Unusual partnership in coronavirus bailout allows Fed and Treasury to share the risk

Steven Mnuchin, U.S. Treasury secretary, right, speaks with Jerome Powell, chairman of the U.S. Federal Reserve, during a Financial Stability Oversight Council (FSOC) meeting at the U.S. Treasury in Washington, D.C., U.S., on Wednesday, Dec. 19, 2018.

Al Drago | Bloomberg | Getty Images

Before he became Treasury secretary, Steven Mnuchin was a banker on Wall Street, where the mantra was “don’t lose money.”

Now, as Mnuchin steers a multi-trillion-dollar project to save the U.S. economy from the coronavirus fallout, the question is how much risk he is willing to bear if the potential reward is preventing total economic ruin.

As part of the CARES Act relief bill signed into law late last month, Mnuchin will pool $454 billion together with the Federal Reserve’s lending facilities to create $4 trillion in loans aimed at helping businesses, states and local governments to weather the economic storm.

The move marks an incredible expansion of the Federal Reserve’s purview, which doesn’t usually involve aid to companies and smaller-scale governments. The institution’s role is to maximize employment and stabilize the economy, not to take risks.

The program is structured so the Treasury takes the first hit if there are any losses. Taking on those risks places it on top of the credit stack so that the Treasury, in essence, becomes the top shareholder deals totaling $4 trillion. That means Mnuchin is in a spot to reap returns from the investment, although such rewards aren’t likely.

So then, the partnership also allows the Treasury to take advantage of the Federal Reserve’s ability to swiftly inject money into the economy. It also effectively shifts debt off of the Treasury’s balance sheet and onto the Fed’s, while splitting political responsibility between the two.

In an election year, when the word “bailout” is a particularly dirty one, some political cover for the Trump administration may be particularly beneficial to the president and his fellow Republicans. Democrats and Republicans alike have taken heat from the populist wings of their parties after the bank bailout of 2008, resulting in the ascent of firebrand leaders such as Democratic Sen. Elizabeth Warren, democratic socialist Sen. Bernie Sanders and, indeed, GOP President Donald Trump.

Potentially too strict

But the arrangement also worries some economists, lawyers and activists who fear that if the Treasury runs the program strictly with an eye toward minimizing losses, it might miss the goal of reviving the U.S. economy.

As a top shareholder, Mnuchin has the right to push – as any banker might  – for demanding protections on his investment, whether that be through interest rates, collateral or shorter-term bonds. And Mnuchin has made it clear he has little appetite for losses.

“We expect we will get paid back on these loans,” he told Fox News last month. “These are temporary support for the American economy that’s very critical.”

If Mnuchin’s terms end up too stringent, however, some worry that could defeat the purpose of the program entirely.

“The question is: are we going to provide a lot of money and maybe fund companies that don’t make it and incur some loses, or are we so worried about risk that some good companies might not have access to financing?” said Kathryn Judge, a professor at Columbia Law School and an expert in financial markets. 

Unlike the Great Recession over a decade ago, the financial pain now emanates from a natural phenomenon, a virus, and not from the financial system, whose holes were plugged with massive cash infusions. The government needs to aid retailers, restaurants, local auto shops and many other kinds of businesses. In one month, the U.S. economy wiped out nearly all of its job gains from the last 11 years.

With that need comes risk and likely failures. In some cases, it may also mean helping out companies that have made themselves vulnerable to risk by loading on debt in hopes of preventing widespread bankruptcies. 

Powell, of course, has a say in the terms. Mnuchin has said he and the Fed chair speak multiple times a day. He has said the Federal Reserve brings program requests to the Treasury which he then approves, often in consultation with the president, when the Treasury’s own money is involved. Mnuchin told CBS at the end of March that he had approved every program the Fed had brought so far. 

Even still, Mnuchin holds certain power cards in his favor as the Fed and Treasury put the structure of those loans in place. He recommended Powell for Fed chair. Trump has often put public political pressure on Powell.

Broad strokes, few details

Last week, the Federal Reserve began to outline in broad strokes how it will begin to use the funds. It is using $75 billion of the Treasury’s pot as equity backing behind a lending program that could support up to $600 billion in loans. The so-called Main Street Program is aimed at businesses with up to 10,000 employees or up to $2.5 billion in 2019 sales. 

It also rolled out several other facilities, purchasing financial securities like bonds and syndicated loans, but has yet to spell out the details of the entire fund. 

But the Main Street Program’s tight credit restrictions and leverage requirements quickly raised an objection from industries like retail and hospitality, which fear the most distressed businesses may be the ones prevented from getting aid.

“A lot of folks are really close to the edge, through no fault of their own. And they need money quickly,” said Tori Barnes, executive vice president of Public Affairs and Policy at the U.S. Travel Association. The group represents companies in hospitality, travel and leisure, 83% of which are small businesses. 

The U.S. Travel Association is lobbying for the Treasury to make loans directly to severely impacted travel-dependent businesses, rather than through the Federal Reserve program.

And the program appeared to lack any constraints that would prevent a company from laying off workers, thereby limiting financial flexibility − and the ability for the government to get its money back. The CARES Act requires any company accepting loans from the Treasury’s fund to maintain employment levels of 90%. The Federal Reserve program rolled last week lacked such language.

“The taxpayer is supporting the lending program, and they should know what a company is planning to do with the money,” said Bharat Ramamurti, part of a five-person congressional committee established to oversee the fund. “If it uses it to finance payroll that’s a good outcome.”

Ramamurti, a former advisor to Warren, wrote the Federal Reserve on Wednesday urging more details around the program, including disclosure of its recipients. 

Mnuchin has said he and the administration support a “full transparency” regime for the program, which includes an inspector general, a congressional committee and a separate board of inspectors general.

Still, the president has pushed back against two of those three oversight prongs.  

The Federal Reserve and Treasury declined to comment. 

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