THE FED WORLD AND THE REAL WORLD


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Last week, the U.S. Federal Reserve announced it was adding new lanes to its $600-billion Main Street lending program, ostensibly designed to help small businesses.
But by the facts, its sales pitch is a lie. The Feds helps the Bigs.
Indeed, small businesses employ, at best, a few hundred people, not tens of thousands. Nor do they earn billions of dollars. The new Fed program will now lend to companies with 15,000 workers, up from the original limit of 10,000; and revenues of $5 billion instead of the former $2.5 billion cap.
The Fed also is offering a new menu of loans: new, priority, and expanded. New and priority loans are in amounts of $500,000 or more, half of the previous minimum; expanded loans are for $10 million and higher.
New loans are limited to a maximum of $25 million or four times the borrower’s 2019 adjusted earnings before taxes, interest, depreciation, and amortization (EBITDA), whichever is less. Priority loans can be no more than $25 million or six times EBITDA.
Expanded loans can reach $200 million, six times EBITDA, or 35 percent of undrawn or outstanding debt.
These technicalities allow businesses to tailor their loan structures to idiosyncrasies of their specific industries, such as peaks and valleys in seasonal sales.
The loans are made for between two and four years and carry an interest rate of 3 percentage points above the LIBOR rate, the standard rate banks charge each other for overnight loans.
Banks making and administering the loans now must carry 15 percent of the loan, up from the previous 5 percent.
The new terms will enable companies to borrow even if they already carry a considerable amount of debt. Companies also will be able to use the new loans to refinance existing debt.
The U.S. treasury has set aside $75 billion to cover any losses the Fed might incur on the loans.
Oil and gas producers lobbied to be included in the plan, but the Fed excluded companies that would apply for loans based on assets instead of creditworthiness.
Additionally, the Fed is considering the possibility of a loan program for nonprofit organizations.
The Main Street program was expanded after the Fed received about 2,200 comments from businesses and nonprofits asking for the changes.
TREND FORECAST: Not-for-profits, college endowments, religious orders, charitable organizations, etc., will be hit hard by the COVID-injected “Greatest Depression” that will sap income and dry up revenue streams from donors to the rich to the middle class.
Thus, in many cases, those among society who need help the most will be getting the least. It will also greatly affect the arts at all levels, which even in the best of times, rely on generosity to keep concerts playing, theater performances live, museums open, etc.
Fed Slows Lending Pace
At the end of April, the U.S. Federal Reserve’s debt-buying program had $6.7 trillion worth of loans in its portfolio, but that portfolio’s rate of growth has slowed.
For the week ending 29 April, the central bank’s balance sheet had expanded by $81.8 billion, a fraction of the $586 billion added during one seven-day period in late March.
Also, the Fed’s loan load for its discount window, the lender of last resort for banks, dropped from $33.7 billion to $31.8 billion from 23 April to 30 April.
The Fed’s collection of government and corporate debt, however, has increased 60 percent from its $4.2 trillion in holdings in early March, when it cut interest rates to zero and launched an array of programs to lubricate credit markets and keep the economy working during the economic shutdown.
The value of the Fed’s assets now equal about a third of the U.S. GDP.
Fed Redefines Its Role in U.S. Economy
By adding direct loans to businesses and the purchase of junk bonds to its economic toolkit, the U.S. Federal Reserve System is cementing its new and expanded role at the center of the American economy.
The Fed recently agreed to buy bonds of 261 state and heavily-populated county and city governments, a move already proving politically unpopular as members of Congress complain that smaller cities and rural areas in their states have been left out.
Also, the Fed is now buying bundles of business loans known as “collateralized loan obligations.” Hedge funds bought the risky bundles before the economic crisis began; therefore, by buying the bundles, the Fed risks being seen as bailing out rich speculators.
During this year, the Fed will accumulate a portfolio of loans and bonds valued at $8 to $11 trillion, economists predict, about half the value of the entire U.S. GDP. The Fed’s holdings had reached nearly $7 trillion by 22 April.
Between mid-March and mid-April alone, the Fed was buying an average of $79 billion a day in treasury and mortgage bonds. In comparison, from 2012 through 2014, it was averaging $85 billion a month as the Great Recession was winding down.
The Fed’s new holdings will more than double last year’s $4-trillion total and be at least twice the size of the central bank’s involvement in the Great Recession.
Analysts and the Fed itself are sensitive to an array of risks this new role opens for it:

  • Politicians will become accustomed to telling the Fed to solve a broader and broader range of economic problems it was not created to address.
  • Some new Fed policies might not work, but politicians will keep them alive to please a segment of their constituencies.
  • Because the Fed’s tools are best able to help corporations that borrow in capital markets, the public might see it as favoring big business and snubbing small ones. Wall Street could once again flourish while Main Street struggles. That could erode the public’s sense of the bank’s legitimacy.

Low interest rates and money flooding markets sparked inflation after World War II and in the 1970s, but the Fed isn’t worried about inflation now because the economy is contracting.
TREND FORECAST: Interest rates will remain at or below zero in the U.S. and around the world for at least the next 12 months.
When economic growth ticks up, which it sporadically will, interest will face upward pressures, which in turn could push inflation higher.
 In addition, when interest rates do perk up, the IOUs the Fed holds will become even more costly. That, in turn, will impose yet more downward pressure across the broader economy as businesses default on loans and deeply indebted governments have to pay more to cover debt… while tax dollars decline.

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