Fed enters Biden era with clipped wings and a warning from Republicans

The Federal Reserve has lived to fight another day after its starring role in the economic relief negotiations. But its battle could get harder in the coming year.

A legislative compromise between Senate Minority Leader Chuck Schumer and Sen. Pat Toomey (R-Pa.) will limit the Fed’s ability to aid businesses, states and cities through emergency lending. In the short run, the deal heads off a political headache that the central bank would’ve faced next year anyway as Democrats pressured it to do more to help the pandemic-battered economy, while Republicans urged it to stop its lending programs entirely.

But it’s also a preview of the kind of scrutiny the Fed could face from Republicans going forward, particularly if Toomey takes the helm of the Senate Banking Committee, as the central bank looks for further ways to boost the economy.

Fed officials might no longer have to fear presidential tweets calling them “boneheads,” as President Donald Trump did last year in one of many missives mocking Chair Jerome Powell. But with millions out of work and the economic recovery beginning to falter, the stakes are much higher for the central bank to help the economy without running afoul of Congress.

How much blowback the Fed gets will depend on how quickly the economy is able to recover, which will in turn drive how aggressive Powell and former Fed Chair Janet Yellen, now nominated for Treasury secretary, feel they need to be in their economic intervention.

“This is a shot across the bow” by Republicans, said Ed Mills, Washington policy analyst at Raymond James. “All of the commentary after Yellen was selected was, ‘They know the Fed’s authority better than anybody else. They could be this dynamic duo that could do whatever it takes to support this economy.’”

“Republicans exerted their prerogative to send a warning to the Fed: The more creative you get, the more political risk you take,” he added.

The push from Senate Republicans was striking, given that the Fed has received bipartisan praise all year for its efforts to prevent a financial crisis when key debt markets began freezing up at the onset of the pandemic.

But Toomey has framed it less as a rebuke of the Fed than as an effort to head off Democratic plans to use these lending programs to “bail out” struggling businesses and municipalities. The move also comes as Democrats have urged the central bank to do more to combat climate change through its lending programs and oversight of banks, a demand that has drawn opposition from Republicans.

Historically, the Fed’s emergency powers have been about ensuring the proper functioning of markets, but as part of the CARES Act, Congress asked the central bank to step in and more directly bolster nonfinancial corporations, as well as state and local governments.

That was within its power to do without authorization, but Toomey has essentially suggested that, going forward, the Fed should ask Congress for permission to do that type of intervention. The message: The central bank should stick to its traditional role.

“Those programs were complete departures from traditional, historical, normal Fed [emergency] functions, which is why the Fed came to Congress to launch them and to fund them,” Toomey told reporters on Sunday.

“The purpose was to restore the normal functioning of the private lending and capital markets, not as a general, all-purpose fix-all for the economy,” he added. “They were remarkably successful. They achieved the results we wanted. Then, the Democrats came along and decided, now, let’s morph this into some other purpose.”

Lending programs for state and local governments and midsized businesses have both been disappointing to Democrats. The “Main Street” business program lent about $10 billion out of a total capacity of $600 billion. Similarly, the municipal program only lent to a couple of borrowers: Illinois and New York City’s transit system.

Democratic lawmakers were hoping that Yellen, assuming she is confirmed, would make the loan terms more generous; the Treasury secretary shares authority over any emergency programs undertaken by the Fed.

It’s an about-face from earlier this year when Democrats like Sen. Elizabeth Warren (D-Mass.) warned the money set aside to boost Fed lending amounted to a “slush fund” for boosting big businesses.

“You stick around D.C. long enough, all political battles come full circle,” Mills said. “This one just happened a little faster.”

“In the spring, Democrats were worried about who the Fed was going to help when [Treasury Secretary Steven] Mnuchin and Powell were setting this up,” he said. “Because of the election of Biden, now it’s Republicans who are concerned who Powell and Yellen were going to help.”

For now, the $900 billion relief bill and hopes for more should lower that kind of pressure from Democrats on the Fed, particularly since the existing programs will now definitively close after this year. The programs also only offer the prospect of more debt for businesses and states, rather than an infusion of cash that only Congress can authorize.

But if Congress is unable to pass additional stimulus next year and if the economy begins sliding back into recession, the central bank could once again be in the hot seat to find a way to loosen its new handcuffs in the relief deal, which prevents the “same” lending programs from being recreated.

The language could give the Fed and Treasury more flexibility to design different programs that help businesses and municipalities, although Republicans would likely object if they tried, suggesting the fight this month over the Fed’s emergency powers could reemerge.

Already, the office of House Financial Services Chair Maxine Waters (D-Calif.) described the compromise as allowing “substantially similar” lending programs to help small businesses, nonprofits and states.

“It’s the predicament of being at the edge of your powers,” said Sarah Binder, a political science professor at George Washington University, since the more the central bank does, the more it risks influencing who is able to borrow money and at what price. “It’s the same debates and pressures the Fed faced during the financial crisis last time. They were accused of determining winners and losers.”

“So long as the Fed remains central to the recovery — and especially with a Democrat in the White House — Republicans are likely to keep Powell in their crosshairs.”