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The biggest economic crisis since the Great Depression has seen the U.S. Federal Reserve do a lot of surprising things. Among them: It’s said it willbuy shares of some bond exchange-traded funds, to help make sure there’s enough demand for corporate bonds. It’s odd to think of the Fed snapping up shares of funds right alongside ordinary investors. But the idea of a central bank buying ETFs isn’t completely unprecedented—the Bank of Japan got there a long time ago.
Japan is to central banking what the old Bell Labs was to the global tech industry: a hotbed of ideas that get adapted by others. Going back to the late 1990s, it was forced to pioneer unorthodox methods to try to spur growth and restart the economy’s credit machine. In doing so, it’s shown other central banks that they have a broad array of options when they’ve already cut interest rates to zero. “The BOJ is doing a big favor for those central banks,” says Shigeto Nagai, head of Japanese economic research at Oxford Economics in Tokyo and a former head of the international department at the BOJ. “A big difference is that the BOJ had created many of its measures during its fight against deflation over a period of years, while the Fed, for example, needed new weapons immediately. They didn’t have much choice but to use BOJ tools.”
In the 1990s, what had been the world’s No. 2 economy suffered an implosion of massive stock and property market bubbles. With banks burdened by nonperforming loans, Japan’s central bank found that the basic tools of slashing rates and buying government bonds was having only a limited effect. By late 2002, with deflation gripping the economy and the stock market in the dumps, Japan’s ruling party was suggesting the BOJ look at buying equity ETFs.
The central bank didn’t do that right away. Instead, it opted to take on some stock holdings from banks to help clean their balance sheets. (The Fed later did something similar during the global financial crisis, when it took on billions of dollars of toxic assets from Bear Stearns and American International Group Inc.) By 2009 the BOJ was also lapping up corporate bonds, another action the Fed is taking now. Finally, in October 2010, faced with a lackluster recovery from the global financial crisis, the Japanese bank rolled out an asset-purchase program that included equity ETFs.
Buying stock ETFs isn’t a step the Fed is looking at now—it’s sticking to bond ETFs. The idea that an arm of the U.S. government would own a broad swath of the shares of corporate America is politically touchy. But not so long ago, the idea of buying a chunk of those companies’ debts seemed radical, too. The terms of the Fed’s plan say it can buy as much as 10% of an issuer’s outstanding bonds, and as much as 20% of the assets of any ETF that provides broad exposure to U.S. investment-grade corporate bonds. The program will stop making purchases after Sept. 30, unless it is extended by the Fed.
The Fed’s goal is to stabilize the market for debt securities at a moment when people are frightened to lend and many investors are racing to sell assets to get cash. The BOJ’s thinking when it moved into the stock and corporate bond markets was that it could help reignite the appetite for risk. Investors were getting little by way of income on bank deposits or safe government bonds because of the main thrust of monetary stimulus, which was to keep rates at rock bottom. But they might have seen prospects for gains by buying corporate securities, with the reassurance that the central bank was making massive purchases, too.
The record has been mixed. On a day-to-day basis, the ETF program has given the BOJ a powerful tool to cushion falls in Japan’s stock market, the world’s third-largest. “It limited the downside movement of equity prices,” says Tomo Kinoshita, a global market strategist at Invesco Asset Management in Tokyo. Buying patterns have shown the central bank to be particularly active on days when equities tumbled during the Tokyo Stock Exchange’s morning session. The BOJ board last month temporarilyaccelerated its program to a 12 trillion yen ($111 billion) annual pace of ETF purchases, while it lifted its total target for corporate bond holdings by 1 trillion yen, to 4.2 trillion yen.
Japan’s Topix Index fared much better than the S&P 500 index in March, with a total return loss of about 6%, vs. a 12% loss for the U.S. gauge. Japan’s market was also likely helped by the relativelysmall number of cases of Covid-19 in that country.
But from a longer-term perspective, Japan’s innovations haven’t produced the results that BOJ Governor Haruhiko Kuroda and Prime Minister Shinzo Abe were looking for. The country still hasn’t shaken what policymakers call a deflationary mindset—an assumption by businesses and consumers that prices will fall and it’s better to put off spending. The bank’s 2% inflation target remains distant. Even before the virus struck, Japan would still see the occasional quarter of economic contraction.
One problem may be that the country rolled out these innovations bit by bit over many years, and many of them started out small before the central bank scaled up. Fed Chairman Jerome Powell has by contrast moved swiftly in recent weeks, slashing interest rates by 1.5 percentage points and announcing an unprecedented array ofinitiatives to prevent the coronavirus crisis from causing a financial meltdown.
Another lesson from Japan’s experience is that unintended consequences arise. After years of accumulation, the BOJ has come to own large stakes in many Japanese companies. And, by not voting its stakes, it’s raised a significant corporate governance challenge. JPMorgan Chase & Co. estimates that within a year the BOJ will hold more than a fifth of the shares of at least five companies, including Fast Retailing Co., the fashion retailer with the Uniqlo brand, and electronics company TDK Corp. That’s a large block of ownership that won’t be pushing companies to move on the Abe administration’s priorities of diversifying boards and deploying stockpiles of cash.
That’s not an issue for the Fed as a buyer of bond ETFs. But ETF ownership also raises the question of disposal. “It is probably hard to unwind the program without negatively affecting the equity market,” Kinoshita says of the BOJ’s program. A similar problem could arise for the Fed. Bonds mature over time, giving them a built-in sunset provision—the central bank can get out of them just by waiting. But ETFs don’t mature, and selling them could hurt the prices of bonds they hold, so managing the exit won’t be easy. Once it becomes a buyer, the Fed may find that the ETFs remain on its balance sheet longer than anticipated. —With Min Jeong Lee, Shoko Oda, and Paul Jackson
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