The writer is an emeritus Harvard Law School professor and directs the Committee on Capital Markets Regulation
The US economy is reeling from the virus surge, new business shutdown orders, continued high unemployment and reduced consumer spending, though vaccination is under way. Small businesses have been among those hit hardest. Treasury secretary nominee Janet Yellen tweeted this weekend that we need to invest in small businesses as they will be at the centre of the economic recovery. Here is how to make it happen:
To start with, the $284.45bn funding extension for the Paycheck Protection Program, enacted in December, is not nearly enough. Expanding it would require legislation. The first order of business should be to activate a new Federal Reserve lending facility — call it Dream Street — to replace the now expired Main Street programme.
The limitations of PPP are extensive. While first-time borrowers can employ up to 500 employees and borrow up to $10m, second-time borrowers are limited to 300 employees and a maximum of $2m. The scheme sets aside $75bn — about 26 per cent of the total — for first-time borrowers, the smallest firms and those in low- or moderate-income areas. And it requires that $30bn of funds be lent through community financial institutions and smaller banks. These limits, however justified, leave less money for other borrowers.
The PPP also adds a head-scratching qualification requirement for second-time borrowers: they must show a 25 per cent loss in gross revenue in any 2020 quarter comparable to the same quarter a year earlier. That means firms with relative losses of 20 per cent in two successive 2020 quarters would not qualify. The programme is geared towards payroll retention. Although it significantly expands covered expenses for all borrowers, it still does not cover maintenance, liability insurance or real estate taxes. The bottom line is that the PPP is not enough to help many needy borrowers.
Immediate help can come from a new Fed facility to replace the now ended Main Street programme. While it did not offer forgiveness, it did cover businesses with up to 15,000 employees and all expenses. But it fell extremely short of its goal of $600bn of loans backed by $75bn from the Treasury. As of January 6 it had made only $17.3bn in loans, although the take-up in December did rise by about $10.5bn.
The Treasury’s desire to avoid credit risk helped cause the shortfall. This led to a requirement that borrowers not only be solvent but meet bank credit standards, since banks were required to retain 5 per cent of every loan they made. Borrowers that could meet these standards, however, did not need Main Street. Borrowers were also deterred by the facilities’ onerous terms — interest rates above 3 per cent, fees and a relatively short repayment period.
While Main Street is dead, a new and different Dream Street facility should rise from its ashes. The Fed should buy 100 per cent of all loans, thus absorbing all credit risk, and offer more favourable terms such as lower interest and longer repayment periods. Financial institutions would be merely processors as under PPP, receiving similar fees and liability protection.
Dream Street would be different enough from Main Street that it would not be hit by the ban in the Cares Act on providing the “same” programme.
While Dream Street would still legally have to be backed by Treasury funds, and the Covid relief legislation clearly rules out using the old Cares Act funds, backing can come from the around $95bn in the Exchange Stabilization Fund.
The new legislation would allow that because the ESF can back any facility that is not the same as an existing Cares act programme. Using leverage, $50bn in ESF funds would be enough to back $300bn in new loans. This should be done immediately to help needy borrowers and our economy.