Corporate America Knows the Bailout Is Baked In
CoinDesk columnist Nic Carter is partner at Castle Island Ventures, a public blockchain-focused venture fund based in Cambridge, Mass. He is also the cofounder of Coin Metrics, a blockchain analytics startup.
In the year 1730, the Irish-French economist Richard Cantillon described the uneven effect of newly issued money as it enters society. He made two common-sense observations: that money must enter the economy at a specific point of ingress; and that the devaluation which often follows issuance does not happen immediately, but over time, as the economy incorporates the new monetary issue. This means that the first spender has an advantage. Society hasn’t had the chance to recognize that their dollars are worth slightly less yet.
A “Cantillon insider,” consequently, is an individual who is able to monetize their proximity to the printing press. (As far as I can tell, the term was coined by Nick Szabo.) In western countries, inflation-derived handouts typically do not happen transparently, because the population would be scandalized to witness them. Instead, they happen obliquely, and they are justified with recourse to euphemisms in op-eds insisting that the government must do something. So let’s explore specifically how the latest fiscal and monetary outlay – equivalent to 25 percent of one year’s worth of America’s entire productive capacity – is being unevenly distributed. In short:
A stimulus consisting solely of payouts to individuals or households would be far more direct, and much fairer, than the obscure and arbitrary handouts the state has devised instead. Instead, the stimulus is directed towards keeping corporations intact, rather than having them suffer messy liquidations or restructurings.
So do shareholders in these insolvent publicly-traded companies deserve bailouts? Is it possible that they, through no fault of their own, suffered an unfair fate, and deserve to be rescued? To evaluate this, we must consider their capital allocation decisions over the last decade. Overwhelmingly, this involved repurchasing their own stock. While there is nothing inherently wrong with buybacks, they have of late been employed by corporate executives with a gusto which would make Crassus look miserly.
When a company perceives there are no productive projects left to invest in, is it common to distribute some of their earnings to shareholders, either through buybacks or dividends (the former are more popular, as they are tax-advantaged). The other instance when buybacks are defensible is when management believes that the stock price is undervalued. But valuations are not low – they are historically rich, on a relative basis.
And when a company not only dedicates their free cash flow almost entirely to buybacks, but combines it with an insatiable appetite for debt, as virtually the entire corporate sector has done for the last decade, something is clearly amiss.
What our largest corporations have done is trade a short term appreciation in the share price (which rewards executives, who are primarily compensated with stock options), for long-term fragility. Lacking a strong balance sheet buffer, the slightest amount of volatility is sufficient to render a company insolvent.
So why would boardrooms and the C-suite make this trade? Surely they knew that a low-volatility regime could not last forever. Even though the virus was unforeseeable, a crisis (of some kind or another) was not. The best answer I have is they internalized lessons from 2008/09. They guessed that, come an economic slowdown, they would be able to successfully lobby the government for a bailout. And this was a good bet, because our society is allergic to failure, choosing instead to stifle all trouble with the opiate of easy money. We set a lingering precedent in 08/09, and now we have opted to double down on the arrangement.
Now what alternative would I propose, you may ask?
Very simple. Pass legislation allowing standard liquidation or restructuring processes to be expedited, so creditors can take over, companies can be bought at fire sale prices, capital can churn, and the corporate sector can refresh itself, as we start to extricate ourselves from the viral gauntlet. Remember: when companies go bankrupt, their assets do not disappear. The shareholders take a loss and restructuring or a sale occurs. As for the government stimulus, allocate it exclusively to households, so that they can support themselves during a forced lockdown. Make everyday folks, and not corporate shareholders, the Cantillon insiders. If corporations fail, equity holders should bear the necessary cost of their poor governance decisions, creditors should take over, and boardrooms should learn the meaning of risk once again. It will be a lesson they never forget.
What many misunderstand is that this is not primarily a debate about the devaluation of the dollar. It’s entirely possible that we escape inflation – although I expect that now extreme fiscal and monetary operations have been normalized, policymakers won’t want to give up their new toys so easily (see Trump’s plea this week for a new $2 trillion infrastructure plan). No, even if the dollar somehow retains its purchasing power as the U.S. government mortgages itself to the hilt, the distortions will persist.
What is happening now is a straightforward reallocation of society’s resources. The specifics have been well covered elsewhere. We all know that airlines spent 96 percent of their free cash flow on buybacks, and will now be bailed out. We know that executives at bailout-candidate Boeing siphoned $5.4 billion from the company, that dilution veiled through the clever employment of buybacks. All of this while refusing to invest in their fleet, leading to the deaths of 346 innocent souls. Then we have tax breaks to the tune of $170 billion for real estate investors, disproportionately benefiting the wealthy. And of course, we have complete non-sequiturs, like $100 million earmarked “for the arts,” of which $25 million is directed to the Kennedy Center. These are the entities that your government is preferentially rewarding with easy money, under the guise of rescuing the economy.
It’s undeniable that money entering society benefits those with the greatest proximity to the spigot. Honest economists evaluating the government’s stimulus plan should bite the bullet and concede that these distortions are simply the cost that society must bear in exchange for stability, rather than feigning that they don’t exist. They should explain to everyday Americans that their direct handout is minuscule compared to the total size of the stimulus and that Congress prefers corporatism as the dominant organizational mode of society, even if the outcomes are profoundly unfair.
Let me remind you why this is catastrophic for society, and for the genuine capitalist impulse. Bailouts are not one and done. The market remembers. The dangled implicit promise of a bailout creates an institutional environment which selects for the most risk-seeking, pro-lobbying companies. And this isn’t the beginning: what is happening now is the culmination of a system which was entrenched for good in 2009.
Think of the corporate environment like an ecology. Under normal circumstances, companies which unsustainably accumulate debt and return capital to shareholders instead of investing it in the business or retaining it as a buffer enter a fragile state, and suffer adverse consequences when faced with a crisis or shock. Their equity holders may be totally wiped out. However, in the pre-crisis period, they outperform their more conservative peers. The existence of this downside risk is what keeps reckless behavior in check.
If you eliminate the negative consequences of risk-taking, you reward these risk-seeking entities. Now the calculus is different. The companies taking on leverage and refusing to buy insurance (in the form of capital retained on the balance sheet) outperform in the short and long term, as the government writes them a gigantic free put option in the form of a bailout. The message is very clear: failure and risk taking is rewarded and encouraged.
See also: Nic Carter - Policymakers Shouldn’t Fear Digital Money: So Far It’s Maintaining the Dollar’s Status
The consequence is that more restrained businesses, who act responsibly and hedge against tail risks, end up getting outcompeted, as they end up overpaying for insurance that the government is giving out for free. The dominant corporate activity shifts away from innovation, R&D, and CapEx, towards ensuring shareholder equity is protected in a crisis by a watchful, paternalistic state. So this evolutionary environment yields a homogenous set of corporates that are socialized into taking on debt, aggressively returning capital, and devoting energy towards wasteful lobbying efforts. We are left with a quasi-nationalized system.
Standing in the way of the standard insolvency, restructuring, or liquidation processes that undergird effective capitalism is a violation of nature: it arrests the destruction of capital and the revaluation of businesses. Individual mortality is what guarantees the thriving of the collective; conversely, prohibiting failure guarantees the stagnation of the whole. If failure becomes unacceptable, the members of that corporate setting reconfigure themselves to exploit the life-giver, to zombify and stagnate. We simply must permit businesses to fail.
After the government rewarded the directors of insolvent financial institutions during the crisis of 08/09, the best we could muster as a response was a ragtag bunch of protestors in Zuccotti park on the left, and the Tea Party and Ron Paul on the right. Today, these movements have been utterly defanged: there is no party that endorses fiscal responsibility or monetary restraint. Printing, easing, and spending at the expense of tomorrow – these are some of the only shared hobbies of the Ds and the Rs.
The truth is, both parties are profoundly beholden to the managerial class and this zombie-capitalist system that they have incubated. The progressive movement tried valiantly to rid the Democratic party of their corporate influence; they were brutally quashed not once but twice. And the Republicans have scarcely ever resisted the capital-political complex.
Ultimately policymakers will make their choice. But unlike in 2009, the population is more prepared now. Even though we have been temporarily cowed by the virus, the outrage will be no less fierce. The solution lies not within politics, but outside of it altogether: no vote can arrest this slide. The only genuine choice is disassociation altogether.