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What are ETFs and why is the Fed pouring billions into them?

Sabri Ben-Achour May 12, 2020
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Johannes Eisele/AFP via Getty Images
COVID-19

What are ETFs and why is the Fed pouring billions into them?

Sabri Ben-Achour May 12, 2020
Heard on:
Johannes Eisele/AFP via Getty Images
HTML EMBED:
COPY

The Federal Reserve today started buying up a type of investment known as exchange-traded funds, or ETFs, and it may spend potentially hundreds of billions of dollars on them. 

ETFs are like when you don’t want to invest in just one stock so you invest in multiple stocks, or certain types of stocks.

“People have religious ETFs, gender equality ETFs. They have environmental ETFs that look at companies that don’t pollute,” said Jay Jacobs, head of strategy at Global X ETFs. And ETFs don’t just work for stocks. “You can invest in stocks, you can invest in bonds, you can invest in commodities.”

Corporate bonds really were not doing so well after the coronavirus hit hard in March. 

“People were selling, [and] they were scared,” said Donald Kohn, a senior fellow at the Brookings Institution. Investors were dumping their corporate bonds and the ETFs that were based on them. Which meant businesses couldn’t issue bonds to raise money, or if they could they would have to pay really high interest rates. 

“Having high, rising interest rates where you’re trying to keep businesses going is exactly the wrong thing to have happen,” Kohn said.

It was looking like a lot of businesses wouldn’t make it. Vincent Deluard, director of global macro-strategy at INTL FCStone, did an analysis of small-cap businesses.

“Fifty percent of them did not have enough net cash to last two months without access to credit or revenues,” Deluard said.

So, the Federal Reserve said it would buy corporate debt by buying ETFs full of corporate bonds.

“Imagine if you were trying to buy 1,000 cars — that’s a challenge,” Jacobs said. “But if you went to the dealership and said, ‘I want to buy your entire lot,’ that’s basically what they’re doing.”

And if the Fed is buying corporate debt and telling businesses they can pay it back at low interest, there’s a better chance those businesses will survive.  And if those businesses survive, there’s a better chance the more than 33 million Americans who’ve lost their jobs might get rehired sooner.

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