Home Economic Trends Is the Main Street Lending Program a Debt Trap? – Robert Aro...

Is the Main Street Lending Program a Debt Trap? – Robert Aro (04/28/2020)

Have you ever noticed how some countries always seem to be having debt crises? For some inexplicable reason they are often in an economic crisis and fail to meet their debt obligations. Sometimes a nation like Argentina resorts to issuing hundred-year bonds, taking on International Monetary Fund (IMF) loans or undertaking other restructuring measures that seem “designed to fail.” Such ideas still seem foreign to many living in the wealthy developed countries, but perhaps the recently announced Main Street Lending Program will change all of that.

Under this program up to $600 billion will be made available in loans to US businesses that meet either of the following conditions:

(1) the business has 10,000 employees or fewer; or (2) the business had 2019 revenues of $2.5 billion or less.

The loans have a four-year maturity and all principal and interest payments are deferred for the first year. Since the Federal Reserve is prohibited from providing small business loans to the public, it circumvents this by lending to a Special Purpose Vehicle (SPV) which will then buy 95 percent of the loans made by eligible lenders for the purpose of the program. The US Treasury will then spend $75 billion as an equity investment in this same SPV.

Each loan will be between $1 million and $25 million (unsecured under the Main Street New Loan Facility) or between $1 million and $150 million (secured under the Main Street Expanded Loan Facility) to eligible borrowers. There are only a few attestations required, such as refraining from paying back other loan balances and the provision below, which takes us to the heart of the matter:

The Eligible Borrower must attest that it requires financing due to the exigent circumstances presented by the coronavirus disease 2019 (“COVID-19”) pandemic, and that, using the proceeds of the Eligible Loan, it will make reasonable efforts to maintain its payroll and retain its employees during the term of the Eligible Loan.

Why are $600 billion in loans being given to businesses that are going through exigent circumstances, and what is the expected default risk on these loans? Without cost-cutting measures such as layoffs and salary reductions or increasing sales, there may be little prospect that the principle can be returned to the SPV and the banks. How many will default remains unknown, considering that the loans were granted not based on any merit nor metric, but based on being distressed due to the pandemic. Like any nation unable to pay back the IMF, the entrepreneur will find that he must take on a new loan in order to pay back the previous loan.

The problem is that the Fed’s intervention completely distorts the profit and loss system required to have functioning markets. Normally a lender will lend money to a business if it believes that the business can expand, innovate, or implement some other method to increase profits. However, a profit motivation on behalf of the lender does not appear to be the case here. In a press release regarding the various loan programs being offered, the Fed said that the loans will support the economy.

It’s unclear how this will support the economy, but it is clear that the Fed will potentially increase the money supply by just over half a trillion dollars. In turn, the loans received will be pyramided by commercial banks, creating a further increase in the money supply. The funds may help keep some business afloat during this crisis and may help keep staff members employed, but without reducing costs or increasing revenues many businesses may find that the only way they can continue after recovery is to take on more debt.

It was often said that during the Great Recession that main street did not receive the support that it needed; this is no longer the case, because during the Great Lockdown “support” is finally on its way!

THIS ARTICLE ORIGINALLY POSTED HERE.