Thursday brought no shortage of drama for dazzled, weary and in some cases, physically ailing, market watchers.
US jobless claims surged for a third consecutive week as 6.61 million more Americans filed for unemployment benefits, bringing the three-week total to nearly 17 million.
Meanwhile, the Fed sprang into action, announcing $2.3 trillion in new lending and liquidity support via a combination of new facilities and enhancements to existing programs. Jerome Powell is now in the market for everything from CLOs to short-term state and local government paper to junk bonds.
“Many of the programs we are undertaking to support the flow of credit rely on emergency lending powers that are available only in very unusual circumstances”, Powell said, in a speech delivered via teleconference. He added the following color:
I would stress that these are lending powers, not spending powers. The Fed is not authorized to grant money to particular beneficiaries. The Fed can only make secured loans to solvent entities with the expectation that the loans will be fully repaid. In the situation we face today, many borrowers will benefit from these programs, as will the overall economy. But there will also be entities of various kinds that need direct fiscal support rather than a loan they would struggle to repay.
Our emergency measures are reserved for truly rare circumstances, such as those we face today. When the economy is well on its way back to recovery, and private markets and institutions are once again able to perform their vital functions of channeling credit and supporting economic growth, we will put these emergency tools away.
To say the Fed is now stretching the definition of what a “loan” is would be an understatement. And there’s something wholly ridiculous about the idea of a “secured” loan from the Fed when the entity providing the guarantee is also the government.
That’s not to suggest Powell’s actions aren’t justified. In a way, it’s to suggest the opposite.
Between the Fed, Treasury and America’s lenders, the country is going to great lengths to create a series of intermediaries and other cumbersome layers of complexity in what, in the final analysis, is simply an effort to avoid telling the truth, which is that the government is creating money and handing it to people, as it should considering the circumstances.
For example, payments on loans made via the “Paycheck Protection Program” (PPP, the small business rescue scheme) are deferred for six months and may ultimately be forgiven. The Fed’s new “Paycheck Protection Program Liquidity Facility” (PPPLF) allows lenders to pledge those federally-guaranteed loans as collateral at face value for funding at 35bps.
“The maturity date of an extension of credit under the Facility will equal the maturity date of the PPP Loan pledged to secure the extension of credit”, the Fed explains, before noting that “the maturity date of the Facility’s extension of credit will be accelerated if the underlying PPP Loan goes into default and the eligible borrower sells the PPP Loan to the SBA to realize on the SBA guarantee”. Further, the Fed notes that “the maturity date of the Facility’s extension of credit also will be accelerated to the extent of any loan forgiveness reimbursement received by the eligible borrower from the SBA”.
So, lenders are extending loans guaranteed by the Small Business Administration, and those loans can then be pledged for cash from the Fed. The maturity date on that credit facility matches the term of the underlying PPP loan and will be brought forward if the loan ends up being simply paid back in default by the SBA.
In essence, the SBA is conjuring risk-free collateral.
An hour after the announcement, the Fed issued another statement, which essentially says as much by clarifying how the PPP loans are treated from a regulatory perspective. Here is that statement:
The federal bank regulatory agencies today announced an interim final rule to encourage lending to small businesses through the Small Business Administration’s Paycheck Protection Program, or PPP. The PPP was established by the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, and provides loans to small businesses so that they can keep their workers on the payroll during the disruptions caused by the coronavirus.
The interim final rule modifies the agencies’ capital rules to neutralize the regulatory capital effects of participating in the Federal Reserve’s PPP facility because there is no credit or market risk in association with PPP loans pledged to the facility. Consistent with the agencies’ current capital rules and the CARES Act requirements, the interim final rule also clarifies that a zero percent risk weight applies to loans covered by the PPP for capital purposes.
Given all of this, you’d be forgiven for asking what purpose the banks and the Fed’s PPP liquidity facility actually serve other than to obscure the reality of what is, at heart, just free money?
Think about this for a minute – bear with me.
Loans under the PPP are guaranteed by the government. Some (likely many) of those loans will be forgiven under the program’s terms, assuming the businesses meet certain conditions, including maintaining payroll levels.
And the Fed has reduced the risk-weight on the loans to zero for the lenders because, by virtue of being government-guaranteed and not tradable, there’s no risk associated with them.
Finally, the Fed’s new PPPLF will facilitate the extension of those loans by “liquefying” them (colloquially speaking), for banks.
Why is it necessary for banks to be involved in the process of intermediating these loans? And isn’t the Fed’s liquidity facility only necessary because the banks are involved? That is, the Fed’s PPPLF only exists because banks need to be encouraged to make more of these loans.
There is something wholly circular and redundant about this, and I can summarize it for you as follows.
A federally-guaranteed loan that has, in its term sheet, a clause explicitly stating that the loan will be forgiven in the event the money is used for the proper purposes (in this case keeping all employees on payroll for eight weeks and paying fixed costs) is just a damn grant. Loans made under PPP aren’t “loans”, they are grants. The only way that won’t be the case is if a “borrower” diverts the funds to something other than paying employees, making rent and keeping the lights on (literally in the form of paying utility bills).
So, given that inescapable reality, why not just allow small businesses (i.e., businesses with 499 or fewer employees) to apply directly to the government for unlimited grants?
It would accomplish exactly the same purpose, and it would do so without creating what will certainly feel like an unnavigable bureaucracy to those who need the funding to keep their businesses open and maintain their employees.
And all for what? Just so we can persist in the fantasy that there’s some distinction between this program and free money.
America is so averse to the idea of “handouts”, that we’re willing to plunge the country’s small business owners into a Kafkaesque nightmare.
Those small business owners account for 47.5% of all private-sector employment.
You might well argue that in Kafka, the government is the nightmarish bureaucracy. But in this case that begs the question. The private sector isn’t functioning. As Jerome Powell notes, “private markets [aren’t] able to perform their vital functions of channeling credit”.
Fortunately, “credit” isn’t what’s needed. Checks are needed. And you don’t need many layers of bureaucracy to mail out checks, although, as we’re about to find out with the direct payments to individuals and households, the government will doubtlessly pretend like we do.