Krishna Kumar is the director of international research at the nonprofit, nonpartisan RAND Corporation and director of the Pardee Initiative for Global Human Progress at the Pardee RAND Graduate School. Shanthi Nataraj is a senior economist and director of the Labor and Workforce Development Program at RAND. Jonathan Welburn is an operations researcher at RAND. The opinions expressed in this commentary are their own.
The impact on the economy from the coronavirus will be substantial. And while the impulse to do something to help companies right now is both natural and well-intended, there is a danger that policies designed to help businesses weather the current health crisis could lead to defaults on loans or further government intervention, sowing the seeds of a larger financial crisis in the future.
The government’s $2 trillion relief package includes $500 billion in assistance to large corporations, $350 billion in new loans for small businesses and over $600 billion for individuals, including $300 billion in cash payments. Some measures in the package are aimed at assisting companies affected by the drastic curtailing of economic activities, such as travel, dining and shopping. These measures are expected to shore up the economy and prevent large-scale loss of jobs. However, this crisis comes at a time of record corporate debt levels, with many companies already at risk.
Since the Great Recession of 2008, nonfinancial corporate debt fueled by low interest rates has ballooned to $10 trillion. In the United States, a whopping 16% of publicly traded companies do not earn enough profits to even pay interest on their debt. And some of the most highly leveraged sectors, such as automotive, retail, restaurants and transportation, are also some of the hardest hit by the current crisis.Lending to large companies that were highly leveraged pre-crisis is a risky bet. If a coronavirus-induced recession is long and deep and demand for the goods and services provided by these companies does not pick up, these companies will default on their loans. A wave of such defaults could lead to a corporate version of the 2008 subprime crisis, potentially causing disruptions on the scale of the Great Recession.What then can be done? Assistance to the larger companies should be carefully targeted, with preference given to companies that were financially sound when the crisis hit. This could ensure that scarce resources are allocated most effectively to maximize the chance these companies will pay back their loans when the economy recovers. Interest rates for loans should not be set too low to ensure companies borrow only if they lack cash reserves and anticipate adequate return on their investment. Read MoreAs brutally Darwinian as it might sound, the cleansing effect of recessions will cause inefficient firms to fail, likely at a higher rate than they do during normal times. While preventing a wave of bankruptcies is important, artificially propping up companies that were in trouble to begin with will deprive sounder companies access to resources and hurt the economy as a whole. More Markets & Economy Perspectives
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The “too big to fail” argument made during the Great Recession is likely to be made again, especially using job losses as a reason for bailouts. However, it would be more effective to directly address the job losses that may result from the failure of distressed firms. Providing assistance to affected families and bolstering unemployment insurance, as the current relief package does, could be even more crucial. Subsidies for market-relevant training of displaced workers so they could move to other sectors and occupations could also help.
Small businesses have been severely affected by stay-at-home restrictions. According to an analysis of small business transactions by JPMorgan Chase Institute, half of all small businesses can handle less than a month of cash outflows if there were no inflows, and a quarter of them only 13 days. The situation is worse for labor-intensive businesses, such as restaurants, retail and personal services, which have been hit hard. Help given to such businesses is less likely to attract the type of backlash as providing help to large companies, since the median income for self-employed business owners is only around $50,000. Moreover, helping small businesses that generate over 40% of US economic activity and serve as crucial links in supply chains could help the economy recover. It is important to remember that many small businesses, especially startups, fail every year even under normal conditions. This is a natural and necessary part of the creative destruction that keeps the economy vibrant.Assistance to businesses large and small could be best directed toward sound enterprises that are likely to survive and will contribute to boosting the economy in the coming years. The oversight provisions of the stimulus bill might prove crucial in ensuring that this happens. Anything else could lead to an uncertain recovery for the US economy.
Source: edition.cnn.com