By: Dr. Charles Lieberman, CIO and Dr. JoAnne Feeney, PM
The meltdown in the markets and the economy seem to be happening at warp speed. How can this be put to bed, so Americans can have a sense that the crisis will end? The policy needs seem reasonably clear. Policymakers are moving with extraordinary speed, although not quite as quickly as incoming news. But we think they are catching up. The US government needs to go big. We hope they will get there.
Policymakers need to move on two fronts: steps to contain spread of the virus and to provide a vast amount of cash to maintain employment while avoiding job losses and business bankruptcies. They are moving on both fronts, but still have further to go.
The Virus Problem
We have the experience of China and Italy to learn from to figure out how to contain the virus in the U.S. Most critically, we need to lock down every area with hot spots and need to separate people everywhere for at least two weeks to prevent contagion. We are quickly moving in this direction, but we’re not there yet. Several major cities are asking people to stay at home. That’s not enough. States or the Federal government need to order a minimum two-week shutdown to prevent people from interacting to prevent the spread of the virus. The auto companies all announced shutdowns, as have many malls, dining facilities, stadiums, government offices and retailers. Even without a direct directive from all state governments, we are moving toward a broad shutdown. But an order from the Federal government to lock down all nonessential business and require people to shelter in place would rapidly facilitate ending the contagion. As testing increases and more cases are found, the urgency for a broad shutdown should become manifest.
One concern that has been raised is over whether we have enough hospital beds to handle a possible large influx of virus patients. Part of the government’s strategy is to reduce contagion so the peak remains within our hospital bed capacity. There are some viable options. The Army Core of Engineers could put up pop-up hospital facilities, as they did in China. But with travel demand down very sharply, the government could also use hotels for patients who do not require intensive care, but do need to be isolated from others, a strategy being employed in Israel.
Manhattan Project 2.0
The government is promoting research on vaccines for this virus, although it seems likely that the private sector will get there much sooner. The administration should be supporting both and throwing everything they’ve got to support the FDA, scientists, laboratories, companies, startups, universities and whomever else may be working on a vaccine. Government needs to go big here. Trials will fail. Errors will be made. But a vaccine will be found.
The Economics Problem
While cases are rising and people are sheltering in place on their own, the decline in demand is weakening the entire economy. The effects are uneven, with activities that involve travel and leisure being hurt the most. The reductions in spending ripple across the economy. There’s no doubt that a sharp recession is already underway. Some preliminary estimates suggest a decline in first quarter GDP in the ballpark of 1% to 4% and a much deeper decline in the second quarter anywhere from 8% to 14%, before the economy could begin to rebound in the third quarter. So, the decline is likely to be quick and large, but should be temporary and followed by a strong recovery, if the government provides the right kind of restrictions to control the spread and assistance to blunt the economic impact. So how can policymakers help the economy? They can spend a ton of money to support demand and to alleviate the cash crunch many companies will face.
As firms retrench because of the decline in sales, they lay off workers, which hurts spending across the entire economy. First, the government needs to implement a major income replacement program, or better yet, to replace employers’ paychecks, so people can keep their jobs. Think of it as unemployment insurance, but on a massive scale and to cover much of the cost of workers. It would be a massive program, but doable. As of February 2020, annual U.S. GDP is about $21.7 trillion. Wages and salaries plus benefits account for $11.5 trillion of that total. So, a $3 trillion program would pay for three months of all worker income. But not all people would lose their jobs and the government would no doubt set income limits on such a program, so $3 trillion would more likely cover at least 6 to 8 months. If it is funneled through companies to enable them to make payroll, it will also greatly reduce the number of business bankruptcies and allow for a faster economic recovery. It’s a lot of money, but it would be less costly to governments, households, and firms than allowing the economy to suffer through a steep recession. This is an investment in America.
To be clear, the government is already taking these steps. The first program already passed, provides for free coronavirus testing, paid sick and family leave, and extended unemployment benefits. The second government program injects far more direct support to keep households and firms afloat during the crisis. That proposal, worth an estimated $1.1 trillion, is being discussed right now between Republicans and Democrats as they work out some of the implementation details. Cash distributions directly to all adult Americans would be delivered in April and again in May and would total $500 billion. Beyond the obvious benefits of eating and paying bills, this could ensure that individuals don’t see credit scores deteriorate during the crisis—and that helps preserve spending power for house and other purchases during a recovery.
Second, the government needs to help small and medium sized businesses. The current plan includes distributing funds to employers to cover payroll and other operating expenses which would help preserve jobs. The Small Business Administration has been tasked with providing more generous cash loans to small and medium sized businesses. The SBA is already set up to make such loans, but the criteria will change and become much less restrictive. The effort will be to lend to companies to keep them alive instead of helping them finance growth. One underlying problem is that many small companies don’t make a lot of money, so they could have enormous difficulty repaying such loans, even if the interest rate is zero. That is why the proposal appears likely to include a provision to forgive these loans provided they are used to cover payroll and other ongoing expenses.
In trying to keep defaults and bankruptcies to a minimum, forbearance will be applied to many. The Administration has already promised support for larger firms impacted by the virus, notably Boeing, airlines and hotels, possibly also malls and others. Zero or low interest loans are the minimum to be expected. But it might also take equity stakes in firms it helps support. Such activity proved highly profitable to the government when it loaned money to the banks and some insurance companies in 2008. These are not bailouts in the traditional sense, but are more like bridge loans so companies which are shut down in order to contain the virus can continue to pay their bills, including payroll. HUD, Fannie Mae, and Freddie Mac have suspended all evictions and foreclosures for at least 60 days. Cities are prohibiting landlords from evicting tenants who are unable to make rent, and many banks are also allowing borrowers to delay loan or mortgage payments. The IRS is postponing taxes due for 90 days without interest or penalties. This is all to ensure individuals and businesses have the cash they need while the economy is effectively put on hold. It also buys time for the government to figure out how badly individuals and small businesses are hurt and how much more assistance they require and how to funnel money to them. It is also why we think a third fiscal package will be coming, probably in the near future.
It is comforting that the Secretary of the Treasury has been instructed to “go big” and to do whatever is necessary. The current program under discussion is large, but the total effort will need to be larger. Some people express concern over how the government can pay for so much spending. To place it into context, the Federal debt outstanding is $22.7 trillion, so a $3 trillion program would increase the debt by about 13%. That’s significant, but we could actually afford even more, if that proves necessary. Moreover, prevailing interest rates are very low. With 10-year Treasury yields now around 1%, the addition to the annual budget deficit would only be around $30 billion. Don’t be surprised if this is financed with 50-year and even 100-year bonds. U.S. Treasury bonds remain highly valued by individuals, firms, and governments around the world as a safe place to save and still offer appealing yields, when compared to bonds from other countries.
The Fed is also playing a helpful role here. It is supplying vast amounts of liquidity to the market, which helps keep markets working and avoids any spillover effects into the economy. It enables lenders to supply capital when it is needed and it is buying commercial paper from corporations to provide liquidity directly. But its role is also longer term. Low rates will not induce firms or people to invest now. But when economic conditions start to improve, low rates will be quite helpful. And to maintain rates at low levels, the Fed will undoubtedly end up being a major buyer of the debt that will be issued by Treasury.
In due course, we think yet another additional program could follow: an infrastructure plan. Not all business will survive here and people will need to get back to work. Work to upgrade airports, bridges, dams, levees, roads, ports, drinking water and schools could produce hundreds of thousands of jobs. Politicians have talked about this for ages and it is badly needed, but helping the economy get back on its feet makes such a program much more likely. That would likely be another $1 trillion effort.
All of the above speaks to the economic recovery process. Left to its own devices, a recovery would likely be slow and extended over a longer period of time. There would be a lot of devastated Americans in the wake. Policymakers can significantly accelerate that recovery by going big. Helping firms limit layoffs, providing support for families and business to remain solvent, and financing investment to promote spending would promote a quicker rebound.
In the meantime, we keep watching the number of positive virus cases that are being reported. Testing is rising rapidly and we will find many more cases. Policymakers are on war footing and are focused on helping our medical system respond to the crisis and to help the economy. It is a reasonable prospect that significant progress can be made on both fronts within a few weeks. We’re not out of the woods, yet. But the appropriate path ahead seems reasonably clear, and most importantly, policymakers recognize it. Go big.