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Opinion

A Federal Program Is Supposed to Keep Midsize Businesses Afloat. Why Isn’t It Reaching Them?

The Main Street Lending Program is intended to encourage banks to lend to midsize businesses by lowering their risk, but few have taken advantage of it. Yale SOM’s William English explains how the program fits into the array of federal stimulus efforts and offers proposals for making it work better. 

The door to a business with a sign reading "Closed due to cororavirus until further notice"
Noam Galai/Getty Images

Can you summarize the rationale for the Main Street Lending Program, and how effective it has been so far?

A significant concern in the COVID crisis is that the economic slowdown could have long-lived effects if it causes a lot of businesses to fail. Once the virus has waned and the economy begins to recover, failed businesses would not be there to ramp up production and rehire workers. Owners and workers at failed firms would not have a job to return to and so would have to look for new jobs, which can take considerable time. Moreover, bankruptcies can be inefficient and reduce the productive capacity of the economy. So it is important to try to support businesses through the period of very weak economic activity caused by the virus.

The Congress, in the CARES Act, established the Paycheck Protection Program to help small firms—those with fewer than 500 employees. And the Federal Reserve was already providing support for larger and less risky firms through its commercial paper and corporate bond purchase programs. But that leaves a substantial set of medium-sized and riskier firms that didn’t get any assistance. The Main Street Lending Program is aimed at those firms. 

“The Fed and Treasury want the terms on the loan to be relatively easy for the borrowing firms, but also reasonably attractive for the lending banks. That sets up a difficult tradeoff.”

The basic idea is that the Fed and Treasury help banks to make loans to such businesses by agreeing to purchase 95% of the loans made by banks under the program (with any credit losses covered by the Treasury). That is, the banks shed 95% of the risk of the loans, and only need to finance 5% of the loans. That should encourage banks to lend to firms that might be somewhat riskier than the banks would want to lend to without the program, but it also leaves banks with some “skin in the game”—ensuring that they underwrite the loans with some care and don’t end up saddling the Fed and Treasury with large losses on the loans. 

The difficulty with the design of the program is that the Fed and Treasury want the terms on the loan to be relatively easy for the borrowing firms, but also reasonably attractive for the lending banks, so that both borrowers and banks will participate in the program. But that sets up a difficult tradeoff; if the terms are too easy, banks won’t want to lend out of concern for possible losses, but if the terms are not easy enough, the targeted firms won’t want to borrow. One way around that tradeoff would be for the Treasury to be willing to lose some money on the program by providing an implicit subsidy on the loans—perhaps in the form of higher fees paid to the banks. But, at least thus far, the Treasury has been hesitant, and with the current terms on the loans the program has not gotten much interest from either potential borrowers or the banks. 

Given the limited effectiveness of the Main Street program thus far, what changes do you think should be made to strengthen it?

In a recent paper I wrote with Nellie Liang of the Brookings Institution, we suggest several changes to the program that we think would help. First, we think the Fed and Treasury should tailor the loan terms more carefully to the needs and risks of potential borrowers. So the program should provide loans at lower rates to safer borrowers, and should be open to smaller loans. At the same time, the program could accommodate loans to riskier firms, so long at the lending bank kept a larger share of the loan to ensure that it had confidence in the creditworthiness of the borrower. In addition, the program could be made more attractive to potential borrowers by easing some restrictions on borrowers, including a requirement that they make a commercially reasonable effort to maintain employment. Second, fees paid to banks should be increased to make them more willing to absorb the costs associated with the program and to encourage loans to somewhat riskier borrowers. 

“Programs such as loan guarantees or forgiveness could better support troubled firms and help promote a more rapid recovery in employment and output and limit long-run damage to the economy.”

These changes would presumably mean an increased risk of losses for the Treasury, but we see such losses as justified in the current circumstances. Even with our recommended changes, the program may have limited demand, since many businesses need equity, not more credit. In addition, banks may not want to make more business loans without even greater protection, given the uncertain economic outlook. Thus, we argue that Congress should be prepared to authorize other types of programs, such as loan guarantees or forgiveness, which could better support troubled firms and so help promote a more rapid recovery in employment and output and limit long-run damage to the economy. 

How important is supporting lending to businesses in mitigating the economic impact of COVID-19, versus other components of the CARES Act, such as enhanced unemployment assistance? 

Supporting lending to businesses is clearly only a part of the needed policy response. Many households have lost jobs and still must pay for housing, food, and other expenses. So direct transfers to such households are necessary to avoid a flood of household bankruptcies. The CARES Act provided for enhanced unemployment insurance to help such households, as well as for direct payments to low- and middle-income households to support spending. Those programs have been successful thus far, and Congress needs to extend them, perhaps with some modifications. 

Another key part of the CARES Act was the Paycheck Protection Program (PPP), which provided government-guaranteed loans to small businesses. If the proceeds of such loans are spent on paying workers and meeting other basic expenses (such as utilities or rent), the loans can be forgiven. Thus, the PPP loans are, for the most part, grants rather than loans, and so should provide significant support for the qualifying businesses.

There are other important policy steps that need to be taken, of course. Many of the costs associated with the virus fall on state and local governments. For example, reopening schools will only be possible if the schools have funding to pay for temporary additions to facilities, modifications to ventilation systems, additional staff, extensive testing, and so on. Since state and local governments generally have balanced-budget rules, and their tax revenues are falling sharply because of the economic effects of the virus, federal support for state and local governments should be a priority for the Congress. 

More broadly, the federal government needs to provide funding for medical care for those affected by the virus, for improved testing, and for the development of better treatments and vaccines. Only once we have an effective testing and tracing regime in place, more effective treatments, and ultimately a vaccine, will we really be able to put the virus behind us. 

Department: Opinion