Central banks around the world have done a good job of making abundant and cheap money following the coronavirus pandemic, but the cure clearly does not suit the disease. Markets continue to fall. This is because it is not a monetary crisis but a crisis of confidence in the credit of borrowers temporarily in difficulty. To resolve this, governments need to consider loan guarantees.
Most commercial banks will lag behind in lending in any capacity to businesses or individuals who will see profits fall off a cliff. In the current crisis, nobody knows how long some companies could remain closed and their employees out of work. And nobody knows if consumers will return in the same number to places where people gather in nearby communities. For banks, which are mandated by regulators, depositors and shareholders to maintain the security and soundness of loans, making loans in this environment becomes extraordinarily difficult.
Governments, however, have the means to look beyond this temporary crisis for greater public good. The waves of “sudden arrests” in all the economies of the globe will end eventually and the activity will return in some form. Many companies and organizations need money to pay employees and expenses through drought in revenue. Most of them should return to good health. It is in the public interest to provide liquidity to fundamentally reliable borrowers.
Government guarantees on emergency loans granted by banks to temporarily troubled but reliable borrowers will directly address the problem. Such a guarantee program would require banks to adhere to safe and solid standards based on the borrower’s financial data before the coronavirus crisis. Existing regulators would monitor the program. A guarantee of most of the capital would largely eliminate the lender’s exposure to the current downtime, while leaving enough exposure to encourage a prudent loan. 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 organizations and people most in need.
There is a precedent for this sort of thing. In the United States, federal guarantees apply to over $ 1.9 billion in loans behind Ginnie Mae mortgage-backed securities. They apply to student loans and loans granted under the umbrellas of the United States Department of Agriculture, the Export-Import Bank and the Small Business Administration. In times of crisis, the United States has secured loans to automakers, defense contractors and foreign allies.
Part of the reason why governments so often like loan guarantees is that they don’t require debt issuance. The money, after all, doesn’t come from the government. The guarantees go very easily on the public exchange.
The United States could protect six months of worker income in some of the hardest hit companies with approximately $ 500 billion in loan guarantees. This would be enough to cover employee compensation in the transportation, entertainment, sports, retail, hotels, restaurants and other similar industries, according to 2018 data from the Economic Analysis Office.
This sum would probably also cover manufacturing and wholesale workers who produce items for these closed sectors and the accountants, accountants and lawyers who assist them. Loan guarantees sufficient to cover staff costs could save governments part of the unemployment costs, both financial and social.
Governments could also strengthen loan guarantees sufficient to cover all other temporarily closed but vital business expenses, such as rent, public services and other basic necessities.
The market continues to struggle with the potential economic damage of coronavirus. Much of it revolves around the prospects of closed businesses, rising unemployment, the pace of transition after the pandemic has passed and any permanent change in business and consumer behavior and the wider social fabric. The tremendous daily swings in the markets attest to this uncertainty. In the meantime, companies and investors continue to raise liquidity.
Yes, the extraordinary liquidity unleashed by the world central banks seems to be united in the financial system or in the balance sheets of organizations already able to overcome the crisis. It does not seem to reach temporarily troubled but reliable borrowers who could keep businesses open and people employed.
It could, though. This is what governments can and should guarantee.
Steven Abrahams is responsible for the investment strategy at Amherst Pierpont Securities in New York