Jeremy Stein on the Fed-Treasury Credit Programs

Well, good afternoon, everybody and welcome to "Dimensional's Thought Leader Series." I'm Mark Gochnour, Head of Global Client Services, and we're very fortunate today to be joined by Jeremy Stein, professor from Harvard. I'll give you some more background about Professor Stein here in just a moment. But I do wanna highlight a couple things as part of the "Thought Leader Series." Last week we had Professor Edward Lazear and we have some questions about his recording, so I just want everyone to know that is available on our website, MyDimensional, and it's also set up to be able to forward to your different constituents, so I wanted to make sure you're aware of that. And then also be sure to get on your calendar for next Tuesday, we will have Robert Novy-Marx back in the studio doing a deeper dive around profitability research, looking at the quality of different companies. And the following Tuesday on the 23rd, we'll have Margaret DiMaggio, who's also a professor from Harvard, talk a little bit about what we're seeing in spending habits and patterns right now within the COVID crisis is well as sharing some of his research he's done around microstructure and a recent paper on trading that he's just released. Okay, so a couple of housekeeping items here before we get into it, I just wanna highlight everybody. Now, it is going to be available for continuing education, and I always say we're very familiar with the drill now. We are required to ask you four questions from the CE board just to make sure you're listening. So when those pop up, just hit in here Enter, enter Yes, and hit Submit. We are getting some feedback, sometimes when you're in full screen mode you don't see those questions. So if you hear a little bell ring that's your notice there maybe to exit full screen mode, complete the question and go back to full screen. If you don't need CE just kinda click it off and ignore it, so appreciate you understanding that one. And then the last thing I wanna mention here is the slides we'll be using today are available for download. Just go to the bottom part of your player there and look on the Event Resources tab, and you'll be able to download the slides and follow along that way. Okay, so let's get into it here, as I mentioned, it is a real pleasure to have Professor Jeremy Stein join us. He leads the Economics Department at Harvard, and also, he was a member of the Board of Governors for the Fed starting in May 2012 through 2014. So needless to say, he's got some serious expertise that he can bring to the table. He's had a real impact on helping design regulations, as well as, shaping some monetary policy, so a lot of good stuff to get in into here today, and with that, I'm gonna welcome Professor, thank you for joining us here today. It's great to have you. Mark, it's great to be here. Thanks very much for having me. And you know, I was just thinking , if we're getting into this, you're the first professor from Harvard that we've had on the show here, so we're starting with the biggest bang possible. I'll take it as a good thing. Thanks. All righty. Now, I think the connection into our webcast today actually was Ken French. You guys taught together at MIT I believe, and you've arranged . We were in collage together for a number of years at MIT in the Sloan school, in business school there, yeah. All right, so at some time I'll get some good stories about Ken from back in the day. I have some stories, yeah. Perhaps some about you, as well, I think during that. Okay, before we get into it here, and I probably should just tell the audience our plan originally and still is , is to present some of the work you've done, just around the Fed and the Treasury, and some of the credit programs in place, and then we'll open up with some general questions. But I have to say, it's not every day we get to talk to a governor from the Fed, I would love to hear that experience and kind of what's a day in the life as a governor, what are all the things you did for those couple years? Well, I say first of all, isn't it sort of an amazing and fascinating experience for me. I'd spent a lot of my career working on these sorts of issues to have an opportunity to actually be involved in the decision making was great. Maybe what's a little different than I would have expected and that maybe most people's image would be, you know, everybody thinks of the Fed in terms of monetary policy. And of course, you spent, I would say, I probably spent about a third of my time, you know, if we have a meeting, there's a monetary policy meeting every six weeks, and the two weeks around that are very taken up with monetary policy. But a big, big part of the job is on other things that the Fed does. In my case, I was on one of the committees that was involved in bank regulation, so that was also a big part of the job. Another thing that was sort of surprising to me is that monetary policy itself, you know, as an academic, you think a lot about macroeconomic theory and macroeconomic evidence. Inside the Feds so much of it is around communication. And as people in markets know about changing the statement, when we take this comma out, do we take the word patient out of the statement, and there were just hours and hours of debates around that. And that's really much more of a black art or anything than a science, so being involved in that was kind of interesting about everything. Well, I suspect there's quite a bit of presentations that are involved too, were you getting this constantly request to go out there and speak at different groups and entities? Yeah, you get a fair amount, and I would say I ended up doing one sort of every cycle, so one every six to eight weeks, something like that you could do more. It's hard to do more and say something sort of different and substantive each time if you do more than that. So something that different people sort of pick their pace, and you know, I think doing one every six to eight weeks is sort of typical. Obviously, if you're the chair you have to speak more and you have to do the press conferences, which are all sort of other capital efficient is that people actually listening to you, so that's you know, that a little most of it. All right well, we got a group ready to listen to you here today. Now for sure, why don't we start out and get into some of your slides here and thinking about, we say that the Fed Treasury and those credit programs and I'd love to get your thoughts in terms of, I know there's a lot out there, you're gonna highlight a few and your thoughts around how well they're working in this current environment, so I will turn you loose on this. Okay, well, thanks so much. Thanks again, Mark. Thanks for having me. So what I thought I would try to do is, I guess as you were just saying, Mark, is speak to some of the Fed Treasury programs that have been rolled out in the last several weeks. And a little bit more specifically, there's a whole range of them. I'm gonna speak to two categories and these are the ones that are aimed at large and medium sized firms specifically. So for the large firms there's something called the Primary Market Credit Funding Facility, PMCCF. This is essentially something that is, it's a vehicle that's been set up to buy bonds from investment grade firms. So these are very large investment grade firms, they can issue bonds and the Fed will basically buy those if need. And then the second is a suite of facilities that's aimed at essentially mid-sized firms, and that's been going by the name of the Main Street facility. So I'll try and talk basically about those two and highlight what I think some of the challenges are in the design of both of those. So Mark, if you can flip to the next. So there's a question and I think the first question you have to ask is, why is the government in the business of supporting firms? And obviously, the answer that can give is gonna have some implications for the design. Now obviously, COVID, you know, the COVID pandemic is an enormous shock, you can think of it as both a shock to supply into demand. In either case we've had, you know, it's just sort of staggering unemployment numbers, shutdown with large parts of the economy. In light of that, I think it's pretty clear why we have things like unemployment, if you sort of divide the world very simply into labor and capital, into workers and firms more or less, I think it's pretty clear, economic theory is pretty clear that you need to essentially insure workers for this sort of unexpected loss of income. And there, it's not about borrowing or lending, it's more or less you just have to give them grant, so it has to be a large expansion of the social safety net. So that can take place in one of two ways; you can have essentially unemployment insurance, or there's something known as the PPP or Paycheck Protection Program, where small firms can borrow but that borrowing is forgiven, it converts to a cash grant if it's spent on payroll. So effectively, in these cases the government is more or less paying workers to make up for the loss income. So that is I think we can debate the magnitudes and sort of some of the incentive effects, but that basic role of the government is, it's pretty well understood. What you should do to support capital as opposed to labor is a little bit less clear cut and to some extent here, we're winging it. Unemployment insurance obviously have been used in past recessions, we're doing it more aggressively, but we're building on something we know how to do, what we're doing for firms less clear cut. So if we can turn to the next slide, I think to some extent the design of these programs, one way to think about them as well, we did some stuff last time around. And let's try and do kind of some of what we did last time. So if you'll recall last time around, the Fed sometimes on its own and sometimes in collaboration with the Treasury was very involved in essentially supporting the banking sector, supporting other parts of the economy. And what they were doing, and I'm gonna caricature it a little bit, can be thought of as a sort of an a turbo version of a classic role of the Federal Reserve or other central banks which is called the Lender-of-Last Resort. And I'm quoting something called Bagehot's rule up here, so Bagehot was a British writer from the 1800s who wrote about the Bank of England, and what Bagehot basically said is the role of a central bank in a situation like this is to lend freely to solvent firms against good collateral at a penalty rate. So the basic idea is you're trying to solve what you might think of as a liquidity problem, but not a solvency problem. So really the kinda classic case for government intervention and government lending is something that looks like a bank run. You Know think of Jimmy Stewart, whatever back in that the 1930s, there's a run on a bank, okay? Underneath it all we have a bank that if people stopped running would be solvent, but it's got a liquidity problem. And the idea is that in that case, that the central bank lends, you break the back of the bank run, and then you're left with sort of the no run outcome, the bank and the underlying loans are solvent and people can pay back, okay? And that's what gets you in this idea that you lend, but you lend with the expectation that if you do lend, you'll get to a good outcome and you can expect to be paid back, okay? So again, you're thinking of, I'm gonna lend to solvent firms, they're gonna give you enough collateral that I'm sure I'm gonna get paid back, and in fact, I'm gonna get paid at a sort of adequate interest rate, okay? And that has been historically the classic argument for government intervention in a lending mode. And again, this is way too superficial and way too simple, but if you look at least in hindsight and what happened in 2008-2009, you can say, "Yeah, that was kind of what happened." We had a good bit of luck, but after the fact, the government's lending, so TARP is the Troubled Asset Program that was the Treasury Fed programs basically, they essentially got repaid back. So they put an enormous amount of money out on the table to banks and to others, and essentially, the banks paid them back. Okay now, obviously, there was a little bit of luck involved, but ex post with the benefit of hindsight, it looks like it was largely a liquidity crisis, and it wasn't really, thanks to some other policies, it wasn't fundamentally the solvency problem, okay? So the question is now when we go to design policies this time, to what extent should we be relying on reporting the same kind of Lender-of-Last Resort logic? Hey, Jeremy. And the Treasury Secretary, I'm sorry, was there a question ? Oh, sorry, I was just gonna ask you a question there. As you go back to '08 and '09 during that time period 'cause I think you were working with Treasury during that time, weren't you with them, Yes. that must have been a pretty intense time. Tell us a little bit about that experience as you highlight some of that. What happened there? That was an extremely intense time, and I said, I was sort of rushing over it a little bit, because in hindsight, everything got paid back and it looked a little bit like sort of a liquidity issue. I should say in fairness it didn't feel like that and many points sort of in the heat of it. So in particular, many of you will remember the insurance company AIG which at one point owed the government something like 170 billion dollars. Now again, hindsight, everything kind of worked out, AIG paid back its entire loan. I remember there were days, there were scary days when it looked like we were not gonna recover quite a bit of the investment just in AIG. So it was a very, very... It was an interesting time. Again, I don't wanna under, you know, It can look, again with hindsight, like it was a smart and thoughtful policy approach. I would not wanna understate the role of luck and of just, you know, things not being quite as bad as we feared at the worst of it. And then making policy during this thing is, it looks after the fact like you had an idea of what you were doing, I think in the middle of it really you're trying, I think that what you're trying to do is to not make the mistake of being insufficiently aggressive. So we tried a lot of things, and some of them are totally forgotten, because they ended up playing no role. But I think at the time it was, and I give a lot of credit to Tim Geithner and Ben Bernanke and others, who basically had the sort of notion that were not gonna make the mistake of not doing enough. And I think that was the one, you know, it was in some place a scattershot, but it wasn't insufficiently aggressive. Well, I'm sure during that time period to you just new information constantly coming in immediately, you just ebbing, and flowing, and pivoting day by day through all of that. Yeah, exactly and so the idea that you're sort of driving a car from point A to point B is probably the wrong analogy. You're sort of tryna surf a tsunami or something, and you may have some idea that you'd like to get to the shore, but exactly the path that you're gonna take you have to have as you suggest sort of an ability to adapt the plan pretty well. Okay, one more question on that then we'll get back to it here. Now, you mentioned that the TARP loans were most of those loans, or did the government take ownership in quite a few of those companies? So that's a good, very good question, and actually, this was a real issue that we struggled with, if you'll remember the government first put equity, I'm sorry, first put capital I should say, first put capital into the banks in, I think it was December in late 2008, and it was in the form of preferred stock. And it was exactly for the reason that you're sort of hinting at which is on the one hand, the banks badly needed capital, they couldn't get it. They couldn't get all they needed from the private market. But the government was very loath to have an ownership position in the banking system, so they designed it as preferred. And then when we did the stress tests, we had to design another round of preferred again, that if the banks were unable to raise all the capital they needed from the private market again, the government was standing by as a backstop willing to put in more. And again, we were sort of tryna fudge this problem of not immediately putting equity in 'cause the thought would be that if the government had a substantial equity stake, that would in many ways sort of the specter of potential nationalization would scare off investors, will make it harder for the banks to retaining top executives and so forth. So at the end of the day, the stuff was primarily preferred, but that tension was always there. And in some sense, the luck we had was that the government position never had to be big enough that at least in the banking sector I should say, that it was never sort of an explicit controlling equity stake. Okay, thanks for that background, super interesting and we could talk for hours I'm sure through all of that but I'll let you move on here. We'll go to, keep going on a-- Okay, so let's, yeah, so what I wanted to say is, you know, getting this there was a sort of Lender-of-Last Resort logic. I think it was helpful last time there was, this is, you just put up a thing from the "Wall Street Journal" where this is now several weeks ago, but Steve Mnuchin, the Treasury Secretary at this quote that was very much in the spirit where he said, you know, like last time, the government should aim to make loans on terms such that they can get their money back, okay? That basically it should be an imperative of the program that you're like a senior lender and we're gonna basically lend but we're gonna lend on terms we expect to get UK. Now, if you could maybe flip to the next slide, Mark please. And so basically, no, I have one main point and this is it which is, you know, this is not 2008-2009. It's a very different, it's a yeah, yeah, the two exclamation points are very helpful. This is just a different thing, and I think if you model the policy response too much on 2008-2009, you're not solving the problem here. So what are the differences? First of all, just the absolute size of the shock is bigger. So 2008-2009 was a lot about amplification inside the banking system. But if you think about the initial impetus, it was, you know, call it $500 billion of subprime loans going back. Now, $500 billion is a big deal when it's sitting on the balance sheet of a handful of leveraged financial institutions, but it's not nearly the size of what we're dealing with this time, if you think about GDP being on the order of 20 trillion a year and we're losing a few months of GDP, this is just an order of magnitude in your shop. Moreover, we just don't know, I mean, we just have this dramatic uncertainty that we didn't have last time about the solvency of a whole broad set of firms in the economy. We don't know how long the health emergency will last, even when it passes to a substantial extent, we don't know whether there'll be industries that will be permanently affected, you know, the cruise industry, the airline industry, the hotel industry, others like that may never fully come back, and it's even a little less clear. Normally, I think we sort of know what we mean when we talk about solvency, and you can sort of mix up economic viability with financial Viability. Because normally if I say, here's a business, and they're gonna have no revenues for the next 12 months and they can't service their debts that's a pretty good sign they're not a super healthy business, and they probably should be put out of their misery. That's less obviously the case here, so for example, I just missed my most recent dental appointment, they told me not to come in. I can imagine if you're a dental practice, you're gonna have essentially no revenues over the next many months, may have terrible trouble paying your debt. It's non-viable in the financial sense, maybe meeting its obligations. It is not something that we think that there's not gonna be a dentist in the future, so liquidation is not obviously the right answer. So let's see if you could, Mark, if you could flip again. So let's sort of take a step back before we design any programs, and think about what are the goals we'd sort of like ideally to have. And you can think of them as sort of at a micro-level and at a macro-level. At a micro-level, you don't wanna destroy socially valuable businesses, and by that I mean in sort of the physical and the organizational sense of the world. It's not that you're trying to avoid bankruptcy because you wanna shield the investors from losses. In an ideal world, it would be good for debt and equity investors to bear some of the losses because that's less for the government to basically pick up. But if you think about how do we do this through the bankruptcy system there are a couple problems. First of all, for smaller firms and smaller firms are gonna be bearing a big piece of the brunt here. The bankruptcy system basically tends to err on the side of liquidation. So one concern is that the walk down the street in any town, going in a restaurant, gym, nail salon, a barber shop, there's a worry that basically there could just be waves and waves of bankruptcy for smaller business that will lead to essentially liquidation. And then even for larger businesses where the bankruptcy system is better positioned is not ideal, but even better positioned to sort of make an informed decision about whether to keep the business as an ongoing entity or to liquidate. Those decisions interestingly, become much less efficient when the system is strained. So there's some very interesting work by one of our former students that basically says, "When you put more bankruptcies into the system, "and judges have just less time to deal with cases, "the outcomes of the bankruptcy cases "become substantially less efficient." So just to give you a sense and this is crude, if you roughly double the number bankruptcies at a point in time which is kind of think of that as a garden-variety recession. The recovery to creditors, the loss given default is basically a set of loss given default is doubled, or said to set upside down. The recovery to creditors is roughly cut in half from sort of the increase in bankruptcies that you get in a garden-variety recession, okay? So if you think about what we're dealing with here, you know, you can really undermine the efficiency of the bankruptcy system, if you have this enormous wave of bankruptcies having to go all at once. So that's one concern, okay? The other concern is all the macro economic amplifiers which is when firms go bankrupt and banks lose money, then the bank balance sheets get impaired, when the bank balance sheets get impaired, if they're not recapitalize the banks can't lend. Or if the lending is coming from the corporate bond market, and there are huge losses to corporate bondholders then you get a ton of pressure on bond funds, credit spreads spike again, you get sort of a very potentially damaging contraction in credits supply. Okay, so you're trying to manage both of these and we wanna make the observation that there's sometimes some tension between the two of them. So for example, somebody might say, if you have so many bankruptcies and the bankruptcy courts are just jammed up, well, then nothing will happen. The firm's can't get liquidated, they'll just be kind of waiting in the queue, and maybe that's not so bad. But maybe that's not so bad from the perspective of tearing up the firms, but of course, if you're a bond holder, and you know that the firm that you're invested in is in bankruptcy, and it's not gonna be resolved for two years, that's maybe not the most comforting thing for you as a bond holder, and that worsens the sort of amplification mechanisms. So it's a difficult thing, the sort of potential or a prospective wave of restructurings is, I think potentially, very damaging to the economy both in micro and macro sense. And Jeremy, so that's what we-- Yeah. in that situation where bankruptcies, perhaps just because of the volume of all of them you can't get to them all, well, banks still lend to companies even though they know they have bankruptcy. That's the concern, that's really the concern is whether they'll be willing to lend to the existing clients that they have that are close to bankruptcy, whether they'll be willing to make new loans knowing that if they make a new loan and something goes wrong they won't have the usual ability to work it out that's another concern. And then the third concern is just their capital is gonna be compromised by all of this. So even if they have no concern with a particular client, they're gonna just not have the lending capacity. So all of those things are sort of in the mix, and at some level what policy would ideally like to do is create some relief from sort of this the various damaging consequences of a large wave of corporate defaults. So click if you . Okay, here we go. So, here's sort of the way I guess I would like to think about this which is again, Lender-of-Last Resort principle is you lend to firms that look like they're really good credits, okay? I just don't think that's the situation that we're in. There's so much uncertainty that if you say, I'm only gonna lend, I'm only gonna make aid available to guys that look like really good credits, we just won't make a lot of loans and you won't be helping solve the problem that's the problem in front of us, okay? So we've been saying what you should be doing is thinking of it as not a lender of last resort but Venture Capitalists of Last Resort. And to be clear I don't mean venture capitalist in the sense of the word like you're gonna be in Silicon Valley in winners or losers. It's not about picking winners and losers, it's how you structure your investment, so venture capitalists are basically giving financing to companies in a situation of high uncertainty. And what have we learned about how to structure investment in the situation of uncertainty, okay? First thing is you can't protect yourself or you shouldn't seek to protect yourself by saying, "I'm only gonna lend to those "who have pristine credit quality." You can do that but you won't lend to many, and you won't be lending to those who are the problem, okay? That's to say you can't try to protect yourself, and of course, the government should try to protect itself and minimize its exposure to loss. But the way you protect yourself in a situation of high uncertainty and this is sort of a lesson from venture capital is with what's sometimes called Stage Financing. You have a firm, you don't know how if it's gonna survive. You don't necessarily say, "Here, I'm gonna give you enough money to last for a year "or for two years." What you say is, I give you enough to last maybe for the next three months, to cover your needs for the next three months, then we come back again in three months and we'll see, we'll see we're gonna learn a lot, I mean, if the flip side of uncertainty is we will know much more about whether there's gonna be a vaccine, what the damage is, whether people who will be out and about without a vaccine, which industries are getting really hit hard, and have very little chance of survival. We'll know much more about that in three months, or again in six months, so let's give people enough to last say three months. Let's reassess if we're sort of branching on a more positive branch of the tree then we can kinda continue to build a bridge to the other side. At some point, if it really looks like a particular scenario is going very bad, or a particular set of industries is going very bad, at that point maybe you have to cut your exposure, and at that point you have to accept that we'll go through the bankruptcy process, okay? But I think the staging is sort of an important part of how you control your exposure, and that the corollary of that is you have to be willing to lose money. To be clear, the congress allocated more than 450 billion dollars to the Treasury for these programs, and I think the idea that you're gonna pay all of it back is tantamount to saying you're not gonna try to attack the problem. So there just aren't that many if you're dealing with the problem itself, there are a few debt safe loans to be made. Again, you can control your exposure, but you can't eliminate your exposure, okay? So again, and then as I've said, this sort of the next bullet would be you have to basically not be too stringent on the upfront credit standards. You can't set two tide of credit box, the idea of sort of I'm confident that they're solvent and then I'm lending against good collateral will cut out too much. And then the final lesson from venture capital is to not give all the financing in the form of senior debt, okay? The problem is if you lend to these firms and it's all senior debt and then with some good luck maybe we're on the other side of the crisis in 12 months, but if they're now staggering under large debt burdens with aggressive repayment schedules then you'll impede the recovery because you'll have a bunch of bankruptcies when we get to the other side, and they're forced to start repaying. So and then that's, of course, the reason you don't saddle startup firms with huge debt burdens as well. They just can't service or they can't in expectation service the debt, and so you do something that looks more like preferred, or preferred plus warrants, or something like that, right? So that allows you to if need be defer interest payments. And again, you can protect yourself, you can protect your economic interest in other ways by for example, taking some of the upside, if it's a public firm with with warrants, okay? So again, I think these are not lessons about picking winners and losers, but just how do you structure, how should you structure government support in a situation of a very large concern? Okay, if we can move. So just to give you a sense of the programs that we're actually dealing with, there are two broad ones as I said, there is the so called Primary Market Credit Facility. This is for investment grade, essentially investment grade firms and firms that were up until March investment grade that has a capacity of up to 750 billion dollars. And then there's this Main Street program which is targeted at firms that are basically mid-sized. So let's flip again to the next slide. An interesting thing is to just do a sort of Venn diagram and to ask yourself, let's think just to make it simple, let's think about publicly traded companies and ask who is eligible for which ones? So if you go with the first row here, there's a line that says included in the primary market in the PMCFF, okay? This is for very big firms. This is for investment grade firms. So only the top 12% of firms really qualify with this thing. Okay, it's only 12% of firms, whereas you go to the next column over, it picks up almost 58% of the employment in public firms because you're getting obviously these very, very big firms. Okay? If you go down to the next row, the Main Street program will pick up about 33% of the publicly traded firms, and roughly another 16% of the employment, okay? But the thing I wanted to draw your attention to are the two rows below where it says excluded, high yield, and excluded mid-sized that basically we're missing, and if you go to the employment columns there, we're missing collectively about 26% of the employment in public firms, okay? So basically a 26% is not covered, why is that? About 19% is not covered because you've got a set of companies that on the one hand too big to qualify for Main Street, but they're junk rated, so they can't, they're not investment grade, so they don't qualify for the primary market neither, okay? And then you miss another, so that's the biggest miss is basically big firms that are not investment grade thus the smaller miss the other 6.7% is firms that are size-wise fit Main Street but they are considered too risky because they have too much leverage, and there's a leverage criterion basically for Main Street. Okay, so just the first interesting point is this sort of design of these things, of course, this is before we get to any questions of take up, but little over a quarter of the universe is just not even immediate to the table to start off, and so if you flip to the next, Hey, Jeremy, quick question for you here. I was just gonna reiterate, so these are the public companies. Right, but there's thousands of private companies out there, do you have a sense of what kind of impact the private companies would have on employment compared to some of the numbers we're looking at here? Yeah, it's very substantial, I'm gonna make up a number. Probably half of all employment is in private companies, and again, that's just missing entirely in this chart. And many of those companies, there's some of them will be eligible for Main Street, and then many of those are gonna be themselves too small even for the Main Street program. And then there's this third program which we talked about at the very beginning called that PPP, the Paycheck Protection Program, and that will cover some of the small businesses. Okay. So again, they're a tiny share. So this is a very good question, Mark. They're, you know, if you go on that row and into the employment column, they will only look like they're 0.3%, that means they're 0.3% of the employment in the public firm universe. They're not that many tiny public firms. Okay, they'd be a much, as your question rightfully suggests, they're much larger fraction of the overall people in the universe. And so everything here is sort of focused on larger public companies. Okay, and then last question for you here, and then I'll stop asking so many questions to get through it. That $450 billion, you mentioned that was available will that apply both for public as well as private companies then? That is an amount that was allocated, yes, excuse me, so that was allocated to the Treasury. So the way all these things are basically designed is that there'll be special purpose vehicles, which will be a collaboration between the Fed and the Treasury. The Treasury will essentially put the equity in layer in, and then the Fed will lend against that equity, so that 450 billion will go to cover these various different programs, but for example, if the Treasury puts in let's say, 50 or 75 billion to the PMCCF, because those are relatively safe bonds, the Treasury can lever that up. I'm sorry, the Fed can lever that up by 10 to one. So when I said that that program had a capacity of 750 billion that was like using maybe 75 billion of the Treasury's congressional allocation and the Fed putting up the rest. Okay. So, I need to be careful, there's the capacities of the programs, but the programs are joint ventures between the Treasury using its congressionally allocated funds and the Fed putting up the rest. Okay, great, thanks. Okay? All right, you know again, so why do we have these gaps? I think these gaps in some sense are reflective of the Treasury's desire not to lose money, so they don't wanna lend to junk rated firms in their big facility in part because it's risky. It sort of goes against this dictum of lend to firms you're sure of solving. So the problem is at least a lot of the universe and maybe the most vulnerable part of the universe we covered. So you know, if I were to suggest a tweak, I would say, let's knock the credit rating screen down a little bit. Let's allow some high junk rated firms BB and D-rated firms in. If you're concerned about the credit risk again, the way I would deal with it is to control the quantity that they can borrow a little bit more tightly to maybe take warrants to improve the government's overall economics. And you know, you're worried about sort of getting the right firms coming in only the ones who really need it. If you put caps on executive comp, or caps on dividends and repurchases that will tend to be helpful from a screening perspective you're more likely to get people who are, you know, for whom it makes sense to take the risk. Okay, so if we go to the next slide, let's see, so this is unfortunately didn't come out all that well, there we go it's a little bit better. So I just want to make a few points here. Again, if you look, let's look at this new loan program, it's helpful. And I should say, by the way, this slide is very obsolete now because just last night the Fed announced some modifications to the terms which I think are helpful. But if you look at this, there's a couple of things to know, there's first of all, there's the under maximum loan size, there's a leverage constraint, so it says you can't exceed a loan of four times EBITDA, down there. The next thing right underneath that is risk, it's gonna say, "Risk Retention". Very important part of the design here is the government is only gonna lend if they will be side by side with the banks. So what that 5% means is they will make a loan and take 95% of the loan, but only if a bank feels good enough about the loan to take 5% of it. Okay, so that's point number two, and then the last point right underneath that is the Repayment. And you'll note that this loan has a pretty rapid repayment schedule, you have to pay it back in years two through four, 33% each year, okay? So these are things that I think are worrisome. I think the rapid repayment I mentioned this before, that's a pretty demanding, the quiddity strain on companies that may be just coming out of a very severe recession. Now, interestingly, this is one of the things that that changed yesterday. So in the new terms which I have, I'm sorry they're not in the slides, they just changed it to stretching it out another year and having it be 15%, 15%, and then 70% as the amortization, so that's better. I think that is listening basically to the feedback, so that will ease the liquidity burden. You know there's still this feature of having to the banks wanna participate which I think has sort of two, I don't know if we can call them offsetting kind of issues; one is, if you're a bank and you haven't lent to this company before, and you're just looking at lending it to it for the first time, that means the loan has to be on commercially acceptable terms to you. And it's not clear that's the right social objective, that in other words, again, you might have to take losses at least an expectation to accomplish the social objective of getting us through this crisis without a huge wave of bankruptcy. So I worry that the banks are gonna be unwilling to make some loans that would be socially desirable for them to make. On the other hand, there's a set of loans where there might be quite eager which is if you're a bank, and you've already lent a company X $100, and that loan is in terrible trouble and the Feds says, "Well now, we'll lend them another 100 "and you only have to put up five of it, "and that might bail you out." Well, those are loans they're gonna be quite interested in making. So there'll be sort of too aggressive with some and not aggressive enough with others. So I think this whole thing, you know again, it's the government trying to protect itself by being side by side with the banks. I don't know that that's really the best design principle. And I think that is gonna again, cut off potentially the participation in the program for a number of firms that need it, and maybe those loans that we do get will be loans that are essentially an attempt to evergreen things that are better than last year. I don't really need to say the other programs are in a similar spirit, we can go through the details, but they're not really gonna tell you too much else. So maybe let's flip. So again, I sorta mentioned their concerns. That's basically on this slide. If you go just one more slide, one thing I really worry about and I don't know if this is given enough thought is again, what happens to companies where the government has lent to them again, side by side with the banks and then they get into trouble? Okay, they can't service their debt. And they're essentially in some kind of a workout situation. Who manages to work it out, right? So now you think the government is a lender, but they're not the only lender, they're in there with the banks as well. My strong guess is the Treasury Department does not wanna be making a lot of discretionary decisions about, "Oh, you know, we're gonna give this company a break, "and this other company we are not gonna give a break." I think as a matter of just political cover, they'll have to more or less set up some kind of vehicle, maybe it's a little bit like a Resolution Trust Company from back in the 1980s and 1990s, and have some third party basically manage the workouts. Okay? But again, you're now managing the workouts on behalf of both the Treasury and a private lender. So it seems like you're gonna have to basically do these on terms that are effectively private market terms. It's hard to imagine that you're gonna treat the banks very differently than they could expect to be treated in a more private thing. And so now you've got a lot of banks that again, are relatively senior in some cases have collateral, and I worry that that's gonna lead to them being relatively prone to wanna liquidate some of these companies, so again, a big part of the reason that I think you wanna be gentle on the way in with the terms is on the back end it's gonna be very hard, and I worry again about a wave of relatively liquidation prone bankruptcies. So again, anything that you can do to make this feel a little bit more like a softer claim, something like a preferred I think would be better. You know having the option to defer interest without forcing default, I think would be a very, very valuable thing. And again, to the extent that we're talking about public companies, and this was done some last time with the banks, we took preferred plus warrants. Again, that's a very standard thing that you do in a kind of high risk situation, so there are other ways to strengthen the government's economic position without it all being hard debt that has this sort of risk of . Hey, Jeremy. Yes, please. Quick question, so you talked about a better option and maybe some tweaks, and yeah, you showed on a prior slide that they are open to changing some of the terms of these different deals. I guess, how do you go about making some of these changes, if it turns out the prefers or warrants are a better solution, how does that actually get into the system? It's interesting and I don't fully understand, my understanding this is an ongoing, it's essentially been an ongoing negotiation between the Fed and the Treasury. The way these program are designed, as I said, the Treasury is essentially the equity holder in these vehicles meaning that they're the first loss. So you know, the first $100 billion that gets lost is a loss to the Treasury Department not the Fed, so the Treasury has been understandably more protective of their position, that is to say, less willing to take a junior position, less willing to do some of these other things. I think some of the negotiation, you know there's a negotiation and then part of what's driving the evolution of the program is on the other hand, it's also it will be a failure. It will be a failure for all involved and for the Treasury Department if nobody shows up. What if they open the door to the Main Street program and they can't give away the loans? That will be a policy failure as well, and so my instinct or my understanding is that some of these design changes have been just an attempt to get some people to participate. So we've been seeing not again, I think they've been moving absolutely in the right direction. Going from debt, I think moving from debt that we paid on three years to debt with a slower repayment was very sensible going the next step to something like preferred, my guess is that's just a harder step that we need to take. It could do it, there's nothing, I don't think there's anything in the law that will prevent them from doing this, but it feels like just from the little that I've heard about the negotiations that's just, it's a bigger deal. So I think it's a combination of just negotiation plus the market test. And again, if they open up this program and nobody comes in the first couple weeks, there's quite likely to be a further round of revisions. So it's a little bit and it's sort of real time evolution. All right, thank you. And I mention this last point again which is again, I think the way that you would ideally do this and the way you sort of protect taxpayers is rather than saying, "If you qualify by being investment grade, "we'll give you whatever you ask for." I would say, "If you qualify, we'll give you enough "to sort of cover your obligations for the next quarter, "and then we'll do another tranche of the program "a quarter from now, "but the size of that tranche will depend on where we are." And if the economy is sort of improving, and we see kind of, you know, another three months, or another six months we can bridge to the other side, you're more willing to do it, if it starts to be that some of these firms really can't be saved. Now, I think you gradually have to allow the bankruptcy option to start kicking in. So again, I'd be sort of, you know, try as much as possible to be able to adapt. And Mark, when you brought this up before in a crisis you have to be willing to adapt to incoming information. There's no brilliant design that you can do up front and then just kind of keep it in place. Okay, so if we go into the last slide here, I think it's the last slide. Yeah, so I think I've pretty much said it. I think that the simple message. This is a different and in many ways much more difficult situation for government lending. I think there's a lot more just, you know, I given you one argument, I think there's more disagreement among academics and others about what to do this time where I thinks operating with much less of a kind of well established theory of the case, so it's just much harder, but again, I think given the uncertainty, you have to design a program that you kind of finance can underwrite uncertainty, so that's our, that's actually the most basic bottom line. And if people would like, I'd be delighted to take some questions. All right, well, thank you for that, and one of them, we've had several submitted by the way. One of them gets into this idea of indiscriminate lending. Yes. Meaning probably in times of chaos you just have to get some funding out there keep these businesses and really it sounds like payroll primarily going, in what point do you get less, more discriminate, less indiscriminate? And a little more careful with your topic imprints. I think this is . I of course, don't wanna be , it's not a good position to be in to be the advocate for indiscriminate, but I guess I am advocating for somewhat less discriminating in the sense of holding a slightly less tight credit rating thing, but again, you trade that off by giving less money, and then you have to have a serious look again in three months and see how we're progressing. And if you're lending by and large to a set of industries where it's looking less and less likely that they'll be able to repay then you don't advance the next tranche. So apart of this, you know, this is very, it's very much analogous, you know, think about what we're doing with all the shelter in place. We're sort of what's that thing you're sort of trying to manage the capacity and not overwhelm the hospitals in the same way, here you're sort of trying to manage it and not overwhelm the bankruptcy courts. It's not that you're telling yourself that people are never gonna get sick, you don't want them all getting sick kind of right away, and the same thing is happening here. So even if in the end, you wait three months, you keep some firms alive, and then ultimately, you learn something that tells you, you can't keep them alive forever, that's not necessarily a mistake. Yeah, well, let me ask you this question. And this comes in a two part one, which is you're highlighting a lot of money that's being made available out there, so the debt keeps getting significantly, significantly bigger. What are your thoughts on increasing debt load, then ultimately, what does that mean or might it mean in terms of potential inflation down the road? So it's gonna really depend, so let me let me start by telling you a sort of relatively more benign story and then I'll tell you a somewhat lesser benign story. So debt to GDP is gonna go up very, very substantially. Now, it all depends on what interest rates are, so interest rates now are historically low, they're essentially zero or negative in real terms. So even if you have 150% debt to GDP, if the real interest rate is zero, that's not a problem. You can service a zero interest rate basically, without much problem. Where it gets to be a problem is obviously if the real interest rate has to go to 3% or something like that then it starts being a struggle. So that in turn raises the question about inflation dynamic. So let me say something that's not a forecast, but just a scenario, so I don't have any reason to forecast. Right now, we see very little inflationary pressure, if anything, we see a little bit of deflationary. There's nothing that I see that would say that my baseline forecast especially in the near term is for inflation. But there's just very, very large uncertainty is if you think about what we were experiencing it's a very large supply shock, and a very large demand shock, okay? And they're both much bigger than we've seen kind of anything in recent memory. And when it all shakes out, if the supply shock is 10X, and the demand shock is nine X on that it's gonna be a supply shock, and it will be inflationary. And if it's the other way around, it'll be a demand shock and it will be deflationary, and it's very hard. And some of these demand effects may work more powerfully in short horizons, and then when people come back to work, the demand effects are gone. But if supply chains, for example, are recast, there can be essentially something that looks like a supply shock, and there could be for reasons that we can't fully anticipate an inflationary impulse. Now then the interesting question is if for whatever reason, and again, this is not a forecast, it's just a scenario, if for whatever reason we have an inflationary impulse, then the question to ask is, with 150% debt to GDP, and a Fed balance sheet that could be literally $10 trillion with some sketchy stuff on their balance sheet, will they be willing to raise interest rates as aggressively as they otherwise might should cut off the inflation? That's an open question, you know, and I think so, and I hope so, but in the wake of, there people have talked about sort of the lessons in the wake of World War II, when the Fed was basically drawn into keeping interest rates low to help with the war effort. After World War II, there was inflationary pressure, and the Fed was essentially too much under the wing of the federal government, and for several years basically, was pressured to keep interest rates low, and that was inflation. That resulted in the 1951 Fed-Treasury Accord where the Fed essentially regained a measure of its independence, but that was only because basically, there was an inflationary problem, and the Fed was sort of heckling on unsuccessful fight. So if you ask me to tell you a story of inflation, that's kind of the story I would say. It comes from somewhere, and then with all this debt to GDP, and the Fed having been sort of a bit subservient to the rest of the government to get through the war, they're not able to find it as independently and effectively as they did . Well, and as you're describing this, there's so many uncertainties involved in everything, it's gotta be incredibly difficult to model all these different scenarios, and so, you know, if you do think about that I'll say as a banker and economist, I mean, how do you adjust your models without really saying we've been through something like this before? You can't, I mean, you know, again, I think you can go through scenarios, I was just working on a model, sort of a statistical model to predict how much the banks were gonna lose through all of this, okay? And we have models, they're very nice models, and you can feed into the model, here's what the unemployment, here's my assumption about the unemployment, the unemployment rate is 18%, what, how much, you know, what our bank credit loss is gonna be over the next year? And the model will spit back something to you. It's a nice well behaved model, but of course, it's been fit on historical data, so it's been fitted on data on past episodes of high unemployment, but those don't look anything like this one. So you can fit it to the last time around when unemployment was very high, but it was 10%. But this time, we're gonna be looking at unemployment that may reach 15% or higher, and it's gonna have a different shape. It's likely to be higher than we've seen since the 1930s, but it might also not be as long lived. So, you're extrapolating, you're just flying blind. I mean, you can make up, you can, you know, the models can only give you what you give them and we don't have a history to give them that really looks anything like this. Which is why I'm shying so much away from really making any forecast. Well, let me ask you this one, you know, as we think you made a comment there just about the banks and perhaps some of the the potential risk with the banks. How do you think about the markets coming in play here? And by that I'm talking about stock market pricing where you look at how the market is assessing kind of the risk within these different types of banks, and depending on the loans and things like that, how do you feel the market does it reflecting those concerns into? Yeah, I do think so, so we just did a project on this literally this week, and on the one hand, the market as a whole to me it defies the explanation, I can't and won't try to rationalize the level of the market, but if you look at sort of the cross section of stocks, so one thing up until very recently, bank stocks have been, were down down like something like 35 or 40%, and if you look at which banks were down the most in the cross section that seemed more rational. So the banks with the biggest exposure to C&I and to consumer loans were hit the hardest. Interestingly, last time around in 2008-2009, the banks whose stocks went down the most, prior to Lehman were the banks that subsequently had the biggest loan losses. So there does seem to be, you know, there's this sort of cliche that markets can be macro inefficient but micro efficient, and that feels like it rings a little true here, that I won't try to explain the overall level of the market, but the market does seem to be trying to say some sensible things about which banks are most exposed. And we did a little kind of homemade stress test exercise, feeding in sort of macro assumptions and getting out loan losses, and it was interesting to see that conformed quite closely with what the stock market is telling us. In both cases, the banks with the most consumer exposure, most exposure like credit card lending, they have had both the biggest stock price declines, and they show up as being the hardest hit on our little homemade stress test, so I think there's some information in the market for sure. Yeah, wait. I won't try to rationalize the level but you can still learn. Yeah, which is obviously a core approach here at "Dimensional" is just the aggregation of all this information is coming into play, and the prices of all these different securities. And I think there's an important policy message in that which is that the Fed when it does the stress testing, tends to not wanna look at market prices at all. They wanna kind of put their heads down and do their loan loss modeling, and, of course, I'm not advocating that you should mechanically use stock prices and just say, well, you have to have this in this ratio of market capital, of equity market capital to assets and investment. But the market gives you useful information, and I think you should have a minimum to be trying to take that on board. And so you know, we've been advocating for is that when a market for bank stocks is down that much, we should at least be asking yourself some hard questions about what is that telling me, or what might that be telling me about what stress scenarios look like? So I think it would be very useful for policymakers to try to be a little bit more open to using some of that market information especially at turning points, you know, in normal times, you can use accounting data at times like this, you know, the difference between forward looking stock price information and backward looking accounting ratios is really dramatic, and I think you're making a mistake if you totally ignore the stock price . All right, well, great comments and a great way to end it for this session as well. And Jeremy, really appreciate you taking the time to join us, you know, I'm glad that you were receptive to Ken's call . We're gonna reach out to him. Yes, yeah, my great pleasure. Thank you, thank you so much for including it. Yeah, pleasure to have you join us and very much enjoyed the whole conversation here, and we'll have to do it again sometime for sure. And thanks to all of you for joining us here for the date. We wanna highlight here just a couple of the webcast we do have coming up on Thursday that we'll be joined by Gerard and we'll be taking a look at some of the different variables that we use and bring in terms of how we implement the different premiums and to make sure we're doing it very efficiently, and very cost effectively. I mentioned that Robert would be coming back next Tuesday looking at some of the research around profitability. And you'll notice here on your screen, we're gonna extend that into two days later, the implementation of profitability. We've come a little over three years there with implementation of profitability and the different strategies and we wanna talk about what we've seen then since we've had them Live in the way that we imagined those portfolios. So thanks again for everybody, we appreciate all of your time and have a fantastic rest of the week.