15 Sep 2020 3 min read

The Fed’s never-lending story

By Tim Drayson

The risks of the US economy stalling in the fourth quarter have risen as fiscal negotiations falter and a Fed programme to help small businesses stumbles.



Hopes for any further fiscal stimulus in the US before the elections darkened last week as a deal proposed by the Republicans failed to pass a Senate vote. Negotiations have become increasingly difficult of late and a failure to pass a deal soon puts millions of Americans in jeopardy.

Both sides still seem far apart on reaching agreement on another round of fiscal stimulus. Republicans do not wish to provide state and local government aid to ‘bail out’ Democrat-run states, while there is disagreement within the party on the type of stimulus and whether another round is even necessary. For their part, Democrats voted against the proposals as they contained some ‘poison pills’, such as funds for the coal industry and a tax break for private school costs.

Meanwhile on Main Street

At the same time, the Federal Reserve (Fed) is having problems with its Main Street Lending Program, designed to help firms too big for the Paycheck Protection Program but too small to tap financial markets.

Larger banks are not participating in it, and the Fed wants Congress to make clear how much credit risk it should take. Only $1 billion in loans have been made so far, out of a total capacity of $600 billion. The Republican bill also prevents the central bank from making further transactions under its lending programmes from early next year; under such a proposal, the Fed’s ability to offset an underwhelming fiscal stimulus would be reduced.

A hearing at the US Senate Banking Committee last week offered some insights into why the programme is struggling. To qualify for it, a borrower must meet certain eligibility requirements such as having no more than 15,000 employees or $5 billion in 2019 revenues. Loans must also fit within certain size parameters, ranging from $250,000 up to $300 million depending on the facility, and must have certain features like a five-year maturity, two-year principal deferral, and an adjustable interest rate of Libor plus 3%.

In addition, participating lenders must hold onto a small piece of each loan they sell to the programme, ostensibly helping to promote discipline on the part of banks by ensuring they shoulder some of the credit risk.

But this is the problem. If you say the banks have to take 5% of the loans, they’re going to apply normal credit standards and needy businesses are not going to get the money. Traditional underwriting criteria would deem these risky loans and banks would be criticised by regulators for making them.

Furthermore, the loans have leverage limits that appear inappropriate and hamper their usefulness to nearly all retail stores and restaurants. The underwriting rules that are in place now simply do not work for any asset-based borrower, whether manufacturers, restaurants, or retailers.

Fed alert

The Fed seems to want legislative change to allow it to relax the rules, and scrap the risk-retention requirement for lenders, but the Republican bill works in the opposite direction.

Overall, the drag on the economy is building but not yet apparent in the data. The blockages in approving further stimulus should not be seen as a cliff, but an increasingly steep downhill ride the longer the standoff continues.

While there is a wide range of outcomes over the next few months, the risk of the economy stalling in the fourth quarter has risen. The consensus probability of a stimulus deal stood as high as 90% a month ago but, with those odds plummeting, economists will need to embark on a series of forecast downgrades if Congress fails to act. This was perhaps a driver of weaker equity markets recently, hidden somewhat by the headline news of the technical squeeze in tech stocks.

Tim Drayson

Head of Economics

Tim keeps a close watch on global economic developments, with a particular focus on the US. He believes nothing good ever happens after midnight, which is why he is rarely spotted out late. Tim joined in 2008 from the number-one ranked economics team at ABN AMRO, with prior experience from HM Treasury, and graduated with a MSc from the University of Nottingham. When not crunching economic data, he can be found studying the weather forecast, analysing his cycling statistics or looking anxious on three-foot putts.

Tim Drayson