(Bloomberg Opinion) -- The Trump administration is hampering a Federal Reserve lending program that could help keep small and mid-sized businesses afloat during the coronavirus recession. To correct that mistake, the U.S. Treasury Department needs to allow the program to take more risks.
There are troubling signs that Treasury Secretary Steven Mnuchin doesn’t see it this way. His testimony before a key Senate committee Tuesday morning reinforced this.
The Fed’s “Main Street” lending program is intended to help businesses that were productive before the pandemic survive until the economy recovers. Business with up to 15,000 employees or 2019 annual revenues of less than $5 billion would get a loan from a bank, which would sell part of the loan — 85% to 95% — to the Fed. This would free the banks to make more loans.
The challenge for Treasury is to determine how much risk to take in these loans. This is Treasury’s decision, not the Fed’s, because the law requires it to provide the capital to cover losses and approve the terms of the program.
It’s admittedly a tough call. The Fed can’t make grants, and so it has to have a reasonable expectation that loans could be repaid. But lending always involves the risk of default. If the Main Street program is too conservative, money won’t go to the firms that need it the most, undermining the recovery.
There are troubling signs that Mnuchin is being more cautious than Congress intended and than the economy needs. He recently declared, “If Congress wanted me to lose all the money, that money would have been designed as subsidies and grants as opposed to credit support.”
This is misguided. Of course Congress did not intend for all the money to be lost. But there’s a lot of distance between that and putting some of the money at risk. Congress clearly expected the economy to benefit if Treasury tolerated some losses in exchange for getting money into the hands of the kinds of crippled businesses that need it the most.
When asked about this by Senator Mark R. Warner, a Virginia Democrat, at a Banking Committee hearing on Tuesday, Mnuchin reinforced the concern. He did say that he anticipated that the Main Street program would incur some losses, a shift in the right direction. But he didn’t give any specifics about how the program would change.
The Main Street program has $75 billion in capital from the Treasury, designed to support $600 billion of Fed lending. This allows for a default rate of around 13%. That loss rate implies that the program’s portfolio will be heavy on companies whose solvency is not in question. But economic recovery is the goal and solvency is the problem. If Treasury and the Fed are serious about addressing the problem, then losses are inevitable.
Indeed, under the terms of the program put in place by the Fed and Treasury, it’s not clear which businesses would qualify for help that couldn’t already access a standard commercial loan. By requiring banks to hold 5% to 15% of loans, the program encourages banks to use normal credit standards. Furthermore, the Main Street program requires borrowers to show that they have highly rated debt, with an internal risk rating equivalent to “pass.”
By requiring banks to use normal commercial lending standards, Treasury may discourage borrowers and lenders from participating in the Main Street program at all.
A new Congressional Oversight Commission created by the March relief legislation known as the Cares Act released its first report on Monday. It found that barely any money appropriated to the Treasury has been lent out under any of the Fed’s pandemic response programs.
Mnuchin may be wary of taking on risk in the Main Street program to avoid the public perception of corporate bailouts. If so, he is overlearning lessons from the 2008 financial crisis, when voters rebelled against bank bailouts under the Troubled Asset Relief Program even though the government recouped nearly all the money it disbursed. Loans to businesses today are going to be much riskier because of the shutdown.
He may also be underlearning a different lesson. After the 2008 crisis, the Fed faced political blowback from the perception that it rescued the financial system but didn’t do enough for Main Street. If today’s Main Street program doesn’t work — if few loans get made, or if funds from the program don’t reach the businesses that need it the most — the political ramifications could be more severe because the lockdowns put in place to slow the spread of Covid-19 have created a true Main Street recession.
To reach mom and pop shops, and not just much larger mid-size businesses, other changes will have to be made. For example, the program has a minimum loan size of $500,000. Many small businesses in need of funds are not in a position to take out a loan that large. And the four years allowed for loan repayments under the program is not enough time for many low-margin businesses.
Congress appropriated $454 billion in the Cares Act to support Fed lending programs. According to Mnuchin’s testimony, only $195 billion has been committed to a program, with the rest being held in reserve. And only $75 billion of this appropriation, 17%, has been allocated to the Main Street program. Additional capital would allow the program to extend riskier loans. Treasury has the money and the authority to make this change immediately.
Economic recovery requires taking risks.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Michael R. Strain is a Bloomberg Opinion columnist. He is director of economic policy studies and Arthur F. Burns Scholar in Political Economy at the American Enterprise Institute. He is the author of “The American Dream Is Not Dead: (But Populism Could Kill It).”
©2020 Bloomberg L.P.
