Fiscal and Monetary Policy Align as Stimulus Sparks Markets
March 27, 2020
Market activity from Tuesday to Thursday this week, represented the strongest three-day U.S. equity rally since 1931. Also, there were some signs of improved liquidity in the fixed income markets. Optimism rose after the Senate passed a massive spending program designed to combat the devastating economic impact of the coronavirus.
With this stimulus package, fiscal policy is now working hand-in-hand with monetary policy in an effort to keep the domestic economy afloat. In total, the $2.2 trillion support package represents approximately 30% of U.S. GDP.
In this Investment Perspective, we summarize the actions taken and highlight key trends we are monitoring within real estate and private equity, including credit lines and capital calls.
After much wrangling, the Senate reached a bipartisan agreement and passed the stimulus bill 96-0 (four Senators were unable to vote due to self-quarantines). On Friday, the House approved the Senate bill and it was sent to President Trump to be signed into law. The package provides direct support to individuals and families as well as aid to small business and a number of industries. For example, $150 billion is earmarked specifically for hospitals.
Though the bill designated only $14 billion to higher education institutions―well under the $50 billion that institutions sought―more aid is likely, according to the American Council on Education.
The Federal Reserve made two emergency rate cuts in March, bringing rates to 0.00–0.25%. The Fed also continues to spend massive amounts of money in its repo operations and its new quantitative easing program.
In addition, the Fed announced a number of new targeted lending facilities. Several of these liquid enhancement programs were taken directly from the Fed’s 2008 playbook, but the purchases of ETFs, corporates, and agency commercial mortgage-backed securities were new initiatives. The housing market has been of particular focus as it is one of the most important areas of the economy. Details of the Senate bill and Federal Reserve efforts are outlined in the Appendix.
Real Estate Update
Both residential and commercial real estate have come under extreme pressure as a result of the coronavirus pandemic. Within a few short weeks a healthy market became threatened by a spike in tenants unable to pay rent and property owners unable to make loan payments or meet covenants. Much of the fiscal stimulus response, and other federal agency responses, have taken measures to attempt to mitigate the situation. These include:
- Fannie Mae and Freddie Mac expanded forbearance relief to landlords, delaying mortgage payments or tacking them on to the end of the mortgage.
- The Fed provided regulatory relief and no penalty to banks for accommodating borrowers (loans will not be classified as troubled).
A number of factors could influence the longer-term impact on the real estate market, including all-time low interest rates, changes in the office work environment, and further deterioration of brick-and-mortar retail.
Private Equity Update
As liquid asset classes have been volatile during the recent crisis, cash flow forecasting (including private capital call projections) have become a growing area of focus. Assessing the potential capital call activity includes not only potential future transaction activity, but also existing balances on fund subscription lines.
Subscription credit lines―also known in the private capital industry as equity bridge or capital call facilities―are short-term loans that allow private capital managers to cover investment acquisitions and fund operating expenses and management fees. They help limit capital calls from limited partners for a period of 30 to 360 days. The subscription lines are secured by the limited partners’ pledged capital commitments.
While subscription credit lines were used prior to the Great Financial Crisis, their use and duration have markedly increased across the industry in the last 10 years. A low interest rate environment, coupled with banks seeking new ways to generate fee revenue after the crisis, led to a dramatic increase in banks providing subscription credit lines. By some estimates, there is $400 billion in total credit lines across the private capital industry.
During this recent period of extreme market volatility, there has been an uptick in private capital managers making capital calls to pay down outstanding credit line balances. While the subscription credit lines typically are not callable by the lender, private capital managers are seeking to reduce or pay off the credit lines in an uncertain market. From our early review of the capital calls, the majority have been used to pay for deals completed in 2020. Consequently, the increase in capital calls should not be viewed as an increase in private capital deal activity, but as simply drawing capital for deals already executed.
For the first time in recent history, monetary policy and fiscal policy are working together in an effort to offset the market malaise caused by the coronavirus. The largest hit to the economy will likely occur in the second quarter. The level of impact is unclear at this point, as are unemployment estimates. The actions taken by policymakers are extraordinary and should help businesses and individuals weather this storm.
When it comes to client portfolios, we continue to advise patience; adhere to the plan we have developed together and do not be afraid to take advantage of investment opportunities. In the meantime, we hope that you, your colleagues, and families remain safe and healthy. Please contact your client service team with any questions.
Appendix: Federal Stimulus Efforts
Major highlights from the Senate aid package:
- $377 billion for small business loans.
- $500 billion for loans and loan guarantees, including $454 billion to backstop Fed facilities.
- Six-month deferral of student loan payments.
- $250 billion for direct payments to individuals.
- $250 billion for unemployment insurance.
- $150 billion for state/local aid.
- $340 billion for direct federal spending.
- $150 billion for hospitals and health care efforts.
Certain industries will directly benefit, including those critical to national security (i.e., Boeing), which will receive $17 billion in loans. Airlines will receive $25 billion in grants (subject to conditions) and $25 billion in loans to passenger carriers, $3 billion to airline contractors, and $4 billion to cargo haulers.
It is noteworthy that the $454 billion to backstop Fed programs would be an equity infusion into special purpose vehicles, which the Fed can leverage 10:1. This could translate into approximately $4 trillion in direct aid to industries and local governments.