NEW YORK – Over the past two months, Congress and the Federal Reserve have taken extraordinary action to stave off an economic catastrophe, including four rounds of Congressionally-authorized bailouts worth $3.8 trillion and a slew of Fed programs worth $2.3 trillion. But new research from Columbia Business School argues that government intervention focused on bond purchases will not solve the problem on their own. In the study – Can the Covid Bailouts Save the Economy? – Columbia Business School Professor Stijn Van Nieuwerburgh finds that interventions that require the Federal Reserve to purchase long-term, risky corporate debt are not nearly as effective as our economy needs. Instead, programs should be aimed at providing direct capital to businesses headed towards bankruptcy.
Through corporate credit facility programs like the Primary Market Corporate Credit Facility (PMCCF), Secondary Market Corporate Credit Facility (SMCCF), and Term Asset-Backed Securities Loan Facility (TALF) plan, the Fed plans to buy about $850 billion in corporate debt, or 8.9% of the outstanding stock (3.9% of GDP). But the study finds that bridge loan programs like the Small Business Association’s Paycheck Protection Program (PPP) and the Fed’s Main Street Lending Program (MSLP) are more successful at preventing many corporate bankruptcies and can prevent the pandemic from spilling over into a ﬁnancial crisis. When combined, PPP and MSLP make a potent cocktail that prevents 8.6% in cumulative output losses and creates significant societal benefits compared to a do-nothing scenario.
“The COVID-19 pandemic has devastated economies worldwide, and there is a clear potential for more damage without government intervention,” said Stijn Van Nieuwerburgh, the Earle W. Kazis and Benjamin Schore Professor of Real Estate at Columbia Business School. “But not just any action will suffice, and the research shows that interventions like the PPP and MSLP are much more capable of preventing a much deeper crisis.”
Van Nieuwerburgh and his co-authors Johns Hopkins Carey Business School Professor Vadim Elenev and University of Pennsylvania Wharton School Tim Landvoigt conceptualized the main factors of the COVID shock and set up an equilibrium model to analyze the effects of three government policy response options on the economy. The first policy option – a combination of the corporate credit facility programs, or CCF – buys risky corporate debt on the primary or secondary debt market, funded by issuing safe government debt. The second option, similar to the Small Business Association’s PPP, allows banks to make short-term bridge loans to non-ﬁnancial ﬁrms at a very low interest rate of one percent and the loan principal is forgiven when loans are used to pay employees. The third policy, like the Fed’s Main Street Lending Program, provides bank-originated bridge loans to non-ﬁnancial ﬁrms that aren’t forgivable and carry a modest interest rate of three percent with banks holding “skin-in-the-game” and sharing the risk with the government. Key findings include:
- PPP saves government money by spending it: With forgivable bridge loans provided to all firms, PPP leads to a substantial dent in non-financial corporate defaults which fall by 2.7% points – a 23% reduction. It also leads to the elimination of 2/3 of all bank bankruptcies. Further, the policy saves about 7.2% of pre-COVID GDP in bank bailouts that do not occur.
- MSLP is less expensive but not as comprehensive: Giving regular bridge loans to firms with a 3% interest rate and 5% bank risk retention, the MSLP reduces firm defaults even without forgivable loans and eliminates most bank bankruptcies. But the reduction in bank defaults do not meet the potential of using PPP since the banks share losses through the risk retention feature.
- CCF not nearly as effective as PPP or MSLP: CCF programs lower credit spreads, keeping the cost of borrowing down for firms and preventing a larger drop in investment, but there is a higher increase in government debt since the government must issue Treasury debt to buy the corporate debt, increasing interest rates and partially offsetting the decline in the credit spread. So, while CCF does not cause harm and overall improves welfare, it is not nearly as effective as expected or needed.
Ultimately, Van Nieuwerburgh finds that the combination of bridge loan programs avoids most corporate bankruptcies and their financial sector and macroeconomic fallout. In contrast, corporate credit facility programs that buy corporate bonds – requiring the government to purchase long-term, risky debt – is much less effective and more likely to make recovery slower.
The study, Can the Covid Bailouts Save the Economy?, is available online here.
About the researcher
Stijn Van Nieuwerburgh
Stijn Van Nieuwerburgh is the Earle W. Kazis and Benjamin Schore Professor of Real Estate and Professor of Finance at Columbia University’s...Read more.