Something's Wrong: Stock Sell-Off Exposes Weak Links In Financial System
The stunning, rapid plunge in stock prices over the spreading coronavirus pandemic has understandably captured headlines for days.
But there's a parallel story that has received much less attention: the health of the underlying financial plumbing that allows banks and markets to operate smoothly.
That system, according to analysts, is now under strain.
The worry is that bankers, traders and big funds might suddenly find themselves in a cash crunch or without quick access to credit. Such a scenario could create an ugly spiral throughout the economy.
On Thursday, the Federal Reserve noticed the market jamming up and decided to step in with an infusion of cash available to banks. The New York Fed said it was injecting the money "to address the highly unusual disruptions to Treasury financing markets associated with the coronavirus outbreak."
Treasurys — U.S. government debt — are typically widely traded. They're the grease that makes the wheels of the credit and trading system function efficiently. But in recent days, the Treasury market has become brittle.
Treasurys "are the most liquid market on the planet bar none," said Gennadiy Goldberg, U.S. rates strategist for TD Securities. "When it's experiencing problems, you know something is wrong."
Normally, when there's a big stock sell-off, investors flee for the safety of U.S. Treasurys. And during the market sell-offs recently, it's exactly what has been happening.
Except on Thursday.
Goldberg said the trading system was sputtering. Dealers — the banks that buy and sell under all conditions — didn't have robust enough balance sheets to meet the demand from buyers and sellers of Treasurys.
So trading markets faltered, Goldberg said. The Fed stepped in to prevent a case of the hiccups from becoming something drastically worse.
The Fed also announced a move reminiscent of dramatic actions it took during and immediately after the financial crisis of 2008. It's called quantitative easing and it's meant to relieve the cash liquidity imbalances in the financial markets.
During the crisis, for instance, the Fed bought massive amounts of Treasury debt from banks, flooding the financial system with money.
Now, the Fed is doing something similar — though, so far, on a much smaller scale. As of Friday, it will be purchasing $60 billion in Treasury debt.
And next week, at its regular meeting, the Fed is expected to slash interest rates — perhaps by as much as a full percentage point — which would essentially bring them down to zero. The central bank already cut rates by a half point in an emergency movelast week.
All these actions are designed to support both the financial system and the broader economy from the sudden stress brought on by the coronavirus.
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