While the focus continues to be on the third Congressional stimulus package passed last night by the Senate, and heading to the House, the Federal Reserve has quietly announced that it will play a larger role in providing loans to businesses than the US Treasury. This is in addition to the significant liquidity that the Fed has provided to the US and international banking systems. The debt side of the capital markets are frozen with investors unsure that companies will be able to pay back loans, including very short term debt like commercial paper. The Fed is intending to reopen the debt side of the market by being a large enough buyer to bring some level of liquidity back to the market. The hope is that with initiating a limited trading market, and establishing prices, it will encourage institutional investors to begin to again start trading debt securities.
The Fed cannot lend money directly to businesses or individuals. To date the Fed has only lent money to its member banks. However, the Fed has announced the planned formation of several “affiliates”, quasi-banks, that will lend to specific sectors of the economy. The Fed has characterized this financing program as “bridge loans” and they are intended for companies with strong credit, and good business fundamentals, but who are shut out of the capital markets during the Covid-19 pandemic. Information on the Fed’s plans is limited but here are a series of articles, starting with the Fed’s own press release. My apology that many of these links are behind paywalls but I was unable to find more generally available reporting on the Fed’s program. The press reports are not all consistent and the Fed has issued only a high level description of what it plans to do. As details become more available, or should our readers or I learn that I have made errors, I will edit the diary to try and keep it current, and as accurate as possible.
Federal Reserve’s press release:
www.federalreserve.gov/...
New York Times article:
www.nytimes.com/...
Bloomberg article:
www.bloomberg.com/…
WaPo article:
www.washingtonpost.com/...
As noted above, there isn’t much specific information available, and some of it isn’t consistent so this may change considerably, but based on current press reports there will be three lending entities. Exactly what structure each quasi-bank will take, who will manage them and make lending decisions, is not yet known.
Loans to companies. One entity will make loans to larger, investment grade, companies in a form that may look like a traditional short term bond. These securities are likely to be structured so that in a normal capital market the Fed could sell these bonds to institutional investors. There will be no loans to companies below “investment grade”, i.e. no “junk bonds”. While there may be additional restrictions two have been posted, companies may not pay dividends or repurchase shares while the loans are outstanding.
There is another element to these large company loans that is confusing, and has been misreported in the press. There were multiple reports yesterday that the Senate passed stimulus package would include funds that would be leveraged by Fed loans to large companies. That was not correct. However, there is an element that is correct and that is that the Treasury will be providing “equity” for these loans in the amount of ten percent. What is unclear is if the “equity” is held by the Fed, provided to the company in a loan that is junior to the Fed’s, or is just ten percent of the loan with the Fed providing the balance? What is not accurate is that these “equity” funds are part of the Senate passed stimulus bill. The equity is coming from a little known Treasury controlled fund, the Exchange Stabilization Fund. The ESF has been in place since 1934 and used for several different “emergency” actions since its inception. The fund currently has approximately $95 billion and something in the $30-50 billion range will be used along side the Fed in this lending program. Here is a very good Brookings Institute article about the ESF and how it is being used in this stimulus program.
www.brookings.edu/...
Loans to consumer lenders. The Fed will purchase bundles of consumer debt in a program they will call Term Asset Backed Securities Facility (TABF). The Fed will purchase bundled auto loans, student loans, credit card debt, SBA loans and other loans that are often structured to be resold to institutional investors. The goal is to provide liquidity to the entities that originate these types of loans so that they can continue to make new loans, even during this economic slowdown. These bundles could also be sold to institutional investors once the capital markets are again open.
Loans to small companies. The Fed has the desire to make loans to small companies. How those loans are sourced, structured and eventually sold or refinanced is still yet to be determined. The disclosure by the Fed and the reporting on this part of the program is scarce, but the Fed believes it has an obligation to play a role in this sector of the lending market so we will see what it plans to do over the next several weeks. One possible answer is to make the loans very short term, maybe 90 days, with the hope that traditional banks will be available at that time to continue lending and will provide new loans that would allow the small business owners to repay the Fed debt.
Please feel free to add additional or new information in the comments. I’ll be monitoring the comments for the next few hours.