By Jeff Tryka, Senior Director
The heroic efforts of doctors, nurses, first responders, and all those battling on the front lines of the COVID-19 pandemic are akin to the efforts of soldiers in landing craft storming the beaches of Normandy. In a similar vein, there are also many efforts on the home front to win the war, and in the case of the current pandemic, those efforts are being led by the Federal Reserve and an army of community banks across the nation. While the economic impact of COVID-19 should always take a back seat to the life and death impact of the virus, we believe it’s still worthwhile to examine some of these efforts that will likely remain long after the virus retreats.
Many economists and business writers have noted some fundamental differences between the current sharp declines in GDP and employment with those seen during the Great Recession of 2008-09 with the main difference being that the latter situation was an economic downturn caused by the collapse of the financial system with a weak economy combining with a weak banking system to create a deep economic downturn. In our current situation, the economy was doing quite well up until February (which seems like an eternity ago!) but was impacted by what amounts to a natural disaster in the form of the COVID-19 pandemic.
Given this fundamental difference between the two downturns, the current efforts underway by the Congress, Federal Reserve and banks are more akin to disaster relief rather than traditional stimulus. After all, it’s hard to stimulate consumer spending when consumers must remain in their homes. Instead, this situation resembles disaster relief and meeting the immediate needs of people impacted by the current restrictions (the disaster). When FEMA or other relief agencies visit an area hit by a tornado or wildfire, they are there to make sure basic needs for food and shelter are met. In the same way, the recently passed stimulus payments are meant to shore up the household financial conditions when consumers find themselves without a regular paycheck, but rent, mortgage payments, groceries and utilities must still be paid.
Beyond the immediate disaster relief of these payments, the Federal Reserve and banking system have stepped in with a number of programs in conjunction with the efforts of Congress. The Federal Reserve has responded in a multitude of creative ways to support markets and liquidity during the pandemic. These efforts have centered around three broad areas: monetary policy, markets and liquidity, and provision of new credit. In terms of monetary policy, the Fed quickly cut rates by 50 bps and then a further 100 bps such that short-term rates are now pegged at 0-0.25%. They have implemented forward guidance and will likely be very cautious when it comes to raising rates, likely overshooting their 2% inflation target. Much of these efforts will likely have an impact once economic activity resumes. For markets and liquidity, the Federal Reserve has injected significant liquidity in the repo market with additional swap lines established for foreign central banks to provide dollar liquidity without forced liquidation of Treasury, MBS and CMBS securities held by those central banks.
For the third broad area – providing credit – the Fed has implemented a number of actions to not only enhance the ability of banks to provide credit to their customers, but also to provide credit directly. To enable the flexibility of banks to provide credit, recent CARES Act emergency relief legislation offered banks the option to delay implementation of the Current Expected Credit Losses (CECL) accounting methodology that was going to be widely adopted in the first quarter of 2020, while also making adjustments to credit ratios to provide more flexibility to banks. For direct lending, the Fed has revitalized several facilities from the financial crisis era, including the commercial paper funding facility, a money market liquidity facility and the Term Asset-Backed Securities Loan Facility (TALF) to provide direct liquidity to the money markets and asset-backed lending markets. The Fed also implemented three new facilities: a primary market corporate credit facility to provide funding to investment grade borrowers, a secondary market credit facility to previously issued bonds and enhancing liquidity in those markets, and a Main Street Business facility to provide credit for mid-sized companies (500 to 10,000 employees).
Beyond the actions of the Fed, the CARES Act has implemented the Paycheck Protection Program to provide up to $349 billion in SBA loans to small businesses with fewer than 500 employees to cover up to two months of average monthly payroll costs with loan payments deferred for six months. These loans carry a low interest rate of 1%, which may be forgiven in full or in part based on maintaining employment levels. These loans are being provided by national and community banks directly to their small business customers with the Fed serving as a backstop for the loans. This program was rolled out on April 3 and is set to conclude at June 30, 2020. Many community and regional banks have stepped up to offer these loans to small businesses, including nearly a dozen of Lambert’s financial institution clients.
Ultimately, the war against COVID-19 will be won within the public health arena, but the financial community is lending support to win. As it stands now, it seems our economy has been placed in what amounts to a financial “medically induced coma” as so many businesses and individuals have been prevented from working. Eventually, the economy will reawaken, and the actions taken by banks and the financial industry will enable the economy to recover faster and more strongly than it might have otherwise.