Credit, Crises, and Infrastructure — Center on Regulation and Markets Working Paper #1 (Brookings)
Summary
Center on Regulation and Markets Working Paper #1 from the Brookings Institution, titled Credit, crises, and infrastructure: The differing fates of large and small businesses, dated April 2022 and written by Todd H. Baker, Kathryn Judge and Aaron Klein. The essay examines how credit creation infrastructure shaped which businesses received government support during the pandemic and afterward. It argues that grants to small businesses addressed short-term cash flow but did little for ongoing private credit, while programs for the largest businesses created expectations of future support. It discusses Federal Reserve facilities and the paycheck protection program (PPP), including the Treasury's initial reliance on banks over fintechs. The paper concludes that policy makers should use non-crisis times to improve financial infrastructure for small-business lending.
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Center on Regulation and Markets Working Paper #1
Credit, crises, and infrastructure:
The differing fates of large and
small businesses
April 2022
Todd H. Baker
Senior Fellow, Richard Paul Richman Center for Business, Law and Public Policy, Columbia Graduate School of
Fin Business and Columbia Law School
Kathryn Judge
Harvey J. Goldschmid Professor of Law, Columbia Law School
Aaron Klein
Senior Fellow, Brookings Institution
ABSTRACT
This essay sheds new light on the importance of credit creation infrastructure in determining who actually
receives government support during periods of distress, and who continues to benefit after the acute phase of
a crisis and the government’s formal support programs come to an end. The pandemic revealed, and the
government’s response accentuated, meaningful asymmetries in the capacities of small and large businesses
to access needed funding. At first glance, it would seem that small businesses benefited more than large ones
from the government’s pandemic-support programs, as more government funds flowed into small businesses.
Yet closer inspection of the range of government programs implemented and their longer term impact reveals
a very different picture. By primarily providing grants to small businesses, the government helped address
their short-term cash flow challenges but did little to encourage ongoing private credit creation for these
businesses. The aid provided was real, but finite in nature. By contrast, the nature of the programs used to
facilitate financing for the largest businesses provided major support at the moment and created expectations
of future support. These interventions enhanced the viability and attractiveness of inherently fragile
intermediation structures and set them up to continue to provide cheap and easy financing for the largest
businesses long after the acute phase of the crisis had passed. This essay further reveals how numerous
seemingly neutral choices were anything but in practice, creating a disconnect between policy makers stated
aims and the actual impact of many of their actions. A key takeaway is that the government should do more
during times of peace to understand and shape the credit creation infrastructure in ways that facilitate small-
business lending in good times and bad.
Todd Baker is an unpaid member of the board of directors of Accion Opportunity Fund, a nonprofit community development
financial institution. The authors did not receive financial support from any firm or person for this article or from any firm or
person with a financial or political interest in this article. Other than the aforementioned, the authors are not currently officers,
directors, or board members of any organization with a financial or political interest in this article. The Brookings Institution is
financed through the support of a diverse array of foundations, corporations, governments, individuals, as well as an endowment.
A list of donors can be found in our annual reports published online here. The findings, interpretations, and conclusions in this
report are solely those of its author(s) and are not influenced by any donation.
_________________________________________________________________________________________________________
Credit, Crises, and infrastructure 1
April 2022
CREDIT, CRISES AND INFRASTRUCTURE: THE
DIFFERING FATES OF LARGE AND SMALL
BUSINESSES
TODD H. BAKER, KATHRYN JUDGE & AARON KLEIN
ABSTRACT
This essay sheds new light on the importance of credit creation
infrastructure in determining who actually receives government
support during periods of distress, and who continues to benefit after
the acute phase of a crisis and the government’s formal support
programs come to an end. The pandemic revealed, and the
government’s response accentuated, meaningful asymmetries in the
capacities of small and large businesses to access needed funding.
At first glance, it would seem that small businesses benefited more
than large ones from the government’s pandemic-support programs,
as more government funds flowed into small businesses. Yet closer
inspection of the range of government programs implemented and
their longer term impact reveals a very different picture. By primarily
providing grants to small businesses, the government helped address
their short-term cash flow challenges but did little to encourage
ongoing private credit creation for these businesses. The aid provided
was real, but finite in nature. By contrast, the nature of the programs
used to facilitate financing for the largest businesses provided major
support at the moment and created expectations of future support.
These interventions enhanced the viability and attractiveness of
inherently fragile intermediation structures and set them up to
Senior Fellow, Richard Paul Richman Center for Business, Law and Public Policy,
Columbia Graduate School of Business and Columbia Law School.
Harvey J. Goldschmid Professor of Law, Columbia Law School.
Senior Fellow, Brookings Institution.
2
continue to provide cheap and easy financing for the largest
businesses long after the acute phase of the crisis had passed.
This essay further reveals how numerous seemingly neutral choices
were anything but in practice, creating a disconnect between policy
makers stated aims and the actual impact of many of their actions. A
key takeaway is that the government should do more during times of
peace to understand and shape the credit creation infrastructure in
ways that facilitate small-business lending in good times and bad.
3
CONTENTS
4
INTRODUCTION
This essay affirms and adds critical nuance to existing
understandings of the way crisis-era programs inevitably shape—and
are shaped by—the existing infrastructure for credit creation. The
2008 financial crisis renewed a longstanding debate about the
appropriate role of the government generally, and central banks in
particular, in providing liquidity and other forms of support during
periods of systemic distress. In the wake of that crisis, two dominant
schools of thought emerged. Some focused on the moral hazard that
comes from any government intervention. They feared that
government interventions distort incentives and encourage risk taking,
leading to the conclusion that the government should rarely intervene,
even in the face of severe shocks.1 A related set of concerns arose
around mission creep, as many saw the Federal Reserve’s (Fed)
actions as moving it far beyond the roles it was originally designed to
play.2 Others—including key policy makers—took the position that
when things get really bad, the government should provide support
almost wherever it could be useful to avoid the macroeconomic costs
that can arise from the failure of financial intermediaries and the real
economy businesses they help support.3
Strikingly, in contrast to the heated debate triggered by the 2008
interventions, the various programs implemented by the Fed and
Treasury Department to help financial intermediaries and businesses
survive the pandemic have inspired minimal reflection or debate. An
1
For an overview of this literature, and efforts to address these challenges, see FIN. STABILITY
BD., EVALUATION OF THE EFFECTS OF TOO-BIG-TO-FAIL REFORMS (2021),
https://www.fsb.org/wp-content/uploads/P010421-1.pdf [https://perma.cc/BR5L-GHTJ]
(evaluating effects of too-big-to-fail reforms for systematically important banks); Emmanuel
Farhi & Jean Tirole, Collective Moral Hazard, Maturity Mismatch, and Systemic Bailouts,
102 AM. ECON. REV. 60 (2012).
2
E.g., LEV MENAND, THE FED UNBOUND CENTRAL BANKING IN A TIME OF CRISIS
(FORTHCOMING, 2022). CHRISTINA PARAJON SKINNER, CENTRAL BANK ACTIVISM, 71 DUKE
LAW JOURNAL 247 (2021).
3
See, e.g., TIMOTHY F. GEITHNER, STRESS TEST: REFLECTIONS ON FINANCIAL CRISES (2015).
5
array of valuable efforts to assess empirically who participated in these
programs—particularly the novel paycheck protection program
(PPP)— have yet to inspire a broader debate about the significance of
the government’s crisis-era interventions.
In seeking to fill that gap, this essay charts a course that falls
between the two, more established views of the way crisis-era
programs are shaped by, and in turn reshape, financial intermediation
infrastructure. We see crisis-era support as sometimes necessary to
protect the long-term health of the economy, and something that
should be provided broadly when critical to maintaining that health.
Yet, we see that as a starting point for discussion, rather than a
conclusion that ends the debate. Looking at 2020 through a lens that
is informed but not fixed by the events of 2008 reveals new and
important lessons.
The first is that seeming neutral choices are often anything but. For
example, a primary way that Congress sought to support businesses
during the early phase of the pandemic was by having Treasury
support credit creation through Federal Reserve facilities created
pursuant to the Fed’s established authority to make loans to nonbanks
under “unusual and exigent circumstances.”4 On its face, this decision
did not favor any particular industry or business type. In practice, this
decision greatly facilitated the flow of funds to the largest businesses
while doing little for mid-sized and smaller businesses. Similarly, in
its first effort to implement an innovative new program to provide
support for “small businesses,” the Treasury favored banks over
fintechs as the intermediaries through which these funds should flow.5
This too was seemingly neutral decision, but resulted in a
disproportionate share of the initial funds going to a subset of small
businesses that favored larger, older businesses who had existing
4 Part II, infra.
5
Part III, infra.
6
lending relationships with banks while disfavoring smaller, younger,
and importantly businesses owned by women and minorities.
These insights also bring lessons. One ramification is the way crisis-
era interventions can and ought to influence the post-crisis regulatory
reform agenda. Second, given that crisis-time support is likely, we
argue that policy makers should use “peace time” to make the
infrastructure changes needed to ensure the smooth flow of money and
credit to those who most need it when crisis strikes.
These insights and implications flow from our analysis of the key
decisions made in early 2020, and the ramifications of those decisions.
We begin by providing a brief overview of the major programs
adopted in 2020 to provide credit or operating support to various types
of businesses, with a focus on who benefitted most and the incentives
these programs created with respect to ongoing access to credit once
the program ceased.6 Given the exigencies of the pandemic response,
our aim here is not to second-guess policy makers who responded
remarkably fast in the heat of the moment. The pandemic was a
massive, sudden, shock, and broad support was critical to minimizing
its economic impact. But, once the acute phases of a crisis wanes, the
6
Financial assistance came through multiple mechanisms. The two most significant were
the Paycheck Protection Program (PPP) and a fund authorizing the Federal Reserve to sup-
port the general economy and markets. Both programs utilized the financial system (banks,
capital markets, other lenders) as a conduit to provide assistance to businesses with the
hopes those businesses would in turn, provide benefits to workers. There are many employ-
ers, and hence employees, who work at entities that are not ‘businesses’ in both the legal
and economic sense. Many of the definitions of these indirect programs, and some of the
programs themselves were targeted for these type of employers. For example, the PPP pro-
vided money to select non-profits, including private schools and non-profit lobbying organi-
zations were eventually eligible for PPP assistance. George E. Constantine, Cynthia M.
Lewin & Andrew L. Steinberg, SBA Clarifies Lobbying and Economic Need Rules for Non-
profit PPP Borrowers, Venable, LLP. (Mar. 5, 2021), https://www.venable.com/insights/pu-
blications/2021/03/sba-clarifies-rules-for-nonprofit-ppp-borrowers [https://perma.cc/XEU2-
8ZK3]. For purposes of this paper we will use the term business as more synonymous with
employer in line with the legal and regulatory implementation of the emergency assistance,
whose purpose was to provide economic support to employers and employees.
7
focus should shift to the lessons both the crisis and the response might
hold. These are the questions we tackle here.
Putting the pieces together, the analysis suggests that policy makers
should seek to re-balance the scales. Small businesses are a key driver
of economic activity. They support the growth and vitality of our
neighborhoods, spark innovation, and provide a pathway that can help
people achieve financial success and independence.7 Lending to small
business often entails greater credit risk, greater informational
challenges and disproportionately high lender costs relative to loan
size. Complicating these challenges, many of the smallest business
loans sit in the blurry zone between corporate cash-flow loans and
personal loans. Yet these inherent differences are more reason—not
less—to be concerned about the way policy interventions may have
inadvertently greased the wheels on large business lending while
leaving small business lending more exposed to credit shocks.
The analysis also brings to the fore the value of paying greater heed
outside of crisis periods to the ways disparate access to credit shape
who can open a small business and which small businesses are likely
to have access to the liquidity often needed to weather shocks. People
of color make up roughly 40% of the U.S. population, but only 20%
of the nation’s 5.6 million business owners with employees.8 Women
are 51% of the population but only 33% of business owners with
employees. Minority- and women-owned businesses also typically
have fewer employees, less revenue, and were less likely to survive
the recession that followed the 2008 financial crisis. Although there
are many reasons for these disparities, access to credit and cost of
credit may well be a significant contributor and could well be worse
7
See Sifan Liu & Joseph Parilla, Businesses Owned by Women and Minorities Have
Grown. Will COVID-19 Undo That?, Brookings Inst. (Apr. 14, 2020),
https://www.brookings.edu/research/businesses-owned-by-women-and-minorities-have-
grown-will-covid-19-undo-that/ [https://perma.cc/59Y3-QYFU] (discussing how minority-
and women-owned business enterprises helped stabilize the economy during the recovery
period ensuing the Great Recession).
8 Id.
8
today than it was pre-pandemic because of the government’s reliance
on private infrastructure it did not fully understand.
Particularly as interest rates start to rise and monetary and lending
conditions tighten, differential access to funding between large
business and small, and among small business could have far reaching
effects. From eating away at the remarkable recent growth in new
small business formation to contributing to structural inequities and
accentuating the excessive concentration that already poses a
challenge to the long-term health and vibrancy of the economy, credit
creation infrastructure is central to the shape of the economy.9 This
essay brings to the fore the importance of understanding how the
government has shaped that infrastructure, how it has relied on that
infrastructure, why it is likely to do so again, and why this reliance and
support is often in tension with other policy aims.
I. THE LATEST CRISIS
The acute phase of the COVID-19 crisis in the spring of 2020 served
as a powerful reminder that existing infrastructure shapes, and
ultimately limits, the government’s ability to provide aid for people
and businesses. This relationship between existing infrastructure and
governmental capacity manifested across most financial and market
policy interventions, including direct payments to individuals and
families, unemployment insurance, small business assistance, and the
Federal Reserve’s bond purchase and liquidity facilities.
A return to the early stages of the pandemic response, and a review
of the processes through which these programs were adopted, make
clear that many of the ramifications of the government’s interventions
were unintended consequences of the need for the government to
move quickly to achieve its goals, with incomplete information and in
9
THOMAS PHILIPPON, THE GREAT REVERSAL: HOW AMERICA GAVE UP ON FREE MARKETS 279-
82 (2019) (discussing statistics regarding highly concentrated markets and the negative
relation between labor market concentration and wages).
9
reliance on imperfect, existing infrastructure. Although both the speed
at which the pandemic hit the economy and the speed of the recovery
were more rapid than the 2008 financial crisis or other periods of
distress, similar dynamics are common during periods of crisis, and all
the more reason to reflect on the structure and adequacy of existing
crisis response tools outside periods of distress.
Just as in 2007 and 2008, the Federal Reserve was the first responder
in the government’s effort to contain the economic fallout of the
pandemic. To provide accommodative monetary conditions and ease
the unexpected and potentially massive dysfunction in the Treasury
market, the Fed again adopted a program of quantitative easing
(“QE”)—buying up Treasury and mortgage-backed securities—on an
unprecedented scale.10 QE, a tool the Fed first used during the 2008
global financial crisis, at the time was considered radical but now has
been used in the last two recessions.11 Yet the Fed’s purchases of
Treasury securities and agency mortgage-backed securities this time
were not only aimed at easing monetary conditions, they were also
used to help ease market dysfunction.12 The Fed bought $1.7 trillion
worth of Treasury securities between March and June 2020.13 To help
10 Lorie K. Logan, Exec. Vice President, Fed. Rsrv. Bank of N.Y., Remarks at SIFMA
Webinar: The Federal Reserve’s Market Functioning Purchases: From Supporting to
Sustaining (July 15, 2020) (transcript available at
https://www.newyorkfed.org/newsevents/speeches/2020/log200715 [https://perma.cc/227W-
CYZ7]) (“Another important measure, and the focus of my talk today, is the asset purchases
that we have conducted at an unprecedented scale and speed to support the smooth functioning
of markets for Treasury and agency mortgage-backed securities (MBS)—both of which play
crucial roles in the American financial system and economy.”).
11 Ben Bernanke, The New Tools of Monetary Policy, BROOKINGS INST. (Jan. 4, 2020),
https://www.brookings.edu/blog/ben-bernanke/2020/01/04/the-new-tools-of-monetary-
policy/ [https://perma.cc/J9T8-2Y9L].
12 Logan, supra note 10 (discussing how the Federal Open Market Committee made
substantial purchases of Treasury securities and agency mortgaged-backed securities, and
directed the Open Market Trading Desk to make purchases “in the amounts needed to support
the smooth functioning of markets”).
13 Jane E. Ihrig, Gretchen Weinbach & Scott A. Wolla, How the Fed Has Responded to
the COVID-19 Pandemic, FED. RSRV. BANKOF ST. LOUIS. (Aug. 12, 2020),
10
stem withdrawals from money market mutual funds as COVID-19
began to hit financial markets in March 2020, the Fed created the
Money Market Mutual Fund Liquidity Facility to provide liquidity and
financial assistance to prevent funds from “breaking the buck” and
losing value, building expressly on the same design used in 2008.14
And the Fed also re-adopted many of the other programs it had used
during the 2008 financial crisis to inject additional liquidity into the
market for various financial instruments and to provide liquidity to
both banks and nonbanks.
Through these programs, the Fed supported market functioning and
signaled its continued willingness to prop up key parts of the financial
system if needed, just as it had done in 2008. The similarity in the
programs the Fed used was also a reminder that once the Fed
intervenes in a particular way—even if the aim is to protect market
functioning—market participants will often anticipate similar support
in the future. This was the case even in the area of money market
mutual funds, where Congress, the Fed, the Securities and Exchange
Commission, and the Financial Stability Oversight Council had spent
substantial time and energy revamping regulations designed to reduce
the need for government assistance in the name of financial
stability.15
https://www.stlouisfed.org/open-vault/2020/august/fed-response-covid19-pandemic
[https://perma.cc/J8HC-RY4U] (“The blue shaded region of the graph below shows how
quickly the Fed ramped up its purchases of Treasury securities—it bought around $1.7 trillion
worth between mid-March and the end of June.”).
14 KENECHUKWU ANADU , MARCO CIPRIANI, RYAN M. CRAVER & GABRIELE LA SPADA,
FED. RSRV. BANK OF N.Y., THE MONEY MARKET MUTUAL FUND LIQUIDITY FACILITY (2021),
available at
https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr980.pdf
[https://perma.cc/CE66-EMJC] (“The Federal Reserve faced the same challenges in 2008,
when it set up the AMLF in response to the MMF run triggered by Lehman Brothers’ default.
Although the type of shock was different, it was natural to design the 2020 facility based on
its 2008 predecessor.”).
15 See also Press Release, U.S. Dep’t of the Treasury, President’s Working Group on
Financial Markets Releases Report on Money Market Funds (Dec. 22, 2020), available at
https://home.treasury.gov/news/press-releases/sm1219 [https://perma.cc/2GC2-JF36] (“The
11
The Fed was not the only major government actor to move quickly
and aggressively. The United States Congress also responded rapidly
with a large fiscal stimulus. The first significant legislative action was
the Coronavirus Aid, Relief, and Economic Security Act (CARES
Act)—a $2.2 trillion fiscal stimulus bill passed by the end of March
2020.16 The CARES Act was designed to provide fiscal firepower,
quickly and in large amounts, to try to blunt the economic damage of
the pandemic. Direct aid included payments to individuals, state and
local governments, health care providers, and others. This was a
traditional Keynesian economic stimulus17 largely delivered through
existing methods, such as enhanced unemployment insurance benefits,
and through revisions to existing federal/state matching grant
programs providing general-purpose aid to state governments.
Alongside direct stimulus payments to individuals, expanded
unemployment insurance benefits, specific funds for grants and other
types of support for particular industries, the bill included multiple
modes of support for businesses and their employees. The two
provisions of the CARES Act most relevant to the viability of
businesses were the Payroll Protection Program and a separate,
innovative effort to have the Fed and Treasury work together to
provide credit support to businesses. Considering each program in
turn, and in context, brings to light the short- and longer-term effects
of the support businesses received during this acute phase of the
economic shutdown.
PWG agrees that while many of the reforms implemented after the global financial crisis
increased market stability, the events of March 2020 show that more work is needed to reduce
the risk that remaining structural vulnerabilities in prime and tax-exempt money market funds
will lead to or exacerbate stresses in short-term funding markets.”).
16CARES Act, H.R. 748, 116th Cong. (2020).
17 See Sarwat Jahan, Ahmed Saber Mahmud & Chris Papageorgiou, What Is Keynesian
Economics?, INT’L MONETARY FUND 53-54 (Sept. 2014),
https://www.imf.org/external/pubs/ft/fandd/2014/09/pdf/basics.pdf [https://perma.cc/3PB4-
CVFK] (explaining that “the central tenet of [Keynesian economics] is that government
intervention can stabilize the economy”).
12
Before doing so, it is worth reflecting briefly on how various
government efforts illuminated the central importance of existing
financial infrastructure in the government’s ability to provide aid
quickly to those who needed it. This was true for the provision of
direct assistance as well as credit. The federal government authorized
expanded unemployment benefits, deeming them critically important
to the well-being of qualifying individuals and to the health of the
overall economy. But the ability of people who had lost their jobs to
actually receive the benefits they were owed varied dramatically,
largely depending on the existing apparatus for distributing
unemployment payments at the state level. The apparatus failed
miserably in many states, with particularly well-documented problems
in New Jersey and Florida.18 The reasons were manifold: outdated
computer systems, application backlogs caused by staffing shortages,
and implementation of new federal rules all contributed.19 This led
observers to compare the unemployment payment and processing
system to the classic infrastructure example of “replacing aging water
pipes.”20 According to one estimate, by the end of May 2020, months
18 See Sophie Nieto-Munoz & Matthew Stanmyre, N.J. Failed to Fix Unemployment
System for 19 Years, Records Show. Now Murphy Pleads Patience, NJ ADVANCE MEDIA (May
14, 2020, 6:45 AM), https://www.nj.com/coronavirus/2020/05/nj-failed-to-fix-
unemployment-system-for-19-years-records-show-now-murphy-pleads-patience.html
[https://perma.cc/6XY8-J3T6] (reporting problems with New Jersey’s archaic unemployment
website and automated call system which prevent many New Jersey residents from receiving
unemployment benefits); Mary Papenfuss, ‘S**t Sandwich’: Florida’s GOP Reportedly
Rigged Jobless Site to Block Applicants, HUFFPOST (Apr. 6, 2020),
https://www.huffpost.com/entry/florida-unemployment-
website_n_5e87b67ec5b6e7d76c63bcf7.
19 Lisa Rowan, Why Is It So Hard To Get Your Pandemic Unemployment Benefits?,
FORBES (Mar. 1, 2021, 8:00 AM), https://www.forbes.com/advisor/personal-finance/why-its-
so-hard-to-claim-unemployment/ [https://perma.cc/DEK9-LGMP] (discussing various
factors that prevented access to pandemic unemployment benefits: computer reprogramming,
application backlogs caused by staffing shortages, and the flood of additional eligible workers
under the CARES Act).
20 Katherine Landergan, America’s Unemployment System Failed When It Was Needed
Most. Can It Be Fixed?, POLITICO (May 19, 2021, 4:30 AM),
https://www.politico.com/news/2021/05/19/america-unemployment-system-failed-
pandemic-483100 [https://perma.cc/Y9A8-Y7RC] (“The not-so-sexy topic of unemployment
13
into the pandemic, only 57% of the 33 million unemployment claims
that had been filed were paid, leaving many unemployed workers and
their families in search of other avenues to scrape by.21 This payment
bottleneck delayed the stimulative effect on the larger economy and
increased hardship on families during their time of need.
Similarly, the stimulus “checks” designed to provide aid broadly
arrived far more quickly for those who could receive the funds
electronically into their bank accounts via direct deposit, using IRS
taxpayer and tax return data,22 than for the 70 to 100 million people
for whom the government either lacked correct bank account
information or was otherwise unable to figure out how to properly
send them their funds. This explains why 25% of American
households needed to wait for a physical check or debit card to be
insurance system reform — the economic equivalent of replacing aging water pipes — has
been quietly dominating policy conversations at every level of government and is about to
break into the mainstream.”).
21 See Eli Rosenberg, Workers Are Pushed to theBbrink as They Continue to Wait for
Delayed Unemployment Payments, WASH. POST (July 13, 2020),
https://www.washingtonpost.com/business/2020/07/13/unemployment-payment-delays/
(“By the end of May, about 18.8 million out of 33 million claims—57%—had been paid
nationwide.”); Manuel Alcalá Kovalski & Louise Sheiner, How Does Unemployment
Insurance Work? And How Is It Changing During the Coronavirus Pandemic?, BROOKINGS
INST. (Nov. 3, 2021), https://www.brookings.edu/blog/up-front/2020/07/20/how-does-
unemployment-insurance-work-and-how-is-it-changing-during-the-coronavirus-pandemic/
[https://perma.cc/65V6-LN8G] (“Andrew Stettner, a senior fellow at the Century Foundation,
estimates that by the end of May 2020, only about 18.8 million out of 33 million claims (57
percent) had been paid nationwide, an improvement from 47 percent of claims at the end of
April 2020 and just 14 percent at the end of March 2020.”).
22 See Coronavirus Tax Relief, INTERNAL REVENUE SERVS.,
https://www.irs.gov/coronavirus-tax-relief-and-economic-impact-payments
[https://perma.cc/L6LS-V8MR] (last updated Jan. 18, 2022).
14
delivered to their home despite the fact that only 5% of U.S.
households lack a bank account.23
While ensuring that ordinary Americans get the direct and timely
support their government has promised to them is not the focus of our
analysis, these examples help illustrate the fundamental importance of
the existing infrastructure—federal and state, public and private—in
shaping the government’s option set and ability to deliver when crisis
strikes.24 With two major crises already this century, one of the
overarching lessons is the importance of considering in advance the
condition of the existing financial infrastructure and acting in advance
to correct deficiencies and inequities that merit attention. Addressing
these issues can have positive spillover effects and may also help
mitigate distributional challenges when times are good. We now turn
to the role that the existing infrastructure played in the government’s
effort to aid businesses, big and small.
II. THE FED-TREASURY FACILITIES
The CARES Act program that sought to provide the most, and
widest ranging support, for businesses entailed an effort spearheaded
by the Fed using support appropriated by Congress to the Treasury
Department. The program authorized the Fed to support the broader
economy by allocating $454 billion in seed capital, which allowed the
23 Aaron Klein, Opinion, Want Your Next Stimulus Check Faster? Congress Needs to
Change Just One Line of Law, BROOKINGS INST. (July 27, 2020),
https://www.brookings.edu/opinions/want-your-next-stimulus-check-faster-congress-needs-
to-change-just-one-line-of-law/ [https://perma.cc/S2WV-DPDC] (“70 million to 100 million
people waited one to three months for money that eventually arrived as a paper check or debit
card.”).
24 The contrast with other countries that deliver all benefits directly through dedicated
electronic interfaces, such as India’s e-RUPI, is stark. See John Xavier, Explained| How
India’sNew Welfare-Focused Digital Payment System Works?, HINDU (Aug. 8, 2021, 4:50
PM), https://www.thehindu.com/sci-tech/technology/e-rupi-how-indias-new-welfare-
focused-digital-payment-system-works/article35682640.ece [https://perma.cc/89FZ-BBY7]
(describing India’s e-RUPI system, which “is a digital voucher that can be redeemed by
beneficiaries when they make use of any specific government services” and “does not require
a card, app or internet access to redeem the vouchers”).
15
Fed—working with the Treasury Department—to theoretically buy
over $4 trillions in assets.25 This was to be accomplished via lending
facilities the Fed created pursuant to its existing authority under
Section 13(3) of the Federal Reserve Act to make loans to nonbanks
in “unusual and exigent circumstances.”26 The scale of the authorized
interventions far exceeded anything done in response to the 2008
crisis, with the Fed itself lauding its potential to provide trillions in
new loans.27 As the context reflects, these funds were designed to
enable the Fed to provide fresh loans to businesses, nonprofits, and
municipalities. The gap between the amount appropriated and the
hoped-for impact of the related credit facilities reflects the fact that the
seed money allocated by Congress was meant to cover only expected
losses, enabling the Fed to make loans far in excess of the money
allocated without suffering a financial hit itself.
This program positioned the Fed to play a meaningful role in
determining who received support.28 But Congress avoided crossing
25 Prior to the enactment of the CARES Act, the Department of the Treasury made a $10
billion equity investment from the Exchange Stabilization Fund into the Fed’s Term Asset-
Backed Securities Loan Facility to support lending of up to $100 billion. Over $4 trillion in
asset purchases or lending could be supported by the $454 billion appropriation assuming
approximately similar leverage ratios. SeeTerm Asset-Backed Securities Loan Facility, FED.
RSRV. BD. (Mar. 23, 2020),
https://www.federalreserve.gov/newsevents/pressreleases/files/monetary20200323b3.pdf
[https://perma.cc/G36K-FBK2].
2612 U.S.C. § 343(3)(A).
27 Press Release, Fed. Rsrv. Bd., Federal Reserve Takes Additional Actions to Provide up
to $2.3 Trillion in Loans to Support the Economy (June 29, 2020, 8:30 AM),
https://www.federalreserve.gov/newsevents/pressreleases/monetary20200409a.htm
[https://perma.cc/878E-AECJ].
28 Kelsey Snell, What’s Inside the Senate’s $2 Trilllion Coronavirus Aid Package, NPR
(Mar. 26, 2020, 5:34 PM), https://www.npr.org/2020/03/26/821457551/whats-inside-the-
senate-s-2-trillion-coronavirus-aid-package [https://perma.cc/923A-2ECH] (describing how
the CARES Act would provide relief to seven main groups of beneficiaries: individuals, small
businesses, big corporations, hospitals and public health, federal safety net, state and local
governments, and education).
16
the Rubicon of having the Fed directly capitalize the facilities with its
own funds, by using the Treasury Department to capitalize newly
created emergency facilities and by retaining the many limitations on
the Fed’s authority already embedded in the Federal Reserve Act,
particularly section 13(3) thereof.
Section 13(3) was added to the Federal Reserve Act in 1932 to give
the Fed the ability to lend directly to the real economy in a crisis.29
The Fed, however, made only modest use of this power during the
Great Depression and failed to use it at all between 1936 and 2008.30
When Section 13(3) was invoked by the Fed in response to the 2008
crisis, it used this authority quite broadly to establish new borrowing
entities controlled by the Fed that supported many nonbank financial
institutions (and indirectly, their counterparties, including banks), that
had played an important role in the financial bubble that caused the
crisis.31 Many of the new 13(3) facilities the Fed created were
29 Parinitha Sastry, The Political Origins of Section 13(3) of the Federal Reserve Act, 24
FED. RSRV. BANK OF N.Y.: ECON. POL’Y REV. 2 (2018) (“This article concludes that the
framers of the section intended to authorize credit extensions to individuals and nonfinancial
businesses unable to get private-sector loans. In other words, Section 13(3) sanctioned direct
Federal Reserve lending to the real economy, rather than simply to a weakened financial
sector, in emergency circumstances.”). Between 1932 and1936, the Fed made a total of $1.5
million in section 13(3) loans. Id. at 27 ("The Federal Reserve Board renewed the 13(3)
authority every six months until July 1936, at which point the Federal Reserve System had
made a cumulative total of 123 loans under the authority, aggregating to $1.5 million.”).
Beyond the limited amount, this fiscal stimulus was also distinct from 2008 and 2020 because
the lending was restricted to commercial enterprises and did not include nonmember banks or
nonbank financial institutions. See id. at 25 (“The Federal Reserve Board took the crucial step
of determining that ‘the term “corporations” does not include banks,’ meaning that 13(3) did
not allow discounts for nonmember banks.”).
30 David C. Wheelock, Lessons Learned? Comparing the Federal Reserve’s Responses to
the Crises of 1929-1933 and 2007-2009, 92 FED. RSRV. BANK ST. LOUIS REV. 92 (2010)
(“The Fed made 123 loans totaling a mere $1.5 million in the four years after the section
was added to the Federal Reserve Act in 1932. Section 13(3) was not used again until 2008,
when it became an important tool in the Fed’s effort to limit the financial crisis.”).
31 See Sastry, supra note 29, at 29 (“In the spring of 2008, Sections 10B and 13(3) formed
the statutory basis for the Federal Reserve’s lender-of-last-resort powers for member banks,
17
designed to provide fresh liquidity into any array of institutions and
sectors of the market that, in various ways, were part of a new system
of market-based intermediation, often referred to as the shadow
banking system. Far more controversially—and in a move that would
be prohibited today—the Fed also used this authority to facilitate JP
Morgan’s acquisition of Bear Stearns and to help AIG avert
bankruptcy.32
The Fed’s only historical experiment making loans to the real
economy was providing working capital pursuant to what was then
Section 13(b) of the Federal Reserve Act. This program was initially
created during the Great Depression and sputtered along until
Congress brought it to an end in 1958, with the full support of then-
Fed Chair William McChesney Martin.33 In short, although direct Fed
lending to the real economy was one of many experiments that tried
to help the economy recover from the Great Depression, it is not a tool
that has ever been widely used or that was particularly successful, and
it is not one that today’s far more powerful Fed had ever embraced,
until the pandemic response.
In order to understand the impact of the decision to use the Fed to
provide fresh liquidity to businesses in particular, it is helpful to have
a rudimentary understanding of the lending landscape. Large,
established corporations have more options accessing credit than
smaller, newer companies. An array of factors makes the debt of large
nonmember banks, broker-dealer firms, commercial paper issuers, and money market
mutual funds as the Fed moved to bolster a financial system that had arrived at the brink.”).
32 MARC LABONTE, CONG. RSCH. SERV. R44185, FEDERAL RESERVE: EMERGENCY LENDING
14 (Mar. 27, 2020), available at
https://sgp.fas.org/crs/misc/R44185.pdf [https://perma.cc/5M5F-N9H2] (discussing that the
Fed financed JP Morgan Chase’s takeover of Bear Stearns with a $29 billion federal loan,
while “prevent[ing] AG’s failure by intially providing it with a line of credit of $85 million”).
33 George Selgin, When the Fed Tried to Save Main Street, ALT-M (Mar. 30, 2020),
https://www.alt-m.org/2020/03/30/when-the-fed-tried-to-save-main-street/
[https://perma.cc/FH5C-AMB8].
18
companies—whether in the form of syndicated loans or bonds—easier
to fund, originate, and hold than that of smaller companies. Two of the
most important challenges are related: smaller businesses generally
present risk profiles more expensive to assess, and smaller companies
generally pose distinct informational challenges.
Large, public companies, on the other hand, are subject to rigorous,
ongoing disclosure requirements, typically have long track records,
and benefit from a body of equity holders who are even more
motivated than a company’s debt holders to monitor the business and
prospects of the companies they invest in. These companies often
issue debt securities that they pay to have rated by rating agencies,
creating free information regarding the credit quality of that debt for
investors to rely on.34 Accentuating the advantage, the past decade
has seen a massive growth in the issuance of collateralized loan
obligations (“CLOs”), open-end bond funds, and exchange traded
funds (“ETFs”) backed by bonds. These products have helped create
ready buyers for newly issued corporate debt and eased the financing
process for large corporations.35 They also create an intermediation
infrastructure that made it easy for the Fed to come up and prop up the
functioning of this overall system, and in ways that seem likely to alter
expectations of future support.
34 Investors who rely exclusively on rating agency opinions may find themselves investing
in assets with greater risk than they realize, as evidenced by the mis-rating of many securities
in the 2008 financial crisis. We express no opinion on the wisdom or efficacy of this reliance,
simply noting that it exists and in the current “originator pays” model, ratings are provided to
investors without cost.
35 See BD. OF GOVERNORS OF THE FED. RSRV. BD., FINANCIAL STABILITY REPORT 22 (Nov.
2019), available at https://www.federalreserve.gov/publications/files/financial-stability-
report-20191115.pdf [https://perma.cc/6WUE-BU75] (“In line with the discussion of price
terms and risk appetite in section 1, demand for institutional leveraged loans has remained
strong and credit standards have remained weak.”); Antonio Falato, Itay Goldstein & Ali
Hortaçsu, Financial Fragility in the COVID-19 Crisis: The Case of Investment Funds in
Corporate Bond Markets 47 fig.1 (Becker Friedman Inst., Working Paper No. 2020-98,
2021), available at https://bfi.uchicago.edu/wp-content/uploads/BFI_WP_202098.pdf
[https://perma.cc/3KFG-RLGL] (graphing the growing importance of funds in the corporate
bond market).
19
The credit intermediaiton structure for small businesses is quite
different along many fronts. Even for an established small or mid-
sized business, the biggest shareholder is often the entrepreneur or
family who runs it. The mechanisms for funneling money from the
capital markets into smaller company debt are far less established,
much more sensitive to overall economic conditions, and far more
expensive. Small business lending is often further complicated in a
variety of ways, as lenders typically require multiple years of business
history, personal guarantees, collateral and other support to reduce
risk. This helps explain why small businesses often have challenges
obtaining capital from outside sources. Only four in nine small
businesses report having obtained credit from a bank in the last five
years, according to the Fed’s 2020 survey.36
That financing is already tilted in favor of large businesses—giving
them a meaningful leg up over mid-sized and small businesses—is all
the more reason to be concerned about the particular microstructure of
the mechanisms through which credit flows to both types of businesses
and the impact of the government’s interventions.
A. Support for the Largest Businesses
During the COVID-19 response, the primary way the Fed supported
the ability of large corporations to access credit was through the
creation of two corporate credit facilities.37 The Primary Market
36 FED. RSRV. BANKS, SMALL BUSINESS CREDIT SURVEY: 2020 REPORT ON EMPLOYER
FIRMS 8 (2020), available at
https://www.fedsmallbusiness.org/medialibrary/FedSmallBusiness/files/2020/2020-sbcs-
employer-firms-report [https://perma.cc/9CPK-3VDE] (summarizing lending sources for
small businesses in graph).
37 See Press Release, Fed. Rsrv. Bd., Federal Reserve Announces Extensive New Measures
to Support the Economy (Mar. 23, 2020), available at https://www.federalre-
serve.gov/newsevents/pressreleases/monetary20200323b.htm [https://perma.cc/VN53-
U3U4] (announcing Fed’s measures to support economy during Covid crisis).
20
Corporate Credit Facility was created as “a funding backstop for
corporate debt,” and allowed the NY Fed to purchase both qualifying
bonds and portions of syndicated loans at issuance.38 The Secondary
Market Corporate Credit Facility allowed the Fed to buy portfolios of
bonds and ETF shares that were already issued and outstanding.39
Both programs were implemented via the creation of a special purpose
vehicle that would hold the bonds and received equity funding from
the Treasury Department to reduce the credit risk to which the Fed was
exposed.40
The mere announcement of the primary and secondary corporate
credit facilities dramatically reduced spreads for investment-grade
borrowers.41 The Fed’s subsequent announcement that it would also
buy “fallen angels” (recently downgraded bonds) and ETFs holding
below-investment-grade debt similarly reduced spreads for companies
in these categories.42 The Fed purchased corporate debt primarily
through the creation of a new index it created to track qualifying
bonds.43 The Fed’s large wallet and assured position as a new entrant
38 Primary Market Corporate Credit Facility, FED. RSRV. BD. (July 28, 2020),
https://www.federalreserve.gov/newsevents/pressreleases/files/monetary20200728a9.pdf
[https://perma.cc/G7PP-EZZ7].
39 Secondary Market Corporate Credit Facility Term Sheet, FED. RSRV. BD. (July 28,
2020),https://www.federalreserve.gov/newsevents/pressreleases/files/monetary20200728a1.
pdf [https://perma.cc/EWB9-CAEQ] (describing eligible assets).
40Id.
41 See Steven Sharpe & Alex Zhou, The Corporate Bond Market Crises and the
Government Response, BD. OF GOVERNORS OF THE FED. RSRV. SYS. (October 7, 2020),
https://www.federalreserve.gov/econres/notes/feds-notes/the-corporate-bond-market-crises-
and-the-government-response-20201007.htm [https://perma.cc/SJ7C-GDKR] (describing
how government responded to corporate bond market crises arising from COVID-19); Falato
et al., supra note 35, at 2 (describing the effects of the Fed’s announcement of coverage to
some high yield bonds).
42 Valentin Haddad, Alan Moreira & Tyler Muir, When Selling Becomes Viral:
Disruptions in Debt Markets in the COVID-19 Crisis and the Fed’s Response, 34 REV. FIN.
STUD. 5309, 5333-34 (2021) (showing the effects of the Fed’s April intervention on some
high yield bonds).
43See Michael D. Bordo & John V. Duca, How New Fed Corporate Bond Programs Damp-
ened the Financial Accelerator in the Covid-19 Recession 1 (Fed. Rsrv. Bank of Dall.,
21
into this market drove down the cost of credit for new corporate debt
and provided existing holders of corporate debt a willing counterparty
to buy, further supporting asset prices.44 As a result, the Fed ended up
holding the bonds of large, robust companies, many of which had not
shown need for government support.45
Moreover, the biggest beneficiaries of the Fed’s bond buying
program may not have been any of the companies whose bonds the
Fed acquired, or the investors whose asset values were artificially
boosted, but the intermediaries through whom these funds flowed.
Recall that the growth of open-end bond funds, CLOs and ETFs
holding bonds had been critical to the growth of the corporate bond
market in recent years and increased leverage in the corporate
sector.46 In the earliest stages of the pandemic, investors were fleeing
from these investments.47 Economists Antonio Falato, Itay Goldstein,
and Ali Hortaçsu document massive and potentially debilitating
outflows from corporate bond funds and ETFs backed by bonds in
March 2020, and further show that these outflows were only slowed
and then stanched by the Fed’s announcement of the corporate credit
Working Paper No. 2029, 2020). https://www.dallasfed.org/-/media/documents/research/pa-
pers/2020/wp2029.pdf [https://perma.cc/8J2N-ZA95].
44See id. at 2.
45Jeff Cox, The Fed Is Buying Some of the Biggest Companies’ Bonds, Raising Questions
Over Why, CNBC (Jun. 29, 2020, 5:21 PM), https://www.cnbc.com/2020/06/29/the-fed-is-
buying-some-of-the-biggest-companies-bonds-raising-questions-over-why.html
[https://perma.cc/T2VG-QQLG].
46 GLENN HUBBARD, DONALD KOHN, LAURIE GOODMAN, KATHRYN JUDGE, ANIL KASHYAP,
RALPH KOIJEN, BLYTHE MASTERS, SANDIE O’CONNOR & KARA STEIN, HUTCHINS CTR. ON
FISCAL & MONETARY POL’Y AT BROOKINGS, TASK FORCE ON FINANCIAL STABILITY, 31
(2021), available at https://www.brookings.edu/wp-content/uploads/2021/06/financial-
stability_report.pdf [https://perma.cc/M7NS-FAKE] (describing the effects of the rapid
growth of bond mutual funds).
47See id. at 38-39.
22
facilities and its early modifications in the terms of those facilities.48
According to the Fed, “[e]ven funds specializing in short-term
investment-grade bonds experienced outflows in March totaling eight
percent of assets, dwarfing the selling pressure they saw during the
global financial crises.”49
In stanching these outflows, the Fed helped to save these fragile
intermediaries—each of which promise daily liquidity despite being
backed by very illiquid corporate bonds. This may have prevented
investors in these instruments and corporate bonds from fully
appreciating the risks embedded in these instruments, in part by
increasing expectations of further support if needed. If anything, the
Fed’s interventions seem to have led investors to be less concerned
than ever about the fragility of open-end bond funds and the potential
for serious losses if seeking to liquidate bonds, CLOs, or bond ETFs
during a period of distress. This helps to explain why these
intermediaries have, and likely will continue, to grow. As Blackrock—
the pioneer in ETFs—stated, “[i]n their biggest test to date, flagship
fixed income ETFs provided deep liquidity, continuous price
transparency and lower transaction costs than were available in
individual bonds . . . . As a result, asset owners — including pension
funds and insurance companies — and asset managers immediately
ramped up adoption.”50
It is useful in this context to observe the evolution of the bond
market and corporate debt in the wake of these government
interventions. Even though the amount of outstanding nonfinancial
corporate debt was at an all-time high going into the COVID-19 crisis,
48 Falato et al., supra note 35, at 9-10 (describing potential outflow effects from the Fed’s
policy).
49 Sharpe & Zhou, supra note 41 (summarizing the effects of the government’s response).
50 A Turning Point for Fixed Income ETFs, BLACKROCK,
https://www.blackrock.com/americas-offshore/en/insights/turning-point-in-bond-etf-
adoption [https://perma.cc/X6DE-R5VG] (last visited Feb. 20, 2022).]
23
it has since increased subsequently.51 Data from SIFMA shows that
“investment grade issuance was strong in March through May 2020
(+178% to 2019 levels on average)” and even though the issuance of
high yield debt fell dramatically in March, it too “had recovered well
by May (+60% to 2019 levels)” following the inclusion of many high-
yield bonds and ETFs in the Secondary Market Credit Facility in early
April.52 As explained in the November 2021 Financial Stability
Report from the Federal Reserve: “Corporate bond issuance remained
robust”; “spreads of corporate bond yields over comparable-maturity
Treasury yields . . . remained very narrow relative to their historical
distributions”; “[t]he excess bond premium, which is a measure that
captures the gap between corporate bond spreads and expected credit
losses . . . now stands at the bottom decile of its historical distribution,
suggesting elevated appetite for risk among investors”; and,
“[i]nvestor sentiment in the leveraged loan market has remained
optimistic.”53 Moreoever, despite the outflows from bond ETFs
creating meaningful price dislocations in March 2020, the Fed’s
prompt interventions resulted in total bond ETFs outstanding crossing
the $1 trillion threshold for the first time in the fall of 2020.54 In short,
the largest companies are having little trouble accessing credit on very,
very favorable terms.
51Patricia Buckley, Monali Samaddar & Akrur Barua, The Pandemic Has Forced Corporate
Debt Higher but Is That a Bad Thing?, DELOITTE INSIGHTS (July 15, 2021),
https://www2.deloitte.com/us/en/insights/economy/issues-by-the-numbers/rising-corporate-
debt-after-covid.html [https://perma.cc/WZ8R-QEKK].
52 Sharpe & Zhou, supra note 41; see KATIE KOLCHIN, SIFMA INSIGHTS: COVID-19
RELATED MARKET TURMOIL RECAP: PART II—FIXED INCOME & STRUCTURED PRODUCTS 5
(2020), available at https://www.sifma.org/wp-content/uploads/2020/07/SIFMA-Insights-
Market-Turmoil_FI-FINAL-FOR-WEB.pdf [https://perma.cc/9NZ4-M2PN].
53 BD. OF GOVERNORS OF THE FED. RSRV. BD., supra note Error! Bookmark not defined.,
at 11-13.
54 Ben Johnson, Bond ETF Assets Pass $1 Trillion in October, MORNINGSTAR (Nov. 3,
2020), https://www.morningstar.com/articles/1008706/bond-etf-assets-pass-1-trillion-in-
october.
24
Shifting momentarily to look at small business access to credit over
the same period of time reveals a very different picture. According to
the 2021 Small Business Credit Survey conducted by the Fed, 23% of
small businesses had trouble accessing the debt they needed in the past
year, only 37% of applicants received all the financing they sought
(down from 51% in the 2019 survey), and 13% saw credit availability
as the single most important challenge they expect to face in the next
year.55
The implications of these developments are mixed. The good news
is that these interventions helped the economy recover at a remarkable
clip once the early phases of the pandemic waned, despite ongoing
public health uncertainty and related political turmoil.56 Given the
uncertainty and the myriad challenges the pandemic posed, these
benefits are hard to overstate. Other implications are more mixed. One
obvious drawback is that the potential systemic threat posed by open-
end bond funds, CLOs and bond ETFs remains unaddressed while the
sector is poised for further growth, while investor expectations of
liquidity assistance from the government during future crises are likely
to distort market mechanisms and pricing of risk. Moreover, the sharp
rise in corporate debt levels could create debt overhang, potentially
impeding investment and growth in the years ahead.57 And, discussed
55 FED. RSRV. BANKS, SMALL BUSINESS CREDIT SURVEY: 2021 REPORT ON EMPLOYER
FIRMS 21 (2021), available at
https://www.fedsmallbusiness.org/medialibrary/FedSmallBusiness/files/2021/2021-sbcs-
employer-firms-report [https://perma.cc/PS9G-P6T6] (summarizing financing outcomes in
2020).
56 Gian Maria Milesi-Ferretti, A Most Unusual Recovery : How the US Rebound from
COVID Differs from Rest of G7, BROOKINGS INST. (Dec. 8, 2021),
https://www.brookings.edu/blog/up-front/2021/12/08/a-most-unusual-recovery-how-the-us-
rebound-from-covid-differs-from-rest-of-g7/ [https://perma.cc/XA8E-M4NC].
57 Some economists believe that a debt overhang can weigh on aggregate demand via
weaker investment growth. See Stewart C. Myers, Determinants of CorporateBorrowing, 5 J.
FIN. ECON. 147, 147 (1977) (forecasting risks of rising corporate debt levels); Larry Lang, Eli
Ofek & René M. Stulz, Leverage, Investment, and Firm Growth, 40 J. FIN. ECON. 3, 4 (1996)
(discussing potential risk with debt overhang preventing fundraising); Christopher A.
Hennessy, Tobin’s Q, Debt Overhang, and Investment, 59 J. FIN. 1717, 1718 (2005)
25
further below, these interventions could place a heavier thumb placed
on the financial scale favoring the largest companies relative to their
smaller counterparts in good times and bad.
B. Fed-facilited support for Midsized and Smaller Businesses
We begin to explore this last issue by comparing the easy access and
relatively low financing costs the largest companies enjoyed during
the crisis with the arguable failure of the Main Street Lending Program
and the conspicuous lack of any program using CARES Act funds to
increase credit support for truly small companies (apart from efforts
to implement short-term operating assistance through the Paycheck
Protection Program (“PPP”)).
The Main Street Lending Program was the Fed’s effort to help
companies that are not large enough to readily access public debt
(explaining debt overhang theory tested in article); Christopher A. Hennessy, Amnon Levy &
Toni M. Whited, Testing Q with Financing Frictions, 83 J. FIN. ECON. 691, 693 (2007)
(explaining the way they tested friction from debt overhang); Murillo Campello, John R.
Graham & Campbell R. Harvey, The Real Effects ofFinancial Constraints: Evidence from a
Financial Crisis, 97 J. FIN. ECON. 470, 486 (2010) (concluding bypassing of NPV projects
slow economic growth); Xavier Giroud & Holger M. Mueller, Firm Leverage, Consumer
Demand, and Employment Losses During the Great Recession, 132 Q.J. ECON. 271, 274
(2017) (describing concern that high leveraged firms more sensitive to demand shifts);
Sebnem Kalemli-Özcan, Luc Laeven & David Moreno, Debt Overhang, Rollover Risk, and
Corporate Investment: Evidence from the European Crisis 4-5 (Eur. Cent. Bank, Working
Paper No. 2241, 2019),
https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2241~cbea165b30.en.pdf
[https://perma.cc/P63C-AF6H] (discussing debt overhang hurts recovery from crises). Others
have challenged this view. See Atif Mian, Amir Sufi & Emil Verner, Household Debt and
Business Cycles Worldwide, 132 Q.J. ECON. 1755, 1757-58 (2017) (summarizing results that
run contrary to other debt overhang arguments); ÒSCAR JORDÀ, MARTIN KORNEJEW, MORITZ
SCHULARICK & ALAN M. TAYLOR, FED. RSRV. BANK OF N.Y., ZOMBIES AT LARGE?
CORPORATE DEBT OVERHANG AND THE MACROECONOMY, 1, 1 (2020), available at
https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr951.pdf
[https://perma.cc/KRX4-XU2Q] (layout out questioning of debt overhang theory).
26
markets.58 Under the Fed’s former guidelines (the program terminated
in January 2021), companies with up to 15,000 employees or $5
billion in annual revenue (as of 2019) were eligible to participate.59
These are not small businesses in the ‘mom and pop’ version but the
definition of small business can be quite expansive and these
businesses are equally not part of the biggest ‘big businesses’ under
the Fed’s definition. To implement the program, the Federal Reserve
Bank of Boston set up a special purpose vehicle to purchase
participations in loans originated by banks and their affiliates
(nonbanks were not made eligible by the time the program ended).60
The idea behind the structure was not all that different than what the
Fed had done with corporate bonds; the Fed did not want to be in the
position of directly assessing a company’s creditworthiness, so instead
it relied on the existing credit creation infrastructure to do that. In this
case, that meant relying on banks rather than credit rating agencies or
investment fund managers to pick “winners and losers.”61 The Fed
further sought to ensure that banks would identify only companies that
had at least a decent chance of paying back the moneys borrowed by
requiring the banks that originated the loans to retain some credit
exposure and by imposing other substantive conditions, e.g., limits on
the total amount of debt a company could have relative to its income.62
This is a significant structural difference from the corporate credit
58BD. OF GOVERNORS OF THE FED. RSRV. BANK OF N.Y, supra note 35.
59Mark Kolakowski, What Is the Main Street Lending Program, INVESTOPEDIA (July 26,
2021), https://www.investopedia.com/main-street-lending-program-4802310
[https://perma.cc/B4TR-LR4S].
60Policy Tools, Main Street Lending Program, BD. OF GOVERNORS OF THE FED. RSRV. SYS.,
https://www.federalreserve.gov/monetarypolicy/mainstreetlending.htm
[https://perma.cc/XD9F-NXGD] (last visited Feb. 20, 2022).
61See William B. English & J. Nellie Liang, Designing the Main Street Lending Program:
Challenges and Options 22 (Brookings Inst.: Hutchins Ctr. on Fiscal & Monetary Pol’y,
Working Paper No. 64, 2020), https://www.brookings.edu/wp-content/up-
loads/2020/06/WP64_Liang-English_FINAL.pdf [https://perma.cc/GV5U-KMLM].
62Id. at 2.
27
facilities, as bond ETFs are not required to, and typically do not, hold
direct liability to the assets they are creating for their investors.63 The
Fed also set the terms of the loans that would be extended under the
Main Street facility, using a structure that allowed repayment
flexibility in the early years while still requiring full repayment of
principal at a meaningful interest rate.64
Importantly, lenders were told to view the eligibility criteria in the
term sheets as the minimum requirements and were expected to apply
their own underwriting standards in evaluating potential borrowers
and conduct an assessment of each potential borrower’s financial
condition at the time of the potential borrower’s application.65 This
was deemed necessary to control risk to the Fed, despite the money
allocated to the Treasury by Congress to absorb losses and allow
greater lending and risk taking. 66 Along with the risk retention
requirement, this criteria and design meant that the Main Street facility
did not provide banks meaningful flexibility to make loans that they
would not have made otherwise, or to make those loans on terms that
were significantly more favorable.
The Main Street Program was announced in late March 2020
alongside the two corporate credit facilities.67 In contrast to those
63See id. at 14-15.
64 Policy Tools, supra note 60.
65 Main Street Lending Program: Frequently Asked Questions, FED. RSRV. BD. (Dec. 28,
2020), https://www.federalreserve.gov/monetarypolicy/files/main-street-lending-faqs.pdf
[https://perma.cc/TX7D-VMWS].
66 Treasury’s expression of an aversion to actually bearing losses may be one reason why
the Fed designed a program that ultimately received little usage and hence had little potential
to actually use the funds allocated.
67Brian D. Christiansen, Seth E. Jacobsen, Stephanie L. Teicher & Collin P. Janus, Updated
Guide to the Main Street Lending Program, SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP
(June 10, 2020), https://www.skadden.com/insights/publications/2020/06/updated-guide-to-
the-main-street-lending-program# [https://perma.cc/S8XB-82RN].
28
facilities, however, there was no immediate favorable impact on the
ability of eligible companies to actually access the financing they need
to survive.68 It was not until July, well after the Fed had started buying
ETFs and a broad array of other corporate debt, generally issued by
companies showing no sign of needing any further financial support,
that the Main Street Lending Facility even became fully operational.69
Moreover, the overall impact of the program was far more muted, to
say the least.
At announcement, Main Street was projected for up to $600 billion
in total loans with $75 billion set aside for potential losses.70 It never
got close. Mains Street conducted only 1,830 loans with a total lending
of $17.5 billion.71 And roughly half of the entire volume conducted
through Main Street occurred in December 2020, just weeks before
the facility was ceasing to accept loans.72 At the end of the day, less
than 3% of potential lending credit was advanced and the Treasury set
aside money to cover losses in excess of 425% of the total lending that
occurred. Putting this in context, 16% of the total CARES Act $454
billion allocated in March was set aside for the Main Street program
to cover possible lending of $600 billion to these types of businesses,
of which less than $10 billion was actually advanced by Thanksgiving.
Even this small amount of support was not well targeted, as according
to the Fed’s own definitions, approximately 30% of loans were to
68Falk Bräuning & Teodora Paligorova, Uptake of the Main Street Lending Program, BD. OF
GOVERNORS OF THE FED. RSRV. SYS (Apr. 16, 2021), https://www.federalreserve.gov/econ-
res/notes/feds-notes/uptake-of-the-main-street-lending-program-20210416.htm#
[https://perma.cc/N5MC-25WE].
69See id.
70 MARC LABONTE & LIDA R. WEINSTOCK, CONG. RSRCH. SERV. IF11632, THE FEDERAL
RESERVE’S MAIN STREET LENDING PROGRAM (2020),
https://crsreports.congress.gov/product/pdf/IF/IF11632 [https://perma.cc/RVN4-23B4].
71Bräuning & Paligorova, supra note 68.
72 Bräuning & Paligorova, supra note 68(describing the timing of the uptake of the lending
program).
29
industries that were not categorized as ‘COVID-19 impacted.’ An
analysis by the non-partisan Congressional Research Service
concluded that the Main Street facility may well have been “too small
to be effective.”73 As Bharat Ramamurti, a former member of the
Congressional Oversight Commission for the CARES Act and
currently a senior member of the Biden Administration National
Economic Council, put it, “[b]y any measure, the Main Street program
has been a failure.”74
There have been a number of explanations for the relative failure of
the Main Street facility. For example, many borrowers generally felt
the terms of the facility were too restrictive. As noted in a review of
the limited lending: “[f]rom the convoluted eligibility requirements to
the prohibition on paying dividends, the benefits provided from the
emergency liquidity (namely, deferred principal and interest
payments) did not outweigh the costs of the strings attached
thereto.”75Yet, the core challenge grew out of the existing credit
creation infrastructure that the Fed relied on, and in the longer term,
the lack of implicit commitments that resulted from the Fed’s
interventions. Ultimately, nothing in the Main Street facility offered
banks sufficiently great upsides relative to risk to encourage broad
lending using this program. This greatly limited the effectiveness of
the program. But, even if the program had been better designed and
more effective, its long-term impact may well have been limited.
Because the program was seen as limited to its terms, and contingent
on continuing support from Congress and the Treasury Department,
its existence did nothing to incentivize banks to invest further to
73 LABONTE & WEINSTOCK, supra note 70.
74 Rachel Siegel, Months into Recession, Fed’s Main Street Loan Program Is at a
Crossroads, WASH. POST (Aug. 7, 2020),
https://www.washingtonpost.com/business/2020/08/07/federal-reserve-main-street-progral/
(discussing issues with Main Street Loan Program).
75 Nathan Volz, How the Main Street Loan Program Failed Main Street, WIS. L.J. (Mar,
1, 2021 1:25 PM), https://wislawjournal.com/2021/03/01/how-the-main-street-loan-program-
failed-main-street/ [https://perma.cc/GMD4-ES7X].
30
improve their origination processes and internal infrastructure for
making loans to mid-sized businesses. This stands in stark contrast to
the corporate bond markets, where the Fed’s interventions—
intentionally or not—seem to have led to expectations of further
support in coming crises.
Shifting to smaller businesses, the Fed created a facility that
facilitated implementation of the government’s separate PPP
initiative, which as discussed below, was designed to provide
temporary operating support for small businesses and those they
employed. But it made no attempt to create a true emergency lending
facility that would have increased access to funding for small
enterprises, despite the fact that pandemic-era surveys suggesting that
just shy of half such enterprises were concerned about cash flow and
the overall health of their businesses.
The Fed could perhaps have promoted more enduring credit creation
for small businesses by creating a lifeline for the issuance of asset-
backed securities backed by small-business loans. Securitization
vehicles allow for the transfer of risk from the loan originator to the
holders of securities backed by those loans, and securitization vehicles
pool risk between multiple individual loans.76 The Fed recognizes
securitization markets as key to credit creation, and re-deployed a
facility in 2020 that it had first used in 2008 to help promote credit
creation via the issuance of asset-backed securities (“ABS”).77 When
relaunching the program, known as the term auction loan facility
(“TALF”) in 2020, the Fed explained the program was “intended to
help meet the credit needs of consumers and businesses by facilitating
the issuance of asset-backed securities.”78 Under the TALF, the Fed
agreed to make non-recourse loans secured by ABS backed by a wide
variety of different assets, including auto loans, student loans, credit
76See Term Asset-Backed Securities Loan Facility, supra note 25 (discussing collateral for
recourse loans under Fed loan facility).
77Id.
78 Id.
31
card receivables (both consumer and corporate), equipment loans and
leases, and leveraged loans made to large businesses.79
Yet, when it came to ABS backed by loans to small businesses, the
Fed followed its 2008 precedent to the letter (from a time when
Fintech and other nonbank origination of small business loans was
negligible) and would accept such loans only if “guaranteed by the
Small Business Administration.”80 These terms not only did little to
change banks’ willingness to extend non-guaranteed small business
loans, but they also effectively excluded billions of dollars in
nonbank-originated small business ABS and the lenders who
originated the underlying loans from market support.81 The Fed’s
approach favored some forms of ABS, including CLOs that have
become a key mechanism through which funds flow to the largest
businesses, but not others such as non-guaranteed small business loans
and personal installment loans.82 This likely reduced the credit risk to
which the Fed was exposed, an understandable aim much of the time,
but one that requires greater scrutiny in light of the funds allocated by
the CARES Act. For, as discussed further below in connection with
PPP and the small-business-lending-landscape, these limitations
significantly reduced support provided to small businesses during the
earliest part of the pandemic and had the effect of denying the
intermediaries that facilitate funding for small businesses the support
akin to that the Fed provided to open-end bond funds and the other
nonbank intermediaries supporting loans to large businesses.83
79Id.
80 Id.
81Todd H. Baker, Fed’s New TALF Has a Major Gap, AM. BANKER (Mar. 26, 2020, 12:30
PM), https://www.americanbanker.com/opinion/feds-new-talf-has-a-major-gap (last visited
Feb. 20, 2022) (“Unless the TALF is changed to include the investment-grade, ABS based
on [consumer] loans, lenders will shut down originations just when they are needed most.”).
82 See id.; see also Todd H. Baker & Kathryn Judge, How to Help Small Businesses Survive
COVID-19, at 4 (Columbia L. and Econ., Working Paper No. 620, 2020),
https://scholarship.law.columbia.edu/cgi/viewcontent.cgi?article=3643&context=faculty_sc
holarship [https://perma.cc/PX4Q-VLXW].
83Baker, supra note 81 (concluding that unless TALF reformed, the Fed “will fail in its goal
of ensuring that credit flows to millions of vulnerable consumers”).
32
Relatedly, the Fed also limited the ABS it was willing to accept
based on the decisions of credit rating agencies.84 Specifically, the Fed
required ABS to have a credit rating in the highest long-term or, if no
long-term rating was available, the highest short-term investment-
grade rating category from at least two eligible nationally recognized
credit rating agencies, provided that the ABS did not have a credit
rating below the highest investment-grade rating category from any
such agency.85 This requirement contrasts with the inclusion of lower
rated, non-investment grade corporate loans and ETFs in the
secondary corporate credit facility. Holding ABS to a higher credit
quality standard than corporate loans or ETFs effectively would have
excluded most securitizations of unsecured private small business
loans at the time.86 Again, these types of limitations reduced the credit
risk to the Fed, but the fact that Congress had provided the Treasury
and Fed, collectively, with substantial loss absorbing capital so that
the Fed could extend credit to impacted sectors of the economy in
need undermines the sufficiency of this explanation for the decisions
made. Given then-current credit market conditions, the Fed’s
84 Baker & Judge, supra note 82( noting “ABS issued by nonbank small business lenders
typically don’t reach” the credit rating grade required).
85Id. at 9.
86 Prior to the pandemic, the highest-rated tranches of small business loan securitizations
by Fintechs, such as Kabbage, FundingCircle, Credibly, RapidFinance and National Funding,
were rated below the highest rating category. See Kroll Bond Rating Agency, 2019 Small
Business Lending ABS Year in Review and 2020 Outlook 6 (Feb. 13, 2019) see also KBRA
Assigns Preliminary Ratings to Kabbage Asset Securitization LLC, Series 2019-1 Additional
Notes, BUS. WIRE (Nov. 12, 2019, 2:49 PM),
https://www.businesswire.com/news/home/20191112005999/en/ [https://perma.cc/3BYG-
CFAR]. OnDeck, the only Fintech lender whose ABS had a top rating from one rating agency,
suspended all non-PPP lending to new and existing customers in April 2020 and was
subsequently sold for a small percentage of its historical market capitalization. See Sean
Murray, OnDeck Reports Q1 Net Loss of $59M, Suspends Non-PPP Lending Activities,
DEBANKED (Apr. 30, 2020), https://debanked.com/2020/04/ondeck-q1-earnings-to-be-
released/ [https://perma.cc/D5X4-QJM3] (“OnDeck has suspended the funding of its Core
loans and lines of credit to new or existing customers (unless the loan agreement has already
been executed).”); see also Press Release, Enova Int’l, Enova to Acquire OnDeck to Create a
Leading FinTech Company Serving Consumers and Small Businesses (July 28, 2020),
https://www.prnewswire.com/news-releases/enova-to-acquire-ondeck-to-create-a-leading-
fintech-company-serving-consumers-and-small-businesses-301101550.html
[https://perma.cc/ZGZ7-JM8C].
33
decisions sharply limited the ability of nonbank lenders to support
their customers with credit and did little to incent bank lenders—in
either the immediate or longer term—to develop or maintain the
infrastructure needed to make small business loans that lacked a
government guarantee.87
The potential economic consequences of the Fed’s decision are
signficiant. In recent years, more than 61 million individuals—almost
one-half of the U.S. workforce—worked in a small business, and small
businesses collectively produced 43.5% of U.S. GDP.88 Even more
importantly, small businesses have accounted for 62% of net new job
creation since 1995.89 The failure to do more for these enterprises
cannot be readily explained away as lying outside the Fed’s
employment mandate,90 nor does it appear that the Fed is unconcerned
about these companies. If anything, the opposite seems to be true.
Chairman Powell explained: “[t]he pandemic is presenting acute risks
to small businesses” and when “a small or medium-sized business
becomes insolvent . . . we lose more than just that business.”91 “[t]he
heart of our economy and . . . the work of generations” is at stake.92
The struggles the Fed confronted in its effort to operationalize both the
87 Baker & Judge, supra note 82, at 2 (discussing Fed’s mechanisms for extending lines of
credit to small business as critical but insufficient).
88 Frequently Asked Questions About Small Businesses, U.S. SMALL BUS. ADMIN.: OFF. OF
ADVOC. (Dec. 2021), https://cdn.advocacy.sba.gov/wp-content/up-
loads/2021/12/06095731/Small-Business-FAQ-Revised-December-2021.pdf
[https://perma.cc/79HG-U638] (finding small firms also constitute 39.7% of private sector
payroll).
89 Id. (stating 12.7 million net new jobs have been added to economy by small businesses).
90See id.
91Jerome H. Powell, Chairman, Bd. of Governors of the Fed. Rsrv. Sys., Semiannual Mone-
tary Policy Report to the Congress, Testimony Before the Committee on Banking, Housing,
and Urban Affairs (June 16, 2020) (available at https://www.federalre-
serve.gov/newsevents/testimony/powell20200616a.htm [https://perma.cc/2PFJ-AHXG]).
92 Id..
34
Main Street Facilities show how hard it can be for the Fed to partner
with the lenders who specialize in making these loans, even when big
dollars are involved.
C. Why the Fed?
Strikingly, given the effect of delegating so much credit creation to
the Fed, there is little sign that Congress had any desire to favor credit
creation for large businesses over mid-sized and small ones. Given all
that the Fed was already doing to fulfill its core mission of monetary
policy while aggressively using emergency authority to stabilize short-
term markets, why did Congress lay such a daunting new challenge on
the Fed’s shoulders? Although there are an array of reasons, one merits
particular attention for purposes of our analysis here: perhaps
Congress felt it did not have a better alternative.
As Neil Komesar has illuminated in his work on the importance of
“deciding who decides,” institutional choice is always relative.93 The
alternatives facing Congress in passage of the CARES Act were to:
(a) come to a bipartisan, bicameral compromise and decide itself;
(b) empower the President to decide directly or through a cabinet
agency; or (c) empower an alternative institution such as the Fed. The
Fed may be ill suited to address many of the challenges it is now being
asked to help solve, but it is still better suited to take them on than
administrators closer to the President or Congress through a more
detailed set of appropriations, at extremis earmarking funds to specific
projects. The Fed may be less susceptible to corruption, more
competent, more able to make credible commitments, and more able
to act quickly when that is what the situation requires, all factors that
matter with these types of decisions. Examining Congress, the
Presidency, and the Fed in broad strokes and then looking at specific
institutional advantages the Fed may possess helps to explain how the
93 NEILK. KOMESAR, IMPERFECT ALTERNATIVES: CHOOSING INSTITUTIONS IN LAW,
ECONOMICS, AND PUBLIC POLICY (Univ. of Chi. Press 1994).
35
central bank became a key part of the line of first defense for providing
fiscal support to businesses in a recession.
Nevertheless, the Fed or the U.S. system of governance generally is
not necessarily well-served by this allocation. As Komesar also
emphasizes, because any effort to pursue a substantive aim will be
mediated by the processes and people of the institution charged with
implementing that aim, institutional choice is of utmost importance.94
And the use of the Fed as “quarterback” for relief efforts—given its
institutional culture and the way it interacts,or does not,with existing
“private” mechanisms for credit creation—highlights just how central
infrastructure is in determining who gets help when crisis strikes.
III. OTHER SMALL BUSINESS SUPPORT: PPP
Congress also created other programs to try to help businesses
survive the unprecedented shock.95 The most important program for
small businesses in the early stages of the pandemic was the PPP. This
program was designed to funnel operating assistance to the employees
of small businesses and discourage mass layoffs in addition to helping
the owners and operators of those businesses weather the storm.96
Small businesses were particularly hard hit in the early part of the
pandemic, as shutdowns were declared and customer traffic imploded
in the country’s business districts.97 According to one study, by May
94Id.
95 Press Release, U.S. Dep’t of Treasury, With $349 Billion in Emergency Small Business
Capital Cleared, SBA and Treasury Begin Unprecedented Public-Private Mobilization Ef-
fort to Distribute Funds (Mar. 31, 2020), https://home.treasury.gov/news/press-re-
leases/sm961 [https://perma.cc/KH7A-S8XL] (describing purpose of Paycheck Protection
Program as protecting businesses and their employees).
96 Id.
97 Iman Ghosh, 34% of America’s Small Businesses Are Still Closed Due to COVID-19.
Here’s Why It Matters, WORLD ECON. F. (May 5, 2021), https://www.wefo-
rum.org/agenda/2021/05/america-united-states-covid-small-businesses-economics/
[https://perma.cc/E5LA-UQF2] (showing large-scale businesses closings across USA in
early 2020); John Eric Humphries, Christopher Neilson, and Gabriel Ulyssea, The Evolving
Impacts of COVID-19 on Small Businesses Since the CARES Act (NYU Cowles
36
2020, 34% of small businesses were still closed compared to January
2020.98 The impact on business owners was not consistent
demographically.99 For example, Asian and Black business owners
were more highly concentrated in places, and in industries, with larger
declines.100
The PPP was a unique program unprecedented in U.S. history. With
the avowed goal to assist small businesses and small business
employees impacted by the COVID-19 shutdown, Congress created
the PPP and set aside $349 billion of CARES Act appropriations for
PPP purposes.101 Congress placed the Treasury Department in charge
of PPP and directed the Small Business Administration to help small
businesses qualify for PPP funding.102 Congress gave the Treasury
Department broad discretion to disburse PPP funding.103 The PPP
was designed to funnel operating assistance to small businesses to
discourage mass layoffs in addition to helping the owners and
Foundation Discussion Paper No. 2230, April 26, 2020),
http://dx.doi.org/10.2139/ssrn.3584745 (survey results showing numerous adverse impacts
on small businesses by April 2020).
98 Ghosh, supra note [104], (listing San Francisco, Boston, and Washington as cities with
sharpest decline in small businesses remaining open).
99Daniel Wilmoth, The Effects of the COVID-19 Pandemic on Small Businesses, U.S. SMALL
BUS. ADMIN.: OFF. OF ADVOC. 5 (Mar. 2021), https://cdn.advocacy.sba.gov/wp-content/up-
loads/2021/03/02112318/COVID-19-Impact-On-Small-Business.pdf
[https://perma.cc/WLX9-CBJ3].
100 Id.
101 See A July Update on the Paycheck Protection Program, COMM. RESPONSIBLE FED.
BUDGET (July 10, 2020), https://www.crfb.org/blogs/july-update-paycheck-protection-pro-
gram [https://perma.cc/2769-VWVD] (stating that PPP’s original $349 billion original fund-
ing “quickly ran out”).
102 See Press Release, supra note .
103 See A July Update on the Paycheck Protection Program, COMM. RESPONSIBLE FED.
BUDGET (July 10, 2020), https://www.crfb.org/blogs/july-update-paycheck-protection-
program [https://perma.cc/2769-VWVD].
37
operators of those businesses.104 As one of its main sponsors, Senator
Marco Rubio (R-FL) described the program: “PPP had two main
goals: help workers keep their jobs, and protect small businesses from
being forced to permanently close their doors.”105
The PPP was ostensibly a “forgivable loan” program run through
existing financial intermediaries, primarily banks and, in the later
stages, financial technology firms (“Fintechs”)106 and other nonbank
lenders. In practice, it functioned as a grant with easily met
conditions.107 Because, it too relied on existing infrastructure,
assistance—particularly in the critical early days of the PPP—was
principally available to small businesses with existing relationships
with participating lenders.
The PPP was structured to reach businesses using lender financial
intermediaries as the disbursement arm, accessed through PPP “loan”
104Id.
105 Press Release, Marco Rubio, Chairman, Senate Committee on Small Business and
Entrepreneurship, Opening Remarks at Congressional Hearing: Small Business in Crisis: The
2020 Paycheck Protection Program and its Future (Dec. 10, 2020),
https://www.rubio.senate.gov/public/index.cfm/2020/12/now-rubio-chairs-hearing-on-the-
paycheck-protection-program-and-its-future [https://perma.cc/3AX8-KVRF].
106 For this paper we will define Fintechs as companies that provide credit primarily
through technological platforms (not in-person or store front) and are not chartered banks,
credit unions, or community development financial institutions (CDFIs). We define fintechs
this way to make the conceptual arguments regarding bank/credit union/CDFI vs. Fintech
cleaner. We realize that in the real world many banks/credit unions/CDFIs use financial
technology extensively, that there are nonbank lenders that do not operate as FinTechs, and
that some Fintechs are or may be considering becoming banks/credit unions/CDFIs. We also
recognize that there are a whole host of financial technology companies that are not lenders
but are commonly referred to as FinTechs.
107 Pandemic Oversight, Paycheck Protection Program, PANDEMIC OVERSIGHT,
https://www.pandemicoversight.gov/data-interactive-tools/interactive-dashboards/paycheck-
protection-program (last visited Feb. 20, 2022) (showing hundreds of billions of dollars
forgiven). As of November 24, 2021, $629.2 billion of the total of $792.8 billion in PPP loans
(79.4%) had been forgiven. Id.
38
applications.108 The Treasury then funded such “loans” through the
lender to the applicant. To achieve the dual goals of the program, the
“loans” were forgivable as long as borrowers maintained employee
compensation levels.109 Originally set at 75% for payroll, that figure
was reduced to 60% in later legislation.110 Thus, up to 40% of funds
supposedly designed to protect paychecks could be spent on “other
eligible expenses.”111 Reflecting the belief at the time that the
economic shutdown would be short, businesses were given eight to
twenty-four weeks to use the funds for those purposes.112 If these
criteria were met, the “loan” was forgiven.113 Thus, the “loan”
effectively became a grant.
Economically there is little distinction between a loan that is
forgiven if key conditions are met and a grant that must be repaid if
certain conditions are not met. Both are contingent gifts that require
repayment if certain criteria are not met. Politically there are important
distinctions between programs that are marketed as “loans” compared
to those marketed as “grants.” Short-term grant programs like the PPP
are designed to support the status quo without making too many
distinctions and “kick the can” down the road until the situation is
clearer or possibly in hopes that a short-term lifeline is all that will be
needed for long-term business survival. These grants are expenditures
108 A July Update on the Paycheck Protection Program, supra note 103 (“[T]he forgivable
loans were provided through banks and other private financial entities who have collected
billions of dollars in fees for their services.”).
109 PPP Loan Forgiveness, U.S. SMALL BUS. ADMIN. https://www.sba.gov/funding-pro-
grams/loans/covid-19-relief-options/paycheck-protection-program/ppp-loan-forgiveness
[https://perma.cc/49UN-ZTDA] (last visited Feb. 20, 2022).
110Id.
111 Id. (requiring also that “loan proceeds are spent on payroll costs and other eligible
expenses”).
112Id.
113Id.
39
not expected to be recouped by the provider.114 Loans, by contrast, are
intended to be repaid over time and availability is dependent upon the
lender’s assessment of repayment risk. This was the approach that the
Main Street Loan program followed, as noted above. The political
sensitivity of this distinction is illustrated by the following
counterfactual. Had the PPP grants actually been true loans with an
expectation of repayment, then Congress, Treasury, or the Fed would
have had to come up with underwriting criteria to control credit risk
or delegated underwriting to lenders (as with the MSLP).
Because loan underwriting necessitates some degree of trying to
separate expected winners from losers—even when the government is
ready to absorb some of the credit risk—using true lending structures
to deliver assistance is challenging even in normal cyclical downturns,
and is particularly so in a sharp crisis when the future direction of the
economy is particularly unclear.115 During the early phases of
COVID-19, for example, there were legitimate questions about
whether infections would continue for mere months or many years and
thus whether the economic recovery would be V-shaped, a swoosh, a
sawtooth, or something else entirely.116 There were signifcant
questions about how it would differentially impact different industries,
outside of the obvious areas of travel and leisure.117 This uncertainty
rendered many of traditional tools of credit analysis, temporarily, far
less reliable. It can also help explain why neither the Fed nor the
Treasury were anxious to try to take more actions that directly
supported small businesses via true credit extensions. Given
Congress’s decision to have the Fed play a central role in aiding the
flow of funds to busiensses under the exigencies of the COVID-19
114Id.
115 Jose Maria Barrero, Nicholas Bloom, and Steven J. Davis, COVID-19 Is Also a Reallo-
cation Shock (University of Chicago Becker Friedman Institute for Economics Working
Paper No. 2020-59, June 25, 2020), http://dx.doi.org/10.2139/ssrn.3592953.
116 See, e.g., Baker & Judge, supra note 82, at 2 (“Nor can anyone foresee what the econ-
omy will look like when people emerge from their shelters.”).
117
See id. (“A severe recession is certain, but questions remain about just how deep it will
sear, how long it will last, and how it will reshape the economy that emerges.”).
40
induced recession, there are still lessons to be learned for the next
crisis, whatever its cause.
The Treasury, in the first stage of PPP, worked with the SBA and a
multitude of banks and credit unions to disburse PPP funds. The
government paid fees to entice banks and nonbanks to originate PPP
“loans.” The fees provided to financial intermediaries facilitated
distribution of PPP funds, and banks worked hard to get money out
the door to their customers. Low-cost funding ultimately provided by
the PPP loan fund set up by the Treasury and the Fed coupled with
capital relief provided to banks by regulators provided additional
incentives for financial intermediaries to engage. 118
Despite the fact that the initial round of funding was expected to be
far shy of demand, the Treasury decided to make funds available in a
“first come, first served” basis. The result was a rush to seek funding.
The entire $350 billion was given out in fourteen days, beginning
April 2, 2020 (barely after the CARES Act was signed and again
before any automatic stabilizer tied to the unemployment data would
have been able to kick in).
The rollout process was chaotic and exposed significant weaknesses
in the SBA’s loan application system. It also created frustration for
many of the lenders attempting to submit and receive approval for
applications and the borrowers seeking funds.119 Getting so much
funding out so quickly was no small feat.120 And, interestingly, in light
118 Regulatory Capital Rule: Paycheck Protection Program Lending Facility and Paycheck
Protection Program Loans, 85 Fed. Reg. 20,387-394 (Apr. 13, 2020) (to be codified at 12
C.F.R. pts. 3, 217, 324).The bank regulators allowed banks to exclude PPP loans from
regulatory capital calculations. Id.
119 Rebecca Jarvis & Layne Winn, What Went Wrong with the Paycheck Protection
Program, ABC NEWS (Apr. 25, 2020), https://abcnews.go.com/Business/inside-paycheck-
protection-program-race/story?id=70330643 [https://perma.cc/P4CX-FYKL]
120Id. (“Collecting the right information, auditing thousands of quickly thrown together doc-
uments, and doing it all under the extreme conditions of the coronavirus pandemic presented
several challenges, but the biggest challenge by far, was submitting the paperwork.”).
41
of the push for digital lenders to be included in the first round, banks
succeeded in getting PPP loans for their customers in most cases by
“throwing people” at the problem instead of automating processes.121
The Treasury made several decisions in implementing PPP that had
the effect of prioritizing larger companies by incentivizing those with
preexisting banking relationships and those asking for larger PPP
amounts. “First come, first served” funding of applications
incentivized speed. Speed in application processing is a function of
relationships—borrowers knew where to go for help and banks could
process the requests of existing customers quickly—but equally the
result of bank self-interest. The Treasury also decided to require anti-
money laundering rules, such as know your customer, to be part of the
PPP underwriting process. This burden increased the fixed cost to
process PPP applications and increased the time it took to gather
information from customers who had not previously been subject to
anti-money laundering review. This very likely had the effect of
prioritizing PPP access for businesses that had previously obtained a
loan over those that just had a transaction account or some other
relationship at the bank.122 Finally, in more of a structural issue than
a decision about implementation, the natural economics of
bank/business relationships also tilted the scales toward providing PPP
121 David Smith, The Ballad of the Small Banker: An SBA Lender’s Experience with PPP
Loans, FICO (May 7, 2020), https://www.fico.com/blogs/ballad-small-banker-sba-lenders-
experience-ppp-loans [https://perma.cc/8JMT-KD2M] (explaining big banks’ “digital
systems are not designed to handle the PPP loan program, and they do not immediately have
the regulatory processes in place to detect risk and fraud for these circumstances”); Miriam
Cross, Small Lenders Embrace Automation for Latest PPP Round, AM. BANKER (Jan. 13,
2021, 3:16 PM), https://www.americanbanker.com/news/small-lenders-embrace-automation-
for-latest-ppp-round (noting PPP distribution prior to automation was inefficient and
cumbersome).
122 Aaron Klein & Staci Warden, Anti-money Laundering Rules: An Emergency Assistance
Roadblock, BROOKINGS INST. (Apr. 8, 2020), https://www.brookings.edu/opinions/anti-
money-laundering-rules-an-emergency-assistance-roadblock/ [https://perma.cc/XTG4-
Y23E] (“When a new small business comes calling, asking for a small two-month loan at a
1% interest rate, the more prudent course from a bank’s risk management perspective, even
with a government guarantee, may simply be to not make the loan at all.”).
42
assistance to pre-existing customers who already had outstanding
loans from the bank. By improving the liquidity and solvency of a loan
customer receiving PPP funds, it became less likely that a bank’s
outstanding loan would go into default.
These dynamic factors favored large businesses and those who had
been in business longer.123 It also favored wealthier businesses—that
is, the businesses that were in better financial position to handle the
economic disruption even without government aid.124 These factors
help to explain why in the first round of PPP allocations to companies
seeking $1 million or more, quite a large sum for what was supposed
to cover mainly six to eight weeks of payroll, comprised 44.5% of all
PPP funds.125 By contrast, funds for businesses seeking $150,000 or
less made up only 17% of all successfully processed PPP
applications.126
This approach disfavored the large number of the smaller businesses
that relied on Fintechs and other nonbank lenders for credit, and the
many very small businesses who were not actively borrowing prior to
the crisis. These categories include proportionally more minority and
123 See Garrett Borawski & Mark E. Schweitzer, Fed. Rsrv. Bank of Cleveland, How Well
Did PPP Loans Reach Low- and Moderate-Income Communities? 1-2 (May 28, 2021),
https://www.clevelandfed.org/~/media/content/newsroom%20and%20events/publications/ec
onomic%20commentary/2021/ec%20202113/ec2021-13.pdf [https://perma.cc/7VTH-
D37N].
124 Stacy Cowley & Emily Flitter, Banks Gave Richest Clients ‘Concierge Treatement’ for
Pandemic Aid, N.Y. TIMES (Apr. 22, 2020),
https://www.nytimes.com/2020/04/22/business/sba-loans-ppp-coronavirus.html (last visited
Jan. 3, 2022) (describing “two-tiered system” where wealthier clients had easier loan
application process).
125Aaron Klein, The Small Business Relief Program Is Still Broken, POLITICO (Apr. 27,
2020, 4:30 AM), https://www.politico.com/news/agenda/2020/04/27/small-business-relief-
206960 [https://perma.cc/Y9VN-S23N].
126 Id.
43
women-owned businesses.127 Given weaker historical relationships
between banks and minority-owned small businesses and
microbusinesses (those with ten or fewer employees), this likely
contributed to such businesses having more difficulty and less overall
access to the first round of PPP funding.128 Although, to be sure, other
factors also played a role contributing to the disparaties in who
actually received funding.129
In initially using banks as the primary distribution channel, Treasury
seemingly paid little heed how various small businesses access
funding, and how the small business credit market has changed since
2008. As two of us noted before those decisions were made: “Banks
are no longer the only source of credit for true small businesses,
especially the type of very small “Mom & Pop” corner stores,
laundromats, beauty salons, and coffee and sandwich shops that line
main streets.”130 Over the last decade, the smallest enterprises have
127 Megan Cerullo, Up to 90% of Minority and Women Owners Shut Out of Paycheck Pro-
tection Program, Experts Fear, CBS NEWS (Apr. 22, 2020, 3:48 PM),
https://www.cbsnews.com/news/women-minority-business-owners-paycheck-protection-
program-loans/ [https://perma.cc/FTP3-GAYQ].
128 Sifan Liu & Joseph Parilla, New Data Shows Small Businesses in Communities of Color
Had Unequal Access to Federal COVID-19 Relief, BROOKINGS INST. (Sept. 17, 2020),
https://www.brookings.edu/research/new-data-shows-small-businesses-in-communities-of-
color-had-unequal-access-to-federal-COVID-19-relief/ [https://perma.cc/HRC8-N6Y3]
(supporting conclusion with empirical data that “small businesses in majority-white
neighborhoods receiv[ed] PPP loans more quickly than small businesses in majority-Black
and majority-Latino or Hispanic neighborhoods”).
129 Humphries et al, supra note [104].
130 Baker & Judge, supra note 82, at 7; See FED. RESRV. BANKS, SMALL BUSINESS CREDIT
SURVEY: 2019 REPORT ON EMPLOYER FIRMS 16 (2019), available at https://www.fedsmall-
business.org/medialibrary/fedsmallbusiness/files/2019/sbcs-employer-firms-report.pdf
[https://perma.cc/Q25K-9HJC] (showing statistical importance of “nonbank” lenders in sur-
vey on small business).
44
increasingly turned to online lenders for their credit needs.131 The
2019 Federal Reserve Banks’ Small Business Credit Survey indicated
that, in 2018, nearly one-third of small businesses that applied for
credit sought it from an online lender (the type of lender we describe
here as a Fintech).132 For less traditionally credit-worthy businesses,
the number was closer to one-half.133 Despite an average loan size
much smaller than that of a typical bank,134 online lenders extended
more than $20 billion in loans to small businesses in 2019, owing
overwhelmingly to very small enterprises.135 Combined with the
approximately $12-15 billion in aggregate merchant cash advances
made to small retail businesses in 2019, nonbank lenders provided
somewhere between one-quarter and one-third of all credit to the
smallest businesses.
Racial disparities also appear larger in bank small business lending
than in Fintech lending.136 While large banks approve at least some
credit for about 65% of loan applications from White small business
131 FED RSRV. BANKS, supra note 130 (showing upward trend in online applications from
2016 through 2018).
132 Id. at iii.
133 Id. (“Medium- and high-credit-risk applicants seeking loan or line of credit financing
were as likely to apply to an online lender as to a large bank (54% and 50%, respectively),
and more likely to apply to an online lender than to a small bank (41%), CDFI (5%), or credit
union (12%).”).
134 Maddie Shepherd, Average Small Business Loan Amounts, Broken Down and
Explained, FUNDERA (Jan. 27, 2021), https://www.fundera.com/business-
loans/guides/average-small-business-loan-amount [https://perma.cc/EL5Z-54SP] (noting
U.S. average small business loan is $633,000.).
135Baker & Judge, supra note 82, at 7.
136Mels de Zeeuw & Brett Barkley, Mind the Gap: Minority-Owned Small Businesses' Fi-
nancing Experiences in 2018, FED. RESERVE (2019) https://www.federalreserve.gov/publi-
cations/2019-november-consumer-community-context.htm [https://perma.cc/RCA2-55ET].
45
owners, this number drops to 45% for Black small business owners.137
In contrast, online lenders approved credit for around 85% of White-
owned small business borrowers versus 83% for Black-owned
borrowers.138 As a result, regardless of intent, it was foreseeable that
in disproportionately relying on banks, the Treasury’s particular
approach to allocating early PPP funding would also
disproportionately go to larger, whiter, small businesses. It was a
decision that albeit neutral on its face, was far from neutral in practice.
“First come, first served” also resulted in PPP grants that were often
disconnected from the level of COVID-19 infection the business’s
home area was experiencing or how tight state-based lock-down
regimes were—both presumably proxies for negative business impact.
For example, Texas companies received the largest share of any state
of initial PPP funding despite a relative lack of the virus at the time
137Id.
138 Mels de Zeeuw & Brett Barkley, Mind the Gap: Minority-Owned Small Businesses’
Financing Experiences in 2018, FED. RESERVE (2019),
https://www.federalreserve.gov/publications/2019-november-consumer-community-
context.htm [https://perma.cc/RCA2-55ET] (concluding that “that minority-owned firms—
particularly black-owned firms—experience greater challenges obtaining or accessing
financing and have potentially large, unmet financing needs”).There is a large disparity in
approval rates between White, Black and Hispanic small business loans in general. FED.
RESERVE BANK OF ATLANTA, SMALL BUSINESS CREDIT SURVEY: REPORT ON MINORITY OWNED
FIRMS, at iii-v (Dec. 2019),
https://www.fedsmallbusiness.org/medialibrary/fedsmallbusiness/files/2019/20191211-ced-
minority-owned-firms-report.pdf [https://perma.cc/7LQF-9WA7] “On average, Black- and
Hispanic-owned firm applicants received approval for smaller shares of the financing they
sought compared to White-owned small businesses that applied for financing. Larger shares
of Black- and Hispanic-owned firm applicants did not receive any of the financing they
applied for—38% and 33%, respectively—compared to 24% of Asian-owned firm applicants
and 20% of White-owned business applicants. A larger share of White-owned business
applicants received approval for all the financing they applied for: 49%, compared to 39% of
Asian-, 35% of Hispanic-, and 31% of Black-owned firm applicants.” Id. Similar issues exist
for women-owned businesses, which are less likely to be approved for business loans than
men-owned firms. FED. RRSRV. BANKS OF N.Y. & K.C., 2016 SMALL BUSINESS CREDIT
SURVEY: REPORT ON WOMEN-OWNED FIRMS 22 (Nov. 2017),
https://www.newyorkfed.org/medialibrary/media/smallbusiness/2016/SBCS-Report-
WomenOwnedFirms-2016.pdf [https://perma.cc/9K7T-RXHH].
46
and having far fewer state based lock-down restrictions.139 The
definition of ‘small business’ in the legislation was quite lenient,
allowing relatively large publicly traded companies and professional
sports teams to qualify (among the most famous were Shake Shack
and the Los Angeles Lakers).140 As firms were eventually named, a
slew of media stories began, and many firms decided to return the
money. The situation was significant enough that a joint statement by
Treasury Secretary Mnuchin and SBA Administrator Carranza noted
“the large number of companies that have appropriately reevaluated
their need for PPP loans and promptly repaid loan funds.”141 That
same release promised greater scrutiny for firms that took more than
$2 million in PPP.
After the initial round of PPP funding provided in the CARES Act
was quickly exhausted, Congress appropriated another $321 billion in
PPP funding in the Paycheck Protection Program and Health Care
Enhance Act of April 2020.142 In an apparent attempt to rectify the
139 Stephen Gandel, Paycheck Protection Program Billions Went to Large Companies and
Missed Virus Hot Spots, CBS NEWS (Apr. 20, 2020, 12:54 PM),
https://www.cbsnews.com/news/paycheck-protection-program-small-businesses-large-
companies-coroanvirus/ [https://perma.cc/Y6S9-VUKT] (explaining that barebones
application set course for disaster).
140 Sarah Hansen, Potbelly, Shake Shack, Axios: Here Are All the Companies Returning
PPP Money After Public Backlash, FORBES(Apr. 29, 2020, 11:15 AM),
https://www.forbes.com/sites/sarahhansen/2020/04/29/potbelly-shake-shack-axios-here-are-
all-the-companies-returning-ppp-money-after-public-backlash/?sh=6b229e497ea0
[https://web.archive.org/web/20200430114300/https://www.forbes.com/sites/sarahhansen/2
020/04/29/potbelly-shake-shack-axios-here-are-all-the-companies-returning-ppp-money-
after-public-backlash/#6a35ac427ea0] (noting that Shake Shack returned $10 million loan
and Los Angeles Lakers returned $4.6 million loan).
141 Press Release, Steven T. Mnuchin & Jovita Carranza, Sec’y & Adm’r, U.S. Dep’t of
Treasury, Joint Statement on Review Procedure for Paycheck Protection Program Loans (Apr.
28, 2020), https://home.treasury.gov/news/press-releases/sm991 [https://perma.cc/885A-
UCYB].
142Paycheck Protection Program and Health Care Enhance Act of April 2020, Pub. L. No.
116-139, 134 Stat. 620.
47
problems in reaching low-income and minority communities, $60
billion of that funding was set aside for small banks, credit unions
(defined as assets of under $10 billion) and community development
financial institutions (“CDFIs”) to allocate. This decision may have
reflected Congress’s belief that smaller lenders were more likely to be
the conduits to reach these communities. At about the same time, the
SBA began authorizing PPP lending by nonbank CDFIs, Fintechs, and
other nonbank small business lenders, further improving access to PPP
by the small businesses that relied on those intermediaries for credit
prior to the crisis.
Unfortunately, systems and operational issues persisted, despite
efforts to correct known problems.143 In addition, according to a
paper by three economists at the University of Texas, the inclusion of
nonbanks as lenders appears to have increased levels of potential fraud
in the program four-fold in the second round, with some estimates as
high as $69 billion total in potentially fraudulent PPP loans.144
Initial research suggests that reliance on the existing system of
financial intermediaries to distribute PPP support may have resulted
in racial bias in allocation of funding, and focusing on bank size to
ameliorate the disparity was not an effective solution. Economist
Sabrina Howell and co-authors found that Black-owned businesses
were less likely to receive PPP funding through a bank, even after
143 Ben Popken & Stephanie Ruhle, ‘Extremely Disappointing’ and ‘Entirely Predictable’
– Slowdowns and Lockouts Plague Second Round of PPP, NBC NEWS (Apr. 27, 2020, 4:31
PM), https://www.nbcnews.com/business/business-news/extremely-disappointing-entirely-
predictable-slowdowns-lockouts-plague-second-round-ppp-n1193421
[https://perma.cc/G4R4-HK9Y] (“Lockouts, login issues and sluggish systems marred the
Small Business Administration’s loan approval process, with each bank unable to submit
more than a few hundred applications.”).
144 John M. Griffin, Samuel Kruger & Prateek Mahajan, Did FinTech Lenders Facilitate
PPP Fraud, (Dec. 6, 2021), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3906395
[https://perma.cc/56AZ-HMNG] (“Overall, we find more than 1.51 million questionable
loans representing over $68.9 billion in capital.”). It would also seem likely that greater PPP
familiarity and preparation time for fraudsters was a contributing factor.
48
145
controlling for other variables using standard economic techniques.
Their study found that 8.6% of total PPP loans went to Black-owned
firms, only 3.3% and 5.3% of PPP loans originated by small and large
banks, respectively, went to Black-owned firms, compared to 6.2% at
top-4 banks, 10.6% at CDFIs and 26.5% at fintech lenders. Overall,
fintech lenders were responsible for 53.6% of PPP loans to Black-
owned firms in their sample.
According to the authors, a principal reason fintech firms were more
successful in reaching minority owned firms than smaller banks was
their level of automation.146 The study also found “suggestive
evidence that preference-based discrimination helps to explain lower
rates of lending to Black-owned businesses among smaller
conventional lenders.” which may help to explain why Congress’s
solution of prioritizing small banks did not rectify the racial disparities
in the first round of funding.147 However, as noted above, other
research suggests that fintechs had their own issues in processing PPP
145 Sabrina T. Howell, Theresa Kuchler, David Snitkof, Johannes Stroebel & Jun Wong,
Automation In Small Business Lending Can Reduce Racial Disparities: Evidence From The
Paycheck Protection Program
(Nat’l Bureau of Econ. Rsch., Working Paper No. 29364, 2022),
https://www.nber.org/system/files/working_papers/w29364/w29364.pdf
[https://perma.cc/7AFS-EB55] (noting that less than 9% of all loans went to Black-owned
businesses).
146 Id. (“We argue that varying degrees of automation across lender types help to explain
these patterns. First, we find that racial differences in loan shares across lenders align with
differences in the rates of automation…. Second, we show that after conventional lenders
automated their lending processes, their rates of lending to Black-owned businesses increased
substantially….”).
147 Id.
49
applications, as they approved significantly more potentially
fraudulent loans.148
Using existing lenders in the financial system to allocate funding
inevitably leads to favoritism towards specific subsections of the
population, and it often means favoring those who already have a leg
up. Just as with the decision to empower the Fed and Treasury,
Congress could have made different decisions in how to structure PPP,
and it could have provided more guidance to the Treasury Department
to minimize some of the disparities on display, particularly in the
allocation of the first round of PPP funding.149 There are inevitable
tradeoffs allocating assistance this way, no matter what decisions
Congress made, precisely because it was so dependent on existing
private infrastructure given the limited public alternatives. In choosing
to prioritize speed—an understandable priority under the
circumstances—Congress also set the stage for exacerbating existing
inequities in access to credit.
Just as with the decision to ask the Fed to play such a central role in
facilitating the extension of credit to businesses, the choice was among
imperfect alternatives. The scope of the banking system, and the
relationships and liquidity it possessed, at least positioned it to serve
as a plausible partner in the government’s effort to quickly distribute
a lot of fresh cash to small businesses and others that happened to
qualify.
A. The Role of Fintechs and Nonbanks
As discussed above, Fintech small business lenders were the main
source of credit for a large and highly vulnerable part of the small
148 Griffin et al., supra note 144, at 24 (noting that 858,820 potentially fraudulent loans
originated from fintech lenders).
149 Press Release, Select Subcomm. on the Coronavirus Crisis, New PPP Report Shows
Trump Administration and Big Banks Left Behind Struggling Small Businesses (Oct 16,
2020), https://coronavirus.house.gov/news/press-releases/new-ppp-report-shows-trump-
administration-and-big-banks-left-behind-struggling [https://perma.cc/5HHD-R63D]
(idenitfying three critical failures in implementing PPP in accordance with Congress’s intent).
50
business ecosystem that banks were not serving effectively.150 Unlike
banks, Fintech small business lenders were faced with an existential
crisis when the COVID-19 pandemic began. Due to their capital
markets-dependent business models, many Fintech small business
lenders were forced out of the loan market just when the liquidity they
provide was needed most.151 Many large Fintech lenders curtailed or
150 Fintech lenders include the new breed of standalone nonbank small business lenders
like FundingCircle, OnDeck, Fundation, Kabbage, BlueVine, Can Capital, StreetShares,
Lendio, and Biz2Credit, as well as more established tech companies like Square, PayPal,
Stripe, Intuit, and Amazon, which include lending as part of their service.
151 Two of the best known Fintech lenders, OnDeck and Kabbage, suspended all non-PPP
lending to new and existing customers in April 2020. OnDeck was subsequently sold to
another nonbank lender for a small percentage of its historical market capitalization, while
Kabbage was sold to American Express, a bank. See Murray, supra note 86; Lea Nonninger,
Kabbage Discontinues Lending Operations amid the Coronavirus Pandemic, BUS. INSIDER
(Apr. 6, 2020), https://www.businessinsider.com/kabbage-pauses-lending-suspends-existing-
credit-lines-2020-4 [https://perma.cc/C9PF-SYPJ] (noting that Kabbage did not give
borrowers notice before cutting off credit).For examples of the instability of capital markets
funding for Fintech lenders, see Lawrence Delevingne, Exclusive: Eyeing Defaults, U.S.
Direct Lender Colchis Capital to Shut Funds, REUTERS (Apr. 7, 2020),
https://www.reuters.com/article/us-health-coronavirus-colchiscapital-exc/exclusive-eyeing-
defaults-us-direct-lender-colchis-capital-to-shut-funds-idUSKBN21P21X
[https://perma.cc/W8KT-CUHN] (explaining decision to shut funds was based on high risk
and uncertainty about future economic recovery); Diana Asatryan, Kabbage Bond Tumbles to
Pennies, as the Rest of SMB Is ‘On Hold’, DEBTWIRE (Apr. 2, 2020); Payne Lubbers &
Jennifer Surane, Online Lenders Fizzling in Crisis with On Deck Agreeing to Sale,
BLOOMBERG (July 29, 2020, 10:17 AM), https://www.bloomberg.com/news/articles/2020-07-
29/online-lenders-fizzling-in-crisis-with-on-deck-agreeing-to-sale
[https://web.archive.org/web/20200730115720/https://www.bloomberg.com/news/articles/2
020-07-29/online-lenders-fizzling-in-crisis-with-on-deck-agreeing-to-sale] (“On Deck
Capital Inc. said late Tuesday it had agreed to sell itself for $90 million, almost six years after
an initial public offering that valued the online small business lender at $1.85 billion.”).
See also Todd H. Baker, Marketplace Lenders Are a Systemic Risk, AM. BANKER (Aug. 17,
2015, 9:30 AM), https://www.americanbanker.com/opinion/marketplace-lenders-are-a-
systemic-risk (noting that MPL “can’t slow down lending and slash operating costs to stay
afloat while collecting cash from existing loans”); Todd H. Baker, OK, Marketplace Lenders,
I’ll Say It: Told You So, AM. BANKER (May 4, 2016, 2:37 PM),
https://www.americanbanker.com/opinion/ok-marketplace-lenders-ill-say-it-told-you-
so(“[L]iquidity is everything, institutional money can’t be relied on, expenses are harder to
51
ceased lending entirely as their ABS were downgraded and funding
costs rose precipitously.152 In the early stages of the crisis, as a recent
paper by Ben-David, Johnson and Stulz showed,153 the pandemic
“led to a sharp contraction in fintech lending to small businesses
around the onset of the crisis. Digital lending in the second quarter of
2020 declined by 75% relative to its $16 billion level in the fourth
quarter of 2019,” and “out of 16 small business fintech lenders
originating loans before the COVID-19 shock in 2020, only six were
still originating loans in the third quarter of 2020.” Strikingly, by
contrast, their analysis found “no evidence of an equivalent collapse
in bank loans to small businesses during the same period.”154
This raises important questions about the implications of the
decisions by the Fed and Treasury (in the context of TALF and the
first round of the PPP, respectively) to take actions that effectively
limited their capacity to provide fresh liquidity to Fintechs that
specialized in small business lending. There are some practical
explanations, but whether those suffice or how informed policy
makers were about the myriad consequences that were likely to flow
cut than add, high rates of loan growth aren’t sustainable and a business model based on
volatile gain on sale margins is inherently unstable.”).
152 Robert Armstrong, Online Lender Stops Making Loans to Small US Businesses, FIN.
TIMES (Apr. 1, 2020), https://www.ft.com/content/c31a20cf-cb17-4958-9454-73763302b5dc
(“We securitise our receivables and we are on the hook for loan performance, which is
suffering because of delinquencies, because our customers have no revenue, because they are
closed…”); Kroll Bond Rating Agency, 10 U.S. Small Business ABS Deals on Watch
Downgrade Due to COVID-19 Concerns, (Mar. 30, 2020.
https://www.krollbondratings.com/documents/report/32339/abs-u-s-small-business-abs-
watch-downgrade-surveillance-report.
153 Itzhak Ben-David, Mark J. Johnson & René M. Stulz, Why Did Small Business Fintech
Lending Dry Up During March 2020?, (Fisher Coll. of Bus., Working Paper No. 2021-03-
014, 2021), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3910549
[https://perma.cc/B4NN-JVZ5]. The authors showed that “the drying up of the loan supply is
most consistent with fintech lenders becoming financially constrained and losing their ability
to fund new loans.”
154 Id.
52
from those decisions, remains unclear. For example, with respect to
PPP, assuming that the decision had already been made to require
certification of bank-level anti-money laundering compliance for
nonbank lenders included in the PPP, those lenders might not have
been prepared to participate directly in the first round in any event.
Many of the Fintech small business lenders that survived the early
stage of the pandemic did so largely by virtue of helping, directly or
indirectly, in the distribution of the PPP funds by banks without acting
as approved lenders or otherwise taking on the primary anti-money
laundering compliance role.155 The speed and simplicity of Fintech
lenders’ processes were, at least theoretically, an advantage relative to
the often more bureaucratic loan origination practices of banks,
helping to explain why so many Fintechs found ways to work with
banks, by generating leads or providing loan origination and tracking
software to allow banks that had previously used manual processes to
convert to digital origination and tracking in the PPP, rather than going
it alone.156
155 The CARES Act permits “other lenders” to become licensed to make 100% guaranteed
PPP SBA loans. CARES Act, Pub. L. No. 116-136 § 1109(b), 134 Stat. 281, 305. The Interim
Final Rule sets out the terms and conditions on which such lenders may participate in the PPP
program. Bus. Loan Program Temp. Changes; Paycheck Prot. Program, 85 Fed. Reg. 20811-
817 (Apr. 15, 2020) (codified at 12 C.F.R. pt. 120).
156 In fact, many banks relied on Fintechs for the software used to process PPP loans.
Darren Hecht, How Independent and Community Banks Used Fintech to Tackle PPP, INDEP.
BANKER (July 8, 2021), https://independentbanker.org/2021/07/how-independent-and-
community-banks-used-fintech-to-tackle-ppp/ [https://perma.cc/89Z4-FXQY] (describing
how this approach strengthened relationships with clients); Loraine Lawson, Lessons
Learned: PPP Spurs New Automations and Fintech Partnerships, BANK AUTOMATION NEWS
(June 7, 2021), https://bankautomationnews.com/allposts/retail/lessons-learned-ppp-spurs-
new-automations-and-fintech-partnerships/ (last visited Feb. 20, 2022); Press Release,
Fintech Companies, Lendsmart and Griffin Technologies, Partner to Improve SBA PPP Loan
Process (May 20, 2020), https://lendsmart.ai/fintech-companies-lendsmart-and-griffin-
technologies-partner-to-improve-sba-ppp-loan-process/ [https://perma.cc/CFA2-CRP8]
(explaining how technology helps banks process loans). A significant portion of the PPP loans
made by small and mid-sized banks were sourced by FinTechs. According to the House Select
Committee on the Coronavirus Crisis, a Fintech called Womply worked with seventeen
lenders to process 1.4 million or more PPP loans. Press Release, Select Subcomm. on
Coronavirus Crisis, Select Subcommittee Expands Investigation into Role of FinTech
53
Whatever the reasons, the government’s initial crisis response did
little to support these nonbank lenders, creating a risk not only to them
but to the many small businesses that relied on them for funding. This
is a classic quandary when important financial activity moves outside
the perimeter of banks and other prudentially regulated institutions.
Usually, migration outside this space—whether by Fintechs, money
market funds or open-end bond funds—brings lower regulatory costs
and other flexibility. This can lead to rapid growth accompanied by
reliance on mechanisms that were, by design, not resilient to shocks
and not regulated in the way needed to ensure resilience. Providing
support can allow the fragility to persist, but can also be key to protect
the real economy actors that rely on the fragile intermediaries.
Although there are no easy or right answers to these quandries, the
numerous places where this type of interplay is at work highlights the
need to better understand and address these challenges before crisis
strikes.
Ultimately, the Fed and Treasury did provide some short-term
assistance to Fintech and other nonbank small business lenders. While
they left the TALF unchanged, late in the first round of the PPP, the
Treasury, the Fed, and the SBA took action to include Fintechs and
other nontraditional lenders like CDFIs with direct access both to the
PPP and the related Paycheck Protection Program Liquidity Facility
(“PPPLF”). However, Fintech and other nonbank lenders remained
subject to various specific application requirements and other
conditions (principally related to the Bank Secrecy Act and anti-
Industry in PPP Fraud (Nov. 23, 2021), https://coronavirus.house.gov/news/press-
releases/select-subcommittee-expands-investigation-role-fintech-industry-ppp-fraud
[https://perma.cc/PXA2-3SJJ] (summarizing reasons for expansion of investigation into
Fintech’s “facilitation of fraud”). While Fintech lenders had the same incentives as banks to
facilitate PPP loans to their existing customers as a means of reducing potential defaults, they
also had significant financial incentives to make PPP loans to new customers. This is because
as monoline lenders become unable to fund traditional loans and lack other revenue sources,
they need the revenue from PPP lending to “keep the lights on” in their origination operations
until conditions improve.
54
money laundering compliance)157 that continued to delay and limit
their participation relative to banks.158
When Fintechs and other nonbanks were authorized to participate
directly in the PPP at the end of the first phase, they began to reap a
larger benefit from the program. research conducted by the Federal
Reserve Bank of New York shows that Fintechs made less than 2% of
PPP loans by dollar amount and less than 4% by number (reflecting
lower average loan sizes) in the first phase of the PPP, with large and
small banks making almost all the rest. As Fintechs and nonbanks
became eligible PPP lenders, their share of PPP lending by both
amount and number quintupled.159 Nonetheless, the fees provided
directly under the PPP and in partnerships with banks may well have
been played a critical role helping many Fintechs remain viable until
conditions improved.
157 Binoy Dharia & Graham Silnicki, Paycheck Protection Program: Participation by
Non-Bank Lenders, WHITE & CASE (Apr. 13, 2020),
https://www.whitecase.com/publications/alert/paycheck-protection-program-participation-
non-bank-lenders [https://perma.cc/QP9B-DJMQ] (announcing interim rule expanding group
of financial institutions permitted to act as lenders under PPP).
158 See, e.g., U.S. Small Bus. Admin., supra note 89 (explaining how to apply for loan
forgiveness); Press Release, Fed. Rsrv. Bd., Federal Reserve Takes Additional Actions to
Provide up to $2.3 Trillion in Loans to Support the Economy (Apr. 9, 2020),
https://www.federalreserve.gov/newsevents/pressreleases/monetary20200409a.htm
[https://perma.cc/HE3M-HXJ6]. Under the PPPLF, established April 9, 2020, the Fed will
extend credit to eligible financial institutions that originate PPP loans, taking the loans as
collateral at face value. While banks are included in the PPPLF at commencement, the Fed’s
release indicates that it is working to include other lenders originating PPP loans “in the near
future.”
159 Jessica Battisto, Nathan Godin, Claire Kramer Mills & Asani Sarkar, Who Received
PPP Loans by Fintech Lenders, FED. RSRV. BANK OF N.Y.: LIBERTY ST. ECON. (May 27,
2021),
https://libertystreeteconomics.newyorkfed.org/2021/05/who-received-ppp-loans-by-fintech-
lenders/ [https://perma.cc/HD64-2N7H] (breaking down which demographics received loans
from fintech companies).
55
The researchers at the New York Fed also found that fintechs played
a critical role getting PPP funds to Black-owned small businesses:
Applicants who approached Fintech lenders for PPP loans
were more likely to lack banking relationships, be minority
owned, and have fewer employees. Moreover, a higher
share of applications by Black-owned businesses were
approved by Fintech lenders as compared to firms with
white, Asian, or Hispanic owners. Since Black owners were
approved for loans by fintech lenders at a higher rate even
before the pandemic, our results suggest that historical
factors that prevent Black owners from receiving bank
credit continued to operate with the PPP.160
Finally, fintech loans appeared to be correlated more closely than
bank loans with areas of particular pandemic need, as measured by
death rates. Other research published by the New York Fed
corroborates this.161 For example, in New York, during the first round
of PPP, fintech lenders’ shares of small loans were almost twice as
large in the counties with the highest death rates as compared to
counties with the lowest death rates. By comparison, bank loan shares
were statistically uncorrelated with death rates during the first round
of PPP funding. In subsequent rounds of PPP, loans of all lenders had
a similar correlation with death rates.162
IV. SOME IMPLICATIONS FOR POLICY
This is a complex story where stated goals did not align with routes
taken. Policy makers in Congress, Fed Chair Powell, and senior
160 Id.
161 Jessica Battisto, Nathan Godin, Claire Kramer Mills, and Asani Sarkar, Who Benefited
from PPP Loans by Fintech Lenders?, May 27, 2021,
https://libertystreeteconomics.newyorkfed.org/2021/05/who-benefited-from-ppp-loans-by-
fintech-lenders/
162 Id.
56
Administration officials suggest an acute and distinct interest in the
health of smaller enterprises. And much money did flow from the
federal government into these businesses. Nonetheless, when the
different pieces of government support are put together, the overall
picture that emerges is one that tilted the scales in the opposite
direction, favoring larger businesses.
The decision to rely on lending facilities established by the Fed
under its 13(3) authority, while neutral on its face, had the effect of
doing far more to facilitate funding for the largest businesses relative
to mid-sized and smaller ones. Similarly, the Treasury Department’s
decision to favor banks over fintechs in the early stages of PPP
implementation resulted in more funds going to larger, more
established, and whiter qualifying businesses.
These actions have ramifications both for this recession and when
the next shock or severe cyclical recession hits. As a starting point,
this highlights the need for ongoing awareness, engagement and
discussion around the nature of the public and private credit
intermediation infrastructure in place. Although the perceived lack of
better alternatives may help explain Congress’s decision to rely so
heavily on the Fed in its efforts to support businesses, that decision
was far from neutral in its allocational impact. Similar dynamicsm are
at play around the decision by Treasury to rely, initially at least, on
banks as the primary conduits for PPP funds.
Another key contribution is to highlight the difference between the
funds that flow from the government to businesses and the extent of
government support provided for a domain. When interventions
change the viability of intermediaries or alter expectations of future
support, they can have long-term ramifications far in excess of the
amount of actual support provided. This was true in 2008, and was a
primary defense for interventions that helped stave off the failure of
key financial instituitons. This was also a key reason for the many
reforms aimed at eliminating too-big-to-fail subsidies. And it was true
again—although far less discussed, and in slightly different forms—
in 2020.
57
A lot of money flowed into small businesses, but the nature of the
PPP program did little to incent banks or nonbanks to find new and
better ways to underwrite loans to small businesses. Nor is there much
sign that the Main Street Lending Facility incentivized investments in
credit intermediation infrastructure designed to help the mid-sized
businesses that qualified for the program.
By contrast, the Fed’s purchases of corporate bonds in ways that
stabilized open-end bond funds and ETFs holding bonds and its
purchases of collateralized assets in ways that may have aided the
functioning of the CLO market are precisely the types of interventions
that can fundamentally alter market expectations, adding grease to the
already well-oiled machine for extending credit to the country’s
largest companies. That so many large companies issued so much new
debt in the wake of these interventions, while so many small business
owners report ongoing problems accessing credit, is a testament to this
disparaity.
Having created an expectation of support, the Fed may well feel
compelled to support bond markets and investors yet again, rolling out
the array of facilities created in 2008 and re-deployed in 2020.
Whether this happens with specific congressional authority of the kind
provided in the CARES Act or without, as was the case for many of
the programs in the 2008 financial crisis and even in 2020 prior to the
enactment of the CARES Act, the structures the Fed uses and the
financial infrastructure the country is operating with will play key
roles in shaping who benefits the most from government intervention.
A. The Persistent and Evolving Challenge of Smalll Business
Financing
This essay also informs, although by no means seeks to resolve, the
current debate regarding the appropriate role and regulation of
nonbank fintechs in credit creation. Fintechs burst onto the scene in
between these 2008 and 2020, and may well continue to play a
58
growing role in the extension of credit to small business. This raises a
host of issues. As this essay reflects, a key challenge to policy
formulation in this area is the role that Fintech lenders increasingly
play in providing credit to small businesses. There are also signs that
the role of Fintech lenders may be especially salient to very small
minority and women-owned businesses, whose viability may be of
particular importance given persistent structural inequities. Despite
this, the extent to which growing Fintech lending volumes can be
explained by lower regulatory burdens, different business models,
historically low interest rates, or other factors has not been adequately
examined by policy makers or academics.
Absent meaningful reform, many of today’s Fintechs are poorly
situated to weather a severe cyclical downturn. Without the significant
and multi-faceted, although inconsistent, government support
provided during the pandemic, far more Fintechs may well have failed.
As the pandemic revealed, most Fintechs rely on wholesale funding
that dries up quickly during periods of distress. This liquidity problem
will likely be even more acute in a more traditional, longer lasting
cyclical credit downturn where loan performance and economic
activity remained depressed for a lengthy period. This stands in stark
contrast to banks that, because of a different business model and far
more rigorous regulation, are better (even if far from perfectly)
situated to make loans through the business cycle.
Now that the acute phase of the COVID-19 crisis has past, policy
makers should seek to understand and address the challenges that arise
from allowing fragile, capital-market dependent lenders to play such
a significant role in the provision of credit to small businesses.163
There can be little question that allowing a large portion of lending to
a critical area of the economy to be provided by companies (a) beyond
163 This is just one aspect of a larger problem involving the resiliency of capital markets in
the face of major crises. Commercial paper, Fed funds, and mortgage and other markets also
struggled to function effectively, requiring intervention from the Fed and Treasury.
59
direct federal regulation and (b) doing business in an inherently fragile
and procyclical manner creates structural risks.
Looking ahead, one implication is the desirability of potentially
doing more to facilitate ongoing credit creation for small businesses
in peacetime, particularly those that have traditionally had a harder
time accessing financing. There are a number of possibilities for
dealing with this issue, and the best path forward may well include
some mix of these approaches. One possibility would be to encourage
banks to make further investments in their ability and willingness to
lend to small businesses, including those that traditionally have had a
harder time accessing credit. If banks build out the infrastructure and
develop the relationships needed to make these loans, this could
enhance credit access during good times and reduce the likelihood that
economic shocks will overly contract credit creation for these
businesses. The role banks, credit unions, and CDFIs can play could
be assisted by their information advantages, knowing their customers
and their communities.164 This type of relationship lending model has
faced structural challenges given the rise of lending commoditization
aided by enhancements in capital markets and computing power,
which have driven down costs for certain types of loans that ‘fit the
standard box,’ while making loans to entities that do not fit the box
relatively more expensive for lenders, borrowers, and investors.
How best to facilitate deeper engagement by banks with
underserved small businesses depends on understanding the frictions
currently inhibiting robust extensions of credit by banks to these
businesses. Given the risks and costs of such credit creation, and the
164 Congress has already taken some steps in this direction. Legislation signed into law in
December 2020 included $12 billion set-aside for CDFIs and Minority Depository Institutions
(“MDIs”). Consolidated Approriations Act, 2021, Pub. L. No. 116-260 ( 2020). Specifically,
the law included a $9 billion Emergency Capital Investment Program, administered by the
Treasury, to provide low-cost, long-term capital investments to MDIs and CDFIs that are
depository institutions, with special set-asides for the smallest institutions. Id. In addition, $3
billion was appropriated to provide grants and other financial and technical assistance to
CDFIs, including CDFI loan funds that serve consumers, small businesses and nonprofits in
their communities. Id.
60
positive social benefits of such lending, the government may well have
a role to play. Regulation can and does incentivize financial
institutions’ lending patterns, including creating hurdles to non-
standard or ‘traditional box’ loans. The way the government supports
housing finance by supporting the securitization of certain home loans
may well serve as a model here too, though it may be appropriate for
the government to take on even more risk—in a calculated fashion—
than it often does with housing.
A related approach would be for the government to do more to
expand the nonbank, non-Fintech mechanisms of getting funding to
small businesses. A key public institution right now, is the SBA, which
proved vital but also deeply flawed and limited during the pandemic.
A key set of institutions are CDFIs, many of which are specifically
focused on serving under-served populations, and the unfortunately
dwindling number of minority-owned depository institutions. By
enhancing these mechanisms alongside enhancing the ability of banks
to serve small businesses, the government would be better positioned
to credibly warn Fintechs that they are unlikely to be utilized in the
same way the next time a crisis strikes, increasing their vulnerability.
Given that a lot of money can be made in good times, particularly
when differential regulatory schemes make it cheaper to be a Fintech
than a bank engaging in similar activities, another question is whether
Fintechs should be regulated in a manner more akin to banks,
including some mix of oversight, capital regulation and liquidity
regulation.165 The aim need not be perfect uniformity, but ensuring
that any set of lenders that are providing capital to businesses (or
households) in sufficient amounts are able to continue to make such
loans when conditions soften. As things now stand, even shocks far
smaller than March 2020 could lead to meaningful disruptions in
credit creation—harming not only the Fintechs who chose to be
exposed to such risks but also their clients, who may not be aware of
the risks they are indirectly taking in choosing to rely on a nonbank
165 This same argument could be made about other areas of financial markets, such as
money-market mutual funds, that have repeatedly required government assistance in crises.
61
lender. Important but beyond our scope, is the question of whether this
is best achieved by compelling Fintechs to become banks, allowing
them to do so, or creating an alternative regulatory scheme with some
but not all of the features long associated with bank regulation.
Yet another option would be for Congress to institutionalize direct
or indirect recession lending (e.g., through SBA/CDFI subsidies) by
other lenders like CDFIs focused on the populations heavily served by
Fintechs, and leave the Fintechs to their fate. Finally, the government
could commit to provide ongoing liquidity support to Fintechs in a
recession, to allow them to continue to serve their customers by
revising programs like the TALF, to support private small business
lending and securitization funding. This would assist credit creation
without the concomitant oversight and responsibilities that
comprehensive supervision and capital and liquidity rules bring to
regulated banking.
Any solution to the Fintech liquidity problem needs to take into
account the large populations of small businesses that banks don’t
serve today, particularly small minority and women-owned
businesses. Comprehensive supervision, “Fair lending”-type anti-
discrimination legislation, and programs like the Community
Reinvestment Act have—so far at least—failed to sufficiently change
this dynamic or extend the reach of banks into those populations.
Exempting classes of insured deposit lenders from the Community
Reinvestment Act, such as what was done for credit unions, has
arguably made the situation worse. Unless structural changes to assure
small business lending liquidity in crises also deal with inadequate
peace time access to funding for underserved enterprises, any solution
will be incomplete.
B. Fragility, Funding and the Largest Businesses
Shifting to large companies, open-end bond funds may be the most
vivid example of an inherently vulnerable product propped up by the
62
Fed’s pandemic interventions. Corporate bonds are not, and have
never been, anywhere near as liquid as equity instruments. Yet,
corporate bond funds promise investors daily liquidity. Adding to the
challenge, the price that investors in open-end bond funds receive for
their shares is also determined by a daily net asset value, a pro rata
share of the estimated value of the bonds held by the fund on the day
of redemption without taking into account the cost of liquidating those
bonds. This structure works fine in normal conditions, as investors are
often entering as well as exiting, and bond funds often hold sufficient
Treasury instruments to cover short-term demands for liquidity. But
as March 2020 illustrated vividly, once liquidity becomes strained,
this structure encourages investors to run for the exit—regardless of
their need for liquidity—by allowing those who exit to impose the cost
of liquidation, and corresponding losses, onto the investors who
remain.
The classic problem of promising short-term liquidity in long-term
less liquid investments is nothing new. Money market mutual funds,
corporate bond funds, and bank deposits are all subject to similar runs.
After the Great Depression, the government largely solved bank
deposit runs through a combination of federal deposit insurance and
substantial regulation. After the financial crisis of 2008, structural
changes to money market mutual funds were supposed to have solved
this problem. As then SEC Chair Mary Jo White stated in 2014:
“Today’s reforms . . . will reduce the risk of runs in money market
funds and . . . make our markets more resilient and enhance
transparency and fairness of these products for America’s
investors.”166 These reforms failed their initial test in the Covid-19
crisis. Whether any such reforms are made to corporate bond funds or
bond ETFs remains to be seen, despite the importance of the fragilities
revealed. As then Brookings scholar and current Treasury Under
166 Press Release, Sec.’s & Exch. Comm’n, SEC Adopts Money Market. Fund Reform
Rules: Rules Provide Structural and Operational Reform to Address Run Risks in Money
Market Funds (July 23, 2014), https://www.sec.gov/news/press-release/2014-143
[https://perma.cc/66YY-B5BF].
63
Secretary for Domestic Finance Nellie Lang remarked in October
2020,
[T]he success to date of the Fed’s corporate bond program to
calm the markets does not suggest that reforms are not needed.
Instead, the reforms are even more critical, since the Fed’s
actions likely raised expectations of such interventions in the
future. It is important that the Fed, through financial reforms or
clarifying its own intent for future emergency actions, reduce
any perception by private entities that they would not have to
bear the costs of their own risk-taking.167
Time will tell whether this wisdom is heeded.
There are an array of tools that could help mitigate these first-mover
advantages,168 and it is beyond our purview to evaluate the right mix.
But the analysis here does highlight that such interventions could be
helpful for a number of related reasons. In addition to addressing a
potential threat to stability, such efforts may be particularly warranted
to counteract the impact of the Fed’s actions during the pandemic.
Even when the Fed should intervene to stop the spread of dysfunction,
that it needed to do so is often a flag of a need of further reforms. When
these two are decoupled, interventions can perpetuate the expectation
of further support and accentuate the fragility already embedded in a
market. Moreover, given the ongoing growth of the bond market,
addressing the ways ETFs and open-end bond funds create
expectations of liquidity in markets where it may not exist could help
slow that growth.
167 Nellie Liang, Corporate Bond Market Dysfunction During COVID-19 and Lessons
from the Fed’s Response, BROOKINGS INST. (Oct 1, 2020),
https://www.brookings.edu/research/corporate-bond-market-dysfunction-during-covid-19-
and-lessons-from-the-feds-response/ [https://perma.cc/N2KC-JK45].
168 Hubbard et al., supra note 46.
64
CONCLUSION
The breadth and swiftness of the government’s response to the
COVID-19 crisis in 2020 is a testament to the capacity of policy
makers to act quickly and decisively.The economic recovery from the
pandemic has been rapid, particularly when compared with the rest of
the world who largely suffered a similar shock. Providing meaningful
support to virtually all Americans and increasing the payments made
to those who had lost their jobs proved to be not only the right thing
to do, but also the wise thing to do. Putting money into the hands of
people who needed to spend it promoted economic activity even as
people were scared, anxious, and leaving their homes far less
frequently. It also played a powerful, even if indirect, role in
alleviating strains in the financial system. Putting money in the hands
of people and businesses enhanced their ability to pay back existing
obligations, reducing the losses that banks and other creditors had to
absorb. And the full panoply of government support ensured that the
economy was positioned to grow as the acute phase of the pandemic
subsided.
Yet alongside reflecting on the many lessons learned from previous
periods of systemic distress, the pandemic has its own lessons to teach.
Taking a step back to consider not only what worked and how, but
also the challenges faced and the collateral consequences of the
actions taken, is key to ensuring that policy makers—and the tools
available to them—are ready when the next crisis hits. America’s
financial infrastructure constrained the rapidity and effectiveness of
our policy responses. It led to an uneven set of beneficiaries among
individuals, families, and businesses big and small. Times of crisis
require rapid response, inherently leaning on existing infrastructure.
As our economic response increasingly relies on financial institutions
and structures, the constraints of the institutions and structures will
shape the options available for response as well as the efficacy of
policies chosen. This is why non-crises times are when greater thought
and attention are required to improve our financial infrastructure.
65
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