Update 462 — As Corona Talks Stall on Hill
Fed Facilities Attract Scrutiny in Congress
One of the biggest Corona relief-related measures enacted thus far by Congress is the $454 billion CARES Act appropriation for Federal Reserve emergency lending facilities. $110 billion of that is to backstop two novel Fed facilities, the Main Street Lending Program ($75 billion) and the Municipal Liquidity Facility ($35 billion).
How have the facilities performed? How effective has this $110 billion been? How does it measure up in terms of opportunity costs, considering alternative uses and the growing need for near-subsistence relief? What is of value, what can be fixed, and what is not just worth trying again?
Good weekends, all…
As of last week, all of the Fed’s emergency lending programs, including the Main Street Lending Program (MSLP) and the Municipal Liquidity Facility (MLF), are set to last at least until the end of 2020. Together, the MSLP and MLF have the capacity to lend $1.1 trillion. But this money has hardly been put to use.
Between the facilities, only $1.3 billion has been lent out due to onerous terms and months-long delays. In today’s Congressional Oversight Commission hearing on the MSLP, Commissioner Ramamurti said, “By any measure the Main Street Program has been a failure.”
Below, we examine these two lending facilities, assess their deficiencies, and offer solutions for how they could improve lending.
Main Street Putative Lending Program
The MSLP is a $600 billion Fed program backstopped by a $75 billion investment from Treasury, appropriated by the CARES Act. It is designed to help small-to-midsize companies that are too large for the Paycheck Protection Program (PPP) and too small for the corporate bond market. Eligible businesses must have fewer than 15,000 employees or less than $5 billion in FY2019 revenue. In July, the Fed expanded the program to include nonprofits with endowments of less than $3 billion.
The program allows banks to make five-year, low-interest loans between $250,000 and $35 million. The Fed purchases 95 percent of the loan from the bank, while the bank retains five percent. Since its announcement on April 9, the MSLP has had issues. After three months, the program fully launched on July 6. Since then the Fed has only purchased 18 loans for $104 million — about .02 percent of the $600 billion capacity.
Banks and borrowers alike have had little interest in the program. Only 509 of the eligible 11,000 federally insured banks and credit unions have joined. The MSLP defers loan principal payments for two years, so 70 percent of each loan will be due in a lump-sum at maturity. For lenders and borrowers, the five-year loan term is too short. The deferred principal payment carries an inherent risk. If a borrower fails to make timely payments of interest and principal, a bank must force the borrower to default or refinance the loan, assuming all of the credit risk.
Compared to PPP, the MSLP can serve only a very narrow set of firms. Companies with high levels of debt can’t access the loans, and these loans can’t be used to pay down existing debt. The loans can only be used to expand business activity or bridge the loss of cash flow from a contraction in economic activity.
Thoughts on Fixing It
While the Fed has adjusted the terms of the MSLP twice to include more borrowers, further changes are needed to stimulate interest:
- Lengthening the Maturity Period: To encourage participation, the Fed could extend the maturity of the loans beyond five years and offer more options for delayed repayment. The Fed could also add incentives for firms that repay their loan early.
- Reducing the Minimum Loan Size: The Fed could lower the minimum loan size (currently $250,000) for the Main Street New Loan Facility to encourage smaller banks and businesses to participate.
- Tailoring Interest Rates: Many creditworthy borrowers are able to find similar or better terms than MSLP loans. The Fed could tailor the interest rate spread based on the size of the loan or creditworthiness, giving the most creditworthy borrowers a smaller spread.
MLF Expanded but Not Demanded
The Municipal Liquidity Facility (MLF) is a $500 billion emergency lending facility backstopped with $35 billion in CARES Act funds from the Treasury. The Fed first announced the facility on April 9, but the Fed didn’t lock in its first borrower until June. The MLF allows the Fed to purchase newly issued municipal debt with up to three years of maturity from states, cities, counties, and Revenue Bond Issuers — excluding U.S. territories.
Early efforts to expand access to the facility focused on lowering the residency requirements for locality eligibility. In response to bipartisan support, the Fed lowered the resident eligibility threshold from 2,000,000 to 500,000 for counties and 1,000,000 to 250,000 for cities.
Illinois was the first and only government to tap the facility. The state secured $1.2 billion at 3.82 percent from the MLF on June 5. Raising the residency threshold, while necessary, did little to spur take-up. Lending rates, not residency requirements, are holding back potential borrowers.
Municipalities in the Penalty Box
According to a Dodd-Frank rule, the Fed must set interest rates for its 13(3) emergency facilities at a premium to what borrowers could receive in the market normally. These are called “penalty rates.” Members of Congress pushed for a penalty rate to help prevent moral hazard and ensure that banks would not get a sweetheart deal from the Fed in the next crisis. Both are valid concerns from lessons learned in 2008. But our current crisis does not have the same type of moral hazard issues, nor is it just banks who are receiving relief from the Fed.
The MLF sets its penalty interest rates significantly above what potential borrowers could expect to see in the market, especially for high-rated borrowers. AAA-rated states have been able to lock in rates below 1 percent this summer for 10-year bonds, significantly lower than the 150 basis point minimum in the MLF for three-year bonds.
The Fed credits the existence of the MLF for calming the muni market, which is likely true. But there is no guarantee that the market will remain this healthy as states and cities face larger budget shortfalls. The Fed could easily lower the rates while still maintaining a “penalty,” but it can’t remove the penalty altogether without revisiting the rule or receiving a legislative mandate.
If the Fed is unwilling to lower rates on its own, Congress should consider directing the Fed to ease the rates in the next relief package. The House Democrats’ HEROES Act lowers the MLF’s interest rates to match the Fed Funds Rate. This decrease would significantly distort the muni market. But it would offer a much-needed lifeline to states in a budget freefall.
Lending Fixes Wanted, Fiscal Relief Needed
As currently constituted, the Fed’s 13(3) facilities can only go so far. It might be too late to save the MSLP, but some members of Congress are pushing for substantial changes to the MLF. Over 50 House Democrats sent a letter to Fed Chair Powell this week requesting that the Fed implement the HEROES Act provisions of lowering the penalty rate and extending the maturity period for MLF loans.
But the Fed’s liquidity programs won’t pull us out of this crisis alone. The Senate Republicans need to pass the substantial fiscal relief in the HEROES Act. At the end of the day, the Fed can’t lend to insolvent businesses, which is what we’ll have if more fiscal relief doesn’t come soon.