CARES Act passed: Will it reduce the risk of a protracted credit crisis?
Significant fiscal response mitigates the risk of a protracted crisis
With an overwhelming majority, Congress passed the coronavirus relief package, the CARES Act. In our previous blog on the topic, we outlined that fiscal policy stimulus needs to be big, bold, targeted, and efficient, in order to reduce the risk that this liquidity crisis turns into a credit crisis. In our opinion, the CARES Act is a significant and necessary step to help support the health of the U.S. economy.
The bill contains several important support measures to help households and businesses suffering from a severe decline in incomes and cash flows:
Provisions and estimates in the CARES Act
|Federal Reserve lending facilities||$454B|
|Small business loans, grants, and subsidies||$376B|
|Rebates to individuals||$290B|
|Unemployment insurance boost||$250+B|
|Corporate tax relief||$232B|
|Relief fund for state and local governments||$150B|
|Support for hospitals||$150B|
|Industry-specific support measures||$32B|
Sources: CARES Act, Cornerstone Macro Research, 3/26/20.
- Tax rebates to individuals of $1,200 for adults and $500 for children for individuals with incomes up to $75,000 ($150,000 for married couples filing jointly), phased out for incomes above $98,000/$198,000, respectively. The government expects the amount to be available within three weeks for tax filers and four to five weeks for non-filers.
- Small business support totaling $349B in support for small businesses/non-profits with fewer than 500 employees, with some exceptions. The provision provides loans up to $10M, or up to the total business expenses on payroll, rent, utilities, mortgages, and insurance for eight weeks some of which will be forgiven if businesses avoid laying off workers.
- A boost to unemployment benefits of $600 per week, on top of the standard unemployment benefit, for the next four months with added flexibility for access to benefits for those self-employed and anyone prevented from working due to containment measures. Estimated to provide $250B of relief for households, but the total amount depends on the magnitude of unemployment.
- Fed lending facility capitalized with $454B, aimed at supporting credit markets. This amount can be levered by the Federal Reserve to provide funding for the purchase of up to $4.5T of credit instruments.
- Corporate tax relief of $232B due to delays in payroll tax payments, higher interest deductions, and improved loss carryback provisions.
- Industry-specific support measures in the form of loans or cash grants to e.g. airlines, air cargo providers, and companies with national security impact. These support measures come with strings attached in the form of restrictions on e.g. stock buybacks and executive compensation.
In total, the package amounts to more than $2T, or around 9% of GDP—a historical record. We believe this aid will help to mitigate the risk of mass layoffs and bankruptcies of the economic downturn. It therefore plays an important role in cushioning the blow from the COVID-19 crisis, by mitigating the risk that the short-term liquidity problem could turn into a longer-term solvency problem. However, as helpful as it is, we would caution against viewing this as a “quick fix” to the issues facing the economy.
How much of a boost to the economy in 2020?
When gauging the impact of the CARES Act on the U.S. economy, the important question is how much of the amount disbursed will impact real spending this year. The near-term impact on GDP will be smaller than the headline amount suggests for several reasons:
- First, a significant portion ($500-$600B) of the bill is in the form of loans, which will need to be repaid. When the economy restarts, loans offer less stimulus to demand than direct transfers. The amount allotted for direct spending this year is more in the order of $1.2-$1.3T, or around 6% of GDP.
- Second, the tax rebates planned for households will not be paid out immediately. When paid, households are unlikely to spend the rebate one-to-one as they remain constrained in their spending patterns due to containment measures.
- Third, support measures for hospitals and state/local governments will only gradually be turned into actual spending and demand.
- Fourth, business support measures (loans and grants) are at risk of being imperfectly targeted towards those hardest hit by cash flow shortfalls, and this may limit the impact on demand.
In reality, the near-term impact on demand in the economy is probably more in the order of 3% of GDP. Adding this to the first two packages passed by Congress, we are anticipating a fiscal support impact of around 3.5% of GDP this year. This is a significant step by historical standards, in fact, exceeding the fiscal impact of the policy response during the 2008-09 crisis.1 However, considering the magnitude of the hit to incomes and cash flows, a significant step was also needed.
Governments catching up
The chart below shows how the top 20 countries in the world compare in terms of the fiscal response enacted so far, relative to their ongoing infection rate (growth in known COVID-19 cases). Compared to the situation a week ago, when the most significant fiscal steps had generally been taken in the countries in which COVID-19 contagion had already tapered off (China and South Korea), we are now seeing governments across the world catch up to the economic reality of the COVID-19 containment measures. Clearly, the U.S. and U.K. are significantly stepping up their efforts of fiscal support. Several other countries are currently working on further fiscal steps as well, so this picture will keep evolving.
Sources: Multi-Asset Solution team, Bloomberg, JP Morgan, 3/27/20. The analysis includes the 20 biggest countries by GDP, for which data is available. Bubble size depicts GDP.
We believe the CARES Act significantly reduces the risk of a protracted credit crisis. The risk of a worst-case scenario of a deep, prolonged recession following the severe containment measures are lower now. The significant bi-partisan support for the package is also encouraging. However, the near-term outlook for the economy remains treacherous, as it will take some time before the effects of these fiscal and monetary policy steps reach Main Street. The key to stabilization and recovery from the current crisis is still essentially medical in nature, and we will continue to monitor the spread of COVID-19 as well as any sign of progress on treatments/vaccines.
1. Source: The Brookings Institution, Hutchins Center on Fiscal and Monetary Policy’s Fiscal Impact measure, which shows a peak GDP impact of just below 3% of the total fiscal response during the 2008-09 crisis.
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