In its latest effort to keep credit flowing, the Fed has essentially endorsed a dubious practice of adjusted corporate earnings.
The longer the coronavirus crisis runs, the more profound the future changes in U.S. economic life. Globalism could go down, and consumer prices up.
The ability of companies to inflate projections, by for example counting expected savings from a cost-cutting program, is generally legal and an accepted practice. But it can distort the lending process and raises questions about the company’s ability to repay loans. That’s especially crucial now. Unlike the government’s Paycheck Protection Program to help small businesses, the Main Street loans are required to be paid back.
“As the Fed issues alarms about certain assets going forward, it raises the question whether private sector participants will listen to it,” said Nathan Sheets, chief economist at PGIM Fixed Income. That marks a stark contrast with a series of Fed warnings going back to 2013 aimed at reining in risky lending practices. A Fed official in 2018“material loosening of terms and weaknesses in risk management,” particularly in adjustments to Ebitda.
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