From February 11th, 2020, the stock market in the United States registered a 34% fall in the following three weeks. The GDP tumbled by a startling 34%, and within two months - from March 14 to May 9, 2020 - 31 million people were unemployed, nearly 15% of the labor force. What caused such an unexpected mayhem?

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On February 11^th, 2020, without warning, the stock market in the United States registered its first drop of the year, which culminated in a 34% fall in the following three weeks (graph 1). Concomitantly, the GDP tumbled by a startling 34% (graph 2), and within two months - from March 14 to May 9 - 31 million people were unemployed, nearly 15% of the labor force (graph 3). What caused such an unexpected mayhem? The culprit was singled out without delay: COVID-19. This gave rise to the shortest, unexplained recession.

Let's hand it to the Trump administration: the rescue operation was beautifully choregraphed and flawlessly executed. In ten days, Republican Senators managed to have Congress approve the "largest economic relief bill in U.S. history": $2.2 trillion - the figure is staggering, 10% of the 2019 gross domestic product (GDP). The Senate approved it unanimously on March 25. It was passed via a voice vote in the House the next day, and signed into law by President Donald Trump the following day (March 27). Common folks received $1,200 per person, plus $500 for each dependent. Unemployment benefits were expanded from 26 to 39 weeks with an additional $600 per week. Quite a feat! And should anyone doubt the officials' intentions, the name of the bill was meant to reassure the skeptics: The CARES Act, short for "The Coronavirus Aid, Relief, and Economic Security Act". The truth is that the package has little to do with the common folks and a lot with the stock market. The beneficiaries were the banks and the corporations, thanks to the Federal Reserve.

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By March 4^th - the last day of the stock market crash - COVID-19 had yet to kill its first victim (graph 4). Similarly, unemployment had not begun to rise by the time the crash was over (graph 5). This raises questions as to what the main driver behind the CARES Act might be, in as much as through February and March, the Federal Reserve was busy rescuing the banking sector through repurchases of Treasuries and mortgaged-back securities on the open market (graph 6). In fact, the Federal Reserve had been busy buying securities since mid-September 2019. On September 17^th, the overnight interest rate shot up to 10% at around noon-time, forcing the Federal Reserve to intervene decisively to bring it down to 5.25% by the end of the day (graph 7).

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In view of these developments, the three-month recession of the first quarter 2020 - the shortest recession ever - takes on a new coloration. It appears to be the continuation of the "repo" [1] market crash of September 2019, and explains the volumes of repurchases by the Federal Reserve since then. The quality of the names of the banking institutions, as well as the volumes they borrowed, is symptomatic of a major financial crisis. From September to December 2019, they collectively borrowed $22,644 billion [2]. In the first quarter of 2020, they borrowed $28,063 billion. Adding the two together, the total comes to $50,707 billion - over three times the amount the Federal Reserve lent to the same banking institutions during the 2008 Subprime crisis, according to the General Accounting Office [3] (graph 8 shows the names of largest borrowers from September 2019 till March 2020).

To further illustrate the unusual character of the Federal Reserve's decisions, graph 9 displays its overnight repurchases since January 2008. At the highest level during the period under consideration, they were nearly ten times greater than they were during the Subprime crisis. The financial crisis of the first quarter of 2020 is no accidental occurrence caused by an overseas virus, but a major choc due to over-extended financial institutions. The Federal Reserve knew it, and so did the administration.

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The Federal Reserve was created in 1913 to avoid a repeat of the financial crisis of 1907. Its role is to define the monetary policy, regulate the banking sector, and prevent bank runs. It's in the name of that last function that the Federal Reserve provided liquidity from September 2019 till March 2020. Banks may run out of liquidity for two reasons: either because of a banking panic or because they are bankrupt. Of course, the Federal Reserve is supposed to provide liquidity only in the first instance, not in the second. One could reasonably argue that on September 17, 2019, there has been a banking panic. However, if that situation reproduces itself over seven months, as it did from September 2019 till March 2020, one can no longer argue that this is the case. Financial institutions were not faced with a banking panic; they were essentially bankrupt.

A similar situation arose during the Subprime crisis. Some of the banks at the time were partially nationalized, as was Citigroup, which received a $45 billion capital injection from the U.S. Treasury. But they should all have been nationalized - to be privatized at a later time once they have recovered from the crisis. The amount of money provided by the Federal Reserve during the present crisis being greater than that provided during the Subprime crisis; the case for nationalization is even stronger. Capitalism is a two-way street that rewards investors for astute decisions and penalizes them for bad ones. The Federal Reserve's liquidity injection policy is a one-way street: profits accrue to the private sector while loses accrue to the public sector. It's the privatization of profits and socialization of losses.

While Congress is to be congratulated for helping the common folks, the Federal Reserve is to be blamed for rescuing poorly managed American and foreign financial institutions, such as Citigroup, Goldman Sachs, JPMorgan, Nomura, Deutsche Bank, and many others. There goes the shortest, aborted, and unexplained American recession - a recession COVID-19 had little to do with!

[1] "repo" stands for repurchase in Wall Street lingo.

[2] Source: Historical Transaction Data - FEDERAL RESERVE BANK of NEW YORK (newyorkfed.org)

[3] Opportunities Exist to Strengthen Policies and Processes for Managing Emergency Assistance. July 2011.

Authors Bio:

Former Vice President Citigroup New York (retired)
Columbia University -- Business School
Princeton University -- Woodrow Wilson School