Corporations plea for relief: beyond the “bail”?
In the wake of further aid for transport firms , Alina McGregor weighs up government bailouts for private corporations.
The reality is that company bailouts give rise to moral hazard. A bailout is financial support to a company or a country facing a potential bankruptcy threat. When fear and uncertainty cause markets to seize up, governments can helps to restore the flow of money and credit. Doing so lays the foundation for a smoother recovery. Due to COVID-19, businesses are continuing to push for a broad freeze on payments to governments and an increase in wage subsidies to avoid mass layoffs. This is definitely a more aggressive approach, but one that is likely needed to avoid another Great Depression; the current approach prioritises speed over perfection.
Bailouts have their known advantages. They ensure continued survival of the unit being rescued under difficult economic circumstances, while a collapse of the financial system can be averted when industries ‘too big to fail’ start to crumble. In these cases, the government steps in to avoid the bankruptcy of businesses that have become integral to our daily lives and the smooth function of society and overall markets.
In the US, the Cares Act allows the Treasury Secretary to spend up to $877 billion in taxpayer money helping corporations, large and small. The Federal Reserve, using money authorised by the Cares Act and through its own initiative, has launched an array of programs to inject even more liquidity into the financial system. This will help companies to access the much-needed credit to survive.
Should bailouts come with conditions designed, for example, to make sure all employees of a business are protected?
But bailouts also have their known disadvantages. Expected bailouts encourage a moral hazard by reassuring not only promoters but also other stakeholders (customers, lenders, suppliers) to take high risks in financial transactions. The assurance is there that when things go wrong, they can simply ask for a bailout of public money and then continue to take on more debt.
After the 2008 financial crisis, moral hazard became a bigger talking point. The public chorus was that in bailing out banks and other financial institutions, the government had saved the very same actors who caused the crisis, which would encourage them to take bigger risks yet again. So we have to then ask, should bailouts come with conditions designed, for example, to make sure all employees of a business are protected?
While this is a similar financial climate to 2008, there is a difference. The virus is a force external to the economic market, unlike the factors which prompted the 2008 crisis. Therefore who to blame and who to hold responsible is harder to discern, though some administrations may beg to differ. This means that the debate about who is responsible and who is not may be best put on hold in favour of deciding the best way to repair the financial system and change it to suit our new needs and ethics.
The decision by many large corporations to take on so much debt in recent years has reduced the capacity of the corporate sector to manage itself. The government might unnecessarily encourage companies and creditors to be even more reckless in the years ahead, and perhaps billionaires should be encouraged to use their own fortune to rescue their own businesses.
Given the massive economic contraction underway (20.4% in April), the government must protect productive enterprises and their employees, but that doesn’t have to entail protecting investors in those enterprises. This brings back the age-old dilemma that it seems we have not yet been able to fix. Those higher up on the economic ladder come away with fewer scratches despite their responsibility in company business. The optimal policy would help businesses in distress get the financing they need to continue operating, while still forcing shareholders and creditors to take losses when appropriate. But governments also now need to prioritise speed over perfection to stop the virus from devastating what has evidently become our global village.