Large Corporations Did Not Need A Bailout

The CARES Act passed in response to the COVID-19 crisis provides billions of dollars in industry-specific loans that will go to large corporations like Boeing and the major airlines. These provisions are part of a larger compromise that also puts important funds into the hands of individuals and small businesses. But one should not be fooled into thinking the provisions benefiting large corporations and their shareholders were a necessary part of a coronavirus bailout. Instead they go against the core principles that should guide policymakers in responding to a crisis of this sort.

As Eric Posner and I explained in a 2015 article, the guiding principles for bailout policy are relatively straightforward. To put it simply, a bailout should preserve value in the way that is as fair as possible to ordinary individuals while minimizing administrative costs. Thus, the principles fall into three buckets: value preservation, fairness, and administrative costs.

The first bucket limits bailouts to situations where they are necessary to reduce systemic risk from unexpected shocks that threaten to spread massive damage throughout the economy. The second bucket argues in favor of bailouts for ordinary individuals rather than corporations or those with political connections whenever possible. The moral case here is straightforward, but there are at least two non-moral bases for this idea. First, perceived equity lends legitimacy to the government action. This will foster popular buy-in and preserve the possibility of public support for future bailouts. The enduring public animosity to the financial-crisis bailouts demonstrates this point. Second, a commitment to equity across individuals can constrain government abuse and cronyism. The third bucket directs the government to choose the most straightforward way to inject bailout funds into the system.

A common challenge in a financial crisis is that these three ideas cut against each other. The most obvious recipient of a bailout aimed at reducing systemic liquidity risk is usually a financial institution. Likewise, administrative costs often favor distributing funds to a single large recipient rather than millions of individuals. On the other hand, considerations of fairness rarely cut in favor of payouts to large financial institutions. In this way, the 2008 financial crisis presented government actors with difficult choices guided by conflicting principles.

That is not the case with the COVID-19 crisis. The principles all point in the same direction – relief for individuals and small businesses. This is not a crisis originating in the financial sector. A collapse of a financial institution does not threaten to shut down the real economy. Rather the real economy has already been shut down, and the risk is that economic shutdown will spread to the financial sector or lead to mass unemployment.

To put it another way, the risk is not that an airline won’t be able to resume operations after the crisis. The planes and the firm will be there, and – as others have pointed out – bankruptcy law is a tried-and-tested method of restructuring the liabilities of large corporations while preserving operations. Instead, the worry is that an airline (or other similar business) will run out of money in the meantime and will stop paying its creditors and its employees. That creates systemic risk – but only in one of two scenarios.

First, if businesses across the economy stop paying their creditors, we could have a financial crisis. But if that is the case, all principles point against bailouts targeting one industry and in favor of those targeting financial institutions.

Second, if businesses across the economy lay off workers, we could have an economic crisis in the form of mass unemployment. This appears to be the immediate threat. Because that unemployment crisis is not limited to a small set of industries, any response must be systemwide. The simplest remedy for economic inactivity is a set of payments directly to inactive workers and small businesses. Doing so achieves three fairness goals: 1) it favors individuals rather than corporations; 2) it avoids political favor or the appearances of political favor; and 3) it allows for benefits to go to vulnerable workers across the economy – not just those working for favored industries.

One might think that administrative considerations point in the other direction. A common argument is that it is less costly to inject funds into the economy at a few dozen corporate spots than at millions of individual spots. But that argument does not hold up in this particular case. Given the widespread nature of the shutdown, it is not cheaper to go industry by industry rather than providing blanket relief.

Similarly, some have argued that the bankruptcy system may not be able to handle the wave of bankruptcy filings that will result from this crisis. But this again argues in favor of relief for individuals and small businesses and against large industry-specific relief. The true crush on bankruptcy courts is not going to come from dozens of large corporate filings in Delaware and New York. Instead, we should be worried more about the thousands of small business and individual cases that will be filed around the country. To borrow a phrase from Vince Buccola, this crisis presents a “too small [and too numerous] to fail” problem. And preventing a handful of airlines from filing for reorganization under Chapter 11 hardly addresses this concern.

Finally, even if there is a special need to inject funds specifically and directly into the airline industry – a dubious proposition as so many other industries are reeling from the exact same shock – fairer and more efficient options are available. For example, the government could have provided liquidity to airlines and other large corporations in the form of senior loans while requiring them to go through the bankruptcy process as it did with GM and Chrysler in the last crisis. By using that mechanism, the government, as senior lender, would have possessed the necessary control to implement the employment goals that have been cited as the raison d’etre of the bailout. Moreover, this senior-loan-plus-bankruptcy approach would have kept the airlines in full operation while pushing some of the downside cost to the equity investors. (Recall that our system has already compensated those investors for bearing the risk of such costs by allowing them to receiving the entire upside profit with limited liability during normal times.)

Of course, the CARES Act does provide individual and small business relief, and that is a good thing. But the inclusion of large industry-specific funds for big corporations introduces major fairness costs. Normally, bailouts must be sensitive to the tradeoff between fairness (and legitimacy) on the one hand and administrative efficiency on the other. But here there is no tradeoff. A bailout heavy on industry-specific relief fails to satisfy any of the principles for a proper bailout. The immediate cost of that failure is the lost opportunity to provide full relief to individuals and small businesses. The long term cost will be a further reduction in the public faith that the government can be trusted with its bailout power.

This post comes to us from Professor Anthony J. Casey at the University of Chicago Law School.