Main Street stands empty amid the Covid-19 pandemic in downtown Louisville, Ky., April 25.
Photo: Stacie Scott/Bloomberg NewsAs Congress debates additional spending to help the economy recover, legislators should remember that their previous stabilization programs haven’t yet been fully implemented. Whatever else is in it, the next economic bill should require that the Treasury Department commit the $454 billion already appropriated under the Cares Act to back the Federal Reserve’s Main Street Lending Program.
When the Cares Act was enacted almost four months ago, Treasury Secretary Steven Mnuchin and Fed Chairman Jerome Powell said the law’s $454 billion in appropriations could be levered by the Fed to support up to $4 trillion of loans. It would be an understatement to say that this lending hasn’t happened. As of July 16, the Cares Act facilities had backed only $13.6 billion of loans. Of this amount, $11.4 billion has been used to support the corporate bond market, with another $937 million going toward securitized-debt markets. Municipal and state governments have borrowed only $1.2 billion, and midsize “Main Street” businesses a mere $12.3 million, in each case with only a single loan.
Mr. Mnuchin addressed the program in a House Small Business Committee hearing last Friday, after it had been operational for 11 days. “I am pleased to announce that Main Street made its first loan for $12.3 million to doctors’ offices consisting of 15 practices in Wisconsin,” he said, quick to add that “there’s a $50 million construction loan” in the works.
Main Street programs are crucial to small and midsize businesses. Unlike the Paycheck Protection Program, which covers businesses with a maximum of 500 employees for core expenses like payroll and rent, Main Street covers businesses with up to 15,000 employees for all expenses, including financing and inventory.
It’s easy to see why the Cares Act’s plan for Main Street lending failed. First, the terms are too onerous for borrowers. The $250,000 minimum loan amount is too large, the cost of interest is too high (Libor plus 300 basis points, with up to 200 basis points of fees), and the five-year term is too short. Second, the loans aren’t attractive to lenders. While the Fed buys 95% of every loan, the lenders are on the hook for 5%, and they still apply normal credit-risk standards. Borrowers that can meet those standards have no need of the Cares Act loans. Boston Fed President Eric Rosengren recently reported that 260 banks had registered to make loans, but many of the largest banks have not.
The Main Street deficiencies can be fixed by making the loans more attractive, with a fixed 1% interest rate, no fees, a lower minimum amount, and a longer term. The Fed should purchase the entire loan, or indemnify the lenders for all or a high percentage of losses on their retained portion, so that the lenders would have little or no credit risk. As with PPP, the lenders would primarily process the loans, and should receive reasonable fees for doing so. In effect the loans would mimic patient equity given the significant risk of nonpayment, but would not require borrowers to recapitalize.
So why haven’t Treasury and the Fed pursued this course? The primary reason is that Treasury, which must approve the Fed’s program and therefore controls its terms, doesn’t appear to want to take the risk of losing the $454 billion Congress appropriated. Mr. Mnuchin stated in April: “I think it’s pretty clear if Congress wanted me to lose all of the money, that money would have been designed as subsidies and grants as opposed to credit support.” But aren’t appropriations meant to be spent? Congress should make this clear.
Perhaps Treasury believes it should emulate former Secretary Henry Paulson’s record of not losing any funds lent to banks through the Troubled Asset Relief Program in 2008. But Mr. Paulson said this May that the objective today should be not to recoup federal funds, but to minimize “the economic hardship the American people are going to suffer before we can get people back to work.”
Another possibility is that the Trump administration believes the economy will have a V-shaped recovery, meaning there is no need for additional support. That would be wishful thinking. Such a recovery is inconsistent with the predictions of the Fed and most economic forecasters, given the path of the virus, elevated unemployment and concern over a possible cascade of business failures in the services sector.
Nor is the generally buoyant U.S. public equity market a reason for inaction. The market indexes are dominated by large-cap firms not representative of American business in general. And Fed liquidity with low interest rates helps keep equity values high without necessarily portending a quick recovery.
Congress should order that the current Main Street backing of $75 billion be bolstered with $259 billion of appropriated funds not yet allocated to other facilities, and that new loans be made on the terms we recommend. This backing could then be levered in Fed lending, with the appropriate risk of default, to help jump-start the recovery of small and midsize firms.
Mr. Hubbard, a professor of economics and finance at Columbia, was chairman of the Council of Economic Advisers under President George W. Bush. Mr. Scott is an emeritus professor at Harvard Law School and director of the Committee on Capital Markets Regulation.
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