Corporate rescues should come with strings attached

Regulators should apply lessons learnt in 2008 from saving the banks

Patrick Jenkins

Ingram Pinn’s illustration of Patrick Jenkins column ‘Corporate rescues should come with strings attached’
© Ingram Pinn/Financial Times

If 2008 was the year of the bank rescue, 2020 is the year of the corporate bailout. As the macroeconomic repercussions of the coronavirus crisis begin to trump the health emergency, much has been made of the spiralling cost of saving swaths of the corporate world — a bill that dwarfs the bank bailouts. What no one is really talking about yet is the quid pro quo.

The popular backlash is certainly tame so far: a bit of sniping about companies paying executives or shareholders too generously, while accepting government furlough payments.

The policymaker backlash is less evident still. The idea that companies might have made themselves vulnerable to disaster through aggressive management, or that shareholders or regulators should intervene to de-risk them, has not even been raised. It should be.

By contrast, when world leaders bailed out the banks in 2008 with cheap funding and government equity, there was an outcry. Logical though the rescues were, because commerce as a whole cannot function without a banking system, there was a widespread perception that hundreds of billions of dollars had been handed to the undeserving rich.

The Occupy Wall Street protest movement was spawned. And the societal inequality that was compounded by the crash, and the policy response to it, spurred populist politicians across the western world.

There were injustices in the 2008 bailouts. Unscrupulous bankers did their reputations no favours by securing large bonus payouts when the ink was barely dry on the bailout cheques.

Many bank bosses, unhumbled by the bust-and-bailout experience, just redoubled their clout atop expanded institutions.

But for all the frustrated popular outrage, there was, as any banker would tell you, a significant programme of payback via the regulatory crackdown that followed.

Most banks are inherently leveraged institutions: they fund their lending by borrowing money — from depositors, bond markets and elsewhere. Very little of the money used in their operations is actually loss-absorbing shareholder equity.

In the boom years before the crash, banks and those who set their terms of trade had become blind to the growing risks that this created. By 2008, according to the Federal Reserve, the proportion of assets backed by equity capital had fallen below 5 per cent at the big US banks.

By last year, as regulators around the world toughened banks’ capital requirements, that US ratio had risen to 9 per cent.

Another post-crisis reform was to insist on closer ongoing scrutiny, particularly through the application of regular stress tests. Disaster scenarios are run through banks’ books to ensure buffers are strong enough.

A third area of regulatory tightening, applied most rigorously in the UK, involved new regimes to hold managers to account.Latest Coronavirus news
 The Covid-19 crisis will be a big test of these new regulations, as the full force of economic decline and mass unemployment weighs on banks’ balance sheets in the months and years ahead. However deep the recession proves to be, it is clear that banks are far better buffered than they were going into the global financial crisis — and may yet come through this one more or less intact.

Many companies will not — and for the same underlying reason that banks failed in 2008: excessive leverage. It is easy to dismiss the pandemic as a freak event that no one could have foreseen. But the triggers of most crises are unpredictable. The key is to be able to withstand the storm.

Corporate leverage is not just about aggressive financing. The whole system of corporate “best practice”, involving just-in-time deliveries, minimal inventory and the use of gig workers in place of expensive permanent staff, is an exercise in operational leverage.

Add to that the growing financial gearing evident across the corporate world. According to Goldman Sachs, the ratio of net debt to operating profits across the S&P 500 has soared to nearly 2.2, more than double the 2008 level, when finance companies are excluded. Corporate leverage will have spiked far higher given the collapse in profits and extra debt taken on during the coronavirus crisis.

On January 7 this year, the Banque de France published a paper about the systemic risk posed by large companies and their increasing indebtedness — the same day incidentally that scientists in China isolated the new coronavirus.

Few could have imagined the extent of the global public health emergency and economic crisis that Covid-19 would unleash. But the vulnerability of the corporate world was obvious to anyone who paused to think, as France’s central bank did.

“To what extent can high debt levels among certain firms be considered a source of systemic risk?” its paper asked.

The study endorsed an earlier decision by French financial regulators to limit big banks’ exposure to the most indebted companies, on grounds of systemic risk. Other markets have a less interventionist culture. But it may be both feasible and desirable to go further than the French.

Bank regulation was toughened when it became clear that public funds were needed to prop up a systemically vital sector. Now companies have been granted a similar handout, and been proved systemically vital as employers and drivers of the economy, there is a strong argument to take a similar regulatory approach: curtail aggressive leverage, stress test regularly and hold managers accountable.

Beethoven and Now

Thoughts In and Around Geopolitics

By: George Friedman

I know nothing about music. I can’t play an instrument, nor can I read music. My singing appalls even me. Yet music has defined my life.

When I hear a song it conjures in me, as it does in others, a particular place on a particular night with a particular person.

Or it conjures a phase of my life. Cyndi Lauper’s songs remind me of the time when I said to hell with duty. “Girls Just Want to Have Fun” is gender neutral.

Edith Piaf’s “Non, Je Ne Regrette Rien” – “No, I Do Not Regret Anything” – reminds me of a thing that had to be done but ought not to have been done. When I hear the Christian hymn “Let There Be Peace on Earth,” I think of my wife and the choices we’ve had to make.

Music is the sound that happens to be permanently linked to a memory, and the memory fixed to an emotion that I felt then. The emotions can be exuberant or thoughtful, but they are always tinged with sadness. They all speak of the past that I cannot forget but cannot relive.

I discovered the music that will always remind me of this time: Beethoven’s “Pathetique.” It is a somber piece but not sad. It tells me that time is not of the essence, and it invites me to think deeply, or as deeply as I can.

And then it breaks into a tempo, with a sound that admits that time is of course of the essence.

And then it breaks into a strange celebration of life, not of its finitude but of the passions that should be embedded there.

Today, time has slowed, and our mood is somber. Thanks to quarantine measures imposed because of the COVID-19 pandemic, we live the same day over and over again until we cannot remember what day it is. We search for an exit, but there is none. We look for something different only to discover that mere difference doesn’t redeem the day.

The sense of rebellion we feel subsides, and we accept that time isn’t of the essence any longer.

But, of course, it is. It is not simply that life is short, but that it has so much to offer. And then you learn to celebrate the things you cannot have now, but in that celebration, as Beethoven teaches, there arises a sense of being that is distinct from doing.

You are drawn into yourself, and find the music that Beethoven tried to teach us. “Pathetique” is far from the pathetic. It is an invitation to see that the somber is the preface to the joyous, but that the work and discipline to achieve that is more difficult than contemplating the status of the Chinese navy. The latter has rules. Beethoven demands that you make your own rules.

That seems to me to be the nature of our moment. We do not know whether it will be long or short. It is in this moment that we live, and the music of the beginning is not that of the end.

This is a difficult and even terrible time. Arguing that it is not as bad as this or that moment is pointless. The moment in which we are living is what matters. The worst part of it is that we didn’t choose it; it chose us, and that is outrageous.

The issue facing us we know how to resist: by not going outside and living with the consequences. But even then we are helpless. Courage won’t save us, and fear really doesn’t protect us.

Beethoven has the virtue of being accessible to those without learning or even taste in music, such as myself. The opening to "Symphony No. 5" fills me with a dreadful anticipation.

"Symphony No. 9" and its "Ode to Joy" remind of the moments of delirious happiness before revolutions turn into monstrosities.

“Moonlight Sonata” draws out the rare moments that make a love affair a moment of redemption. And "Pathetique" reassures us that ennui and sorrow are a preface to triumph – and that is for me the music of this moment.

The virtue of feelings is that no one can tell us that we are wrong. What we feel is what we feel.

The virtue of Beethoven, for me, is that he evokes feeling, where there is much music that I can’t understand. I take meaning from The Doors because they remind me of a night I treasure.

But these are merely reactions. I rarely have time to consider these things. But now there is time, and that has transformed living.

One of the singular characteristics of the moment is that there is time, time in excess of what we might be able to bear. For some, this time is a period of reprieve from a life of endless urgency and activity. For them, this time may be a gift, a time to be free from the constraints of the urgent, to the consideration of the urgent. It is also a dangerous time.

With endless empty days, we have a chance to confront who we are and what we have been and what, because of the choices we made, we will never do. We may also confront, with our significant others, what we have been together, the answer to which may be the discovery of mutual loathing or the rebirth of the joy we once felt.

As humanity suffers from a host of maladies, this may sound like narcissism, but it is merely the inevitable outcome of the cessation of happening that these past few months have brought us, and which will likely continue for a long time. Our civilization has been built around doing, and doing is seen as a sign of our success.

Those who had failed in life were thought not to be busy. Those who were busy were in demand, and the demand for our time was affirmation of our worth.

Many of us remain busy today, but even the busiest among us have had the pattern of our lives changed. Most of us thrive in social life, be it tennis, dinner parties or getting drunk together.

Those moments now carry with them the possibility of disease and death, so we avoid them.

And so even for those who eagerly await a teleconference, time has changed its shape. More precisely, time has emerged, demanding that we fill it.

Importantly, this emergence of time is greater for the older than the younger among us, especially for the younger who have children who never cease to devour every moment. But for those who never had children or whose children now need little from their parents, their lives have vast gaps in them.

Beethoven is making a vital point. Life is difficult and tedious, and for many of us it will always be that. We all long to be free of constraints, to shape our lives, but that is an illusion. The most brilliant investor makes his money by aligning his actions with the market. Generals align their orders with the reality of the enemy they are facing.

Doctors align with the reality of nature. The brilliant can see what must be done before others, but in the end they are no more free for that. They are held in the constraints of the beginning of the “Pathetique” like anyone else.

They live life by its own rules.

When I play the songs I remember, and think of the things I was doing at the time, I realize what I didn’t know then: When I broke free of all responsibility, the constraints of life dictated the exit and the return.

When I heard Edith Piaf regretting nothing, regrets were too late. And when I heard the alien sounds of Protestant hymns and wondered whether I could live with them, the decision had already been made and there could be no other answer.

This is not a sense of helplessness. As the last movement of the “Pathetique” makes clear, the logical necessity of the music takes us to the logical necessity of our lives and times. What we feel does not matter to a virus. But it matters to us.

This for now is our life, and Beethoven is inviting us to listen to Cyndi Lauper. We may not be able to do what she says, but we can think, and that thought can be enough.

Long live Jay Powell, the new monarch of the bond market

Scale of central bank action to fight pandemic emblematic of profound shift

Robin Wigglesworth

US Federal Reserve chair Jay Powell on a school visit last year. Interventions in bond markets are becoming more heavy-handed in successive crises © AP

Move over Bill Gross. Get outta here Jeffrey Gundlach.

There’s a new bond king in town. Over the years there have been many pretenders to the crown once worn by Pimco’s founder.

But the new monarch of the bond market is undoubtedly Jay Powell, head of the Federal Reserve.

Led by the Fed, central banks have now committed $17tn to fight the economic devastation wrought by the coronavirus pandemic, according to estimates from JPMorgan Asset Management.

That even overshadows the scale of measures taken through the entirety of the financial crisis in 2008-09.

The aggressiveness has led some investors to declare that central banks have in practice nationalised the bond market — fears the Fed chairman sought to allay in Congressional testimony last week.

“I don’t see us as wanting to run through the bond market like an elephant or snuff out price signals,” Mr Powell said.

Whatever Mr Powell may say, the Fed elephant has been doing a tap-dance all over markets.

Just last week, the average yield of US investment-grade corporate bonds hit the lowest ever level, at a time when many companies are seeing their revenues shredded. This may be a shortlived recession, but even optimistic economists reckon it could take years before activity is back at the levels reported when the last bond yield low was seen in early February.

This is natural. The Fed’s $250bn planned purchase of corporate debt alone is nearly as big as Mr Gross’s famous Total Return Fund was at its peak in 2013.

The US central bank’s balance sheet has since March grown by almost $2tn, more than Pimco’s entire assets under management. The enormity reflects the scale of the coronavirus crisis.

But perhaps more importantly, it is also emblematic of a profound but under-appreciated shift in the financial system, the consequences of which we are now starting to realise.

Banks have since their emergence in Renaissance Italy been the central locus of capitalism, the dominant lenders to people, companies and countries around the world.

But the bond market now accounts for well over half of all global debt, according to the Bank for International Settlements.

The magic of securitisation means that virtually any loan can now be packaged into a bond and sold on to investors.

This is a secular trend that shows no sign of slowing down. And for the most part this is a healthy development.

Capital markets are in many respects a better warehouse for the financial risk that any loan represents. When there are issues it doesn’t imperil depositors, or the functioning of the payment system that banks still dominate. But it also has major implications for the conduct of monetary policy — especially at times of crisis.

Central banks were originally set up to backstop commercial lenders and eventually began regulating the level of economic activity by controlling the price of their funding.

But the increasing importance of the bond market means that they have had to dabble far more in what would once have been considered radically unorthodox areas.

Think of central banks as old-school mechanics, but the current financial system as a modern Tesla. They may be able to pop the hood and do rudimentary repairs, but when a Tesla breaks down you’ll probably need an electrical engineer to understand the problem.

Similarly, to fix economic crises today, it is not enough to merely open the spigots to commercial banks. Central banks have to dive deep into the plumbing of the bond market to ensure that they are functioning properly.

Of course, the Fed has often intervened in markets in past crises. But the scale was humdrum compared with what we have seen this year. Although Covid-19 has been an exceptionally abrupt and brutal shock, we are likely to see more heavy-handed bond market interventions in any future downturns as well.

The result may well be far more political scrutiny and regulatory control of various parts of the fixed income industry. If banks had to accept more onerous shackles in return for their rescue in 2008, it makes sense that bond funds — which have now enjoyed an indirect bailout — are also subject to more control.

More immediately, the next natural step may be for the Fed to follow the Bank of Japan in instituting “yield curve control” — in other words dictating a specific target or ceiling for long-term Treasury yields and vowing to buy an unlimited amount of US government debt to keep it there.

Whatever happens in the short term, though, the Fed’s reign over the bond market is from now on likely to be even more total, and potentially permanent.

The COVID Shock to the Dollar

No country can afford to squander its saving potential – ultimately, the seed-corn of long-term economic growth. That’s true even of the United States, where generations of policymakers have come to regard the long-standing belief in American exceptionalism as though it applied to the laws of economics.

Stephen S. Roach

roach117_sefa ozelGetty Images_useconomygraph

NEW HAVEN – Pandemic time runs at warp speed. That’s true of the COVID-19 infection rate, as well as the unprecedented scientific efforts under way to find a vaccine. It is also true of transformational developments currently playing out in pandemic-affected economies.

Just as a lockdown-induced recession brought global economic activity to a virtual standstill in a mere two months, hopes for a V-shaped recovery are premised on an equally quick reopening of shuttered economies.

It may not be so simple. A sudden stop – long associated with capital flight out of emerging markets – often exposes deep-rooted structural problems that can impair economic recovery. It can also spark abrupt asset-price movements in response to the unmasking of long-simmering imbalances.

Such is the case for the pandemic-stricken US economy. The aggressive fiscal response to the COVID-19 shock is not without major consequences. Contrary to the widespread belief that budget deficits don’t matter because near-zero interest rates temper any increases in debt-servicing costs, in the end there is no “magic money” or free lunch.

Domestic saving, already depressed, is headed deep into negative territory. This is likely to lead to a record current-account deficit and an outsize plunge in the value of the dollar.

No country can afford to squander its saving potential – ultimately, the seed-corn of long-term economic growth. That’s true even of the United States, where the laws of economics have often been ignored under the guise of “American exceptionalism.”

Alas, nothing is forever. The COVID-19 crisis is an especially tough blow for a country that has long been operating on a razor-thin margin of subpar saving.

Heading into the pandemic, America’s net domestic saving rate – the combined depreciation-adjusted saving of households, businesses, and the government sector – stood at just 1.4% of national income, falling back to the post-crisis low of late 2011. No need to worry, goes the conventional excuse – America never saves.

Think again. The net national saving rate averaged 7% over the 45-year period from 1960 to 2005. And during the 1960s, long recognized as the strongest period of productivity-led US economic growth in the post-World War II era, the net saving rate actually averaged 11.5%.

Expressing these calculations in net terms is no trivial adjustment. Although gross domestic saving in the first quarter of 2020, at 17.8% of national income, was also well below its 45-year norm of 21% from 1960 to 2005, the shortfall was not as severe as that captured by the net measure. That reflects another worrisome development: America’s rapidly aging and increasingly obsolete stock of productive capital.

That’s where the current account and the dollar come into play. Lacking in saving and wanting to invest and grow, the US typically borrows surplus saving from abroad, and runs chronic current-account deficits in order to attract the foreign capital. Thanks to the US dollar’s “exorbitant privilege” as the world’s dominant reserve currency, this borrowing is normally funded on extremely attractive terms, largely absent any interest-rate or exchange-rate concessions that might otherwise be needed to compensate foreign investors for risk.

That was then. In COVID time, there is no conventional wisdom.

The US Congress has moved with uncharacteristic speed to provide relief amid a record-setting economic free-fall. The Congressional Budget Office expects unprecedented federal budget deficits averaging 14% of GDP over 2020-21. And, notwithstanding contentious political debate, additional fiscal measures are quite likely. As a result, the net domestic saving rate should be pushed deep into negative territory.

This has happened only once before: during and immediately after the 2008-09 global financial crisis, when net national saving averaged -1.8% of national income from the second quarter of 2008 to the second quarter of 2010, while federal budget deficits averaged 10% of GDP.

In the COVID-19 era, the net national saving rate could well plunge as low as -5% to -10% over the next 2-3 years. That means today’s saving-short US economy could well be headed for a significant partial liquidation of net saving.

With unprecedented pressure on domestic saving likely to magnify America’s need for surplus foreign capital, the current-account deficit should widen sharply. Since 1982, this broad measure of the external balance has recorded deficits averaging 2.7% of GDP; looking ahead, the previous record deficit of 6.3% of GDP in the fourth quarter of 2005 could be eclipsed.

This raises one of the biggest questions of all: Will foreign investors demand concessions to provide the massive increment of foreign capital that America’s saving-short economy is about to require?

The answer depends critically on whether the US deserves to retain its exorbitant privilege.

That is not a new debate. What is new is the COVID time warp: the verdict may be rendered sooner rather than later.

America is leading the charge into protectionism, deglobalization, and decoupling. Its share of world foreign-exchange reserves has fallen from a little over 70% in 2000 to a little less than 60% today. Its COVID-19 containment has been an abysmal failure. And its history of systemic racism and police violence has sparked a transformative wave of civil unrest.

Against this background, especially when compared with other major economies, it seems reasonable to conclude that hyperextended saving and current-account imbalances will finally have actionable consequences for the dollar and/or US interest rates.

To the extent that the inflation response lags, and the Federal Reserve maintains its extraordinarily accommodative monetary-policy stance, the bulk of the concession should occur through the currency rather than interest rates. Hence, I foresee a 35% drop in the broad dollar index over the next 2-3 years.

Shocking as that sounds, such a seemingly outsize drop in the dollar is not without historical precedent. The dollar’s real effective exchange rate fell by 33% between 1970 and 1978, by 33% from 1985 to 1988, and by 28% over the 2002-11 interval. COVID-19 may have spread from China, but the COVID currency shock looks like it will be made in America.

Stephen S. Roach, a faculty member at Yale University and former Chairman of Morgan Stanley Asia, is the author of Unbalanced: The Codependency of America and China.

Gold: ring the changes

If economies show signs of sustained recovery, expect the yellow metal to take a hammering

Gold has rallied 27% over 12 months, outrunning all other traded commodities in this Covid-stricken year © Bloomberg

Like the metal itself, reasons to buy gold are malleable. Own the yellow metal for its untarnishable beauty, or as a store of value, or both. Jewellery is the largest stable component of demand. But when gold soars, as at present, bling starts to lose its zing. This can presage a price drop.

Demand for gold as an investment had outstripped purchasing for jewellery manufacture just three times in the past decade. That was until the last quarter. The switch suggests a speculative bubble is building.

Gold has rallied 27 per cent over 12 months, outrunning all other traded commodities in this Covid-stricken year. The push has been driven by anxious investors snapping up gold bars, coins and exchange traded funds. Jewellery retailing has meanwhile been obstructed by the closure of shops and postponements of weddings, a trigger for purchases particularly in India.

These problems should be only temporary.

Bulls will offer as many reasons to invest in gold as there are carats. One of these is that the metal — primarily traded in dollars — performs well when real US interest rates (adjusted for inflation) decline. That has happened this year, as reflected in the collapse of US bond yields.

Since 2006, for every one percentage drop in real US Treasury yields, gold prices have increased by about a fifth according to Citi. The debasement of fiat currencies by central banks and world instability are other reasons for gold bugs to hoard the stuff. There is a case to be made that the metal is now overbought.

Real annual gold price returns are again approaching those in the 2008-11 bull run, which were in the 20-25 per cent area, after which gold slumped.

Perhaps the best reason to question gold’s rally is that it is hard to find bearish commentators these days.

Even crotchety Lex became a cheerleader early last year.

The current rally is yet young — less than two years old.

But if economies show signs of sustained recovery, expect gold to take a hammering.