Too Frail to Fail? Fed Tailors Loans for an Ailing Oil Patch

Learn more about NRDC’s response to COVID-19.

At the end of April, specific changes publicly requested by oil interest groups and a group of friendly Senators were included in in the final version of the Federal Reserve’s Main Street lending program, which is authorized under the CARES Act. These changes target and benefit oil companies’ shareholders and bankers.

The changes do not target or benefit the workers in the industry that are suffering. Unlike the better known Paycheck Protection Program, borrowers under the Main Street program have no obligation to use funds to maintain or restore payroll—but only to make “commercially reasonable efforts” to so.

As insisted upon by the industry and its congressional supporters, beneficiaries can now use government funding to repay their debts; and the Fed will evaluate their borrowing capacity based on unaudited EBITDA (i.e. rosy and squishy) calculations of their earnings. These changes are in tension with the Fed’s mandate, the goals of the CARES Act and sound lending practices. If implemented, they are risking public funds on companies that weren’t creditworthy before the COVID pandemic hit.

Well before the COVID crisis, swaths of the oil industry couldn’t profitably compete with international producers, but kept loading up on debt in order to increase uneconomic production in the hope that prices would recover before loans come due. Investors saw through this, spied the other headwinds the industry was facing and were losing confidence.

Last month, too much oil chasing too few buyers sent oil prices below zero for the first time, meaning sellers were paying buyers to take their product. In the ensuing chaos, the oil industry and its allies stealthily sought to slip an industry bailout into the Trojan horse of COVID relief.

Normally, the boom-bust oil herd would be thinned waves of by bankruptcies, tempering risk taking. But this time, the coincidence of the COVID-19 crisis makes the influential industry look too frail to fail, and the bail out may encourage unsound risk taking.

Congress has so far resisted attempts to have the federal government buy up unwanted excess oil, but the Trump administration keeps trying to come up with ways to throw money at this industry.

It’s especially unfortunate that the Fed program looks like the first success in this effort.

The Fed is a critical actor in the economy that many of us take for granted because it usually acts indirectly behind the scenes by influencing the cost of borrowing money and the behavior of banks and investors. A key function of the Fed is to use monetary policy to promote maximum employment, stable prices, and moderate long-term interest rates.

The Fed’s independence is fundamental because its mandate is to support the economy as a whole and over the long term, not to pick winners or losers in terms of companies or industries or to support the electoral strategy of politicians.

Because the mission of keeping the economy humming transcends the short-term interest of politics, Congress gave each Federal Reserve Governor a 14-year term, beyond the reach of shorter electoral cycles. Importantly, the Fed does not rely on Congress for its funding.

Due to its ability to act independently and access to early data on the impacts of COVID-19 on the economy, the Fed was able to act extremely quickly and effectively to stabilize markets, before Congress could put any aid package together. And because of its unique role in promoting functioning financial markets, Congress later entrusted $454 billion appropriated under the CARES Act to set up special lending facilities to ensure that credit markets keep functioning, including the Main Street facilities.

Under the Fed’s emergency authority, these facilities are required to be “broad based” and not targeted to a particular industry. Because the Fed’s is a bank that makes loans, not grants, participants in the programs also must fundamentally be creditworthy—i.e. able to repay their loans.

The Fed hasn’t publicly explained why it made the changes to the Main Street program, but the trajectory is clear. The industry, together lawmakers like Texas Senator Ted Cruz, demanded that the Fed weaken terms of its lending programs so that struggling oil companies could benefit from the support—and the Fed has acted in the way they had requested.

But these changes in the program’s design are not the end of the story. As the program ramps up, the Fed’s independent analysts must ensure that only creditworthy companies get support, and that one industry—i.e. the oil industry—doesn’t get undue support.

And the public has a right to know what is happening with the program—promptly and on an ongoing basis as it evolves. The Fed should fully disclose all loan documents and details and immediately course correct if problems are discovered.

In order to restore our economy, we will need an effective, independent and technocratic Federal Reserve to make crucial decisions. This must be done in a credible and unbiased way, as the Fed has successfully been doing. Looking to tailor programs to specifically bail out oil companies simply cuts the other way.