The Markets the Bailout Forgot

Asset managers call for the Fed to help the municipal bond and securitized credit markets.

Andrew Harrer/Bloomberg

Andrew Harrer/Bloomberg

Asset managers are calling for measures to ease liquidity problems in the municipal bond and mortgage-backed securities markets, including relaxing some banking rules and having the U.S. Federal Reserve step in.

The Fed has implemented a number of programs to support markets this month, establishing a facility to lend to money market funds and securing $10 billion from the U.S. Treasury to guard against losses. In addition to buying Treasuries, agency mortgage-backed instruments, and other securities, the Fed has also implemented the Term Asset-Backed Securities Loan Facility, or TALF, to support the flow of credit to consumers and businesses. TALF helps the new issuance market in asset-backed securities collateralized by student loans, auto loans, credit card loans, and other assets.

Still, the municipal bond market and the mortgage-backed securities markets have been overlooked, said Rob Waldner, chief strategist and head of macro research at Invesco, in an interview. Invesco manages $283.5 billion in fixed income instruments.

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Invesco argues that banking regulations put in place after the global financial crisis to prevent a repeat of the meltdown are now causing different problems in the fixed income markets.

“In 2008, it was a financial crisis because of bad lending that came due, creating a massive contraction. What’s happening this time is fundamentally different,” said Waldner. “There’s a sudden stop in economic activity and when that happens, everyone needs credit. We now have a massive shortage of credit.”


But banks can no longer provide it, Waldner said, leading to unintended consequences.

“We fixed the financial system, making sure we can’t have the kind of crisis we had before, and we’ve set the stage for this crisis,” he said. “Last time the crisis started in the financial system. This time the crisis is starting in the economy, and the financial system can’t buffer it.”

Michelle Russell-Dowe, head of securitized credit at Schroders, argued that some type of secondary market support is needed.

“Even if prices appear attractive, if you have no confidence that securities won’t be much lower the next day you’ll wait,” she said. “You need conviction. With uncertainty, you have to put such wide parameters around assumptions.”

Russell-Dowe added, “Most people have been surprised that the Fed included only new issue consumer ABS in TALF. Why that choice? We think secondary consumer ABS and triple-A MBS or triple-A CMBS should be included. These need support, given forced sales.”

Waldner emphasized that Invesco is not calling for a rollback in crisis-era banking regulations, but modifications that could help banks improve the functioning of the markets.

“Unfortunately, in our view, some of these safeguards have reduced the financial system’s flexibility to cushion credit needs and provide market intermediation when confronting an exogenous economic shock like the one we are experiencing today,” wrote the authors of an Invesco Fixed Income paper entitled “The Coronavirus ‘Sudden Stop’ Needs Credit Support.”

According to Invesco, one of the reasons the Fed has had to expand its balance sheet in crises is that banks haven’t been able to act as intermediaries in the market, forcing the Fed to act as the dealer of last resort. To increase liquidity, Invesco believes the Fed will have to reduce regulations on dealers or transact with counterparties beyond just banks and primary dealers, including asset managers and hedge funds.

“There are still areas that need help. This isn’t about credit risk, it’s about very solvent entities that are important,” Waldner said. “There are very few buyers, even for the highest-quality bonds financing things like hospitals, schools, and roads.”

Russell-Dowe said people need to realize that efforts to help consumers and main street can also affect bond holders. Relief programs on the front end are intimately tied to investors.

“There have been major calls for relief for people who have lost income and lost jobs, tenants who can’t run their businesses who may need rent relief. That puts uncertainty around cash flows that bond holders receive. So you’re asking bond holders to implicitly support that relief,” she said. “We have to be mindful about connection and compassion. These aren’t inappropriate moves. But cash flows become more uncertain. As a fiduciary, you drop your bid to build in that cushion to account for uncertainty.”