Jeff Meli:              Welcome to this episode of "The Flip Side." This is another in a series of episodes focused on the economic and market implications of COVID-19. My name is Jeff Meli and I'm the Global Head of Research at Barclays. I'm joined this week by Mike Gapen, our Chief U.S. Economist. Thanks for joining me, Mike.

Mike Gapen:         Thanks for having me, Jeff.

Jeff Meli:              This week, we're going to focus on the CARES Act, the largest ever stimulus package which was passed by Congress in March, and whether or not it will be effective at reducing the economic consequences of COVID-19.

Mike Gapen:         Well, I believe that the legislation will be effective, but I think we also need to be clear about what that means. We both think we're going to have a severe recession in the U.S. About all fiscal and monetary policy can do at this stage is prepare the economy for the eventual recovery, but neither of us think that monetary and fiscal policy can offset the direct effect of the virus on economic activity, particularly given that 80 percent or more of the country is already under statewide stay-at-home orders.

Jeff Meli:              Yes, that's right. And the evidence, Mike, of the contraction is already coming through the latest data. That's been particularly obvious in labor markets, where it looks like 10 to 15 million Americans may lose their jobs in April.

Mike Gapen:         Indeed. It's hard to get your head around that kind of number, so I think we do need to define effectiveness. And I think stimulus probably isn't the right word. This is more like fiscal support or disaster assistance. I think the legislation was designed to keep as much of the economy on stall speed and on a waiting pattern and a holding position by replacing lost revenue and income while keeping credit flowing.

                              Sectors important to national security will receive loan guarantees and direct assistance. And for small- and medium-sized business, there are programs that will enable companies to make rent and mortgage payments and hopefully keep people on the payroll through a temporary disruption. That should help the economy restart from a place that somewhat resembles where we left off.

                              So yes, there will be severe job losses. Much of the lost services activity will not be made up in my opinion. But I do think the legislation will both ease the burden that job losses impose on workers and provide some firepower to jump start demand once we come back online.

Jeff Meli:              Well, Mike, I'm a bit more pessimistic. And to be clear, I'm not critical of the bill. Many of the programs that are inside of the CARES Act are well intentioned, and I'm not sure that there was actually a better bill that could've been passed in such a short timeframe.

                              But I think the small business focused efforts will not get the take-up that the legislators envisioned because of the structure and challenges of actually getting money into that part of the economy.

                              I expect that the bulk of the lending to larger corporates will go to companies that had access to other sources of financing, whereas a lot of mid-size companies will get left out. And finally, I think there's too little municipalities which are going to suffer maidenly in the next few months.

Mike Gapen:         OK. Well, at least let me start with why I think this bill will be effective. We don't have the full CBO scoring of the bill as of yet, but let's think about the size. It's in the ballpark of $2 trillion, which is about 10 percent of the economy and more than twice what was passed in the TARP legislation during the global financial crisis. Our forecast is for a full-year contraction of GDP on the order of 4.5 percent. So this kind of fiscal response is certainly sized to have an impact.

Jeff Meli:              Mike, I have struggled with these aggregate comparisons of the size of a stimulus package to the size of the economic contraction associated with COVID-19. The CARES Act is really a number of programs.

                              It's rebate checks to consumers. It's got loans to some companies. It's got forgivable loans or effectively grants to other types of companies. A lot of the loans would need to get paid back. We'd have to think about fiscal multipliers of any of the direct assistance that's happening. So, how much activity that actually gets generated by each specific program is what matters, not just the aggregate size versus the size of the contraction.

Mike Gapen:         That's fair enough. And I would agree there's conditional spending here depending on how bad things get. It's definitely different than increasing budget caps in any fiscal year. My point is just to suggest that, relative to phase I and phase II, this particular bill, the CARES Act, has the potential to be meaningful, but let's go through the programs.

                              How about we start with the programs that are intended to help individual households and consumers? There are several things in this bill that are important here. This would be the $1,200 rebate checks for individual taxpayers' forbearance in terms of student loan payments, mortgages and consumer credit and expanded unemployment benefits. These should help provide a bridge to when social distancing ends and should help ease the burden for households that are adversely affected by these widespread stay-at-home orders.

Jeff Meli:              Well, the rebate checks and the forbearance on the various forms of credit certainly would help ease the economic distress that's being caused by COVID-19. However, one of the effects that you didn't mention just now was that they would provide a stimulus or a boost to the economy.

                              And I actually don't think they will provide a stimulus or boost to the economy. I think it doesn't really matter how big of a rebate check you get in the mail this month or next month. You're extremely unlikely to go out and spend it if you're forced to stay inside your home. I'm not sure that these sorts programs actually could provide a stimulus or boost to the economy right now.

Mike Gapen:         Right. Well, I don't think these parts of the bill are intended to be stimulus per se. I think what they really are is efforts to prime the pumps such that when the economy begins to reopen again, consumers and household have money which to spend and begin improving activity.

Jeff Meli:              I also have some concerns about the expanded unemployment benefits. So, to be clear, the bill provides for an additional $600 a week in unemployment benefits for people who are laid off because of COVID-19. That's well in excess the standard of unemployment benefits that workers receive when they get laid off.

                              We've already read reports that there are companies out there that are laying employees off because they will be able to take advantage of those additional payments. In some cases, they'll be able to make more money as a result of those expanded unemployment benefits than they were making in wages at their job in the first place.

                              I think there's a risk that some of these employees remain detached from the labor force, even after the effects of the virus start to wear off and we can all start going back to work.

Mike Gapen:         There is evidence that it's harder to return to the workforce once you're laid off, Jeff. That's true, but I wouldn't be so quick to presume that unemployment benefits lead to too much detachment because workers also have incentive to retain their benefits, which they lose when they get laid off.

                              I think that's a good segue into another one of the components of the CARES Act, which is intended to support small- and medium-sized business. This would be the PPP, or the Payroll Protection Plan.

Jeff Meli:              Yes, that's a plan where small businesses, those with fewer than 500 employees, can take out loans that to use against payroll, rent, utilities, et cetera. The loans are actually forgivable up to certain limits, so long as you keep a certain percentage of your employees on the payrolls.

Mike Gapen:         And that's important because about half of our workers that work in the United States in small- and medium-sized enterprises. You're talking about 63 million people that are on payrolls of firms that have 500 employees or less. So, it's very critical that we get that assistance out to small- and medium-sized enterprises to limit the amount of unemployment or distress that we'll see at these institutions.

Jeff Meli:              OK. Look, the principle here is a good one. I think you do want to keep those businesses sort of frozen, and then you can kind of thaw them out once the social distancing ends, and they can try to regain the momentum that they had before the disruptions of COVID-19. But I have a couple points of reality. First, many of these small businesses experience very high turnover.

                              So for example, I've spoken to some folks who run franchises, where they have turnover that's very high, say as high as 200 percent a year. For a business like that, why bother taking out a loan and then applying for forgiveness, et cetera? It could be more efficient just to lay people off, let them collect these higher unemployment benefits, and then rehire different people later where there's likely to be no shortage of potential employees, given how we've seen the unemployment numbers flow through already.

                              A second point is that we actually don't know what the economy is going to look like in three months. We're professional economists; we don't have any idea what it's going to look like, never mind if we were running a small business.

                              And so, there's a risk that, three months from now,  social distancing may not have worked, or we may have had a second round of the virus and the associated infections, such that companies that took these loans could look back and say they wish they hadn't, that they had let their employees go in the first place.

                              For these two reasons, I think we might get less take up these programs than one might otherwise expect.

Mike Gapen:         So, actually, Jeff my critique of the program is different. It's not that it won't get taken up or firms won't seek to use it. I actually think many will and the program's probably not large enough. So as I mentioned, about 63 million workers work in small- and medium-sized business.

                              If we do the math here and assume that they worked 34 hours per week, which was the average before the coronavirus outbreak and had hourly earnings that were equal to leisure and hospitality, that industry earned about a little under $17 an hour. And then across the eight weeks of support that the bill provides, that's already a number around 300 billion that almost tops out the program's current size.

                              On top of that, you need more to cover mortgage interest, rent and some of the other components, like utilities that you had mentioned. So in my view, I think – and looking at other estimates, it suggests that maybe a trillion or more is the minimum amount that you would need in the Payroll Protection Plan to make it viable.

                              And I'd note that just today, the Senate is suggesting that they're already looking at adding another 200 billion to the size of the program, which I think is an admission that it was too small to begin with.

Jeff Meli:              Well, Mike, if your concern is that the program is too small and that there are limited funds, then I think we could end up in a situation where only those businesses that have established banking relationships are actually able to access the money, which probably means that it's the smallest of the small businesses that get left out and don't end up getting the kind of financing that they might need.

                              But I think we should pivot here from the smallest companies in the economy to the largest companies in the economy because the CARES Act had a number of provisions that targeted aiding big U.S. corporations also.

Mike Gapen:         That's right. So, there's about $50 billion in the CARES Act for the airline industry and other sectors of the economy that are important for national security. This would be funds that would go to loan guarantees or other direct support. And if you received this financial support, you're not eligible to receive assistance elsewhere in the CARES Act. So this is really targeted and designed for airlines and industries important to national security.

                              And then there's a second component here, there's a $454 billion outlay to go the Federal Reserve and support Federal Reserve lending facilities. These would be facilities where the Fed and the Treasury get together and the Treasury's providing the Fed loss protection. But the Fed would extend credit to the private sector, which would be available to medium-sized business and potentially municipalities. And I think the key here is that the size of these programs can be much larger than the amount appropriated.

                              So, if the Fed levered these facilities, these lending facilities up in the same way that they did during the global financial crisis, you're talking about providing perhaps as much as $4 trillion in lending support to the overall economy.

Jeff Meli:              Well, Mike, on the one hand, I think the direct to aid to companies like airlines and other industries that are most affected by COVID-19 makes a lot sense. Those companies probably have very limited access to financing from other forms and certainly in any form that would keep them in business. But the larger sum of money, which is targeted for companies in other industries, to me, might seem like a lot of firepower that will go unused.

                              So, large companies in the U.S. have access to all sort of financing. We've seen large companies drawdown revolvers from banks. We've seen them access the corporate bond markets during any periods of calm. So I'm not sure we really that $4 trillion of firepower. That could be a waste of that $450 billion. As evidenced, the programs that the Federal Reserve has rolled out so far seem to have very little take-up.

Mike Gapen:         Well, I wouldn't point to take-up as being the only measure of success for these facilities. If we do go back to the global financial crisis and look at some of the lending facilities that the Fed put in place, several of them got very little take-up, yet their mere presence allowed for improved conditions in financial markets, and lenders were willing to engage and transact with each other, just knowing that the Fed was an arm's length away.

                              So, I think there are other measures of success, and I think these programs added value and improved the functioning of both markets and the economy just by being a backstop.

Jeff Meli:              Fair point, Mike, that if these programs provide confidence to investors, they could provide benefits even if the take-up is relatively low. But I'm worried that the low take-up is actually being driven by another factor, which is all the strings that come with these programs. So, companies that access this kind of lending will have to give warrants to the government which means that the government would participate in any eventual equity upside.

                              They would also have restrictions on buybacks and dividends, restrictions on executive compensation. They would have limits in how they approached any collective bargaining issues. And there could be a stigma associated with having to tap into those facilities, meaning that you have no other choice, that you're in such dire straits, you needed to accept all of these strings. And if that's the case, the stigma could keep companies that might otherwise need it from using it, which again takes away from the effectiveness of the programs.

Mike Gapen:         Well, I think that's true. If there's naming and shaming involved in the – in the Treasury-lending components and the direct assistance in the CARES Act, then the legislation would be self-defeating in the sense that the firms you want to have take-up that assistance don't have the incentive to do so.

Jeff Meli:              So I have one final critique, Mike, which we haven't talked about, which is the effect on municipalities. The CARES Act doesn't have a lot of help in there for municipals, but between sales taxes, hotel taxes, income taxes we're going to see a significant amount of budget pain at the municipal level.

                              For example, during the GFC, we saw municipal revenues decline by something like 40 percent and our forecast for the aggregate economic pain caused by COVID-19 are roughly on a par with what we saw during the financial crisis.

                              Municipals don't have the ability to deficit finance, and so what we saw during the financial crisis was a dramatic decline in municipal employment, and it took years before that really rebounded. I think the gap in helping municipals is a major hole in the CARES Act and one that the government needs to address.

Mike Gapen:         So, I think that's right. And I would point to Phase 4 is likely where that assistance is coming. So Congress is already discussing a Phase 4 bill which we think will provide some support for states and municipalities to compensate for that lost revenue. And I also think we'll see some support for the healthcare sector in any Phase 4 bill. I think that sector of the economy is also in trouble and is hurting financially and deserves some additional support.

                              But that can be accomplished in a subsequent bill.

Jeff Meli:              Well, that will be the subject of future episode of "The Flip Side."  Thanks for joining me, Mike. Clients of Barclays can read our latest research on the effects of COVID-19 at #virus available on Barclays Live.