Small Businesses and Bailouts: The Federal Reserve and You

Imagine you own a mid-tier restaurant in an average American suburb. Your margins are razor-thin, but you manage to pay yourself, your staff (with the help of tips) and still cover the costs of business. Every month you pay for food inventory, labor, utilities, and the dreaded rent bill. Downtown real-estate ain’t cheap.

Suddenly, COVID-19. Nobody’s going to restaurants anymore. You don’t deliver and you haven’t set up UberEats (or what have you) yet. Gross revenue is zero. Your cash reserves are zero--where would you have saved up from? You want to keep paying your staff. You don’t want to lose the property and the years of your life you’ve poured into this place. What do you do?

You run down to the bank, and take out a loan, and you see a proverbial line-out-the-door. Every other hardware store, boutique, salon, dive bar, food truck, and other small business needs a loan, too. The bank is out of money to loan--remember how banks have a reserve requirement[1]? The law says they can’t loan money they don’t have (for some definition of “have”).

Here’s where your pal the Federal Reserve (Fed) comes in. They see businesses across the country about to fold in response to an economic upending unprecedented in our lifetime, the kind of thing that scars a generation economically to the point that they bury gold in their backyard. The Fed has two goals: maximize employment, and stabilize costs. If businesses fold, employment goes down. The Fed is gonna do something, but what?

Believe it or not, the Federal Reserve does not have a big money printer. They have a big balance sheet that they can play with numbers on, and that’s how money gets made--over 80% of money isn’t physical, it’s just numbers[2]! So, banks need money, the Fed can give money, and they have government-given autonomy to do so.

In response to the economic crisis, the Fed has done two major things[3]. First, it has cut the fed fund rate to zero. Remember how earlier I said that banks legally need to keep some cash on hand, even as they loan much of it out? To cover their butts on a day-to-day basis, they borrow from each other overnight, at (simplifying here) the fed fund interest rate[4][5]. If the fed fund rate is lower, short-term interest rates on actual loans lower as well, cash flows more freely, and business owners have easier access to liquid cash.

Second, the Fed has engaged in large amounts--trillions of dollars--of quantitative easing. This is where the Fed steps into the repo (Repurchase Agreement / Overnight lending[5][6]) market to inject massive liquidity--money that banks can lend to small business owners like yourself--into the economy[7]. Basically, the Fed says to banks, “I will buy 500 billion dollars of long-term securities (Treasury bonds) and sell them back to you in 3 months for 500.001 billion dollars.” Then, the Fed takes the bonds, they increment a number on their balance sheet, and poof! “““new””” money. If the banks default, the Fed can sell the bonds and lose basically nothing. The banks can take their new liquidity and pass it on to businesses. Repo loaning like this happens all the time, but usually far less money changes hands than is right now.

In short, other than Congressional stimulus bills, no one is “spending” $1.5 trillion. That money was never “there,” and it still isn’t really “there.” It certainly could not have canceled student loan debt, or paid for medicare for all, despite Bernie Sanders’s insistence[8]. AOC brings up a fair point[9], which is that mortgages or student loan debt collection could be paused as a form of liquidity stimulus to ordinary people. That’s true, but the government cannot provide $1.5T of cash loans to ordinary citizens--$4500 per person, roughly--without Congressional spending because, unlike banks, the population does not have $1.5 trillion of highly reliable, readily transferable collateral. Moreover, pausing rent payments, which 36% of households pay, isn’t easy. One person’s rent is another’s income.

[1] https://www.investopedia.com/terms/r/requiredreserves.asp
[2] https://www.businessinsider.com/heres-how-much-money-there-is-in-the-world-2017-10
[3] https://www.fool.com/investing/2020/03/23/federal-reserve-pledges-unlimited-quantitative-eas.aspx
[4] https://www.investopedia.com/terms/f/federalfundsrate.asp
[5] https://www.newyorkfed.org/markets/domestic-market-operations/monetary-policy-implementation/repo-reverse-repo-agreements
[6] https://www.investopedia.com/terms/r/repurchaseagreement.asp
[7] https://www.investopedia.com/terms/q/quantitative-easing.asp
[8] https://twitter.com/sensanders/status/1238223131204030466?lang=en
[9] https://twitter.com/AOC/status/1238497357261660163