On Monday, the Federal Reserve announced another expansion of its efforts to keep the financial system running smoothly during the coronavirus-driven economic crisis. The announcement describes several programs, each aimed at shoring up a different part of the credit markets. I think this is the best way to understand what the Fed is and isn’t doing: The Fed is taking steps to promote business liquidity. Liquidity is important, but it’s not enough to get us through this crisis. Businesses need to be liquid and solvent. It’s going to fall primarily to Congress, in the form of the stimulus bill being debated now and others that will likely follow it, to help businesses stay solvent so they can make good use of the liquidity the Fed is promoting.
Let me define those terms. Liquidity means you have access to the cash you need to make the payments that are due now. Solvency means you expect to be profitable in the long run, so it makes sense to make those payments. You can only make good use of liquidity — by borrowing money to pay ongoing expenses — if you are solvent.
Suppose you run a restaurant in a state where restaurants have been ordered to close due to the virus outbreak and the Fed’s new programs make it possible for you to get a loan. (The supposition that you can get a loan may not turn out to be true — more on that below — but let’s assume it is for now.) Are you going to be eager to borrow money to pay your employees their normal salaries even though they are not at work? Probably not, because doing so will load your business up with debt that will make it harder for you to recover when the epidemic has abated. You are better off laying off your staff even if you have access to credit. If the government wants you to keep making payroll, it’s going to have to do what the U.K. is doing and give you money instead of lending — and that’s up to Congress, not the Fed.
So suppose you’ve decided it’s a business necessity to lay off your staff for the duration of your closure. What about your other business costs, like rent or financing payments on equipment? Should you take advantage of a loan that lets you keep up with those costs, or should you go into default on your payments, expecting you may never reopen your doors? That choice depends on when you think this crisis is going to end and what you think the business environment is going to be like afterward. If you have confidence that consumers will come back and dine in your restaurant when the crisis is over, it may make sense for you to take on debt to keep the lights on. But if you think this crisis is going to go on for a long time and we’re going to be in a depression at the end of it, where consumers won’t have any money to eat in restaurants, you may be more inclined to hand your landlord the keys and close for good. Again, it’s up to Congress to provide the needed support to protect consumers’ balance sheets and prevent a deep depression — and up to many arms of government to fight the virus effectively — such that you decide your business is viable and worth spending money to keep alive. The Fed’s actions to protect the credit markets may be necessary to help you make that decision, but they won’t be sufficient.
All that said, liquidity is important, and what the Fed is doing to promote it is an important part of a suite of policies to protect the economy from the worst possible outcomes. For some businesses, the economic problem right now really is mostly a liquidity problem, with solvency not in question. Lots of businesses aren’t affected as direly by the crisis as your theoretical restaurant is, and for them, problems in the credit markets — much higher interest rates or limited availability of credit — could be the difference between staying in business and folding. Keeping the credit flowing so they stay in business is important.
The Fed is doing a lot of things to promote the availability of credit. Normally, the Fed supports credit markets by providing money to banks on the theory that this will help banks provide credit to businesses. The Fed has already been doing that, but now it will also buy bonds directly from large corporations with good credit. (The bonds must be “investment-grade,” which is to say rated BBB- or higher.) It will also buy already-outstanding corporate bonds from those sorts of businesses; by doing so, it will help hold down the interest rate at which corporations can borrow, much in the same way that the Fed helps push down the rates on long-term government bonds through quantitative-easing programs. The Fed says it will also buy other kinds of debt: It will buy asset-backed securities tied to the markets for various kinds of consumer debt, including auto loans and credit cards, to promote the availability of these kinds of credit. And it will buy certain kinds of short-term debt issued by municipal governments.
The Fed also says it intends to set up what it is calling a “Main Street business lending program” intended to support borrowing by small and midsize businesses that don’t issue the sort of bonds the Fed can just buy up. This is presumably where your restaurant would go to borrow money with the Fed’s help. But it is the least-well-defined part of the Fed’s announced actions, and some experts I spoke with were uncertain how it would work.
“How do you apply for this loan?” asked Tim Duy, a Fed-focused macroeconomist at the University of Oregon. “I don’t think those details have been entirely worked out.” Duy noted that the infrastructure for getting money from the Fed to small businesses is less obvious than for large businesses, and scaling up may be a challenge.
The Fed package is also limited in what it does for state and local governments, which face coronavirus-related challenges that look similar to those faced by many businesses. Cratering sales at restaurants also mean cratering sales tax revenues. Transit agencies face particular difficulties, with their tax revenues and fare revenues falling simultaneously and with service cutbacks being discouraged since you want relatively empty buses and trains so riders can engage in social distancing. And the market troubles that have pushed up borrowing costs for businesses have also pushed up interest rates on municipal bonds, making it more challenging and more expensive for states and localities to borrow during this time of financial stress. While the Fed is acting to support short-term government borrowing — which may help states bridge a revenue gap that emerges as taxpayers who owe payments with the filing of their income tax returns take advantage of delayed filing deadlines while taxpayers expecting refunds file early to get their refund checks now — it is not yet supporting the market for longer-term municipal borrowing like it is doing for corporate borrowing.
“It’s very telling that there are pretty aggressive measures on the investment-grade-corporate-credit side,” said Skanda Amarnath, a former analyst at the Federal Reserve Bank of New York now working at the monetary-policy advocacy group Employ America. “All 50 states are investment-grade.”
“I’m sure the Fed’s thinking that this is really a fiscal problem,” says Duy. That is, if state governments need financial support, the Fed would prefer that they turn to Congress to get it through an appropriation rather than coming to the central bank. “They don’t want to get in the business of buying state debt and backing state debt directly, and so I’m sure that’s the hesitancy here. I think they might, for that, think that they need explicit permission from Congress.”
Of course, the Fed probably does not really want to be in the business of buying corporate debt directly either, and here we are. If problems in the municipal-bond market worsen, that’s another place where the Fed might expand its liquidity-promotion efforts. But as with businesses, the Fed will only really be able to help state and local governments by making it easier to borrow if borrowing makes sense at all. As state government receipts fall sharply and some necessary expenses go up, direct federal payments to state governments will be necessary to avoid state budget cuts that would add to economic austerity and slow our recovery. The Fed may also be able to play a supporting role by intervening in the municipal borrowing market, but the primary responsibility to support state and local finances will lie with Congress.
