When the Federal Reserve announced on March 23 that it would purchase eligible corporate debt, syndicated loans, and exchange-traded funds (ETFs) via a special purpose vehicle (SPV), backstopped by the Treasury, moribund markets jumped. Highly leveraged companies like Carnival, Ford, and Boeing, which were unable to obtain funds in the bond market, suddenly found themselves able to borrow at rates that discounted the true credit risks. BlackRock, which will be managing the SPV, recorded a record inflow of nearly $4 billion to its iShares iBoxx High Yield Corporate Bond ETF in April, and also attracted investors to its iShares U.S. Investment-Grade Corporate Bond ETF.
Real versus Pseudo Credit Markets
Although the Fed’s intent is to provide temporary liquidity to large U.S. firms, the promise of supporting corporate bond prices and making loans to highly leveraged companies undermines corrective market forces: real markets are supplanted by pseudo markets in which the central bank will be subsidizing distressed companies and politicizing the allocation of capital. Initially private investors may purchase more corporate debt, but if corporations use that credit to pay off existing debt, and do not invest in productive capital, losses may continue. Private investors then will have an incentive to offload their holdings to the SPV, effectively socializing those losses. Moreover, the Fed’s financing of those purchases will further expand its balance sheet and make it difficult to exit the corporate debt market without creating additional financial turmoil. Perhaps that is why the Fed has been slow to roll out the SPV.
Those who value private, free markets recognize that the Fed’s promise to revitalize corporate debt markets is, in reality, a step toward market socialism. In a dynamic market economy, private investors have many options and will take prudent risks based on expected future profits. If investors decide to buy bonds rather than stocks, they will do so only if the interest rate offered exceeds the opportunity cost of tying up their capital in one use relative to their next best alternative. With millions of investors and constantly changing circumstances, market interest rates will adjust to new information: some investors will gain, others will lose. That is the logic of the market.
Freely competitive markets ensure that relative prices reflect opportunity costs and that capital is allocated according to consumer preferences. Whenever governments or central banks interfere with that free-market process, the allocation of capital will diverge from that preferred by consumers—and there will be a loss of economic and individual freedom.
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