A Simple Way Forward to Address the Economy During the Pandemic

Bernard R. Horn, Jr., President of Polaris Capital Management LLC

While Congress and the Administration wrestle with a massive $2 trillion response and many suggest expansive new loan programs, the simple way forward is to use existing Federal programs to provide working capital loans. Andrew Sorkin, for example, in the NYTimes  proposes a good solution, new bridge loans, but it violates the KISS principle in that it would be necessary to establish an entirely brand new lending systems funded by Federal and State governments. By the time we design, implement, and fund a new lending bureaucracy in the Federal and 50 state governments, it will be too late.

The coronavirus economic shock of 2020 will go down as the greatest working capital problem in financial history. Working capital problems result in equity- and debt-holders having to negotiate over cash flows. While the Sorkin proposal to provide working capital financing is the right idea, the question is how to implement it quickly and efficiently and with programs that can self-liquidate as the problem fades into the past.

There are two parts of the Sorkin proposal, funding lost wages and working capital bridge financing. Germany had the best solution for funding lost wages in the 2008-2009 Great Financial Crisis. The government allowed companies to furlough workers but keep them working at the firm, funded by unemployment benefits. The result was firms were able to quickly ramp up business as the economy rebounded from the liquidity shock. The additional benefit of this program is that otherwise unemployed workers had money to spend during the crisis, moderating the impact of the downturn in Germany. Today, governments worldwide all have unemployment programs in place. All it takes to implement this program is to allow those benefits to be paid for furloughed workers who can remain in place until social distancing policies are ended.

The second problem is working capital finance. The U.S. currently has Small Business Administration (SBA) lending programs that can more quickly lend money to small firms. The terms of these loans are well-established and have been tested over many market and credit cycles. The approval process between banks and the Federal Government works extremely well and does not need to be re-invented. The securitization process to finance SBA loans is also well-established.  

To the degree the program needs to be modified, for example around use of proceeds or credit metrics, the legislative or administrative rules could be changed quickly. The term of the loans could be adjusted to meet cash flow recovery as it might occur, but generally SBA terms would be sufficient to meet working capital term loans. The well-established credit underwriting standards and fair credit pricing in this program are performed by the many banks in this country, large and small. A new system with no mechanism to compensate taxpayers for improperly priced credit is not the right solution. The banking system is under high stress and could use the earnings stream of SBA loans either from gains on sale or ongoing interest income at this very critical time for the industry. And banks and small business will likely find innovative, win-win solutions when negotiating these loans. Any new program could not provide the same care, diligence, and underwriting standards as this time-tested program, and is not needed.

Today’s demand shock is not about the willingness of consumers to spend, which has been remarkably resilient pre-virus. It is about society’s determination to stop the spread of a virus by limiting social and civil interaction. Countries can design and fund any stimulus program imaginable, but until we let consumers out of their houses and apartments, they cannot and will not spend however much cash sovereigns drop in their hands. Cash may well assist in meeting short-term financial obligations like rent and other fixed expenses.  Mortgage payment deferrals are easily implemented and the beauty of that policy is that it is already being implemented. Rent forgiveness can be mostly funded by unemployment benefit programs like the proposal above. Let’s forget borrowing to hand out cash where this is no direction on how it will help.

One cautionary note. Let’s make sure that the response to this crisis does not push sovereign credit risk to dangerous levels. Credit markets have already responded with slightly higher Treasury yields at the thought of what might come out of current deliberations. If sovereign credit risk is pushed higher, real rates will increase and push private borrowing costs up and threaten a recovery. Let’s not focus on low interest rates; rather we must calculate at what date does the federal government earn more tax revenues than it spends. Only then will there be surplus cash flow to begin reducing outstanding federal debt. No matter how much $1 trillion burns a hole in Washington pockets, let’s resist the temptation to fix a short-term problem with a long-term danger. But let’s get to work by expanding unemployment payments and provide working capital loans through the Small Business Administration.