We’ve seen Fed rate cuts before, during the 2008 crisis. Now small businesses also need support.
You have seen all of this before.
If you have been in the business since 2008, you’ll understand that the Federal Reserve’s shock-driven inter-meeting rate cut of 50 basis points validates that we are officially in crisis mode. The last few times they cut rates on an inter-meeting basis were during the global financial crisis (GFC) in 2008 and, before that, in the aftermath of 9/11 in 2001.
The coronavirus is a shock to the global economy, leading to quarantining and the instantaneous shutting off of economic activity in affected countries. Most recessions start from an environment of very low unemployment (over-employment?) and an unexpected shock. The actions from the Federal Reserve were both fair and appropriate. As Chair Jerome Powell correctly stated, the rate cut cannot “slow the rate of infection” or “fix broken supply chains,” but it can help to “boost household and business confidence” and “avoid tightening in financial conditions.” More importantly, it reduces the funding pressure across the financial system and could lead to the next round of mortgage refinancings, giving cash to U.S. consumers to spend. In a quarantined world, aggregate final demand needs to be stimulated somewhere. Why not with the U.S. consumer?
Here is one observation of what is different this time. In 2008–09, the crisis was all about the consumer balance sheet and the damage to mortgage loans caused by falling home prices. This time, it’s all about corporate balance sheets. As many consumers ‘shelter in place,’ companies are sending out earnings warnings that say topline revenue is rapidly shrinking. While large companies have the financial flexibility to weather the storm, small and medium-sized enterprises (SMEs) are suffering. In China, we estimate that one third of small businesses could run out of cash in a month and another third in two months. In the U.S., we estimate that small businesses have enough operating cash to survive for up to two months. We have already seen China respond with significant loan programs to small businesses. Japan is doing the same and European policymakers are talking about doing likewise.
What about the U.S.? What should the policy response be here? We believe that the Federal government should act swiftly to backstop the Small Business Administration (SBA). The U.S. government needs to put adequate funding in place for U.S. small businesses to access a liquidity lifeline if parts of the U.S. roll into quarantine. The Federal Reserve has paved the way by lowering the cost of the funding. Now we need to see a mechanism for it to be rapidly deployed. These are just some of the levers available to the government. We expect the government to respond, starting with a supplemental appropriation focused on immediate health care funding needs and support for the increased administrative burden on SBA. The government’s efforts will likely continue, including in the coming days and weeks support of SMEs, potential business lending options and other elements that are still being debated.
Much like the GFC led to TARP (after policymakers debated TALF... and PPIP1), there needs to be immediate bipartisan support to get substantial funding to small and medium-sized businesses. Fiscal policymakers should consider creating an emergency lending program that will support these businesses most at risk.
Every crisis is different. This time, it’s not the consumer and the housing market. It’s corporate America and small businesses that are at risk. Waiting for the flu season to pass is not the right policy response. The Federal Reserve courageously removed one question mark. Now is the time for fiscal policy to step in, put in place a firewall that could support small businesses and remove the other big question mark.
1TARP: the U.S. Treasury’s Troubled Asset Relief Program TALF: TALK: the Fed’s Term Asset-Backed Securities Loan Facility; PPIP: Treasury’s Public-Private Investment Program.