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MNI EXCLUSIVE: US May Need New Tools in Bankruptcy Wave

(MNI) WASHINGTON
WASHINGTON (MNI)

U.S. policymakers may need a new set of tools to cope with a wave of bankruptcies including Treasury-backed Fed rescues and perhaps even outright capital infusions, policymakers and former central bank officials told MNI.

Sector-specific problems, most evident in Covid-hit industries like restaurants, entertainment and commercial real estate, could mount in ways that damage the banking system. U.S. corporate bankruptcies have already surpassed the 2008 total in terms of affected firms' total assets -- and summer's not even over.

The inability to process and digest a rush of conflicting and cascading debt claims all at once -- already a strain on the court system in normal times -- could also devolve into a crisis scenario faced with waves of Covid-led Chapter 11 filings, Randall Kroszner, a former Fed governor now at the Chicago Booth School, said in an interview.

"Policy should be focusing on the next wave of the economic consequences, the restructurings that will be necessary," said Kroszner. "The key here is to make sure that if there is a broad mass restructuring in a particular sector that that is contained to that sector and doesn't turn into a challenge for the broader financial system."

Role Reversal

That's a role reversal from the global financial crisis a decade ago where banks had to be rescued to keep credit flowing to sectors outside of the housing market. Fed Chairman Jerome Powell already warned in May that "avoidable household and business insolvencies can weigh on growth for years to come."

"We ought to do what we can to avoid these outcomes," he said.

The Fed may have some tools to address the problem, including the existing legal authority make sure banks can keep lending to "debtor-in-possession" entities in financial distress, those sources said.

The Fed's concerns about bankruptcies are part of a renewed focus on its emergency credit facilities, which itself stems from the realization that early optimism about the chances for a speedy recovery have now largely evaporated.

The limited use of the Fed's existing credit facilities to corporations, states and municipalities as well as small businesses--despite an explicit Treasury backstop of USD450 billion--hints at the troubles the Fed might face in dealing with any bankruptcy logjam.

Pain Only Delayed?

"The main difficulty is that banks don't really suffer from a lack of liquidity -- witness that even the [corporate credit] facility is not much used, and forget Main Street that has its own design problems," Roberto Perli, a former Fed board economist, told Market News.

"Why would they lend more, and to entities in bankruptcy, if the Fed made even more liquidity available, even very cheap?"

And some of the pain on corporations and households has been in many cases merely delayed by a USD2 trillion fiscal stimulus and the Fed's wide-ranging actions.

MNI Washington Bureau | +1 202 371 2121 | pedro.dacosta@marketnews.com
MNI Washington Bureau | +1 202 371 2121 | pedro.dacosta@marketnews.com

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