A decade after the Great Financial Crisis (GFC) and bailouts are once again on the political agenda. Back then, banks all over the world were supplied with government guaranteed liquidity lines and had their capital replenished to prevent systematic risk spreading across the financial system. In the aftermath, the great criticism of the bank bailouts of 2008 and 2009 was the way it socialised the losses incurred by banks who had enjoyed massive profits from the risk taking that eventually brought them to their knees, so, after the GFC, regulators reacted by implementing a myriad of new regulations, all aimed at a singular goal: to reduce the risk banks were able to take, now that it had been clearly demonstrated that too big to fail was indeed a thing and the banks were not allowed to go bankrupt.
Fast forward ten years, and the world finds itself in another crisis of historical proportions. But this time it is not a liquidity crisis in the financial sector, it is a solvency crisis in the real economy. Coronavirus has all but shut down the global economy for the time being, and once it is gradually reopened for business, we will find ourselves in an economic slump to rival the Great Depression of the 1930ies.
While the trigger is a “black swan event” in the form of a global pandemic, the world was set up for a major economic disaster long before most people had ever heard of Wuhan and Coronavirus. The debt bubbles that were the underlying cause of the GFC were never allowed to deflate; on the contrary, central banks have pursued even more ultra-loose monetary policies over the last decade. It’s not just governments that have enjoyed access to an almost unlimited supply of cheap funding, businesses have also taken advantage of historically low borrowing costs to leverage their balance sheets: at the end of 2019, corporate debt in the US was approaching a record £10 trillion, equivalent to almost 50% of US GDP. The business world has mountains of debt and no savings for a rainy day.
And so, today, it’s not the banks, but factories, restaurants and travel agents who are looking for a government handout – and politicians are obliging. Whether it is government funded employee furlough schemes or guaranteed loan schemes, as in the UK, or actual bailouts, as President Trump has all but promised the airlines in the US, it is clear that taxpayers will be providing a safety net for businesses that would otherwise collapse. The global bill will run into trillions of dollars – and as emergency loans will have to paid back to the government, the long-term future of bailed out businesses is far from certain.
It is not difficult to predict what will come next: politicians will want payback and will feel mandated to increase regulatory oversight in ways that were unthinkable just a month ago. The UK already has a blueprint for especially targeted taxation: a bank levy, introduced in 2011, to charge banks for the implicit bailout guarantee they called on in the GFC. Expect higher corporate taxation to hit in the aftermath of the Coronavirus crisis and expect politicians to be creative as they attempt to prevent businesses from leveraging up once again. One thing they are already eying up is stock buybacks. Businesses such a Boeing, who owes $41 billion away to banks and bondholders but bought back £43.4 billion worth of shares over the last decade, are likely to be forced away from such strategies in the future. Could corporations find themselves subject to regulation akin to the capital rules that govern leverage in banks and insurance companies? Don’t rule it out.
Repercussions abound across society. Economic growth stagnates as businesses struggle to grow in an already depressed economy. Unemployment becomes entrenched. Stock market yields plummet, a disaster for pension funds and insurers who need yield on their asset portfolios in order to meet their liability commitments but can’t find it in debt markets with zero interest rates. Where do they turn if stock markets become low yielding as well?
Of course, the only actual remedy to the leverage bonanza is to price money and risk correctly. That requires a complete rethink of the global financial system, away from fiat currency systems with their ultra-loose monetary policies. Interest rates must be allowed to adjust to where they reflect actual supply and demand for money; debt bubbles must be allowed to deflate; the pain endured as the economy adjusts. It’s the same medicines that should have been prescribed after the GFC. It won’t happen this time either.