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Central banks around the world have done a good job of making plentiful and cheap money in the wake of the coronavirus pandemic, but the cure clearly does not match the disease. The markets continue to decline. Indeed, it is not a monetary crisis but a crisis of confidence in the credit of borrowers temporarily in difficulty. To solve it, governments must consider loan guarantees.
Most commercial banks will be reluctant to extend loans on any terms to businesses or individuals who are on the verge of falling income. In the current crisis, no one knows how long some companies could be closed and their employees out of work. And no one knows if consumers will return in equal numbers to places where people congregate in close community. For banks, which are charged by regulators, depositors and shareholders with maintaining the safety and soundness of loans, lending in this environment becomes extremely difficult.
Governments, however, have the means to look beyond this temporary crisis for the greater public good. The waves of “sudden stops” across the world’s economies will eventually come to an end and activity will return in one form or another. Many businesses and organizations need cash to pay their employees and expenses during the income drought. Most of them should be in good health. It is in the public interest to provide liquidity to fundamentally creditworthy borrowers.
Government guarantees for emergency loans from banks to temporarily troubled but creditworthy borrowers would directly address the problem. Such a guarantee program would force banks to subscribe to safe and sound standards, based on the borrower’s finances before the coronavirus crisis. Existing regulators would monitor the program. A guarantee of most of the principal would largely eliminate the lender’s exposure to the current pause in activity, while leaving sufficient exposure to encourage prudent lending. Banks already have relationships with these borrowers and are well aware of their financial situation. In this way, the commercial banking system becomes an extremely efficient means of distributing credit directly to the most needy organizations and individuals.
There is a precedent for this sort of thing. In the United States, federal guarantees apply to more than $ 1.9 billion in loans underlying Ginnie Mae’s mortgage-backed securities. They apply to student loans and loans made under the auspices of the United States Department of Agriculture, the Export and Import Bank, and the Small Business Administration. In times of crisis, the United States guaranteed loans to automakers, defense contractors, and their foreign allies.
One of the reasons governments so often like loan guarantees is that they don’t require debt issuance. The money, after all, does not come from the government. Guarantees go very easily out of public money.
The United States could protect six months of workers’ earnings at some of the hardest hit companies with around $ 500 billion in loan guarantees. That would be enough to cover compensation for employees in transportation, entertainment, sports, retail, hotels, restaurants and other similarly affected businesses, according to 2018 data from the Bureau for Economic Analysis.
This would also likely cover the manufacturing and wholesale workers who make items for these closed industries, as well as the bookkeepers, accountants and lawyers who serve them. Loan guarantees sufficient to cover staff costs could spare governments some of the costs of unemployment, both financial and social.
Governments could also step up loan guarantees sufficient to cover all other expenses of temporarily closed but viable businesses, such as rent, utilities and other essentials.
The market continues to grapple with the potential economic damage from the coronavirus. Much of it revolves around the prospect of business closures, rising unemployment, the pace of transition after the pandemic is over, and any permanent changes in business and consumer behavior and the wider social fabric. The enormous daily fluctuations in the markets bear witness to this uncertainty. In the meantime, businesses and investors continue to raise funds.
Already, the extraordinary liquidity released by the world’s central banks seems to be pooled in the financial system or on the balance sheets of organizations already able to weather the crisis. It does not appear to reach the temporarily struggling but creditworthy borrowers who could keep businesses open and people employed.
It could, however. This is what governments can and must guarantee.
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Steven Abrahams is Head of Investment Strategy at Amherst Pierpont Securities in New York