Written by: Mark Blyth and Eric Lonergan | Foreign Policy
At a time of coronavirus-induced panic in the financial markets, there are two wrong ideas about supporting the economy in a downturn that still haunt us. One possible upside of the current crisis is that these two ideas may finally be buried for good. And when they are, we might use this rare moment of clarity to fundamentally rethink who these markets, and their perennial bailouts, benefit in the first place.
The first of these ideas is that investors, when they decide to buy or sell their assets, are responding rationally to information. That is, markets are “efficient,” and therefore the best way to organize how a society chooses to invest. This idea is challenged by what we have seen in the financial markets over the past two weeks. Panicking investors are responding to uncertainty, not information. Central banks around the world have rightly intervened to try to stabilize markets that have been anything but efficient.
The second is that the best way to deal with a collapse in spending by consumers and companies—such as we face as a result of the coronavirus pandemic—is to restore confidence by cutting government budgets, also known as austerity policies. That governments around the world have rushed to announce emergency spending measures to compensate for a sudden and colossal seizure in economic activity suggests that this bad idea, too, is finally dead.The response so far has been mostly impressive. Why, then, are markets still falling?
Attempts to stabilize the markets began last week. The U.S. Federal Reserve has cut interest rates as low as zero, pumped liquidity into the markets for Treasury bills and commercial credit, and relaxed collateral rules and reserve requirements for banks to keep cash flowing. Congress is now debating not whether to spend, but how much—up to $1 trillion. The executive branch has authorized a payroll tax deferral of 90 days and is planning direct cash transfers to households.
After sitting on its hands last week, the European Central Bank has now announced its own “bazooka”—a 750 billion euro ($800 billion) bond-buying program, looser collateral requirements, a new refinancing program for banks, and an expansion of existing “quantitative easing” programs. Various fiscal spending programs are emerging too.
The most obvious answer is that the fiscal response is not big enough and that more must be done. We think that’s half-right. More must and will be done. But maybe we should return to that first bad idea about the efficiency of markets. Are these markets that we have built—that we are bailing out again with taxpayer money, and that are tanking our savings and retirement plans once again—really fit for their supposed purpose?
One clue that the markets aren’t working for us are those U.S. airlines that are now asking for a $50 billion bailout. Those same airlines spent the past decade abusing customers, charging usurious fees for basic services, and squeezing their employees. They then used almost their entire free cash flow to buy back their own shares, juicing the returns to stockholders and C-suite insiders while leaving the companies themselves financially fragile. Surely their shareholders and management deserve to bear the cost this time around?
The airlines were not alone. Since 2008, the world’s corporations have accumulated debts totaling some $13.5 trillion, as they counted on the Fed and other central banks to keep interest rates near or below zero for the long term. Yet rather than invest the cash they raised in productive investment, including in their employee’s skills, they used most of the cash to buy back their shares and award themselves profits on their options. Why bother with real engineering when financial engineering is so much easier? And now this pile of debt may also have to be bought or guaranteed by the Fed, which is backed by the taxpayer at the end of the day.Why do we continue to aid and abet a small class of insiders using their overleveraged companies to extort bailouts from society?
The result of such largesse and excessive risk-taking was to make the system as a whole extremely vulnerable to a shock. This was the lesson we should have learned in the previous financial crisis—instead, we doubled down. This vulnerability reaches all the way down to the ordinary people our market economies are supposed to serve. In 2016, most Americans still had not rebuilt the wealth they had in 2007. Nearly half of Americans would struggle to get $2,000 together in a crisis, and even a $400 expense could render many insolvent. At the same time, the United States has cut taxes to the tune of $1.5 trillion, almost all of which went to the richest Americans—the same folks who own almost all the stocks and bonds that are now tanking, and who will benefit the most from any bailouts.
Let’s stop for a moment and ask what society needs most at this moment. In fact, let’s ask a more fundamental question: Why do we continue to aid and abet a small class of insiders using their fragile, overleveraged companies to generate their own profits and extort bailouts from society? Should we not fundamentally rethink this perverse social contract, and reform markets so they cannot hurt us this way in the future?
Given this moment of clarity, we should recognize that governments around the world face a crisis that they can turn into an opportunity. As a first step, there is a compelling case for a “post-interest rate” monetary policy that no longer relies on interest rates as a primary lever to influence markets. Specifically, central banks should directly finance government spending and directly finance or underwrite credit to important sectors of the economy.