personal finance

Moral hazard, again


As the “stimulus” package for Covid-19 rolls out, and it becomes clear that it doesn’t include the proper checks on corporate behaviour that it should, including limits on firing employees and giving bonus money to the C-suite, I’m becoming increasingly worried that we are right back to where we were in 2008-09 — with large corporations and investors favoured over small businesses and individuals who are feeling so much pain right now.

Everyone seems to have forgotten that this is what brought us the political paradigm we have today. I was struck, for example, by a scoop last week from some of my colleagues on how US private equity groups were seeking access to small business rescue loans.

A couple of high-level investor sources have told me that they expect private equity groups to be hit hard because of bad bets they made on assets that were essentially plays on the ability of working people to repay debt obligations — not only on homes, but also on things like cars or motorcycles, and such like. The algorithmic investing models used to make such bets simply don’t account for the possibility that all the borrowers represented in a single security might renege on debt obligations all at once — such models would consider even a 10 per cent default rate a black swan event.

There is grim irony in the fact that some of the wealthiest people in the country, people who made their money on debt and leverage, bet wrongly on the ability of the less fortunate to pay back loans, and are now asking for bailouts because of it. Needless to say, they shouldn’t be able to turn back the rules that prevent private equity backed shell companies from accessing public aid in this emergency. Ed, I’m curious what outrages you most of all about the Covid-19 pandemic right now? Or conversely, what parts of the current crisis do we worry too much about?

There is also a bigger point here, which is that Wall Street and Main Street are finally converging after decades of moving apart. I had a fascinating conversation recently with Patrick “Duke” Dujakovich, president of the Greater Kansas City branch of the American Federation of Labor and Congress of Industrial Organizations. He served at one point on the Federal Reserve’s community advisory council, which brings together a diverse group of voices to provide central bankers with a sharper sense of what’s happening on Main Street.

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As he told me, most people making financial policy (not to mention doing financial speculation) don’t have a clear sense of how working people think about money — and I mean working people, not the truly poor. “In a crisis, people will think, what will kill me first?” says Dujakovich.

They will then select from among the multitude of bills they have what to pay first (or not at all). Since they’ve usually lived pay cheque to pay cheque for their entire lives, they can predict to the day how long it will take to foreclose on a home, or repossess a car. “Banks might say they don’t have any subprime loans,” he says, “and maybe they don’t, officially.” But that can change when someone with a steady job who looks good on paper gets laid off and suddenly has to make those choices.

I can’t help but wonder if the folks at the epicentre of today’s market turmoil, many of whom made big bets on now troubled loans, think about that. If they didn’t before, I bet they will before it’s over. The Covid-19 crisis didn’t start on Wall Street, but it will continue to resonate there, as corporations and investors struggle with the implications of a real economy emergency that is likely to require many more bailouts, and much higher levels of public debt. That may not matter right now. But it will at some point — on both Wall Street and Main Street.

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Recommended reading

  • On that note, debt jubilees have been done for thousands of years. Are we headed towards another one? Some economists say yes. I will explore that possibility and its ramifications in a future column.

  • At a time when so many people believe we are in the post-American age, Ruchir Sharma makes a powerful counterargument. I don’t agree with all his assumptions, but the piece is definitely worth a read.

  • And of course, the FT continues to do terrific work around the coronavirus and all its implications — some of my favourite pieces from the past week include Camilla Cavendish’s piece about UK universities looking for bailouts after becoming overleveraged (this will happen in the US too since colleges have pursued exactly the same strategy), Tim Harford’s piece on the value of a life and in the TMI category, how to colour your own hair at home.

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Edward Luce responds

I share your concern about a repeat of 2008. Central banks and treasury departments around the world are pumping hundreds of billions of dollars into the financial sector with an emphasis on speed over probity. Alacrity is critical. But the potential for things to go wrong is manifold and profound. I don’t need to emphasise just how badly the aftermath of 2008 further eroded trust in America’s system of government (and other democracies as well). I worry deeply that we may be seeding a repeat of that today.

Big financial players know how to make the system work in their favour. America’s already thinly-stretched regulators are also working from home. 
In contrast, many small businesses are reportedly facing great difficulty in securing emergency lending from the Small Business Administration’s $350bn fund because of lenders’ uncertainty about the rules. Some banks will not extend cash to small business account holders that have no prior history of borrowing from them. They will only lend to businesses on which they’ve already done their due diligence, which takes time. This is highly problematic. It is small businesses that are being hit hardest and whose capital is drying up quickest. We should not be penalising them for a history of low or zero indebtedness. 

The more we in the media scrutinise this, the better. At some point, Congress will need to enact a fourth stimulus package after the $2.2tn one it passed last month. The latter will only tide people over for a few weeks. Compared to the alternatives, the bill could have been a lot worse. However, Donald Trump has made it clear that the inspector-general overseeing the disbursment of the $445bn Treasury-managed corporate fund will be answerable only to him, not to Congress. That is unacceptable. Congress must win that fight and ensure that someone other than Brian Miller, the White House impeachment lawyer whom Trump has nominated, takes the job. The battle over who takes that job — and with what responsibilities — will be the canary in the coal mine. 

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Your feedback

And now a word from our Swampians… 

In response to Let’s keep God out of it, shall we?
“Edward II, Richard II, Charles I all thought they were appointed by God and look what happened to them…That aside, God may have been involved in directing Fleming to Penicillin and may have directed doctors to vaccinations but He is not going to go ‘zap, bye bye virus you are all forgiven go back to your old ways.’ Our churches here are shut and some of them are finally embracing the online community. I don’t think there can be one person out there who considers the closures as ill advised.” — Lesley Stevens, former investment banker, Southampton, UK

“Political power is important to the evangelical movement because it has been marginalized by dominance of intellectual and scientific thought. Hence the support of Trump who openly advances a number of issues of importance to evangelicals. Hence the cynical assertion of this point of view that the current pandemic is punishment for our errant behavior by those supporting Trump from a public platform. Facts are stubborn though. When infection rates in red state congregations soar, it will be hard to spin.” — Neil Winward, managing director, Strategic Solutions of ORIX Corporation USA

We’d love to hear from you. You can email the team on swampnotes@ft.com, contact Ed on edward.luce@ft.com and Rana on rana.foroohar@ft.com, and follow them on Twitter at @RanaForoohar and @EdwardGLuce. We may feature an excerpt of your response in the next newsletter.





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