Wharton Finance Faculty Research

Can the COVID Bailouts Save the Economy

Vadim Elenev, Tim Landvoigt, Stijn Van Nieuwerburgh
Wharton working paper

  • This paper studies the effectiveness of policy interventions in the corporate debt market prompted by the COVID-19 crisis. The authors use a macroeconomic model mirroring actual programs that U.S. policymakers have already enacted, to stave off the worst effects of the pandemic on the U.S. economy. These programs include purchases of corporate bonds targeting large firms, such as the Federal Reserve’s Corporate Credit Facilities, and direct (forgivable) loans to small firms such as the Paycheck Protection Program.
  • The model shows that the direct lending programs are successful at reducing the number of corporate bankruptcies and mitigating the decline in corporate investment that COVID-19 is precipitating, thus tempering the economic fallout. By comparison, a large bond purchasing program in isolation is much less effective.
  • Looking at the programs in combination (i.e., the real-world scenario) shows that together, they offer a “potent cocktail” for mitigating COVID-19’s economic consequences. By the end of 2020, when the programs are fully rolled out, the model indicates that corporate defaults and losses will be reduced by 40%, bank bankruptcies by 80%, and bank net losses by 50%, compared to a “do nothing” scenario. Credit spreads will rise significantly less than in do-nothing scenario. With a lower cost of debt, corporate investment will decline by 41%, instead of by 70% absent any policy interventions.
  • The analysis also considers a hypothetical policy intervention: a better targeted loan program, which would support only firms deemed most likely to default if they do not receive a temporary loan. Such a program would be even more effective at eliminating corporate default and protecting the banking sector, and would be less costly for the government, but would be much harder to implement.
  • An extension of the model considers a world in which similar pandemic shocks could recur in the future. The model predicts that this “new normal” economy is permanently smaller.