Fed is entering a risky new world with the Main Street loan program

WASHINGTON (AP) – As the US economy plunges into a severe recession, the Federal Reserve will embark on a risky program that it is starting for the first time since the Great Depression.

More than the eight other credit facilities the Fed put in place in the nearly two months since the economy collapsed from the virus outbreak is Loan program on the main street will be the most complex and demanding to date, say economists. It will likely pull the Fed into greater public scrutiny than it has since the 2008 financial crisis.

In setting up a lending program that inevitably excludes some companies, the Fed is criticizing that it is in fact picking economic winners and losers – an area the central bank, an independent agency, has long sought to avoid.

Critics already claim that the Fed has changed some of the program’s terms to allow highly indebted oil and gas companies to borrow under the program. The Fed says its changes came in response to requests from many different industries. Many economists fear that the Fed’s intention to minimize its losses, in part at the direction of the Treasury Department, will force it to limit its lending.

Nellie Liang, a senior fellow at the Brookings Institution and former director of the Fed’s Financial Stability Department, said the Fed and the Treasury Department have set a tight target for the program: to provide loans to small and medium-sized businesses in need of financial assistance to survive the slowdown caused by the virus. And they want to avoid lending to troubled companies that will soon fail despite their ability to borrow from the Fed, or to relatively healthy companies that would have survived anyway.

“They’re trying to target this middle segment of businesses,” Liang said. “It limits what you can offer if you don’t want to take losses.”

That task may have been made more difficult when Treasury Secretary Steven Mnuchin told reporters last week that he expected the Fed to repay the $ 454 billion the Treasury Department allocated to halt the Fed’s loan programs. The $ 454 billion was approved by Congress in late March as part of the government’s $ 2 trillion aid package. The money is intended to offset potential losses on the Fed’s loans.

“We look at it in a baseline scenario where we get our money back,” said Mnuchin.

But that priority arguably clashes with what many economists see as the need to distribute credit quickly and widely. This would likely mean that many loans would default and much of the Treasury’s money could be lost.

“In the midst of a severe recession, you are rushing to make many loans to many companies, some of which will not survive,” said George Selgin, senior fellow at the Cato Institute. In this atmosphere, if the Fed is concerned about repaying the funds, it may not be able to lend as much as it hopes.

The Fed has announced that it will provide up to $ 600 billion in Main Street loans. The money can either include new loans or top-ups on existing loans. The Treasury Department has allocated $ 75 billion to offset any losses. The banks make the actual loans, but the Fed will buy 95% of a loan to minimize the risk to the banks. However, Selgin estimates that this backstop is insufficient and that the Fed may need to stop lending in excess of $ 300 billion.

However, this is a bigger buffer than for any of the Fed’s other lending initiatives, including its upcoming programs for the Fed Purchase of predominantly higher rated corporate bonds. This suggests that the Fed sees Main Street lending as riskier.

The Fed could benefit from the corporate bonds it buys, interest payments, and the ability to buy bonds at low prices before they eventually bounce back. Those gains could offset some of the Main Street program’s losses and still allow the Fed to repay the Treasury in full.

Chairman Jerome Powell reiterated on Wednesday that the Fed cannot lend bankrupt companies or “give money to certain beneficiaries.” In those cases, Powell suggested, the small business loan program in the federal aid package would be a better option. These Small Business Administration Paycheck Protection Program loans can be made to companies that have spent most of the money keeping their employees or reinstalling all of their laid-off employees. Congress has made available US $ 660 billion for this.

The Main Street Program requires borrowers to use “commercially reasonable” efforts to keep all of their workers. However, it does not require redundant workers to be reinstated, as is the case with the PPP.

Last week the Fed updated the terms of the loans so that some borrowers can bear more debt than the original proposal. The maximum workforce for creditworthy companies has been increased from 10,000 to 15,000. And the maximum loan amount has been increased from $ 150 million to $ 200 million. In some cases, borrowers can use the loan to refinance existing debts.

Environmental groups pointed out that these changes reflected the demands of the ailing oil and gas industry, which the collapse in oil prices has made more difficult in part because driving and flying have fallen sharply around the world. The Fed said its changes are aimed at expanding the availability of its lending across all sectors. It is forbidden by law to grant loans to insolvent companies or to design loans for a specific industry. The central bank has also announced that it will identify the borrowers.

William English, a finance professor at Yale and a former director of monetary affairs at the Fed, noted that in the roughly 2,000 comments the Fed received, retailers and other industry groups also called for many of the same changes as the oil and gas industry.

Despite its name, the Fed’s Main Street Facility targets midsize companies, essentially halfway between the PPP and the large companies that can sell bonds on the Fed’s corporate credit facilities. Initially, the Fed set a minimum loan of $ 1 million, but in its latest draft it was reduced to $ 500,000. That should open it up to some smaller businesses, English said.

But the average loan on the first round of the PPP was about $ 200,000 and dropped to less than half by the second round.

“If you really want to lend to small businesses and call something Main Street, you should lower the floor,” said Glenn Hubbard, a critic of the program and an economics professor at Columbia University. But because smaller companies are riskier, “they have to take losses”.

Source link

About Alexander Estrada

Check Also

Chelsea defender Fikayo Tomori reveals why he’s moving to London rival West Ham. refused

Chelsea defender Fikayo Tomori has announced that he has turned down a move to West …

Leave a Reply

Your email address will not be published. Required fields are marked *