Love the blog, but I think you missed the mark describing the Fed's actions in this way. What the Fed does at the most basic level is print money. This decreases the value of money and therefore makes it cheaper to borrow (hence the drop in interest rates for Carnival). You could think of it as a subsidy to anyone who wants to borrow throughout the entire economy. But the more accurate way to think about it is as on offset to the deflation brought on by the virus.

This is standard economic theory. Due to the virus, many people are laid off and companies are losing money. Therefore, having cash on hand becomes much more important than it was a few months ago, as salaries and corporate revenues are not coming in the way they used to. Therefore, demand for cash is higher than it was before the crisis. Higher demand with the same supply leads to increased value of money (deflation). The Fed prints money (inflation) to offset this deflation and move the value of money back towards its pre-crisis level. In broad terms, you are correct that this is a tax on lenders and a subsidy to borrowers. But there was also a very sharp, unexpected tax on borrowers and subsidy to lenders when coronavirus caused deflation. This is very necessary as deflation has large, real impacts on the economy.

In addition, the Fed has publicly stated their goal to maintain inflation at 2%/year. Corporations and many individuals use this rate in their financial projections. So the covid shock, if the Fed did not offset it, would drive inflation below this rate and make many in-flight investments no longer worthwhile. This is the entire reason the Fed exists and is a very, very positive thing for the economy. You are framing it in a misleading and negative light. Like I said, in a sense you are correct when you say the Fed gives subsidies. But the Fed is not giving handouts. Carnival still borrowed the money and has to pay it back, they just did so at a lower value of money than the crisis levels- but still a HIGHER value than the pre-crisis levels. Stabilizing the value of money is this way is a good thing and I wish you had recognized this while writing your analysis

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May 2, 2020Liked by Matt Stoller

Speaking of subsidies, a bank of England economist once estimated the global TBTF subsidy to be $300 billion. Not all that bad when you consider the size of the global economy, but still, they shouldn't be receiving any subsidy..


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Totally agree, they shouldn't be receiving subsidies. Even if they are TBTF, we have bankruptcy to make sure operations aren't disrupted! If a company is insolvent, equity holders get wiped out, debt is converted into new equity, and the company continues business. No subsidy required. I hadn't heard that estimate before though, appreciate the pointer.

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"at the most basic level" is the key. The fed isn't acting in its most basic sense when it's creating SPVs in order to buy junk bonds or when it is intervening into stock and bond issuance negotiations in order to incentivize cheaper rates.

I'm not picking a bone with your presentation of "standard economic theory," but I want to emphasize that we are living in unprecedented times with regard to fed policy and I think it's important that we identify these unprecedented mechanisms.

Regarding your last graf, what do you think the chances are that the Carnival will be able to pay back its note by 2023? Ought the fed act like a bridge loan facility for the next 10 years in order to stabilize the economy?

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Agreed but it is a very similar principle. During normal operations the Fed prints money and buys T bonds. Under SPVs they may buy different assets but it works the same way, print new money and purchase assets on the market. This new demand does increase the prices of those assets which is a subsidy to the previous owners, but it is a market offer that any holder of those assets can take, not a targeted subsidy specifically helping certain actors over others.

As far as Carnival paying the loan back- total repayment by 2023 (3 years) would be $5.5B. So $1.5B profit for the lenders if paid back. If you assume a binary outcome of paid in full vs. full default, then the bank is weighing $1.5B profit against a potential $4B loss. 75% chance of payback is the break even point, so the bank calculated Carnival has at least that chance of paying it back. Obviously once you introduce partial default it gets way more complicated but the bank has lots of expertise in the this area. Regardless, the important thing in my mind is that there is no risk to the taxpayer. The bank assesses the loan and takes the risk if it can't paid back. That is no bailout, that is normal business lending.

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"A central bank announcement of intent itself provides a subsidy."

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