Credit Markets and the Visible Hand

When: 20 Jun 2022, 14:15-15:30
Where: HoF 3.45 + online
Speaker: Peter Conti-Brown

Hybrid event.

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Meeting ID: 663 7191 4697


This Article joins a growing conversation about the appropriate role for government in the credit markets. Although the government, through the US Federal Reserve, has edged in this direction, the Fed continues to cling to ist traditional roles in conducting conventional monetary policy and, in the face of crisis, sprinting toward the politically costly provision of lender-of-last resort interventions. We argue that th e Fed should take on a new role that would moderate its need to break the glass on its emergency powers, even as it extends its reach in the face of econ omic disruption. That new role is to channel credit policy in the event of disruption in the proper functioning of the credit markets, through the Fed’s discount window authority.

To show how the credit channeling function might work, we focus on a market that currently is highly dysfunctional: the market for credit in bankruptcy. For the largest corporate debtors, bankruptcy financing is available but extremely costly, due to th e monopoly held by debtors’ inside lenders. Smaller debtors, by contrast, are almost completely locked out of these markets. We propose that the Fed create a DIP Discount Window facility tailored to fit the two segments of th e market. With large corporate debtors, the facility would only be available to outside lenders, so that the facility could inject more competition into the market to ensure more value preservation in bankruptcy. With small debtors, the debtor’s current lender would be eligible; indeed, the program would seek to draw these lenders into the DIP financing market, a place they have been unwilling to venture because of the cyclicality and risks that inhere to it . In each context, the fa cility would be limited to banks.

In addition to improving bankruptcy financing, the DIP Discount Window facility would bring other benefits as well. It would shift more lending from the shadow banking to the formal ba nking sector, for instance, and would enhance the Fed’s visibility into the participating banks. It would also provide an intermediate option in the event th at more extreme fiscal, monetary, and emergency options are taken off the ta ble because they are so politically disruptive. Finally, the nove l and modest credit channe ling role we advocate in this Article could also be used in other contexts where structural flaws impede the smooth functioning of a credit market.