April 28, 2020 / 3:02 PM / a month ago

Breakingviews - Dixon: Bailouts will store up lots more trouble

LONDON (Reuters Breakingviews) - Struggling individuals, businesses and countries deserve financial support during the pandemic. But let’s not kid ourselves. Taxpayer-funded bailouts are likely to encourage excessive risk-taking in the future and provoke new populist backlashes when the bills need to be paid.

People who lost their jobs are reflected in the door of an Arkansas Workforce Center as they wait in line to file for unemployment following an outbreak of the coronavirus disease (COVID-19), in Fort Smith, Arkansas, U.S. April 6, 2020.

Unlike in 2008, there’s little talk of “moral hazard” as governments shower their economies with cash to cope with lockdowns designed to stop the spread of the coronavirus. After all, those receiving bailouts today were not to blame for the emergence of Covid-19 in the way banks were partly culpable for the previous financial crisis.

But the support packages are so far-reaching that many who don’t meet the obvious definition of poor and deserving will get cash. What’s more, if investors, companies and countries think a sugar daddy will always ride to the rescue, they will take less care to manage their finances conservatively in the future.

CENTRAL BANK PUTS

The vast central bank liquidity programmes are bailing out investors and large enterprises. How else to explain the fact that the S&P 500 Index is only around 15% below its February peak - and is still over four times higher than it was in the depths of the credit crunch - despite the fact that the global economy is receiving its worst clobbering since the Great Depression?

These central bank fire hose operations aren’t cost-free. They anaesthetise investors to risk. We are seeing a new version of the Greenspan and Bernanke “puts”, when previous chairs of the U.S. Federal Reserve stopped stock markets from collapsing.

Remember how the cheap money after the Asian financial crisis helped fuel the dotcom bubble? Or how measures to stop the financial system collapsing after Lehman Brothers went bankrupt let borrowing go through the roof again?

Global debt at the end of 2019 reached $255 trillion, or 322% of gross domestic product, according to the Institute of International Finance. That was 40 percentage points higher than at the onset of the financial crisis. Governments are the biggest source of the increase. Their debt has doubled to $70 trillion since 2007. But non-financial corporations were not far behind, with their borrowing going up 70% to $74 trillion. These numbers will shoot up again as a result of the pandemic, making the world even more vulnerable to the next shock.

REWARDING JUNK

Companies are getting bailed out in three main ways. First, central banks are buying their bonds. The Fed led by Jay Powell is even buying junk bonds, while the European Central Bank, presided over by Christine Lagarde, is under pressure to follow suit.

Second, governments are bailing out high-profile companies. For example, over the weekend, the French and Dutch governments prepared an aid package of up to 11 billion euro for Air France-KLM.

Third, states are guaranteeing bank loans. Germany and Switzerland are underwriting all the new debt. The UK, which initially wanted to guarantee only 80%, this week went the whole hog for the smallest firms because banks didn’t want to hold even 20% of the risk of lending to companies that could easily go bust.

While all this will stop many businesses from being wiped out, it could reward foolish behaviour. After all, private equity companies deliberately loaded up their acquisitions with debt to take advantage of cheap money and tax breaks on interest payments - and airlines have historically relied too much on borrowing and buying back stock. With governments helping them out, they may go back to their old tricks once the crisis is over.

Meanwhile, if banks can make loans without bearing any of the risk, they will have no incentive to conduct due diligence. Zombie firms will be kept alive along with the viable ones.

What’s more, if some countries are more generous than others, their companies may survive while more efficient ones in other countries may go bust. This is particularly concerning in the European Union, because most governments are not as rich as Germany and so can’t match its aid programme.

MAGIC MONEY

These rescue packages are going to cost trillions of dollars. But since most governments’ finances are in poor shape, they themselves need bailouts.

Some countries are directly supporting others. For example, the Group of 20 major economies has agreed to freeze debt service payments for the world’s poorest countries until the end of the year. Meanwhile, EU leaders in April agreed a 540 billion euro package to support struggling European workers, businesses and countries - and started planning a joint recovery fund.

But the central banks are again doing the heaviest lifting, by buying trillions of dollars of government bonds from investors. This makes it possible for the governments to sell new bonds to the market at low interest rates.

All this has a cost. Populists may be tempted to turn to their central banks in the future rather than make difficult choices over how to raise money and spend it wisely. And when one country bails out another, those on the receiving end may not do enough to balance their books - and that could cause resentment in those countries which have ridden to the rescue.

BACK TO NORMALITY?

But there are ways to stop economies getting crushed without storing up too much trouble. One is to ensure those who get cash share the risks. This is roughly what is happening in the EU. For example, Italy is getting most of its help via debt - and the need to pay that back means it can’t throw caution to the winds. Another solution is to make clear that these are one-off rescues. It is, of course, hard to make that sound credible given the world’s recent history of mega-bailouts. But governments and central banks could promise to bring their debt to manageable levels and return monetary policy to normality after the crisis, while weaning companies off their addiction to debt.

Many policymakers argue that the current emergency is so great that we shouldn’t waste time thinking about moral hazard. But if we don’t prepare the ground now, we’ll be in a worse position when the next crisis hits.

Breakingviews

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