Fear of Risk Could Diminish the Economic Rescue by the Treasury and Fed

As the United States plunges into the worst economic downturn in decades, there is growing concern that the Federal Reserve and the Treasury are being too timid and halting in their approach as they scramble to rescue the economy.

Mr. Mnuchin and Mr. Powell have been given buckets of money to gird the economy as the coronavirus lockdowns continue, tanking revenues and heightening the risk of long-term economic damage. When the pandemic eventually recedes, the trajectory of the recovery will largely depend on whether the federal government went to the necessary lengths to keep businesses and households afloat.

Mr. Mnuchin has resisted taking on too much risk, mindful of the optics involved in bailing out large companies or those already heavily indebted. He has said he does not expect to lose the money that Congress has handed him to support emergency lending, which could be driving the Fed to be more cautious. While Mr. Mnuchin has said the Treasury could take losses if the economy worsens, his base case scenario is that it will return all $454 billion.

“I think it’s pretty clear if Congress wanted me to lose all of the money, that money would have been designed as subsidies and grants as opposed to credit support,” Mr. Mnuchin told reporters in late April.

“There’s plenty of scenarios where we lose all of our money,” he said. “There also could be scenarios where the world turns out better and we make money.”

The Treasury’s desire to recoup its investment may seem fiscally prudent, but economists and former government officials say it could limit the Fed’s ability to get credit to places where it is needed, undermining the recovery. The money Congress has given the Treasury is intended to provide a layer of insurance, ensuring that the Fed is not on the hook if a loan goes bad and that the Treasury will cover any losses. If the programs were expected to lose money as a base case, they might be able to extend loans to riskier borrowers, comfortable with the reality that some would probably default.

Lawmakers have begun warning the Fed and Treasury that they may fall short of congressional intent by being too risk averse and designing programs that could exclude borrowers in desperate need of help.

“It was always my intention, and I think the intention of my colleagues, that the Treasury would inevitably take some losses on that capital,” said Senator Patrick J. Toomey, Republican of Pennsylvania. Mr. Toomey, in an interview, said that “no losses at all” would probably suggest that the programs were not reaching enough companies, though he was “hoping that losses are smaller rather than larger.”

Senator Mark Warner, Democrat of Virginia, suggested the Fed and Treasury needed to act more aggressively to ensure that companies can make it through the dry spell.

“When it comes to helping Main Street businesses, we should err on the side of doing a little too much, rather than doing too little,” he said.

Whether the Treasury and the Fed are being assertive enough will be front and center on Tuesday, when Mr. Mnuchin and Mr. Powell testify before the Senate Banking Committee on the programs for the first time. Mr. Warner plans to ask about the degree of risk being taken, and in a letter sent to Mr. Mnuchin and Mr. Powell on Monday, he argued that “all taxpayers will be better off to the extent more businesses can access affordable financing.”

Mr. Toomey said he expected questions to arise about the time it had taken to roll out key programs. “I’m starting to get a little concerned about that,” he said.

For his part, Mr. Powell plans to explain the Fed’s actions to save the economy — which have gone beyond even its 2008 crisis response — and to reiterate that while the central bank will keep moving, it needs continued help from other parts of the government.

The Fed has already gotten several lending programs not backed by congressional money fully set up, but of the five that use funding from the March stimulus law, known as the CARES Act, only one is partially running. The rest are in various design phases as officials try to make sure they can get credit to companies and local governments that need it without violating the law or risking excessive losses.

When asked why they are not pushing further with Congress’s appropriation, Fed officials have consistently pointed to the Treasury.

“I do think we’re clearly moving into areas where there is more risk than there has been in the past,” Mr. Powell said at his April news conference. “But in terms of the way to think about that money, I think that’s really a question for the Treasury Department.”

The Fed and Treasury have sometimes clashed over the details of program design, with some at the central bank pushing for greater risk-taking, though they have agreed on the overall purpose and on which sectors, be it the municipal loan market or corporate credit, need a program.

The Treasury has pushed back on the idea that it is being too cautious. Mr. Mnuchin thinks that if the Fed were to take on more risk, it would insist on having even more financial backing. He has been holding about half of the funds in reserve as he assesses the economic effects of the programs rolled out so far — and keeping some powder dry in case the downturn becomes more dire.

Mr. Mnuchin’s decision to limit risk seems to be informed partly by precedent. He has viewed the 2008 emergency lending programs rolled out during the financial crisis, which returned all of Congress’s money, as instructive.

But the architect of those programs, former Treasury Secretary Henry M. Paulson Jr., said that recouping the bailout funds should not be the primary motivation.

“The objective now shouldn’t be on whether we get our money back,” Mr. Paulson said. “The objective should be to minimize the number of insolvencies and bankruptcies and the economic hardship the American people are going to suffer before we can get people back to work and leading somewhat normal lives.”

Mr. Paulson, who speaks with Mr. Mnuchin regularly, said the fact that no money was lost on the 2008 programs was a welcome development, “but the measure of success was our ability to avoid catastrophe.”

Most of the scrutiny has been aimed at a Fed program that will extend loans through banks to midsize businesses, which have diverse needs and lack credit ratings, unlike their bigger corporate counterparts, making their risk extremely difficult to assess. To limit its exposure to bad loans, the Fed has imposed restrictions, which include requiring banks to retain a slice of all loans extended and a solid chunk — 15 percent — of riskier ones.

Those limitations have prompted criticism that the Fed and Treasury, in trying to protect their capital, could fail to avert a wave of bankruptcies and layoffs. If companies fail to qualify or find the terms too onerous, they might choose to lay off workers instead of borrowing.

“The terms are not going to induce a sufficient mix of lenders and borrowers to participate,” Mr. Hubbard said. “The original sin there is the unwillingness to take losses.”

To be fair, it is hard to say what the ideal amount of risk-taking would look like. The programs offer loans, not grants, so the money needs to be paid back. Handing them out to fragile companies could serve to increase those firms’ debt without ensuring their survival.

“If you are willing to take more risk, you will reach more firms who can survive,” said Nellie Liang, a former central bank official who is now at the Brookings Institution. But the program would also take on more firms that will ultimately fail.

“The goal isn’t to get as much money out as possible because some firms won’t benefit from a loan they cannot repay,” she said.

The program details are politically fraught for the Fed and Treasury. The midsize business sector is broad, and some Democrats have objected to an early revision of program terms, suggesting that they are a giveaway to the oil industry. They have also warned against bailouts for troubled companies.

“The Federal Reserve must only lend to businesses that need loans due to the pandemic,” Senator Sherrod Brown, the committee’s top Democrat, said in a letter Monday.

Politics are also playing a role. A former Trump administration official who speaks to staff at the Fed and Treasury said the Treasury Department had been concerned with the optics of bailouts even as it looks to buttress the broader economy. There is deep concern about the appearance of having enriched wealthy private equity investors or provided lifelines to firms that were already on the brink of insolvency, while neighborhood shops go under.

While it has become a common refrain among Fed officials that they have lending and not spending powers, Capitol Hill is relying on the central bank lending programs as the government’s first line of defense. If they fail, through their own fault or the Treasury’s, censure will likely follow.

“It’s the Fed’s reluctance to take risk that’s going to lead to backlash,” said George Selgin, a senior fellow at the Cato Institute in Washington. “They’re going to err on the conservative side.”

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