Paycheck protection program will reduce scarring - Capital Economics
US Economics

Paycheck protection program will reduce scarring

US Economics Update
Written by Michael Pearce

The Paycheck Protection Program (PPP) of forgivable small business loans has come too late to prevent the huge initial wave of layoffs, but will be more useful in helping less directly affected firms stay afloat while limiting the rise in unemployment. By reducing the scale of economic dislocation, an expansion of the program would raise the prospects of a more rapid economic rebound, albeit at the cost of an even larger increase in the Federal budget deficit.

  • The Paycheck Protection Program (PPP) of forgivable small business loans has come too late to prevent the huge initial wave of layoffs, but will be more useful in helping less directly affected firms stay afloat while limiting the rise in unemployment. By reducing the scale of economic dislocation, an expansion of the program would raise the prospects of a more rapid economic rebound, albeit at the cost of an even larger increase in the Federal budget deficit.
  • The $350bn of small business loans, forgivable if firms keep workers on the payroll, are a key component of the near-$1trn of direct support measures or permanent fiscal transfers provided as part of the $2.2trn CARES Act recently passed by Congress. (See here.) The program is limited to businesses with fewer than 500 employees, including independent contractors, and provides loans of up to 2.5 times firms’ monthly payroll, up to a maximum of $10m.
  • The demand for such loans has been huge, presumably reflecting the extremely generous terms on offer. Two-year unsecured loans are provided through commercial banks with a 0.5% interest rate and repayments deferred for the first six months. The most attractive part of the program is that the loan amount is completely forgivable for firms that do not reduce headcount and maintain pay at least 75% of previous levels over the next eight weeks. The program is similar to the “Kurzarbeit” wage subsidy programs many European countries have introduced and is designed to help firms return to normal more quickly when lockdowns are eventually lifted.
  • Despite widespread reports of the online application system crashing, banks approved $215bn of loans in the first 10 days. The largest small business lender, Wells Fargo, initially capped applications at $10bn, reflecting concerns about the size of its balance sheet. That should not be a huge constraint going forward, with the Fed announcing last week that it would begin buying the loans, freeing up commercial banks’ balance sheets to originate more loans. The program is on track to burn through its allocated $350bn by the end of the week, with Congress likely to authorise an additional $250bn of funding soon.
  • Of course, none of this has come fast enough to prevent the 16 million layoffs in the past few weeks. It’s possible that some businesses will try to rehire staff once they receive loans, although that could prove difficult given the generous unemployment payments on offer. Many of those initial layoffs will have come in the worst affected firms in the travel, restaurant and hospitality sectors, which are likely to struggle with subdued demand even as restrictions are lifted. The design of the program is better suited to firms in less-directly affected sectors, which have nonetheless suffered from the knock-on hit to demand as orders have dried up and projects put on hold.
  • The $250bn extension could go a long way to preventing even more widespread job losses and economic dislocation, with the combined $600bn total enough to fund nearly half of the private wages and salaries due over the next two months. In addition to the enhanced unemployment insurance payments, that will go a long way to offsetting the huge hit to personal income from the shutdowns. (See here.) But the PPP offers the best chance of firms being able to return to normal faster than otherwise, by allowing more firms to retain their workforce and by reducing the need for firms to increase their borrowing through the various Fed-administered lending schemes or pre-existing credit lines.
  • Many of these loans will end up being converted into grants, which will boost the permanent fiscal cost. If the program is extended, it will mean a rising share of the fiscal stimulus is titled more to permanent transfers than pure lending programs. With unemployment claims rising more rapidly than most anticipated in recent weeks, the ultimate cost of the expanded Federal UI benefit scheme is also likely to rise. That means the ultimate size of permanent fiscal transfers could climb above the 5% of GDP that seemed likely when that CARES Act was originally passed.
  • That larger fiscal transfer will reduce businesses’ dependence on federal loan schemes, raising the prospect that the economy stages a sharp rebound once restrictions are lifted. Even so, the sheer scale of economic disruption seen in recent weeks means we think GDP will remain below its pre-virus trend for at least the next few years.

Michael Pearce, Senior US Economist, +1 646 583 3163, michael.pearce@capitaleconomics.com