Fed Set to Buy Risky Small Business Loans from Banks

The Federal Reserve keeps coming up with new and creative ways to get more people deeper into debt while simultaneously shielding banks from any risk.

On Monday, the Fed announced it will purchase risky small-business loans from banks.

The $2 trillion-plus stimulus bill passed by Congress included $350 billion remarked for small business loans to enable them to continue paying workers and meet basic expenses during the government-mandated shutdown. But the rollout of the loan program has been less than smooth. CNBC called the relief provided by the federal stimulus bill “slow, piecemeal and confusing.” According to Reuters, bankers have been reluctant to take on the risk of these small business loans, particularly at such low interest rates.

So, in steps the Federal Reserve.

As Reuters put it, the Fed backstop “eases concerns among banks about getting stuck holding the low interest loans.”

This is nothing more than a private debt monetization program. It provides another avenue for the central bank to print money out of thin air and inject it into the economy. As the Fed purchases loans from banks, it will free the banks up to make even more loans.

It’s a nice gig for the banks. The Fed program will effectively shield banks from risk.

Of course, it will also create a significant moral hazard in the lending process. Moral hazard is defined as a “lack of incentive to guard against risk where one is protected from its consequences.”

Lending money to small businesses is inherently risky. They generally operate on much thinner margins than big corporations. They don’t tend to have deep pockets to get them through lean times. They certainly don’t have pockets deep enough to weather a complete government-mandated shutdown of the economy. A loan may keep them afloat for a time, but people tend to forget you eventually have to pay back a loan. How many small businesses will be able to make an extra loan payment on top of their normal operating expenses during the recession that will certainly follow the coronavirus lockdown?

The fact is a lot of these loans will never get paid back. Luckily for the banks, the risky loans won’t be on their books.

As ZeroHedge put it, banks are about to make a risk-free killing on the small business bailout.

And so, what was supposed to be a no string attached rescue of America’s small business, the PPP program has now mutated in yet another massive handout to the big banks, who will collect servicing costs ranging from 5% for small loans to 1% for larger ones, using Treasury capital (no origination risk) and then immediately selling these loans to the Fed if they turn sour (no balance sheet risk).”

Nobody seems concerned about these massive interventions in the market by both the Federal Reserve and the federal government. After all, we’re in the midst of an emergency. But interventions always result in unforeseen consequences. What those might be are among the questions nobody is asking.