC), the federal body set up after 2008 to monitor risks to the system, commissioned a report that pointed out many of these vulnerabilities. In spite of this and other warnings, the FSOC ultimately declared asset managers to be exempt from the “too big to fail” regulatory framework.
Cracks in the Structure
The first cracks in this structure engulfed a new frontier of the industry — exchange-traded funds (ETFs). ETFs are passive funds, but with the additional wrinkle that shares can be traded throughout the day. They allow investors to dip into markets for more thinly traded assets like corporate bonds by trading ETF shares that track a bond index. Dealers who keep the market supplied with ETF shares make their money from small deviations in the value of the share from that of the asset being tracked. This is supposed to bring the values back in line with one another.
ETFs tracking both bonds and equities grew to about $6.4 trillion by the end of 2019, riding on promises of transparency, low risk, and low volatility. But risk in financial markets can never be banished completely. It seeks out the weakest link in the chain of finance. That link turned out to be the market for corporate debt.
Fueled by low interest rates and the Fed’s permissive monetary-policy regime since 2008, US nonfinancial corporations have gorged on debt. The Bank for International Settlements and the International Monetary Fund (IMF) have been expressing alarm about the fragility of corporate balance sheets. Corporate debt in the United States reached $10 trillion — nearly half of US GDP — in 2019. The marketable component (bonds and other securities) of corporate debt had risen to about $6.5 trillion. So corporations are more and more reliant on capital markets for funding.
But evidence of corporate vulnerability has also been growing. By 2015, the ratio of corporate debt to earnings, a sign of fragility, had soared past its last peak in the early 2000s. The share of riskier bonds has grown from 18 percent in 2010 to 45 percent in 2019. The market for leveraged loans has nearly doubled in volume since 2009, reaching $1 trillion last year. These loans are the corporate analog of subprime mortgages used to fund indebted companies with the lowest credit ratings that struggle to issue even junk bonds.
In February, Macy’s and Heinz joined the ranks of so-called “fallen angels” — companies that have been downgraded to junk debt status. “Zombie firms” that are unable to cover their debt-service obligations with operational earnings are stalking the corporate landscape alongside these fallen angels. While the nonfinancial sector descended deeper and deeper into debt, it has also been using this debt to promote financial accumulation rather than build up productive capacity. These companies have used the bulk of this debt to fund payouts to shareholders, stock buybacks, and a flurry of mergers and acquisitions. The growing corporate bond market rests on shifting sands.
The buildup of low-quality, riskier debt in the portfolios of mutual funds and other institutional investors eventually triggered a wave of fire sales. The panic spread to the ETFs, resulting in a stampede to exit the market.
The tremors in the ETF sector reverberated through the financial system, including the market for US Treasury bonds, as asset managers joined the rush to sell US Treasuries that were no longer considered safe. The Big Three asset management funds have shed about $2.8 trillion of their assets since January. BlackRock alone lost about $1.4 trillion, and its profits fell by 23 percent in the first three months of this year.
The context for the Fed’s extraordinary incursion into the market for corporate bonds and ETF shares was due to the profit-seeking actions of private dealers who weren’t able to keep trades moving through the market. Having already taken the debt of the banking system and its shadow auxiliary onto its books in 2008, the Fed is now starting to absorb corporate debt in order to keep these markets from stalling. The mere announcement of this backstop contributed to the rebound of the market for junk debt. In April, US companies sold about $32 billion of their junk bonds, a monthly high for the past three years.
But there’s another striking aspect to this unprecedented entry into the market for corporate debt. Having established a special entity whose task is to buy corporate bonds and ETFs, the Fed has handed control over corporate debt to BlackRock’s consultancy arm. To put it simply, BlackRock has become a key player in the market with a clear conflict of interest.
The Fed had already tapped BlackRock in 2008 to manage the assets of Bear Stearns and American International Group (AIG). Since then, the company has built up a formidable network of political connections and financial heft. Its history and now-pervasive presence in the corporate debt market have solidified its position as the Fed’s partner.
The share value of BlackRock’s signature investment-grade bond ETF, LQD, usually stays within fifty cents of the value of the tracked basket of bonds. But it had dropped to more than $6 below that value by the middle of March this year. LQD shares then shot up to a high of $5 above its asset value the day after the announcement. About $1.5 billion poured into BlackRock’s ETF funds, with the assurance of $2.3 million in fees for the company.
Breaking the Loop
Observers have compared the power now exercised by asset managers like BlackRock, Vanguard, and State Street to that of financiers like J. P. Morgan and John D. Rockefeller in the early twentieth century. That was another era marked by corporate mergers and acquisitions, with a select cabal of financiers — a money trust — controlling industry. We can go back even further for parallels, to nineteenth-century England, where two major financiers, Barings and the Rothschilds, dominated the international market for sovereign bonds.
However, the concentration of power and wealth in the hands of the new financial titans, the extent of their influence, and the deep implication of the Fed in the imperatives of big finance go way beyond anything that we’ve seen before. The Fed’s extraordinary interventions may have forced the broken wheels of cash and credit into motion again, but the discrepancy between the financial rebound and the persistent growth of joblessness should serve as a warning that finance is tightening its grip even more firmly in the wake of the pandemic.
Twenty-seven asset manager groups, led by three megafirms, now manage 61 percent of the industry’s funds. Banks and asset managers have launched an offensive, demanding that the authorities rewrite the rules in their favor, claiming that the pandemic has imposed an onerous burden on their business.
Private finance and the Federal Reserve are locked together in a doom loop. It can only be broken if the balance of power shifts to curb the dominant position of finance and the Fed’s subordination to its needs. Working-class and progressive movements must pay close attention to the far-reaching consequences of the Fed’s recent policy innovations and push forward with campaigns and initiatives to make the Fed independent of big finance.