Central banks around the world have done a good job of making money plentiful and cheap in the wake of the coronavirus pandemic, but the cure clearly does not fit the disease. Markets keep falling. This is because it is not a monetary crisis but a crisis of confidence in the credit of temporarily distressed borrowers. To solve it, governments need to consider loan guarantees.
Most commercial banks will baulk at making loans on any terms to businesses or individuals about to see earnings drop off a cliff. In the current crisis, no one knows how long some businesses might remain closed and their employees out of work. And no one knows if consumers will return in the same numbers to places where people gather in close community. For banks, which are charged by regulators, depositors and shareholders with maintaining safety and soundness in lending, making loans in this environment becomes extraordinarily difficult.
Governments, however, have the wherewithal to look beyond this temporary crisis for the greater public good. The waves of “sudden stops” across the globe’s economies will come to an end eventually, and activity will return in some form. Many businesses and organisations need cash to pay employees and expenses through the revenue drought. Most of them should return to good health. It is in the public interest to provide liquidity to fundamentally creditworthy borrowers.
Government guarantees of emergency loans made by banks to temporarily distressed but creditworthy borrowers would directly address the problem. Such a guarantee programme would require banks to underwrite to safe and sound standards, based on the borrower’s financials prior to the coronavirus crisis. The existing regulators would monitor the programme. A guarantee of most of the principal would largely eliminate the lender’s exposure to the current pause in activity, while leaving enough exposure to encourage prudent lending. Banks already have relationships with these borrowers and know their financial situations well. In this way, the commercial banking system becomes an extremely efficient means of distributing credit directly to the organisations and individuals most in need.
There is precedent for this sort of thing. In the US, federal guarantees apply to more than $1.9tn of loans behind Ginnie Mae mortgage-backed securities. They apply to student loans and loans made under the umbrellas of the US Department of Agriculture, the Export-Import Bank and the Small Business Administration. In times of crisis, the US has guaranteed loans for carmakers, defence contractors and foreign allies.
Part of the reason why governments so often like loan guarantees is that they do not require issuance of debt. The money, after all, does not come from the government. Guarantees go very easy on the public purse.
The US could protect six months of workers’ incomes in some of the most severely affected businesses with about $500bn in loan guarantees. That would be enough to cover employee compensation across transportation, entertainment, sports, retail, hotels, restaurants and other similarly affected businesses, according to 2018 data from the Bureau for Economic Analysis.
That sum would also likely cover the manufacturing and wholesale workers who make things for these shuttered sectors, and the bookkeepers, accountants and lawyers who service them. Guarantees of loans sufficient to cover staff costs might spare governments some of the costs of unemployment — both financial and social.
Governments could also step up with guarantees of loans sufficient to cover all other expenses of temporarily shuttered but viable businesses, such as rent, utilities and other essentials.
The market continues to struggle with the potential economic damage from coronavirus. Much of it swirls around the prospects of closed businesses, rising unemployment, the pace of transition after the pandemic has passed, and any permanent changes to corporate and consumer behaviour and the broader social fabric. The tremendous daily swings in markets attest to that uncertainty. In the meantime, corporations and investors continue to raise cash.
Already, the extraordinary liquidity unleashed by the world’s central banks appears to be pooling in the financial system or on the balance sheets of organisations already able to make it through the crisis. It does not seem to be reaching the temporarily distressed but creditworthy borrowers who could keep businesses open and people employed.
It could, though. That is what governments can, and should guarantee.
Steven Abrahams is head of investment strategy at Amherst Pierpont Securities in New York
Source: Economy - ft.com