A Taxonomy of Bailouts: Comparing the Coronavirus Rescues With Rescues Past
Neil Irwin ,The New York Times • March 19, 2020
A week ago, the big question in Washington was: Which industries will be bailed out of their losses because of coronavirus?
This week, the question is: Which industries won’t?
With stunning speed, it has become clear that many mainstays of American industry are facing potentially existential risks from their looming financial losses, and that Congress and the Trump administration are determined to prevent widespread bankruptcies and corporate collapse.
But not all bailouts are equal. There are distinctly different rationales for industry bailouts, each with different implications for how a rescue is (or ought to be) designed and carried out. And the surprisingly rich history of the U.S. government’s stepping in to backstop major companies and industries shows what forms they might take.
In normal times and in most cases, the process for dealing with a company that runs out of money is straightforward. It goes to court and files for bankruptcy protection; shareholders generally get wiped out or close to it; and the business is either restructured (in Chapter 11) or liquidated (in Chapter 13), with whatever is left divided fairly among those the company owed money to.
But for lots of different reasons, and in many different eras, government officials have decided that major companies, or entire industries, needed some form of special treatment.
To understand what form the coronavirus bailouts might take, it’s worth looking at these different rationales and programs, and the lessons they offer. Note that these categories aren’t mutually exclusive, and several past bailouts can fit into more than one.
The Systemic Risk Bailouts
Companies in the financial industry are unlike other companies in important ways. They provide the funding that the rest of the economy relies on, meaning that if financing freezes up en masse, a recession can result. The companies that make up this industry are deeply intertwined through a web of debts and obligations.
As such, they tend to have “systemic risk,” the possibility that the failure of one firm or one key market could ripple through the economy and make everybody worse off. In that case, the usual arguments against bailouts — especially moral hazard, the idea that rewarding firms that made irresponsible bets encourages more irresponsible bets in the future — tend to get pushed aside.
This systemic risk drove the Bush and Obama administrations and the Fed under Ben Bernanke to give emergency loans to AIG; arrange the sale of investment bank Bear Stearns; and invest money on favorable terms in hundreds of banks, starting with the handful of giant “too big to fail” institutions like Citigroup and Bank of America.
These actions were deeply unpopular, but they succeeded in stabilizing the financial system and helping to end the financial crisis. And they turned out to be profitable for taxpayers, as the investments in question ended up making about $15 billion.
Many of the industries being discussed as possible recipients of coronavirus bailouts don’t have the same systemic issues. If a hotel chain or cruise line goes bankrupt, it will hurt employees, creditors and shareholders of that company, but probably not the broader economy.
The current efforts to shore up the financial system have more to do with systemic risk. With many lending markets freezing up as investors and companies hoard cash, the Fed has already announced a program to fund commercial paper — a form of short-term borrowing used by companies in a range of industries.
The way things are going, the Fed will most likely consider other efforts that would amount to subsidies of other forms of lending, such as to state and local governments and corporations large and small. It is a recognition that allowing those markets to falter can cause broad economic damage far beyond that experienced by any one company facing tough credit.
The Act of God Bailouts
When the terrorist attacks of Sept. 11, 2001, caused the air travel industry to shut down for a time, creating enormous losses, one option would have been to allow major airlines to go into bankruptcy and restructure.
Instead, Congress and the George W. Bush administration decided to offer $7 billion in grants and loan guarantees to prevent bankruptcies. The logic behind the action was straightforward: The airlines were innocent victims of the terrorist attacks, and the government ought to stand behind them to prevent their unnecessary failure.
It’s the corporate equivalent of disaster relief. When a hurricane decimates a state, the federal government sends billions in aid to help the area get on its feet.
This rationale could end up applying to numerous industries in the current situation, including the airlines (again), cruise lines, hotels, restaurants and others being shut down by forces far beyond their control.
The ‘Economic Pain Is Too Great’ Bailouts
With the economy in free fall in late 2008 and 2009, the automobile industry was on the brink. The Big Three American automakers had built too much manufacturing capacity and had unsustainable contracts with their labor unions and auto dealers, just as demand for cars collapsed.
In theory, auto companies could go bankrupt and come out the other side as leaner, more efficient versions of themselves. But the Obama administration worried that because of the freeze-up in global credit markets, automakers would be unable to obtain the financing that normally allows companies to keep operating during a restructuring.
The fear was that General Motors, Chrysler and Ford would instead collapse, bringing down thousands of suppliers and millions of jobs with them — during what was already a severe recession.
So they directed funds from the bank bailout toward loans to help GM and Chrysler through a restructuring. It was hardly a free lunch for the automakers. Both went through a Chapter 11 bankruptcy, autoworkers unions agreed to restructured contracts, and the companies were allowed to end onerous contracts with dealers. But the industry stayed open for business.
This kind of bailout can apply even to companies that have some culpability in their difficulties — like the auto companies that made plenty of mistakes, and were helped out anyway because the cost of not doing so would have been so great.
Expect to see this rationale used extensively in coming debates, with companies of all types seeking federal assistance by arguing that otherwise they will have to cut more jobs or shut down entirely.
The National Security Bailouts
In 1971, Lockheed had made a series of ill-advised decisions, making overpriced planes for which there was little demand. Facing bankruptcy, its leaders sought a rescue from Congress.
A key part of their argument: The demise of the nation’s largest defense contractor and maker of airframes would threaten national security, eliminating supplies the Pentagon needed during the Vietnam War.
That argument was enough to secure a $250 million loan guarantee, despite the strategic errors by the company that led to that predicament.
It sounds remarkably similar to the situation facing now Boeing, the nation’s premier aerospace company. It was already facing a crisis from its crash-prone 737 MAX plane. And now its main customers, airlines, are canceling orders and mothballing existing planes, threatening to cause its revenue to plummet in the coming months.
If Boeing finds itself in a financial hole, expect to hear a national security argument for saving it, given that it is the United States’ second-biggest defense contractor. No. 1? That would be Lockheed Martin, the descendant of the firm President Richard Nixon bailed out five decades ago.
The Obligatory Bailout
Sometimes the government has less leeway than it might seem.
When Fannie Mae and Freddie Mac experienced huge losses on faltering mortgage loans in 2008, the Bush administration certainly didn’t want to let them fall victim to the whims of the marketplace. But it also didn’t have much choice.
Those firms were “government sponsored enterprises,” entities that may have lacked an explicit legal guarantee, but existed in a gray area where federal backing was widely assumed by owners of the firms’ debts. If the administration had allowed them to go bankrupt, it could well have caused global investors to question the credibility of the United States to honor its obligations.
Sometimes, in other words, the government can find itself on the hook for a bailout through the curious sequence of events in which there is an explicit or implicit legal obligation to cover some losses.
It’s hard to think of any parallel bailouts-of-obligation under discussion so far in the coronavirus crisis. But in a fast-moving situation that will affect nearly every worker and corner of the economy, it wouldn’t be a shock if some government or quasi-government agency ends up in the line for help as well.
This article originally appeared in The New York Times.
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