At the beginning of the COVID-19 pandemic, governments around the world implemented a series of measures to contain the spread of the new virus, including international travel bans, quarantines, and business closures. Xue Xiao wondered how the global closure of physical spaces would affect the global economy.
What began as an academic curiosity for the then-PhD student quickly transformed into a quest to understand the larger socio-economic impacts of the world coming to a standstill.
Xiao, now an assistant professor in the Blackwood School of Real Estate, co-authored the study, “Did the Paycheck Protection Program Help Small Businesses? Evidence from Commercial Mortgage-Backed Securities,” delves into the broader economic impact of the U.S. federal government's Paycheck Protection Program during the early stages of the pandemic. By examining the performance of securitized commercial mortgages, the study sheds light on the program's impact on the broader economy as the pandemic caused widespread closures and economic disruption.
Through an analysis of commercial mortgage-backed securities, Xiao and his co-authors estimated that the Paycheck Protection Program prevented $36 billion in mortgage delinquencies in 2020 alone. This lifeline to small businesses rippled across the commercial real estate sector, most notably in the hospitality and retail sectors.
Paycheck Protection Program
In April 2020, the federal government established the Paycheck Protection Program as part of the $2 trillion Coronavirus Aid, Relief, and Economic Security Act, which was intended to provide economic relief to small businesses and certain other entities adversely affected by the pandemic.
The program allowed businesses to apply for low-interest, forgivable private loans to pay for payroll costs, interest, utilities, and rent. Initially, these loans were made in two installments between April and August 2020, resulting in over $525 billion in federal loans being provided in 2020.
Securitized Commercial Mortgages
The emergence of the Paycheck Protection Program offered a ray of hope for a struggling economy, but Xiao and his co-authors recognized that there were potential channels through which the true impact of such policies could extend far beyond direct financial support for small businesses and the labor market, leading to “spillovers” to other sectors of the economy.
“We realized early on that the economic impact of the pandemic was significant, with most physical spaces, from offices to hotels to retail stores, closed,” Xiao says. “We began to worry about the impact the pandemic would have on commercial real estate and the commercial real estate credit market.”
There is little public sentiment against commercial property owners as they are perceived to be very strong financially, but according to Xiao, the group is heavily indebted due to the capital-intensive nature of real estate, making them vulnerable to economic turmoil as most commercial property owners repay their debts with ongoing rental income.
The majority of the debt is held as non-residential commercial mortgage-backed securities (CMBS) loans. CMBS are financial vehicles that bundle mortgages secured by commercial real estate and issued by many lenders into a single trust and sell them to multiple investors in sections, or tranches, with differing risk exposures. CMBS are one of the common channels for providing credit and liquidity to commercial real estate investors.
Spillover effects
Although the Paycheck Protection Program (PPP) explicitly prohibited commercial real estate landlords and investors from participating, there were channels through which its funds indirectly benefited these passive investors. Xiao identified one such channel as the “tenant channel,” in which renters could continue to make rent payments after receiving a loan. This spillover effect, made possible by PPP loans, was measured in Xiao and his co-authors' study.
“The most pronounced impact on delinquency rates occurred in regions that were hardest hit by the pandemic, where banks performed above expectations in providing PPP loans,” Xiao said. “The positive impact on delinquency rates was greater if commercial properties were located in areas more likely to obtain PPP loans.”
Beyond demonstrating the effectiveness of Paycheck Protection Program loans in averting a financial crisis, Xiao's findings underscore the importance of evaluating outcomes beyond short-term goals when assessing the effectiveness of government interventions.
“When analyzing the impact of a program, various aspects other than the primary goal need to be considered,” Xiao said.