The Economy has hit an Iceberg. Uncle Sam is handing out Life Preservers. Who gets one?

In the wake of to the Covid-19 pandemic local, state, and the federal government have taken actions to slow the spread of the disease…

In the wake of to the Covid-19 pandemic local, state, and the federal government have taken actions to slow the spread of the disease, resulting in a dramatic cessation of economic activity that threatens businesses large and most especially small. In response, the federal government has announced several new programs to funnel money to businesses in the hopes that they, and the jobs they provide, can be preserved until the crisis passes and relatively normal economic activity can begin again. Like a life preserver, receipt of relief funds won’t necessarily guarantee survival, and not getting them isn’t necessarily a death sentence, but it is likely fair to assume that receipt of relief funds will improve the odds of a firm surviving relatively intact and being able to function when economic activity can be resumed more fully.

In other words, the allocation of these funds will likely impact what the American economy looks like when we get on the other side of the crisis. Like it or not, it is inevitable that the government is going to end up picking winners and losers, whether intentionally or as a byproduct of how the programs shake out. However, it isn’t just the government who may influence who gets a life preserver and who needs to learn how to swim on their own. The private firms the government is relying on, including banks and investment advisors/asset managers will also have some discretion and control over who gets relief, and this introduces its own concerns that need to be reckoned with.

Many of these programs take the form of loans made by private lenders like banks and backed or purchased by the federal government, including the Paycheck Protection Program (PPP) and the Federal Reserve’s Main Street New Loan Facility. (The Federal Reserve is also purchasing or backstopping corporate debt issued by eligible businesses in the securities market, with assistance from outside firms to manage the programs, but for the sake of brevity I will just focus on the lending.)

Banks and other lenders are the conduit through which the loan money will flow. Firms can’t go to the government directly, they need a lender to make them a loan.

This has already proved controversial. A group of small businesses sued Bank of America because BoA placed conditions on being eligible to apply for a PPP above and beyond the requirements in the statute. The plaintiffs are concerned that because the PPP relies on a large but finite pool of government money that is allocated on a first-come, first–served basis they might not be able to get loans if BoA won’t process their application. The plaintiffs argued that BoA was adding a bunch of additional eligibility requirements to access the PPP that Congress did not authorize or intend. BoA has argued that their gating is necessary to best process the applications it does receive, helping BoA distribute more money to more firms faster than if it had to take all comers.

So far BoA has prevailed, with a Judge refusing to grant a temporary restraining order to the plaintiffs. In her opinion, Judge Stephanie Gallagher found that it was doubtful Congress intended to allow frustrated borrowers to sue lenders under the CARES Act (the act establishing the PPP) and that even if they did the CARES Act does not prevent banks from imposing additional requirements. The court points out the fact that an earlier version of the CARES Act did limit lender discretion but that language was removed. The court also points out that numerous lenders are conditioning application to PPP loans on numerous bases, such as veteran-owned businesses, rural businesses, and economically disadvantaged owners.

As a matter of law BoA is probably right, but this does highlight one of the challenges with using agents as conduits for relief aid. The firms who have the right type of relationship with the lender, or fit the profile of the type of borrower the lender wants to assist, will be in the best position to get aid from a program that itself imposes very minimal criteria to qualify. In effect, lenders are thrust into the position of gatekeeper, establishing their own private access criteria for government aid.

Some of that criteria may be overt, such as BoA conditioning access of already having a loan with BoA, or at least not having a loan with another bank. There is the potential risk that lenders’ conditions will be aimed at benefitting themselves in ways that are inconsistent with the purposes of the act. This is what the plaintiffs suing BoA allege, claiming that BoA’s criteria are meant to protect BoA’s bottom line by prioritizing firms that already owe the banks money so the banks can insulate themselves from risk that their borrowers will fail and the bank will suffer a credit loss. (It should be noted that this is just an allegation and not proven true and that an argument could be made that even if true it wouldn’t be a problem because businesses in need would still be being helped.) And of course, some banks may simply refuse to do business with some industries out of a desire to de facto regulate.

Some private screening will be implicit and potentially unintentional however. For example, there is concern that lenders like Community Development Financial Institutions (CDFIs), community banks, and credit unions, are being in-effect out competed for access to PPP funds because they are not able to initiate and process loans efficiently compared to larger banks. Given that these lenders tend to have customers who are less likely to be able to get loans from larger banks this might result in smaller and relatively weaker firms, as well as firms owned by under-represented groups or located in more challenged areas being disproportionately excluded from the PPP program. This wouldn’t be by design, but because of what type of firms have relationships with lenders who can effectively access the program.

So what do we make of this? Is this a desirable outcome? An acceptable one? Are we risking a world where the relatively rich and connected firms will get the government lifeline while the relatively poor and unconnected will not? Are we comfortable with various private actors effectively adding additional criteria to access relief funds meant to preserve the firms and jobs that existed before nature punched a hole in the hull? If we aren’t comfortable with this possible outcome what should we do about it?

As a threshold matter it is important to remember that these programs are the result of an emergency, and were put together with impressive speed. It is easy to criticize, but it should be acknowledged that policymakers and lenders have been forced to bail water with what they have at hand. As such, it isn’t a surprise they utilized existing programs and bureaucracies, even if they aren’t ideal.

That said, unfortunately it is likely that the need for relief and relief programs will exist for a while, and while there was a need to do something immediately, that doesn’t mean that suboptimal policy choices should be maintained when it is possible to improve on them. If the idea that private lenders will be able to determine who gets relief based on their preferred criteria makes us nervous then Congress or the Treasury/SBA/FRB should provide more clarity on what criteria should and should not guide their agents’ decisions. Additionally, the various oversight bodies established by the CARES act should demand transparency as to how specific decisions are made from lenders and other agents of the government. Finally, amending the CARES act may be appropriate if agent’s decisions are impeding the overarching goal of the law, which is to provide broad-based support to American businesses.

Update: The “large but finite pool of government money” used for PPP loans has been exhausted as of April 16, 2020. Congress has so far been unable to agree on providing more to the program. As Professor Nizan Packin points out this will likely more negatively impact some groups more than others.