Three rules for post- covid corporate rescues.
Canadian bank earnings rolled out last week. Profits were way down because of large provisions set aside for future loan losses. This spells danger ahead for the economy in general but especially for taxpayers, who will be asked to provide financial help to businesses that get in trouble. Now is the time to think through how governments should respond.
After more than two months of governments shutting down much of the economy and also providing massive financial relief, we are taking the first, cautious steps toward a restart. But for some businesses, there will be no return to profitability until people feel safe being close to others. Airlines, retail outlets, hotels and restaurants may never be the same again. Many businesses, some large, many more small, will fail.
A hallmark of any healthy, dynamic economy is frequent business failures. Governments usually stand aside and let these failures proceed, secure in the knowledge that new business creation is equally frequent. But the nature of our current “pandemic recession” suggests the scale and speed of business failures will be like nothing we have seen. The pressure on governments to rescue companies will be enormous.
To avoid both the reality and perception of playing favourites in coming to the aid of any specific company, governments need to be guided by principles. The last major downturn offers some useful lessons. The recession of 2008- 09 began as a financial crisis in which the collapse of a few private banks led to fear the entire banking system might soon fail. Businesses caught in the financial lockdown and unable to refinance their debts began to default. The economy ground to a halt as people and firms stopped spending. Thousands of Canadian businesses closed their doors for good.
In two high- profile cases, Canadian and U. S. governments helped restructure GM and Chrysler. In contrast, despite pleas for government help, Nortel was allowed to fail without taxpayer support. Why did governments support some firms and not others? Three key principles emerged.
The first was that governments would support firms only if their failure posed a risk to the broader economy. In the case of GM and Chrysler, the systemic risk came from their supply chains. The firms that supplied GM and Chrysler were also suppliers to Ford, Honda and Toyota. The concern was that a failure of GM and Chrysler would cascade to their suppliers and through them to the other assemblers. In contrast, Nortel didn’t pose the same supply-chain risk to the broader economy.
The second principle was that firms were not just given “free” money: governments imposed restrictions on them. Taxpayers went to the head of the line for repayment of loans. Equity holders were wiped out, while bondholders received pennies on the dollar. Management was replaced. New business plans required government approval. All of this was possible only as part of court- supervised bankruptcy.
The third principle was that the companies had to demonstrate a clear path toward successful operation without continuing government support. Intervention’s goal was not permanent government involvement but temporary support only until the private firm was back on its feet. With few exceptions, governments are not — and do not want to be — in the business of running businesses.
We should make use of these principles in our current situation.
First, before providing any assistance, governments should be required to make a clear case that there is systemic risk to the economy if a particular firm fails and also demonstrate that all options for private sector support have been exhausted.
Second, whether or not they have already loaned the company money, governments should insist on formal bankruptcy so taxpayers get the maximum security for their support. Taxes are for financing government services, not trying to keep private firms from failing.
Third, governments should recognize that some businesses will not have a realistic path to profitability over the next few years, no matter how much public support they receive now. In such cases, governments should focus on supporting displaced workers while allowing these businesses to die a natural death. This is always difficult for governments to do, but it is crucial.
Given the early- warning signal from bank earnings last week, we should be expecting a wave of business failures in the months ahead. Demands for taxpayer assistance will soon follow. Now is the time for governments to commit to clear principles to guide their response.
Airlines, retail outlets, hotels and restaurants may
never be the same again.