Loans — Not Grants
11/11/20
As we look to the future, among the highest political priorities of the new administration will be the next round of federal stimulus, where the path forward is anything but clear. That said, assuming the Republicans continue to hold the majority of seats in the senate, we can reasonably expect the scale of the next round of support to fall short of the $2.2 trillion that had been passed by the house several month back in the Hero’s Act. The composition of the package, however, is highly uncertain. Both parties appear to be comfortable with some extension of unemployment supplements, albeit to varying degrees, and both appear to be on board with a further allocation for the Payroll Protection Plan (PPP). On the other hand, the biggest point of contention seems to be in connection with assistance to state and local governments. The Democrats have a substantially more generous orientation in this area, while the Republicans seem unwilling to support this sector much beyond spending directly for education.
While the PPP component of the next package will likely represent a minor portion of the total, I believe it deserves more scrutiny than it seems to be getting. Despite the parties’ seeming agreement in this area, I’m not a fan. I see PPP as a misdirection of resources. It’s a giveaway to business owners in the guise of helping the employees. This is just the latest rendition of trickledown economics, and the Democrats shouldn’t be a party to it. It’s another form of corporate welfare that serves the interests of the status quo; and given the dire circumstances of the most severely insecure with respect to food, shelter, and medical care, that status quo deserves to be reconsidered.
To be sure, without additional assistance, many businesses will likely be forced to close; but I don’t think giving grants to business owners — which is essentially what happens in the vast majority of PPP cases — is the right way to address this problem. The better approach would aggressively expand the availability of credit to companies that have suffered under the Coronavirus without the loan forgiveness features of PPP. Business owners who expect current conditions to be relatively short-lived should be willing to shoulder the responsibility of raising the needed capital to carry on, and they should bear the associated costs and risks if they expect to reap the rewards if and when they’re able to achieve success. Those who make a different judgment and are unwilling to bear those costs and risks shouldn’t be getting grants.
Restricting the use of grants is clearly an approach that would cause unsustainable businesses to fail faster than they might otherwise, but that’s not a bad thing. Propping up businesses that aren’t self-sustaining with grants should be reserved only for the most critically essential firms. In any case, under the capitalistic system that we have, we should have high confidence that normal market incentives will bring businesses back to satisfy a real economic demand after the ravages of the Corona virus are more controlled. In many cases those new businesses will offer somewhat different goods and services, many with different ownership, but that’s how capitalism is supposed to work.
I don’t want to minimize the pain and suffering that comes with businesses failing and workers losing their livelihood, but the best way to address this concern is by expanding the safety net — e.g., more generous and extended unemployment benefits and the like.
Returning to the effort to increase the availability of credit to distressed firms… The CARES Act provided for new direct lending arrangements to businesses and municipalities by the federal government for the first time, but the future of those programs appears to be in doubt. At present, the NY Times is reporting somewhat of a battle brewing between the Treasury and the Fed on this issue. Authorization under the Cares Act expires at the end of the year; and while the Fed reportedly is be inclined to extend the deadline, the Treasury seems poised to allow these initiatives to lapse. [Source: NY Times]
Beyond the direct lending, the Fed also initiated its Main Street Lending program. Under this program, participating banks make business loans to qualifying companies, but they get to sell a large portion of those loans back to the Fed. Banks earn origination fees and also defray their credit risk, and in return, the Fed relies on the credit analysis of the banks to try to ration loans to organizations that seem to be reasonable credit risks — i.e., firms that are likely to survive and ultimately repay the loans. Unfortunately, activity under this program has been disappointingly low. By way of comparison, as of October 31, the Fed had supported the Main Street Lending program with less than $4 billion, while PPP lending/grants reached over $62 billion. The terms of the Main Street Lending program (or its successor) need to be adjusted to make the funds more readily available — by a lot!
The difficult part of expanding the volume of lending to cash-strapped companies is aligning the two sides of borrower/lender transactions. Given the elevated risk that some portion of borrowers will default on their payment obligations, lenders need some added incentive to lend (e.g., higher interest or fee income). Federal policy could/should mitigate these elevated costs for qualifying borrowers, however, by subsidizing the borrowers’ interest expenses.
There’s a big difference between providing outright grants and enabling companies to borrow at subsidized rates — even at 0% or maybe even negative! Consider this: A grant directed to a single company might otherwise be spent to subsidize interest expenses for scores, or even hundreds of businesses. Grants are a step too far. Subsidizing loans is a policy alternative that is more equitable and more far-reaching, and we’ll get more bang for the buck.
