The Fed Started Buying Corporate Bonds. That Had Never Happened.
To keep credit flowing to large employers, the Federal Reserve created facilities that purchased corporate debt, including exchange traded funds holding it. It was a genuine first in the institution's history.
A New Line Crossed
Quantitative easing had always meant government backed paper. The Federal Reserve bought Treasury securities and agency mortgage backed securities, both carrying explicit or implicit government support. Corporate bonds are different. They carry the credit risk of an individual company, and buying them means the central bank is taking a view on private credit.
In spring 2020 the Fed announced facilities to do exactly that, purchasing corporate debt in the secondary market including through exchange traded funds that hold corporate bonds, and supporting new issuance in the primary market. It was the first time in its history the institution had done so.
Why Corporate Credit Was the Pressure Point
When the shutdowns began, investment grade companies faced a simple problem. Many had debt maturing within months and had planned to refinance it, which is routine. Suddenly no one wanted to buy new corporate bonds at any reasonable price. Credit spreads, the extra yield investors demand over Treasuries to hold corporate debt, widened dramatically.
A company that cannot refinance a maturing bond has to repay it from cash, and companies do not hold enough cash for that. The path from a frozen credit market to mass layoffs at otherwise healthy firms is short, and it does not run through the stock market at all.
Most people watch the stock market to judge a crisis. Professionals watch credit spreads, because that is where a liquidity problem becomes a solvency problem.
The Announcement Effect
The most studied feature of these facilities is how little they had to buy. Credit spreads began narrowing and new issuance restarted almost immediately after the announcement, well before large scale purchasing took place. The eventual purchases were modest relative to the size of the market and to the headline capacity.
The mechanism is expectations. If investors believe a buyer with unlimited capacity stands ready, the risk of being unable to sell later drops sharply, so holding becomes tolerable and selling becomes less urgent. The promise substituted for the purchase. Economists call this the announcement effect, and 2020 produced its clearest modern demonstration.
The Objections, Taken Seriously
Two criticisms deserve real weight. The first is moral hazard. If the central bank backstops corporate credit in a crisis, companies have less reason to keep conservative balance sheets, because the downside is partly socialized. Some of the firms that benefited had spent the previous decade borrowing to fund buybacks, leaving thin cushions precisely when a cushion mattered.
The second is distributional. Support flowed to large companies with access to public bond markets. Small businesses, which employ a large share of the workforce, could not issue bonds and depended on the slower and blunter Paycheck Protection Program. The tool reached whoever the plumbing already reached.
What It Changed Permanently
The lasting effect is on expectations. Investors now price corporate credit partly on a belief that the Fed will intervene in a severe enough dislocation. That belief compresses spreads in normal times, which lowers borrowing costs and also lowers the compensation investors receive for genuine credit risk.
Whether that is stabilizing or quietly destabilizing is unresolved. It makes crises shallower and may make the system more leveraged going into the next one. Both effects are real, and anyone claiming certainty about the net is overreaching.
The Bottom Line
The corporate credit facilities worked, mostly by existing. They also permanently changed what markets assume a central bank will do, and that assumption is now embedded in the price of every corporate bond.