(Bloomberg Opinion) -- There is an important subtext to the Federal Reserve’s announcement on Thursday that it would provide up to $2.3 trillion in loans to prop up the economy. It’s not just that the central bank is diving into uncharted waters by buying “fallen angels” and municipal debt. Nor is it that the amount of firepower being thrown at the economy is unprecedented.
It is that the Fed is using the announcement to put pressure on the Treasury Department. The two institutions, which need to be in sync about the bailout, are not right now. To put it simply, Treasury believes that after the crisis is over, the government should be able to recoup — and perhaps even turn a profit on — the loans it will be making. The Fed believes that this crisis is so dire that the government needs to be willing to lose money to keep the country from falling into a depression.
Treasury’s model is the 2008 financial crisis. Recall that Congress passed a $700 billion bailout fund — the Troubled Asset Relief Program, or TARP — which the Treasury Department distributed to a handful of big banks along with General Motors, American International Group and several other companies. In return, the government received either equity stakes, interest on the loans or both.
Most of those loans made money for the government. Fannie Mae and Freddie Mac, for instance, required a $191 billion bailout. The two government-sponsored entities have not only repaid that amount but have sent an additional $100 billion or so to Treasury, according to Bloomberg. The government made more than $13 billion from its bailout of Citigroup, $5 billion on its stake in AIG, $4.5 billion from Bank of America and so on. In total, the government made $121 billion on the 2008 bailout, according to ProPublica.
It’s understandable that the Treasury Department would want to repeat that financial performance. After all the criticism officials received when they were handing out TARP money, the subsequent profit is something they now point to with pride.
But that crisis was man-made, which came about because of the foolish belief that home prices could only climb and that triple-A mortgage-backed securities were safe. When the system collapsed, there was a lot of blame to go around, and moral hazard was an issue.
This crisis is the result of an exogenous event — a deadly virus that is no one’s fault. In his webinar Thursday morning, Fed Chair Jerome Powell stressed that point: Companies that need federal support, he said, were not at fault for making bad business decisions. There is not the same need to extract something to minimize moral hazard.
That’s one issue. Another is uncertainty. How long will this crisis last? Nobody knows. That also means nobody knows how long companies will need federal support. Yes, some companies will absolutely survive this crisis no matter how long it lasts, and the Treasury Department could lend them money — and the Fed could leverage that money — with minimal risk.
But those aren’t the companies that most need help. Rather, it is the midsize companies — the ones in the middle of a larger company’s supply chain, for instance. Or regional restaurant chains, and retailers that have had to shut down. These companies have zero insight into their future cash flow, and some of them will probably fail.
According to a poll conducted in late March by the National Center for the Middle Market, 25% of mid-market companies believe that the coronavirus crisis will prove “catastrophic.” Should companies like that still receive government bailout money? The Treasury is reluctant to go all-in. (A Treasury representative did not respond to an email on Thursday.) The Fed’s view is that the only way to save the largest number of companies is to take lending risks that would normally be unthinkable.
The problem for the Fed is that it doesn’t have the authority on its own to take excessive credit risk. And as part of the financial reforms passed in the wake of the 2008 crisis, Treasury has to sign off on any Fed lending facility — and has to take the first loss.
In effect, by putting out its Thursday announcement, the Fed is pressing Treasury to see things its way. For one thing, it is planning to create a facility to buy Paycheck Protection Program loans, which will allow banks to multiply the number of loans that can be made to small businesses. Those loans are the least likely to be paid back.
It is also putting $600 billion toward a lending program aimed at midsize companies with 10,000 or fewer employees and less than $2.5 billion in revenue. These are the classic kinds of companies with fixed costs that haven’t gone away even though their business has evaporated. The loans have a duration of four years, but even companies that pull through may never have the kind of cash flow required to pay them back. Treasury is going to put in $75 billion in equity.
And there’s the rub. Will Treasury be willing to lose that $75 billion — and more? Ultimately the Treasury Department, not the Fed, will decide which companies receive bailout money. The Fed has sent all the signals it can. Now it’s up to Treasury.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Joe Nocera is a Bloomberg Opinion columnist covering business. He has written business columns for Esquire, GQ and the New York Times, and is the former editorial director of Fortune. His latest project is the Bloomberg-Wondery podcast "The Shrink Next Door."
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