Unprecedented Debt + Encouragement to Borrow More

(Note: the above 75-year debt chart shows debt as a percentage of U.S. GDP and is from the Wall Street Journal)

Even before the coronavirus-induced recession, United States consumers, businesses, and state and local governments had borrowed at unprecedented levels.

The conventional worry is that paying back the debt will be a drag on the recovery: [bold added]

The debt surge is set to shape how governments and the private sector function long after the virus is tamed. Among other things, it could be a weight on the expansion that follows.

Many economists believe low interest rates will help the nation manage the soaring debt load. At the same time, they say high levels of private sector debt could lead to a period of thrift, slowing the recovery if businesses and individuals try to rebuild their savings by holding back on investment and spending.

But these are unconventional times. Paying back the debt is a future concern. The problem is making more loans now to keep businesses alive.

In normal recessions businesses tap their lines of credit. If they reach their limit, banks will be nervous about lending more. The unavailability of credit flushes weaker players out of the system and primes the economy for recovery.

However, all sectors of the economy are struggling. Some of the biggest employer names--who were doing fine a few months ago--will collapse without funds to keep them going, The "normal recession" model of weeding out the weaker companies won't work if entire sectors--for example, the airlines--are gone.

Because prudent lenders won't make loans or purchase debt in this environment the Federal Reserve has become the lender of last resort for the entire economy, not just the banking sector.

On Thursday, the central bank expanded those efforts and further unveiled a new generation of lending facilities to prevent a liquidity crunch from turning into a solvency crisis for American businesses, states and cities.

The Fed said it would offer through banks four-year loans in which payments can be deferred for one year to businesses with up to 10,000 employees or revenues of less than $2.5 billion. Loans through this Main Street Lending Program, which will initially fund up to $600 billion in loans, will be subject to restrictions on stock buybacks, dividends and executive compensation. Firms that have received separate forgivable loans for payroll costs from the Small Business Administration will be eligible to seek Main Street loans as well.

To ease funding strains for cities and states seeing large revenue drops and rising expenses from simultaneous economic and health crises, the Fed said it would purchase up to $500 billion in short-term debt directly from U.S. states, the District of Columbia, U.S. counties with at least two million residents, and U.S. cities with at least one million residents.

Your humble blogger was taught in Paleozoic-Era economics courses that the Federal Reserve only participated in capital markets by buying and selling Treasury Bills. In succeeding crises the Fed bought long-term Treasuries and bank debt.

Now the Fed is buying corporate debt--even some risky pieces that pension funds won't touch--and the debt of state and local governments. It has crossed a line and can't go back. ("Why are you letting [State name] go bankrupt?")

Eventually the tidal wave of government debt and paper money will cause an inflation that will dwarf that of the 1970's. Thankfully, with a life expectancy of perhaps 20 years, I won't have to suffer through much of it.