Update 448 — Fed Confronts COVID Surge
Complicating Policy Calculus for Congress
Fourteen states — including California, Texas, Florida, and North Carolina — all in some phase of reopening, set single-day records this month for new coronavirus cases. A statistical error in the BLS unemployment rate understating the true figure by three percent in May will be corrected in the June report (we will take this up Friday). The possibility of a reversal of the nation’s economic fortune in terms of recovery is discernible.
This week, Congress heard Fed Chair Powell’s Humphrey-Hawkins full employment hearing testimony and had questions for him. Powell heard appeals for help for Main Street from all sides. What did he say? What is the Fed doing to address unemployment in exigent circumstances? Was Congress satisfied? Details below.
This week, the Senate Banking and House Financial Services Committees held hearings on the Federal Reserve’s semi-annual Monetary Policy Report. When Fed Chair Jerome Powell delivered the last report in February, unemployment was at a fifty-year low and the coronavirus was just starting to make headlines.
The Fed slashed interest rates to near zero in mid-March and then established an unprecedented eleven emergency lending facilities. Last week, the Fed announced it will keep interest rates near zero until 2022, offering a grimmer outlook for the economy. Below, we analyze two novel emergency Fed facilities and key issues that arose at the hearings.
Main Street Lending Program
On Monday, the Fed officially launched its Main Street Lending Program (MSLP) after months of revisions and delays. The MSLP is meant to help medium-sized businesses that are too large for Paycheck Protection Program (PPP) funding and too small for the Fed’s corporate bond facilities.
- The Basics: The MSLP is a $600 billion lending program backstopped by $75 billion in Treasury funds. Eligible businesses must have fewer than 15,000 employees or less than $5 billion in revenue from 2019. The program currently has three lending facilities, which can purchase new loans or expand existing loans. The loans range from $250,000 to $300 million depending on the facility. Borrowers must apply through a bank that will determine eligibility. The Fed will purchase 95 percent of the loan from the banks. Unlike PPP loans, MSLP loans are not forgivable.
- MSLP in the SBC: Questions about the MSLP came primarily from Senate Republicans. Chair Crapo focused on when the MSLP will be fully operational. Powell said that once lenders are approved, the Fed is encouraging them to issue loans right away. Powell said the Fed could begin purchasing loans from banks next week.
Crapo also focused some questions on the newly-proposed non-profit lending facilities under the MSLP. Powell stated the new facilities would be analogous to the for-profit facilities under the MSLP but tailored to non-profits’ financial needs. The Fed and Treasury are currently accepting comments regarding the non-profit facilities.
Sen. Moran had concerns that banks would not have any incentive to originate these loans. Powell pointed to various incentives including a generous origination fee and the opportunity to help their communities.
Critics have argued that the $600 billion lending program is too narrowly focused and that loan terms are too onerous for businesses. If the facility has high take-up, it can save thousands of businesses from shuttering and help secure jobs. If not, the time required to revise the loan program could spell death to many medium-sized businesses. Even with changes from several redrafts, the MSLP may fall flat and fail to provide necessary relief.
Municipal Liquidity Facility
The Fed last directly purchased municipal debt in the 1930s. It ended this streak on June 5 when it purchased $1.2 billion in debt from Illinois, the only jurisdiction so far to tap the new Municipal Liquidity Facility (MLF).
- The Basics: The MLF is a $500 billion lending facility backstopped with $35 billion from the CARES Act fund. Through this facility, the Fed purchases short-term debt (maximum maturity of three years) directly from states, cities, counties, and “Revenue Bond Issuers” such as port authorities. Borrowers may use these funds to pay for COVID-related expenses or to plug revenue shortfalls. Using this facility could help bridge borrowers until the economy recovers or they receive grants from a Corona IV package.
- Bipartisan Rebuke: The rollout of the MLF was contentious with the Fed updating the term sheet multiple times. Republicans and Democrats have been frustrated with the residency requirements and delays in opening the facility, first announced on April 9. Originally, only states, counties with more than two million residents, and cities with more than one million residents could directly borrow from the facility.
Facing criticisms that the MLF excluded too many jurisdictions, the Fed lowered the eligibility threshold to counties with 500,000 and cities with 250,000 residents. States such as Alaska and Wyoming that lack localities meeting those thresholds may designate up to two cities or counties to borrow from the MLF. During Tuesday’s hearing, Sen. Sinema remained skeptical that the facility offers broad enough eligibility.
Lowering the residency requirement has expanded eligibility, but MLF’s terms are still unfavorable for many states and localities. A significant barrier for potential borrowers is the Fed’s interest rates, which are above the private market’s. The terms may only be attractive to the lowest-rated borrowers like Illinois, whose bonds are one step above junk status, or jurisdictions facing tight short-term liquidity restraints.
Meanwhile, in the corporate bond market, Fed intervention has been swift and aggressive. If there’s no significant uptake in the MLF even as states and cities bleed money, the Fed, or Congress itself, should consider liberalizing the lending terms, especially around interest rates.
- Fed’s Role in Addressing Inequality: Powell was vague but said the best thing the Fed can do to support low-income workers is to make sure the economy gets back to maximum employment. But with the Fed forecasting unemployment remaining above 5.5 percent until 2022, it may be years until low-income Americans see the benefits of a tight labor market again.
- Who Are the Facilities Helping?: In the House hearing, Rep. Jim Himes inquired if the Fed is ensuring that corporations receiving assistance are directing the funds to workers rather than shareholders. Powell said that the Fed is not mandating that recipient companies assist workers since the CARES Act did not direct the Fed to do so. Unless Congress specifies that the Fed should structure facilities to help workers, the Fed will not add these terms.
- Call for More Fiscal Action: Powell repeatedly refused to endorse specific fiscal policies but did say it would be wise for Congress to pass more fiscal support for unemployed workers, state and local governments, and small businesses.
One theme running through Powell’s hearings was his insistence that the crisis is ongoing. This is not the time for the federal government to take its foot off of the gas. As Powell repeatedly stated, many workers will not have jobs to return to even as states reopen. The Fed can only do so much to ensure the economy does not spiral further downward — many members of Congress asked Powell this week what the Fed can and cannot do without additional statutory authority from Congress. As we’ve seen with the MLF and MSLP, the Fed cannot always implement programs quickly. Instead, Powell all but urged, the economy needs more robust fiscal packages to get workers and businesses through this crisis.