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BPEA Article

Business credit programs in the pandemic era

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Editor's Note:

This paper is part of the fall 2020 edition of the Brookings Papers on Economic Activity, the leading conference series and journal in economics for timely, cutting-edge research about real-world policy issues. Research findings are presented in a clear and accessible style to maximize their impact on economic understanding and policymaking. The editors are Brookings Nonresident Senior Fellow and Northwestern University Professor of Economics Janice Eberly and Brookings Nonresident Senior Fellow and Harvard University Professor of Economics James StockRead summaries of all the papers from the journal here.

The Federal Reserve’s Main Street Lending Program for small and medium-sized businesses should take more risks to meet the unique challenges posed by the COVID-19 pandemic, suggests a paper discussed at the Brookings Papers on Economic Activity (BPEA) conference on September 24.

Jeremy C. Stein

Moise Y. Safra Professor of Economics - Harvard University

Adi Sunderam

Marvin Bower Associate Professor of Business Administration - Harvard University

Eric Zwick

Associate Professor of Finance and FAMA Faculty Fellow - University of Chicago

The Treasury Department, under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, is investing $75 billion in the Main Street facility to absorb any losses on these loans. Nevertheless, like the Fed’s credit facilities during the 2007-2009 financial crisis, the Main Street program is designed to take very little credit risk. Therefore, it is unlikely to be as effective as it could be, write Samuel G. Hanson, Jeremy C. Stein, and Adi Sunderam of Harvard University and Eric Zwick of the University of Chicago.

With the Treasury backing, the program has the capacity to lend up to $600 billion to small and medium-sized businesses but, through September 2, it had lent only $1.2 billion.

“The government needs to embrace the prospect of losing money on its programs if it is to have any hope of mitigating the economic and financial fallout from the pandemic,” the authors say in Business credit programs in the pandemic era.

The challenges presented by the pandemic crisis are different from the challenges presented by the earlier financial crisis, the authors write. In 2007-2009, the Fed created credit facilities to address a liquidity crunch and prevent runs that could topple solvent financial institutions. This time, fundamental uncertainty about firms’ ability to remain solvent is the primary challenge, not liquidity.

As a result, the Fed must be willing to lend to firms that, although likely viable in the long term, have suffered precipitous revenue declines during the pandemic and would not be able to survive in the short term without government support, the authors say. However, the credit standards of the Main Street Lending Program, targeted at businesses and non-profit organizations with 15,000 or fewer employees, are more conservative. In part, that’s because the banks making the loans on the Fed’s behalf must finance five percent of the loan (the Fed finances 95 percent), and they require a satisfactory return on their stake.

“Thus … the Main Street program seems unlikely to lead banks to make any additional loans that they would not already be willing to make,” the authors write.

They suggest softening the terms of Main Street loans by making firms with heavier pre-existing debt loads eligible to borrow, by relaxing collateral requirements, by reducing the seniority of the government’s claim, and by giving firms some flexibility to defer repayments. The government could reduce its risk by staging its lending—much as venture capital firms do—by lending a relatively small amount at first and then lending more as firms show they can survive.

The paper also examined the Fed’s programs for larger businesses: the Primary Market Corporate Credit Facility, which buys newly issued corporate bonds, and the Secondary Market Corporate Credit Facility, which purchases already-issued bonds. The mere announcement of the programs in late March relieved tremendous strains in corporate bond markets, and so far, the Fed hasn’t had to follow through with very many purchases. Through September 2, the corporate credit facilities have only used $12.8 billion of their $750 billion capacity. But, the authors warn, bond investors may be over-interpreting the Fed’s implicit “whatever it takes” promise, risking a bond market crash down the road if economic conditions deteriorate, bond ratings slip sharply, and the Fed declines to purchase bonds near default (by law, it cannot buy the securities of bankrupt firms). The key challenge for the Fed will be communicating its bond-purchasing intentions as economic conditions evolve, the authors say.

“We could well skate through. If things turn out OK, this will look brilliant,” Stein said in an interview with Brookings. “If things turn out not so OK, it may still have been the right policy, but it may be considerably more challenging to manage.”

David Skidmore authored the summary language for this paper.

CITATION

Hanson, Samuel G., Jeremy C. Stein, Adi Sunderam, and Eric Zwick. 2020. “Business Credit Programs in the Pandemic Era.” BPEA Conference Draft, Fall.

CONFLICT OF INTEREST DISCLOSURE

Jeremy Stein, Samuel Gregory Hanson, and Adi Sunderdam have served as unpaid consultants for the Federal Reserve Bank of Boston President Eric Rosenberg on the design of the Federal Reserve’s Main Street Lending Programs. Jeremy Stein also served as consultant to Key Square Capital Management through March of 2020 and on the board of directors of the Harvard Management Company. Other than the aforementioned, the authors did not receive financial support from any firm or person for this article or from any firm or person with a financial or political interest in this article. Other than the aforementioned, the authors are not currently officers, directors, or board members of any organization with an interest in this article.

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