Leading the charge is Thomas Barrack, a friend and supporter of President Trump’s and manager of a real estate investment fund. Barrack has taken to CNBC and Bloomberg to make the case for expanding the scope of the extraordinary lending and bond-buying spree that the Fed announced late last month, one that could eventually involve trillions of dollars. His only purpose, he says, is to protect employees from losing their jobs and prevent viable companies from going out of business.
Before considering the merits of this strategy of “no junk bond left behind,” let’s be clear about a few things.
First, while it is true that nobody could have predicted the pandemic and the economic damage that it would cause, everyone should have known that allowing companies and investors to gorge on record amounts of debt would make the economy and the financial system much more vulnerable when an unexpected shock came along, as it always does. Things didn’t have to be this bad.
Second, the aim of opening the Fed’s spigot even wider isn’t merely to rescue companies and their workers. It is also about protecting the wealthy investors and fund managers, including Barrack, who are now looking at huge losses on all those mortgage-backed securities, collateralized loan obligations and leveraged loans they bought.
Third, this is not simply a short-term problem of insufficient “liquidity” in credit markets. One reason lenders and investors are no longer willing to buy and hold these credit instruments — to provide liquidity — is that they fear that some of the original borrowers will not be able to keep up with their monthly loan payments and may be forced to default. Scratch a liquidity crisis and you usually find a credit crisis lurking underneath.
Finally, it’s worth noting that this would be the third time in 22 years that the Fed is being asked to bail out a shadow banking system that earns outsize profits precisely because it is unregulated, undercapitalized and never charged for being rescued.
That said, there is a good case to be made for providing a lifeline to viable businesses with lower credit ratings that can’t roll over existing debt or borrow more to cover operating losses while their sales are impaired. More than half the bonds and credit instruments issued in recent years have carried ratings below investment grade. And if those companies are unable to continue paying employees, landlords, suppliers and bank lenders, that would create a dangerous ripple effect in the economy and the financial system.
If the Fed were to announce such a program, the bonds and credit instruments tied to those firms — which are now selling at 60 to 80 cents on the dollar — should immediately return to more-normal levels. And the higher trading prices, in turn, would make it possible for these lower-rated companies to issue new bonds or get new loans. That’s what happened with short-term commercial paper and investment grade corporate bonds when the Fed announced it would join with the Treasury to buy those securities. There is no reason the same thing wouldn’t happen with riskier credit.
That doesn’t mean, however, that these companies and their lenders should get terms as favorable as blue-chip companies’.
To reflect the greater risks involved, the Treasury should contribute a larger portion to the new lending facility (30 percent instead of 10 percent), so that taxpayers absorb any losses, allowing the Fed to honor its legal obligation to traffic only in riskless securities. The riskiest tranches of loan packages should be excluded from the program. And if banks decide to use these lower-rated loans and securities as collateral to borrow additional funds from the Fed, the presumed value should be deeply discounted.
More important, Congress should include in its next rescue package a small tax on every financial market transaction, collected every time a stock, bond, loan package or derivative is bought and sold. The revenue could be used to repay taxpayers for any money that might be lost in the current bailout and build up an emergency reserve fund to be used in the next crisis. Just as regulated banks pay a premium to the federal government to insure their depositors against losses, the shadow bankers would be paying the government for protecting its funders. A transaction tax of 0.2 percent could raise around $200 billion a year.
Up to now, Wall Street has used its influence with the Treasury and Republican allies in Congress to squelch any talk of a financial transaction tax, even as Democrats fantasized that they could use it to finance new social programs. This would be the perfect time for Democrats to push through a financial transaction tax as a condition for their agreeing to bail out the shadow banking system again. Heading into the November election, I wouldn’t want to be the Republican senator trying to explain why she voted against an arrangement that required Wall Street to pay for its own bailout.
Over the last month, the Fed and the Treasury have moved quickly and effectively to prevent the pandemic and economic lockdown from triggering a full-blown financial crisis. Expanding on those efforts by providing a lifeline to noninvestment grade borrowers and their lenders seems like a logical next step.
At the same time, the Fed needs to be mindful that there are limits to how much more government should lend to an already over-indebted business sector and an overleveraged shadow banking system. Companies can take on only so much debt before they lose their economic viability. At that point, they need to be restructured or closed and their shareholders and creditors forced to accept their losses, even if this means slowing the economic recovery. the Fed has no mandate to reflate credit bubbles, particularly those that it should never have allowed to develop in the first place.