U.S. Can Get Bailouts Right This Time
Terms in the financial crisis were too generous to most companies, but at least one rescue offers a promising template.
Bloomberg, March 23, 2020
The prescription was a mix of monetary and fiscal responses, though monetary stimulus did most of the heavy lifting. The worst economic effects eventually subsided and the economy more or less recovered. But the remedies brought with them a heavy dose of unintended consequences: The reliance on monetary policy disproportionately benefited those with capital, leading to big gains in equities and a recovery in residential real estate. Other effects included greater wealth inequality, not to mention the rise of new conspiracy theorists and political opportunists. Around the globe, there was a surge in populism, anti-globalizaton and a disdain for science and expertise.
Today, we have a new crisis, one with roots in the last rescue plan. In fashioning our response to the 2020 Covid-19 pandemic, we should be careful to avoid the mistakes made in haste then. Consider three broad categories of the last crisis’ errors: 1) inadequate fiscal stimulus; 2) lack of support for the social safety net; and 3) overly generous bailouts terms for banks and other companies. All were unpardonable, but for now let’s focus on the third error.
We eventually learned just how much the banks and brokers had leveraged themselves and how little capital they had. Managers across the board had failed to consider the possibility that the good times would end one day. New post-crisis rules were put into place, ensuring banks took less speculative risk and had greater capital reserves. Most of the government bailout money was repaid, though it was not a rewarding investment. And then there were those unintended consequences.
Today, the banks are in better shape, but wide swaths of the rest the economy are in deep trouble: Social-distancing rules mean entire industries have ground to a standstill. No one is buying new houses, building cars or shopping for durable goods. Retail, travel, restaurants, entertainment, tourism are all confronting a business collapse unlike anything experienced since at least World War II.
That’s the bad news. The worse news is that most of these companies have lots of debt, disappearing revenues and no rainy-day funds. They are all starting to come to Uncle Sam looking for a bailout. Just to cite one example, the White House is considering a $50 billion bailout for the airlines, an industry that clearly failed to plan for hard times.
When considering rescuing these companies, we have a variety of past bailouts to select as a template. The bailouts of Citigroup, Wells Fargo, Bank of America were at one end of the spectrum, while the rescue plans for automakers General Motors and Chrysler are at the other end. The American International Group bailout was a more complex, while mortgage giants Fannie Mae and Freddie Mac, which were creatures of government anyway, were essentially nationalized.
Of all the bailout plans of that vintage, the one that made the most sense was the GM rescue. Rather than allow GM to collapse — which surely would have had disastrous consequences — the government instead helped manage a so-called prepackaged bankruptcy.
This turned out to be smart. There was little in the way of panic. There were no mass job losses. The plan adhered to the basic rules of capitalism: when your company is insolvent, it either reorganizes its debts or liquidates. Shareholders were wiped out, bond holders got a haircut, some management was fired and the company was reduced to a sustainable size. GM eventually recovered and went public. The government recouped some of the money it injected into the company when it sold the stake it had taken to facilitate the program. 1
The airlines were not as reckless as the banks, but they certainly were irresponsible with their capital. As Bloomberg News reported Monday, U.S. airlines spent 96% of their free cash flow, or about $12.5 billion, on buybacks. These companies should have planned better and acted more responsibly; instead, they thought the best use of their cash was to reduce their share count and boost their stock prices.
If ever there was a case of moral hazard, this is it: Profitable companies that failed to save money for a downturn now want help from the government. If they get a bailout today, what’s to stop them from being even more reckless in the future, knowing the feds will ride to their rescue?
If we’re going to bail out the airlines, that $50 billion should be in the form of a loan secured by the companies’ physical assets. Then that $12.5 billion of stock they bought back during the past decade gets sold to the government at a 30% discount to the repurchase price or to the current share price, whichever is lower. The industry will kick and scream, but if they can get better terms from what the private-equity funds might offer instead, they should take them.
This is but one troubled sector. Will hotel chains be next? Automakers? Restaurants? The entire economy is suffering from cash-flow problems. How can we bailout one sector but ignore most of the others? And that’s before we discuss small businesses, hourly workers and people in the gig economy.
The least we can do is avoid many of the same errors we made the last time.
1. Many observers prefer the fire sales of Washington Mutual and Bear Stearns to cash-rich buyers.