Fed Main Street Lending Program Already in Trouble, Likely to Get Worse

COMMENTARY Markets and Finance

Fed Main Street Lending Program Already in Trouble, Likely to Get Worse

Jun 10th, 2020 7 min read
COMMENTARY BY
Norbert J. Michel, Ph.D.

Director, Center for Data Analysis

Norbert Michel studies and writes about financial markets and monetary policy, including the reform of Fannie Mae and Freddie Mac.
A pedestrian wearing a mask walks by the U.S. Federal Reserve building in Washington D.C., the United States on May 18, 2020. Xinhua News Agency / Contributor / Getty Images

Key Takeaways

One problem with this new arrangement is that it embroils the Fed deeper than ever in the politics that come with lending government funds to commercial businesses.

These kinds of programs reflect the dangerous notion that took hold in the 2008 financial crisis: the concept that the Fed is supposed to save everyone. 

If Congress wants to send money to people and make loans to businesses, they should stand up and do it rather than pass the buck off to the unelected officials.

From March to April, the Federal Reserve announced 11 new lending facilities to keep the economy going amid the COVID-19 crisis. Most of the lending programs were designed to provide broad-based liquidity to financial markets, but several were not. 

These other facilities—as several people have pointed out—were a dangerous departure from the liquidity norm because they allowed the Fed to lend directly to private commercial (non-financial) companies. One problem with this new arrangement is that it embroils the Fed deeper than ever in the politics that come with lending government funds to commercial businesses.

Unsurprisingly, one of these new facilities—the Main Street Lending Program—is in trouble already, before it has even gotten off the ground, for this very reason. Politico reports

Some potential borrowers complain that the "Main Street" lending program—so named because it's aimed at helping midsize companies hit hard by the coronavirus crisis—imposes interest rates that are too high and requires businesses to pay back loans too quickly. 

Under the program, expected to be rolled out this week, companies will also face unwelcome curbs on stock buybacks, dividend payments and executive pay.

These complaints, of course, are directed at the government and are hard to differentiate from basic rent-seeking (individuals petitioning the government to increase their own wealth at the expense of the broader public).

In the private market, when a customer does not like the terms of the loan, he can shop at other banks. That competitive process is what is helps get money from the people who are willing to risk funds to those who need them. The more competitive the market, the more effectively—and fairly—the funds flow.

This process does not work with a government agency, in part, because no private capital is being placed at risk. The terms are negotiated purely on political grounds with those in power. The structure of the Main Street Lending Program ensures that Fed officials will be squarely in the middle of members of Congress and the administration, bank lobbyists, and the potential borrowers best able to represent their interests on Capitol Hill. 

To set up the Main Street Lending Program, the U.S. Treasury will contribute $75 billion to the program (actually to a special legal entity), as appropriated to the Exchange Stabilization Fund via the CARES Act. The Fed will make (as of now) a maximum of $600 billion in loans through this program, but there is another layer of complexity.

Specifically, private banks will facilitate the loans and then keep only a 5 percent stake. The Federal Reserve will hold the remaining 95 percent of the loans. In other words, the Fed is effectively lending to commercial firms. (The loans have 4-year maturities, amortization of principal and interest deferred for one year, minimum size of $1 million, and eligibility for U.S. companies with no more than 15,000 employees or a maximum of $5 billion in 2019 annual revenues.)

If the program should lose $75 billion, then the Fed would lose an amount of money that Congress was willing to risk when it appropriated the funds. If, however, the Fed’s lending program loses more than $75 billion, then the Fed would lose more than Congress was willing to risk. Thus, these operations blur the lines between fiscal and monetary policy in a way that serves to undermine confidence in both.

These kinds of programs reflect the dangerous notion that took hold in the 2008 financial crisis: the concept that the Fed is supposed to save everyone. 

Decades ago, the Fed was supposed to provide liquidity to the system in a way that preserved the par value of money. Over time, especially during the 2008 crisis, this idea was expanded to include money substitutes, such as money market funds, commercial paper, repos, etc. 

Supposedly, this sort of rescue was necessary to prevent financial market turmoil from spreading to the “real” economy because so many people were now relying on these money substitutes. Little weight was given to the fact that the people using these substitutes were, in fact, knowingly taking financial risks, and there was virtually no consideration as to why people were taking these risks. 

Predictably, the definition of money substitutes broadened during the crisis. Prior to the 2008 crash, there was nothing close to universal agreement that these broader money substitutes were a key component of the money supply. Now, though, the Fed has created the expectation that it is committed to underwriting virtually all emergency spending. Everyone, it seems, must be made whole.

Naturally, the Fed cannot disappoint that expectation without disrupting markets. So, the Fed is increasingly at the mercy of markets and the markets are increasingly at the mercy of the Fed. Combined with the fact that the Fed’s credit facilities displace private banks, the U.S. now has a financial framework in place that is little more than government banking.

For a nation that already had major debt problem—due largely to its entitlement spending problem, an issue described in detail in this new Heritage Foundation Backgrounder—this notion that some kind of new monetary policy can fix bad fiscal policy is particularly dangerous. And the longer-term risks of these policies are much worse than the political problems the Fed has experienced so far. 

These crisis policies—along with the new operating system that the Fed maintained after the 2008 crash—threaten to turn the Fed into a pawn of the Treasury (or Congress). The new opportunities for political groups to pressure the Fed for direct funding, and the political problems it faces, will multiply quickly. (As it stands, House Financial Services Chairwoman Maxine Waters, D–Calif., has called on the Fed to do more, and Bharat Ramamurti, a member of the congressional oversight commission charged with overseeing federal coronavirus relief efforts, has criticized the Fed’s Municipal Liquidity Facility because it excludes “certain cities and counties… such as Atlanta, Detroit, and Baltimore.”)

The Fed should be lauded for its efforts to provide much needed liquidity at the beginning of the COVID-19 crisis. These direct lending programs, on the other hand, should be shut down now. 

If Congress wants to send money to people and make loans to businesses, they should stand up and do it rather than pass the buck off to the unelected officials who work at the Federal Reserve. After this crisis passes, the Fed should shrink its balance sheet and revert to an operating system that allows it to maintain a minimal footprint in credit markets, one that keeps it out of messes like this in the future.

This piece originally appeared in Forbes https://www.forbes.com/sites/norbertmichel/2020/06/08/fed-main-street-lending-program-already-in-trouble-likely-to-get-worse/#6b84e27577ae