Recently, the People's Bank of China (PBOC) announced the creation of the Securities, Funds and Insurance companies Swap Facility (SFISF) to support eligible securities, fund, and insurance companies in exchanging high-quality liquid assets such as government bonds and central bank bills for pledged assets like bonds, stock ETFs, and constituents of the Shanghai-Shenzhen 300 Index. On October 10th, the open market operations office began accepting applications from eligible securities, fund, and insurance companies. The previously announced targeted re-lending program aims to guide banks to provide loans to listed companies and major shareholders to support stock buybacks and increases. From a market effect perspective, the series of innovative policy tools introduced by the PBOC have stimulated market vitality and ushered in a new era for China's stock market.
The policy tools created by the PBOC to support the capital market reflect several innovative features. Firstly, the design of the Securities, Funds and Insurance companies Swap Facility aligns with the central bank's asset portfolio management principles. Generally, due to the risk level of the stock market, central banks do not directly purchase and hold corporate stocks (with the exception of the Bank of Japan), but rather purchase more bonds, especially high-quality bonds such as government bonds and policy bank bonds. In routine operations, the PBOC accepts high-quality bonds like government bonds as collateral; the new policy tool expands the list of acceptable assets to include stock ETFs and constituents of the Shanghai-Shenzhen 300 Index. Since the new tool is an asset swap, the PBOC does not bear the risk of stock devaluation (market risk) but only the risk of bond devaluation.
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Secondly, the PBOC lends out highly liquid assets such as government bonds and central bank bills, rather than directly lending to securities, fund, and insurance companies, thus the total money supply remains unaffected. Securities, fund, and insurance companies can use these high-grade bonds to obtain almost equivalent financing. Thirdly, according to sources close to the central bank, the swap facility has a term of no more than one year, with the possibility of extension upon expiration, which investors might consider as medium to long-term financing. Ordinary collateral loans have shorter terms, while the collateral loans under the new policy tool should have longer terms because stock assets are highly volatile in the short term but relatively stable in the long term. The longer-term arrangement should be the original intention of the new policy tool's design. If the swap term is too short, given the high volatility of the stock market itself, securities, fund, and insurance companies would not dare to pledge or hold stocks for a long term, but would rather hope to redeem stocks and cash out as soon as possible, which is not conducive to the healthy and stable development of the capital market. Lastly, the new policy tool aims to provide long-term support to securities, fund, and insurance companies, changing the institutional investment structure of China's capital market, which is beneficial for establishing a long-term mechanism for the intrinsic stability of the capital market and enhancing its breadth and depth. Generally, central bank policies favor commercial banks, only providing liquidity to securities, fund, and insurance companies during periods when the economy needs to be stimulated. The new policy tool expands the coverage of the PBOC's monetary policy.
The capital market is most concerned about the effectiveness of the new policy tool, as it is a bold attempt by the PBOC. There is a saying in the foreign exchange market: Never bet against the central bank. This saying also applies to the stock market; trusting the central bank is always right! Looking at the practices of foreign central banks, the policy effects of central banks supporting the capital market are very significant.
The Federal Reserve's market rescue policy has significantly stabilized the financial market.
In the last decade or so, the United States has experienced two major financial crises. The Federal Reserve quickly introduced unconventional monetary policy tools, stabilizing the financial market situation in a relatively short time, and the stock market returned to a long-term upward trajectory.
From 2007 to 2009, the U.S. financial crisis erupted due to the collapse of the housing mortgage market bubble. Its destructive power was second only to the Great Depression period from 1929 to 1933. The S&P 500 index once fell by 51%, and financial institutions were in distress. According to data from the Federal Deposit Insurance Corporation, the number of bank failures from 2008 to 2011 were 25, 140, 157, and 92, respectively. At the same time, the crisis almost paralyzed the American International Group (AIG, an insurance company) and led to the collapse of three investment banks (securities companies). The crisis led to a rapid disappearance of liquidity in the financial system, forcing the Federal Reserve to intervene urgently, with capital market policy tools as shown in Table 1.
The Federal Reserve's market rescue was effective, and the stock market returned to normal. In 2008, the U.S. S&P 500 index fell by 38.49%, but the performance from 2009 to 2012 was an increase of 23.45%, 12.78%, 0.0%, and 13.11%, respectively. Of course, the subsequent changes in the stock market were influenced by other factors, but the Federal Reserve's market rescue at least boosted market confidence and allowed investors to regain their sanity. As shown in Table 1, the Federal Reserve's support for primary dealers was the greatest, with nearly $9 trillion in loans, far greater than other policy tools in the table. The Federal Reserve also introduced other unconventional market rescue policy tools, such as "Asset-Backed Commercial Paper Money Market Fund Liquidity Facility," "Commercial Paper Funding Facility," "Money Market Investor Funding Facility," and "Term Asset-Backed Securities Loan Facility," but their impact was smaller, or the loan amounts were lower, so they are not listed.
The COVID-19 pandemic in 2020 once again put the U.S. financial market in a precarious situation. Faced with the sudden pandemic, the U.S. financial market and investors were panicked, and it seemed that the only risk-avoidance strategy was to rapidly sell off their assets. From non-U.S. dollar currencies, oil, gold, stocks, cryptocurrencies to commodities, all showed a synchronized sharp decline. Since the introduction of the circuit breaker mechanism, the United States has experienced five circuit breakers, except for the one in 1987, the other four occurred consecutively on March 9, 12, 16, and 19, 2020. The financial market situation deteriorated so rapidly, which was unprecedented! On March 11, 2020, then-President Trump of the United States convened a meeting at the White House with the presidents of major Wall Street banks to discuss market rescue measures, but the Wall Street tycoons were at a loss.In the face of an extremely severe financial situation, the Federal Reserve acted decisively and with full force. Since February 19, 2020 (when the S&P 500 index reached a historical high), the average volatility index soared from 13.79 to 39.84; on March 20, the daily fluctuation of the U.S. ten-year Treasury bonds reached 65.1, with a normal fluctuation level below 10; the daily average volatility of the U.S. dollar index increased from 0.2% in the first phase to 0.94% in the second phase. The financial and economic situation prompted the Federal Reserve to respond quickly, and thus the timing density and policy intensity of the bailout measures were unprecedented. The Federal Reserve massively purchased Treasury bonds and mortgage-backed securities; lent a large amount of money to banks and bond brokers; provided dollar loans to foreign central banks through currency swaps to alleviate the overseas dollar shortage; established multiple loan facilities to provide credit to the money fund market, corporate bond issuers, local governments, and various ordinary enterprises. The Federal Reserve's bailout plan and scale have transcended the traditional functions of a central bank, but due to the severity of the pandemic, the Federal Reserve took the initiative to undertake the bailout task.
The Federal Reserve's intensive bailout measures played a role in stabilizing the financial situation and injecting confidence into the market. In 2020, the S&P 500 index rose by 18.4%; in 2021 it rose by 28.7%; under the high pressure of the interest rate hike cycle, it fell by 18.11% in 2022, but rose by 26.29% again in 2023. The stability of the U.S. stock market has had a strong spillover effect, and European, Japanese and other stock markets have also reaped dividends. Unlike the financial crisis from 2007 to 2009, this time the Federal Reserve saved the economy by expanding its balance sheet, so the funds lent through various non-traditional monetary policy tools have actually decreased significantly, and financial institutions have obtained greater financial support directly from the asset purchase plan launched by the Federal Reserve.
The Federal Reserve has also paid a heavy price for these policy operations: the risk of bond depreciation has increased. In order to curb inflation, the Federal Reserve had to start aggressive interest rate hikes from March 2022, increasing the floating losses of bond investments, and other financial institutions have also suffered varying degrees of floating losses. In 2020, the Federal Reserve suffered a loss of $926 million, and in 2021 it was flat; in 2022, as interest rates soared, the bonds held by the Federal Reserve depreciated, resulting in a loss of $16.6 billion that year, and due to high interest rates, the loss soared to $133.3 billion in 2023. In addition, other financial institutions have suffered huge losses in bond investments, and the collapse of banks such as Silicon Valley and Signature is a footnote to the adjustment of monetary policy too quickly. However, compared with the performance of the U.S. stock market, the price paid is worth it.
Analysis of the Bank of Japan's Bailout Policy Operations and Their Effects
In order to suppress interest rate levels and support the stock market, the Bank of Japan has long purchased Japanese government bonds and corporate bonds, as well as indirectly supported the stock market by purchasing trust products and ETF funds. The proportion of government bonds held by the Bank of Japan in the total market value of Japanese government bonds increased from 32.68% at the end of 2015 to 46.95% at the end of 2023; as the Bank of Japan further intervened in the domestic stock market, the highest proportion of stocks held reached 5.38% in 2022.
The Bank of Japan's capital market support policy operations do not conform to the central bank's usual practices, nor does it have an exit schedule. The Bank of Japan's long-term large-scale intervention in the market has suppressed the market's operating mechanism (especially the interest rate market). The Bank of Japan has become the largest holder in the domestic bond market, and controls the medium and long-term interest rate levels through the buying and selling of government bonds, rather than adjusting short-term interest rates. The Japanese stock market has indeed improved, and the Nikkei 225 index has made significant gains in the past decade, breaking the record set 34 years ago at the beginning of this year.
The Federal Reserve's policy strategy to support the capital market differs from that of the Bank of Japan: the Federal Reserve's policy focus is to support the bond market, and it is a short-term action. Once the market returns to rationality, the Federal Reserve begins to exit in an orderly and slow manner; the Bank of Japan's focus is on the bond and stock markets, and it is a long-term action. The policy effects of both central banks on supporting the stock market are very significant.
The capital market has the highest degree of marketization, and the forces of buyers and sellers determine the price level. However, it is also a market participated in by many investors, and it is inevitable to be affected by investor sentiment. The market may sometimes fail, and investors may lose their rationality for a while, leading to market chaos. Government intervention in the market is completely necessary. Looking at the central banks of Western countries, market intervention is also one of the central bank's functions, and it is the time for central bank intervention when market pessimism is rampant.
The new policy tool of the People's Bank of China is the "timely rain" for the stock market, which is expected to provide liquidity support to securities, funds, and insurance companies for a long time. It is a long-term good news for capital market investors, indicating that the development of the stock market has ushered in a new turning point. Investors need to wait patiently for the policy effects. The market cannot be reversed overnight, and there will be some small twists and turns, but the basic development direction is good.The central bank's capital market support policies require corresponding supporting reforms, and the governance of listed companies should be another focus of effort. Corporate governance reform is already on the agenda, necessitating the discovery, mining, and release of the potential value of listed companies, as well as the enhancement of the stock prices of listed companies. Corresponding measures should include board reform, mergers and acquisitions and restructuring, competitiveness improvement, company stock buybacks, institutionalization of dividend distribution, and increased return on equity. In summary, corporate management must further prioritize the enhancement of the monetary value of enterprises.