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Op-Ed: How To Fix The Fed’s Broken Main Street Loan Program

By on March 9, 2021 0

It has become clear that the Main Street Lending Program, the emergency loan program created by the Federal Reserve to help small and medium-sized businesses weather the coronavirus outbreak, is not structured to meet its goals.

This needs to be corrected. Small and medium
large businesses are an essential part of our economy. They represent about 40% of all jobs in the United States, and they have substantial enterprise value that would be lost in bankruptcy. It would have high social costs, especially now, as most of these businesses could not get up to speed quickly. Temporary layoffs could become permanent.

The Main Street program has not garnered much interest from banks or borrowers. Although the Fed said the program could be as big as 600 billion dollars, and the Treasury Department allocated $ 37.5 billion to support the loan, only around 230 loans were made, for a total of approximately $ 2 billion.

Main Street loans are offered at a moderate interest rate and for a term of five years, with principal and interest deferred, giving businesses the time and flexibility to manage their losses over time. To limit the risk to the government, the program relies on banks to guarantee loans. Banks keep 5% of new loans and the Fed buys 95%, with the Treasury providing capital to cover possible losses.

Banks say that because they still have to take out loans from Main Street to meet their own criteria, the program does not increase their willingness to give loans to riskier businesses. On the contrary, a recent poll says banks have significantly tightened lending standards, mainly due to the increased risk and uncertainty generated by the coronavirus crisis.

At the same time, potential borrowers seem reluctant to take on more debt, for the sake of servicing the debt once the crisis is over. Borrowers may also be concerned about Main Street limits on dividends, compensation, and job cuts.

The Fed’s large business loan programs have been very effective, although their use has also been modest. By committing to be a back-up source of credit and buying debt in the secondary market, these programs help large companies borrow in the bond market and reduce risk for lenders. Conditions in the corporate bond market have eased considerably since the spring, and large corporations have issued record levels of bonds and built up their cash reserves.

In contrast, Main Street borrowers typically rely on banks, and the program itself is not a safety net. The program only benefits borrowers when banks use it to provide loans. Some have suggested that the program could still be useful if the recession lasts longer than expected. But it is essential to support companies that are currently in difficulty.

The slowdown has been very deep. High unemployment rates could cause permanent damage to labor markets. When business resumes, it will likely do so slowly. The Fed and the Treasury should take action to improve the Main Street program.

For example, the program could offer higher fees to banks to encourage them to participate and make riskier loans. Loans could also be made more flexible, with lower rates and longer terms, which would lower costs for small businesses that have fewer alternative sources of credit.

Finally, the Fed should clarify and, if necessary, ease the conditions imposed on borrowers. In particular, some companies may be reluctant to borrow under the program because they are unsure how the Fed and Treasury will determine whether they have made “commercially reasonable efforts” to maintain payroll and retain employees. Some of these changes would force the Fed and the Treasury to accept larger losses on program loans, which they might be willing to do with congressional support.

Even with these adjustments, legal constraints on the Fed’s lending programs may limit the effectiveness of the Main Street program. Congress should therefore consider even more fundamental changes.

For example, many countries have put in place credit guarantee programs that directly reduce risk for lenders. This can do a better job of encouraging loans. To limit fiscal costs, guarantees could be limited to loans for small borrowers, for whom liquidation likely has higher social costs.

Congress could also allow conditional debt forgiveness, which means loans could be canceled if the pandemic lasts longer than expected. This would limit the credit risk facing banks. It would also reduce the risk for borrowers to take on more debt when there is great uncertainty.

These alternative approaches would require significant budgetary resources, but as noted by President Jerome Powell, additional budgetary support is appropriate under the current circumstances. And if implemented quickly, such changes could offer huge benefits to the economy. We need small and medium-sized businesses to survive the pandemic – and to rehire workers when the effects of the crisis finally wear off.

William English is Professor in the Practice of Finance at the Yale School of Management. Previously, he was Director of the Monetary Affairs Division of the Federal Reserve. Nellie Liang is a senior fellow at the Brookings Institution. Previously, she was Director of the Financial Stability Division at the Federal Reserve.

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