Taxpayer Backing for Fed’s Virus Loans Has Strings Attached

The Federal Reserve rolled out six emergency lending programs in a space of seven days this month, acting swiftly to backstop everything from bond dealers to the commercial paper market. It’s now ramping up programs to directly help businesses, and Congress has a few things to say about that.

If taxpayer funds are used to backstop a new vehicle called the Primary Market Corporate Credit Facility, there will be restrictions on executive compensation, according to the $2 trillion coronavirus rescue package signed by President Donald Trump Friday.

Loans to mid-sized businesses by the U.S. Treasury Secretary, Steven Mnuchin, also have guidelines on corporate behavior that range from staffing levels to a ban on sending jobs overseas.

In recent decades, Fed leaders have had an automatic revulsion to anything that pushed them toward fiscal policy such as direct assistance to companies. When lawmakers asked former Chairman Ben Bernanke if he could loan to automakers during the 2008 financial crisis, his answer was: Sorry, no.

Political Risk

That kind of lending is fraught with political risks and can impact the distribution of wealth in the economy by favoring certain industries over others.

But the virus-induced economic crisis facing the country is upending such policy dogma and Fed Chairman Jerome Powell has positioned the central bank as the rapid purveyor of credit of last resort. That unprecedented shift will have political consequences and lead to constrained independence on Fed direct lending, economists said.

“They are going to be watched; every move they make is going to be watched,” said Julia Coronado, founding partner of MacroPolicy Perspectives LLC in New York. “They are going to want to work closely with the Senate Banking and House Financial Services committees” which oversee the Fed.

So far, several of the Fed’s facilities targeting markets have relied on the Treasury’s Exchange Stabilization Fund for a loss-absorbing cushion against risk. There are few constraints on that money. The Fed can move quickly and backstop markets any way it wants with the only precaution being not to lose money with market or credit risk.

Lawmakers have earmarked an additional $454 billion in taxpayer funds to give the Fed even more firepower for existing market programs and to start direct lending. In theory, those funds could be leveraged up to $4.5 trillion by the central bank.

Strings Attached

Those funds do come with stipulations regarding how Treasury uses the money. There is also an unusual flexibility clause for the Fed that may be politically risky.

The bill specifically grants the Fed discretion for a Main Street Lending Facility, while putting strict guidelines around the Treasury Secretary’s lending to mid-size companies, which lawmakers define as those with 500 to 10,000 employees.

These would, among other things, prohibit sending U.S. jobs overseas and demand companies retain at least 90% of their workforce at full pay with benefits. The Fed is working on standing the facility up, but has yet to publish any details.

That presents the Fed with an dilemma: even though the Fed may not be obliged to abide by these restrictions, evading them may spark lawmakers’ ire.

Hands Tied

Fed watchers are divided on how the Fed will interpret the legislation in practice.

“Fiscal policies are for legislators to decide,” said Mark Spindel, co-author of a book about the Fed’s relationship with Congress. “I don’t think he is independent here,” he said, referring to Powell’s use of taxpayer funds to expand direct Fed lending to business. “He can’t act independently of what the law is directing the Treasury Secretary to do.”

But Gilbert Schwartz, a partner at Schwartz & Ballen and a former Fed lawyer, said if Congress wanted the Fed to abide by restrictions they would have written the law that way. “Congress knows how to write the statute,” he said, while noting that Mnuchin can impose whatever conditions he wants to the funds Treasury provides the Fed.

Loaning to potentially thousands of medium-sized businesses, likely done with the help of local banks, will be a gigantic undertaking and perhaps make this the largest Fed facility ever. That would probably involve its 12 regional branches, who have deep knowledge of businesses in their districts.

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