Response to COVID-19: Break Out the Financial Crisis Toolkit?

As stock markets plummet and economic activity in the United States is nearly brought to a halt due to COVID‑19, a natural question many are asking is:  What tools were used by the government in the last financial crisis?

Below we have provided a succinct answer to that question to assist clients as they consider what steps the U.S. government might take, or should be urged to take.  We have also highlighted the authority utilized and what new restrictions now apply to that authority, in some cases as a result of the Dodd-Frank Act.

The next questions are:  Which of those 2008 crisis tools could help us today?  And what else do we need?  Unlike the 2008 financial crisis, which stemmed from within the financial sector, today the immediate risks are posed by a pandemic that is affecting nearly all sectors of the economy.  Thousands of businesses will be unable to generate revenue in the coming weeks or months, and as businesses stop paying workers, families will lack money to buy goods and pay bills.  Therefore, it is businesses and individuals that need liquidity support in the first instance, and financial institutions may be sources and conduits for assistance, rather than the primary targets of aid. 

While today’s challenge will therefore require some measures that differ from those used in the last crisis, those tools will likely provide models to be adapted, and some 2008 crisis measures either have been or likely will be adopted in a form similar to 2008.  In the short term, the turmoil in the market is likely to unfold in some respects similarly to what we saw in 2007-2009 and require similar responses.  In the medium term, if there are widespread failures and defaults, financial institutions themselves could again be threatened.  In many cases, however, measures taken during the last financial crisis depended on authorities that either no longer exist or were curtailed through post-crisis legislation.  For example, if money market funds were to require support similar to that provided in the 2008 financial crisis, including guarantees, this may require congressional authorization.  And just as the TARP authority was used to assist the auto industry, new congressional authority will likely be required to permit the government to provide assistance to industries hardest hit in this crisis, such as the airlines.  This is particularly the case given that the Federal Reserve’s lending authority was curtailed to prevent assistance to particular institutions, as opposed to “broad-based” programs.

Aside from programmatic responses, U.S. bank regulators have begun to use their supervisory authority to provide flexibility for banks to answer client calls for liquidity.  Regulators have begun to alleviate concerns about capital and liquidity requirements, encouraging the use of  “management” buffers held above banks’ minimum capital and liquidity coverage ratios.  More could likely be done, however.  In the last crisis, quick release of temporary or interim rules added flexibility, particularly in allowing banks to lend more freely to affiliates.  Similar initiatives could be announced in this context, such as temporary lifting of lending limits or relaxation of investment grade analyses for the purchase of bonds.  Other ideas range from delaying deadlines for new credit loss accounting standards to postponing implementation of the new stress capital buffer.  

To assist our clients as events unfold and responses are considered, below is a concise outline of the measures taken so far to confront the financial impact of COVID-19 and the key 2008 financial crisis programs and restrictions on their use today.

Please click here to read the full alert memorandum.