The essential facts of the coronavirus economic disaster are these: Federal and state governments have shut down most American commerce, robbing tens of thousands of successful companies of revenue through no fault of their own. Mass layoffs are already underway, with 6.6 million new jobless claims in the week that ended April 4, and cascading bankruptcies loom.
That’s the backdrop for the Federal Reserve’s unprecedented $2.3 trillion expansion of its lending and bond-buying programs on Thursday to offer a liquidity lifeline. The Fed isn’t scrimping on the firepower, but the details released Thursday are disappointing, and perhaps even dangerous to a robust recovery. The Fed is rescuing weaker credits as well as the strong, is diving ever-deeper into risky assets, and is putting Wall Street ahead of companies across Middle America.
Financial markets reacted well to the news, but look below the price surface and the complications appear. The big winners included non-investment grade corporate bonds and real-estate investment trusts that will now qualify for Fed programs despite their credit risk. High-yield and municipal bond prices also rose. Growth companies like Amazon, Intel and Nvidia fell or were flat, and the overall market reaction was underwhelming.
This reflects the priorities of the Fed’s new lending facilities, and how far out on the risk curve it is going. Take the Term Asset-Backed Securities Loan Facility that the Fed first used in 2008 and that it revised last month. In 2008 TALF accepted only triple-A-rated securities and it made money on the loans. On Thursday the Fed said it will now accept much riskier credits including commercial mortgage securities and collateralized loan obligations.
These are loan pools packaged into securities by Wall Street, which lobbied the Fed and Treasury hard for the TALF expansion. This means the Fed will in effect buy the worst shopping malls in the country and some of the most indebted companies. The opportunities for losses will be that much greater. Treasury is backstopping losses, but the taxpayer risks here are greater than what the Fed took on in 2008-2009.
The Fed may feel all of this is essential to protect the financial system’s plumbing and reduce systemic risk until the virus crisis passes, but make no mistake that the Fed is protecting Wall Street first. The goal seems to be to lift asset prices, as the Fed did after the financial panic, and hope that the wealth effect filters down to the rest of the economy.
Contrast that with the Fed’s new Main Street Lending Program, which these columns have pushed. This is aimed at middle-market companies from zero to 10,000 employees and up to $2.5 billion in 2019 annual revenue. These companies are the backbone of the U.S. economy, typically well managed, with modest leverage. They need liquidity because banks won’t lend to them now and the government has eliminated their customers.
Yet the details make us wonder if the Fed really wants anyone to take up the offer. The Fed will accept comments on the program until April 16, which means it probably can’t launch until May 1, and money might not start flowing for weeks after that. By then many of these companies will be going bust.
The Fed has also attached strings that will make the loans far less attractive—including bans on stock buybacks and limits on compensation and dividends that weren’t stipulated in the recent Cares Act for Fed loans made “in the ordinary course of business.” The Fed seems to have imported strings that were intended for Treasury’s direct lending to companies. This sounds like political protection for Treasury and the Fed from getting banged on by Congress.
The loans will last four years, which makes these strings even more unappealing and extends the Fed’s reach into private business far longer. The companies will also have to “make reasonable efforts” not to lay off employees, which means it will be harder to manage after the crisis.
The better solution would be no-strings loans to all-comers with good collateral and only for the short-term. But the Fed is forcing lenders that make Main Street loans to keep 5% of the risk, which means the borrowers will have to meet both bank covenants and the Fed’s terms. The risk is that many companies will resist taking the loans until they are in the ICU, and then it may be too late.
All of this adds up to the following contrast: A company bought by a Wall Street firm and loaded up with debt that is part of a CLO security will now face far easier terms for liquidity relief than will a similar privately owned company in the Midwest that never took on too much debt. This is employing political discretion, and picking winners and losers, far more than the Fed did in 2008.
Perhaps, with a lot of luck, the economy will restart faster than we fear and these Main Street firms will manage to survive. That was the note Fed Chairman Jerome Powell hit Thursday when he paraphrased predecessor Ben Bernanke’s comment that “you’ll be looking back on this and you will, you won’t see much, only modest effects, I think he said, on the economy from this event.” Mr. Powell and Treasury Secretary Steven Mnuchin may underestimate how much this shutdown is hollowing out the heart of the U.S. economy.
It is also putting the future of American capitalism at risk in a way even the financial panic did not. The Fed and Treasury are becoming the main lenders to American business, and in this storm there is no choice. But will they recede when the virus is defeated?
Mr. Powell said Thursday that this is a “truly rare” intervention by the Fed, which will retreat when the virus plague is over. But that is what the Fed also said during the financial panic, and it never did come close to normalizing policy. If the shutdown lasts for many more weeks, the Fed could become America’s lender of first resort.
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