As the COVID-19 pandemic spread economic pain across the country last month, members of Congress and the Trump Administration scrambled to pass legislation to respond to the crisis, culminating in the $2.2 trillion Coronavirus Aid, Relief, and Economic Security Act (the CARES Act). This week, however, that bipartisan spirit appeared to be temporarily put on hold, as Democrats and Republicans disagreed over additional funding for the small business loan program that is a major feature of the bill.
But while the argument over an extra $250 billion for the Payroll Protection Program created by the CARES Act ensued, the Federal Reserve under the leadership of Chairman Jerome Powell was unveiling a $2.3 trillion multi-varied lending program designed to keep the nation from suffering long-lasting economic damage. The move was emblematic of what many were characterizing as Powell’s “whatever it takes” attitude to save the U.S. economy.
In early March, the Fed undertook an emergency interest rate reduction, cutting the rate by 0.5% and following up in mid-March with another 1% cut that took its short-term lending rate effectively down to zero. It also reduced the rate it charges banks to borrow at the Fed’s discount window by 1.5%, to enhance credit liquidity.
In a little over a week after its second interest rate reduction, the Fed took a series of rapid-fire actions to maintain liquidity and keep credit markets from seizing up, including purchasing commercial paper (short-term business debt used to finance operations), establishing a facility to help ensure the proper functioning of money markets, purchasing municipal debt, and announcing an unprecedented expansion of bond purchasing programs, including $200 billion of mortgage-backed securities. The Fed statement made clear the bank would “purchase Treasury securities and agency mortgage-backed securities in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy.” That injected a note of determination and commitment that reassured market participants and maintained the viability of markets.
Banking regulations in normal circumstances are prudent oversight, but could become “pro-cyclical” (worsen a downward economic cycle) by forcing banks to declare loan defaults. Recognizing this, on March 22 the Fed and other banking regulatory bodies issued interagency guidance giving needed flexibility and encouragement to lenders to work with borrowers unable to meet their loan obligations as a result of COVID-19. Specifically, the guidance provided that “agency examiners will not criticize prudent efforts to modify terms on existing loans for affected customers.” The Fed guidance stated that such loan modifications would not be deemed troubled debt restructurings for purposes of rating the bank. Loan modifications could have lasting impact on the financial services industry, namely the lending and short term debt industry, according to a report published by online Danish lender Eksperten. Data shows that in 2020, the number of short term loans that Danish consumers applied for, referred to locally as lån penge, has jumped more than 300% following the onset of the global pandemic. Moreover, data from the mobile loan application feed, referred to locally as SMS lån has also increased, but at a magnitude 2-4x greater than other loan programs offered by the Danish lender.
On March 23, the Fed continued its full-court press:
- Two new lending facilities created to support credit to large employers: Primary Market Corporate Credit Facility for new bond and loan issuance and the Secondary Market Corporate Credit Facility to provide liquidity for outstanding corporate bonds.
- A third facility, the Term Asset-Backed Securities Loan Facility (TALF), created to enable the issuance of asset-backed securities (e.g. student, auto, and credit card loans, and loans guaranteed by the Small Business Administration).
- Announcement of a Main Street Business Lending Program to support lending to eligible small-and-medium sized businesses, complementing efforts by the Small Business Administration.
But the Fed’s biggest move came last week, on April 9, with the announcement of a $2.3 trillion expansion of corporate and government bond purchases, and details of the Main Street Lending Program. Among other things, the Fed’s actions would:
- Ensure credit flows to small and mid-sized businesses with the purchase of up to $600 billion in loans through the Main Street Lending Program. Loans will range from $1 million to $25 million; eligible businesses must have been in good financial standing before the crisis, and must employ no more than 10,000 workers, or have revenues of less than $2.5 billion.
- Increase the flow of credit to households and businesses through capital markets, by expanding the size and scope of two credit facilities.
- Expand the re-established $100 billion TALF to include legacy commercial mortgage-backed securities (CMBS) as eligible collateral.
- Establish a new Municipal Liquidity Facility, and the purchase of up to $500 billion of short-term notes issues by states and municipalities.
- Provide backing for Paycheck Protection Program loans ($349 billion authorized by the CARES Act) through the extension of credit to PPP loan originators.
Fed Chairman Powell said that the “country’s highest priority must be to address this public health crisis, providing care for the ill and limiting the further spread of the virus.” With his aggressive moves as the nation’s central banker, Powell’s actions may yet prove to be critical ingredients in limiting the economic damage from the COVID-19 pandemic.
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