By Karen Petrou
- Pre-COVID inequality evidenced itself instantly in post-COVID consumer-finance extremis.
- A unique construct of ground-up recovery policies is an essential, urgent response.
- Regulatory revisions would help and long-overdue equitable liquidity facilities would do still more.
- New public guarantees are critical.
Ever since the U.S. economy crept out of recession, the Fed has represented its slow, inequitable recovery as a “good place.” Its own 2018 economic well-being survey contradicted this and the latest data released on May 14 are no better before COVID came and a lot worse thereafter. These data make it still more clear that the Fed must quickly reorient its trickle-down rescues to move money starting at ground level, but even that won’t be sufficient given the magnitude of COVID’s economic impact. The combination of macroeconomic harm and financial-system hurt also requires a reset in which new public guarantees for prudent private financing fully recognized by new rules play a major part.
Bad Before Worse
As in 2018, the 2019 pre-COVID numbers were generally better than 2013, but that’s scant praise given that the Great Recession was then well under way. Before COVID hit, 28% of all American in 2019 were still unable to pay monthly bills at all or in the event of a $400 surprise. About thirty percent of Americans had no resources with which to cover three months of expenses by any means if they lost their job.
Even though the Fed thought 2019 wasn’t all that bad given some improvements over 2018, lower-income Americans were back were they started in the Fed’s first 2013 survey. In October, 75% of adults reported doing ok or living comfortably, the same as in 2018. Adults with a bachelor’s degree or higher were significantly more likely to say that they were doing well than those with only high-school educations or less – 88% to 63%. This gap widened by six percentage points since just 2017. Racial gaps also remained where they were in 2013 – 8 in 10 white adults reported doing alright compared to only two-thirds of black and Hispanic households.
And that was in October. By the first week of April, the percentage of households overall who couldn’t pay their monthly bills jumped from 16% to 18%, a 12.5% leap doubtless because almost 40% of workers with household incomes less than $40,000 lost their jobs in March alone. Overall, only 64% of Americans who lost a job or had hours reduced in March expected to be able to pay their bills in full in April. That was before another 20 million Americans lost their jobs in April. Given that at least one-third of American adults did not have three-months’ expenses in liquid savings before the COVID crisis hit, it’s safe to say that most Americans impacted by COVID already are or soon will be in financial extremis even with the help of a bit of credit forbearance.
Data beyond the Fed are even more stark – in February, 80% of working-age Americans had a job; this slid below 70% in April and is doubtless considerably lower now. Demand shocks – e.g., a huge slump in retail sales is upon us and deflation – an early warning sign of incipient depression is also evident.
What to Do
There are four ways to provide economic sustenance to hard-hit households: political demands, regulatory relief, monetary-policy intervention, and fiscal stimulus. We briefly take each in turn, concluding that carefully-crafted guarantees for distressed households and micro businesses are the quickest way to provide economic lifelines without long-term risk to financial-market integrity or to taxpayers.
Political demands are of course for sure. Their chief benefit is stimulating private financial institutions to do the best they can to avoid sanction, but the best private capital is likely to be able to do at present is not much. Banks have capital reserves, but these can be stretched considerably farther with public guarantees. Nonbanks have essentially no capital reserves and thus require not just guarantees, but also a secondary-market if they are to take on additional credit risk. A public guarantee can create a rapid-fire secondary market, but risk constraints are essential to prevent a race to the bottom of higher-and-higher risk credit that strapped borrowers can never repay. Been there, done that with mortgage finance prior to 2008.
What about regulatory relief? Congress mandated this for small-business loans under the Paycheck Protection Program (PPP), albeit only with regard to risk-based capital. Limited capital and liquidity “neutralization” has also been mandated by federal banking agencies for exposures related to various Fed windows. However, only one of these windows – a liquidity facility for the PPP – supports vulnerable groups. New loans or exposures such as overdraft protections still eat up a lot of capital even though many of them pose minimal or even no risk. Over time, the overall U.S. regulatory-capital framework needs an equality-focused rewrite; for now, the banking agencies should generously increase capital neutralization, using revised and expanded stress testing to be sure no bank has gone farther than it should. Loans with guarantees (see below) are already neutralized for risk-based capital, but they should also be freed of the leverage ratio; the agencies have done so only in limited ways so far. The agencies should do the same for exposures that counter COVID for households and micro businesses.
The Fed should also play a far larger macroeconomic role. See our prior blog post on a Family Financial Facility for how and a subsequent memo for more details.
Finally to credit guarantees. A recent global study concluded that these are the most capital-efficient ways to stretch bank capital for counter-COVID stimulus, and this is even more true in the U.S, which depends like no other nation on nonbank financial entities with limited capacity to make equality-enhancing loans without a public backstop. The Federal Credit Reform Act (FCRA) also makes guarantees a more efficient way to deploy taxpayer resources, reducing or even obliterating deficit impact if guarantees are carefully designed.
Careful design is critical not just to taxpayer protection, but also to program success – see the PPP again, this time for how not to launch a public-lending program. Careful targeting to households and micro-business cash-flow challenges are also critical, as are lengthy repayment schedules and funding – preferably from the Fed – reflecting these unique asset designs. Given the likelihood of ultra-low or even negative rates, these equality-critical loans should have better than market rates low enough to ensure debt service and eventual repayment but high enough to gain institutional and secondary-market investor support.
These scant public-guarantee details make new programs seem easy, but they aren’t. But they also aren’t anywhere near as hard as restarting an economy eviscerated by a decade of anti-equality policy that resulted in widespread household and small-business fragility. That will take years if new recovery facilities are not quickly – very quickly – mobilized for faster recovery into a less fragile future.
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