“Congress left a lot of discretion, a lot more than people realize,” one former Fed official said.
The half-trillion-dollar corporate bailout amounts to a quarter of the $2 trillion emergency relief package that Congress passed with overwhelming bipartisan support last week. Washington is still scarred by the intense political backlash against the $700 billion Wall Street bailout of 2008, when the insurance giant AIG used taxpayer dollars to pay bonuses to the reckless executives who brought down the company. This time, Democratic leaders have made assurances that they have reshaped a Republican plan for a blank-check bailout to avoid a reprise, crafting the CARES Act’s aid to companies with over 500 employees to prevent mass layoffs without enabling recipients to redistribute money from taxpayers to their own executives and investors.
“We ensured in the bill that any taxpayer dollars given to industry goes first and foremost to worker paychecks and benefits, not CEO bonuses, stock buybacks or dividends,” Speaker Nancy Pelosi declared in her floor speech before the House passed the CARES Act.
But the complex language and multiple caveats in the section of the CARES Act devoted to Federal Reserve programs leave significant room for the central bank’s leaders and their partners at the Treasury to structure the assistance however they want. And there are already indications that they’re leery of weighing down the bailout with overly burdensome conditions.
Running the bulk of the bailout through the nonpartisan Fed helped ease Democratic fears that the Trump Treasury would create a partisan slush fund to reward the president’s allies. The Fed’s massive financial leverage will also amplify the bailout’s power, expanding the $454 billion in capital into more than $4 trillion of lending. But the central bank has never been in the business of making sure its borrowers protect their workers, and the most prescriptive language in the CARES Act applies only to the Treasury aid to airlines and firms designated vital to security, which most likely will mean Boeing and perhaps some struggling oil companies.
Senator Mark Warner (D-Va.) did insert one provision with a sweeping list of restrictions on bailed-out companies—including retention of 90 percent of the workforce, pay cuts for executives earning more than $3 million a year, bans on outsourcing and offshoring, and even protections for collective bargaining agreements and union organizing campaigns. But that provision only directs Treasury Secretary Steven Mnuchin to “endeavor to” set up a program with those specifications, and insiders suggest the Fed doesn’t feel bound by them. And while the CARES Act does seem to limit companies that receive direct loans through Fed programs from buying back stock, paying dividends, or raising executive pay for a year, it allows Mnuchin to waive those provisions as long as he explains his rationale to Congress.
Democrats also managed to insert some oversight provisions into the legislation, including a special inspector general to oversee the spending, but President Trump has already issued a signing statement signaling his intention to ignore many of them. Even Democratic congressional aides who worked on the deal concede that Mnuchin and Fed Chairman Jerome Powell will have broad flexibility to design the bailout in the coming days. But Democrats hope they can ratchet up enough political pressure to avoid a repeat of the 2008 Wall Street rescue.
“The Fed has the power and the responsibility to require any big corporations that take taxpayer money to put workers first,” said Senator Elizabeth Warren of Massachusetts, a vocal proponent of a strings-attached approach. “Congress and the American people will be watching closely to make sure the Fed and Treasury Secretary Mnuchin do this right.”
Neither Fed nor Treasury officials would comment on the record. But the Fed quietly began to signal its discomfort with onerous conditions on Monday when it unveiled the terms of two new corporate credit programs that are likely to play a significant role in the bailout. One had no restrictions on how borrowers can use the money, while the other had extremely mild limits on stock buybacks and dividends, and only for firms that defer their loan payments.
Those two programs represent an extraordinary escalation in fighting the crisis, empowering the Fed for the first time to buy investment-grade corporate bonds and financial instruments backed by corporate bonds, with the potential to expand to even riskier corporate debt once the Treasury injects some bailout funds as a backstop.
But while the programs don’t look like the “Trump slush fund” some Democrats feared, they don’t look like the worker-first initiatives some Democrats promised. Unlike the CARE Act’s separate $360 billion small business bailout, they impose no requirements that the beneficiaries use the money to retain their employees. And unlike the 2008 bank bailout, they impose no limits on executive pay.
The Fed has also announced a “Main Street” lending program that could take the central bank even farther out of its comfort zone, providing liquidity to mid-sized companies that wouldn’t dream of Fed assistance in normal times. Senator Warner’s restrictions were designed with a program like this in mind, but as vice chairman Krishna Guha of the research firm Evercore ISI wrote in a note to clients, the few-strings approach in the term sheets for the corporate bond programs “might hint that Fed lawyers are preparing to take a minimalist rather than maximalist interpretation of the new legislation,” rejecting “the new conditionality.”
In a statement, Senator Warner suggested that even if the Main Street lending program doesn’t include the conditions he wanted, it’s a victory considering that the Fed didn’t even want to do a Main Street lending program when he started pushing for one a few weeks ago.
“I’m encouraged the Fed has moved off that position and is preparing to offer targeted programs that will help businesses keep their doors open and workers employed,” Warner said.
It’s natural for central bankers confronting a crisis to feel uneasy about restrictions that could make more creditworthy borrowers who need loans less likely to seek them and riskier borrowers who get loans less likely to pay them back. But some veterans of the 2008 bailouts worry that even if the Fed has a strong legal and economic justification for focusing on keeping credit flowing during the pandemic, it could face another intense political backlash if millions of Americans keep losing their jobs and it’s seen as insufficiently attentive to their plight.
“From a legal perspective, the Fed has a lot of flexibility,” says former Fed general counsel Scott Alvarez, who had to sign off on a litany of envelope-pushing actions in 2008. “But you can do everything legally correct, and you can still get a bad political reaction.”
The Fed is already rerunning much of its 2008 playbook. It has re-launched programs to backstop money market funds, short-term “commercial paper” that big companies use to fund their day-to-day operations, and securities backed by auto loans, student loans and other consumer credit. Former Fed vice chairman Donald Kohn says the central bank’s top priority right now needs to be providing as much support to the locked-down economy as possible, which means trying to prevent avoidable corporate bankruptcies as well.
But the Fed is also supposed to avoid taking credit risk, and even though massive infusions of bailout money from Treasury should help absorb loan defaults, letting borrowers skip payments or requiring them to keep their workers would presumably increase loan defaults, which is why the Fed has never done that in the past. At the same time, cracking down on executive compensation would presumably discourage some executives from seeking loans, which could complicate the Fed’s efforts to help cash-starved companies survive the epidemic with their workforces relatively intact.
“You don’t want to put so many handcuffs on these loans that people would rather shut down their businesses than borrow,” Kohn says. “You want to help them get to the other side.”
An aggressive central bank that takes more risk early in a crisis can improve its chances of defusing the crisis, which can reduce defaults and save taxpayers money in the long run. The 2008 bank bailouts were a good example, turning a profit for the government. But the bank bailouts were also politically toxic, and Kohn recalls his brutal Senate testimony after the AIG fiasco as a low point of his career. Ultimately, he says, crisis responders have to strike a balance between economics and politics, especially when they might have to ask Congress for more money down the road.
“Public support really matters,” says Kohn, who is now at the Brookings Institution. “You might not do exactly what Senator Warner wants you to do, but you don’t want to ignore that kind of sentiment, either. Everyone’s making sacrifices right now, and it could be really harmful to make loans to businesses that turn around and pay huge bonuses to their CEOs.”