Government deficit spending will reach unprecedented proportions to combat the self-induced economic coma of COVID-19 shutdowns. Part of these massive fiscal packages will include government loans for corporations that may otherwise go bankrupt — also known as bailouts.
Before going further, it’s important to clarify the term “bailout” is a misnomer, usually deployed with political motivations to evoke connotations of corporations receiving government handouts. This pretense isn’t true; the bailout money provided to corporations during the 2008 financial crisis were loans repaid with interest, actually making the Treasury and taxpayer money. So when you hear the word, know it typically means the government is essentially investing in distressed companies and getting favorable terms or even equity stakes in return for a capital infusion. It isn’t free money.
This clarification is not a defense of the practice in the least. The government intervening and quasi-nationalizing private industry is not capitalism. Poor risk management must be held to account, and competent organizations must be situated for both economic feast and famine. Rather than bemoan how unjust this is, I’d like to offer a solution that will effectively end the practice of corporations seeking government loans.
First, it’s helpful to understand what’s known as the “Bob Rubin trade.” The term, coined by preeminent risk scholar Nassim Taleb, serves as a real-world exemplar for the moral hazard present in many executive decisions: reaping rewards for their success and socializing their losses, passing on excessive risk-taking to the taxpayer.
Heads I win, tails you lose.
Bob Rubin, a former Treasury secretary, collected over $100 million in compensation from Citibank in the decade leading up to the financial crisis. While there, he was directly responsible for risk-taking policies largely responsible for Citi’s massive $20 billion-plus financial crisis losses, 88% decline in share price, and $45 billion bailout from the federal government.
Do you know how much of that $100 million in pay Rubin was made to return? Zero. He walked away with a fortune and left behind a wreckage.
The architect of any policy must reap the rewards as well as bear the risk of his decision making. A system of governance that permits such manifest moral hazard will eventually implode. It is time for this to be incorporated into regulatory repercussions for corporate bailouts.
Exhibit A: airlines. You might think it’s unfair to target an industry so disproportionately harmed by an act of God like a pandemic. Context will help make clear why they do not deserve your pity.
The airlines have a history of bankruptcies and operate on rather thin margins with high debt. Yet they spent 96% of their cash flow on stock buybacks over the last 10 years, totaling about $50 billion. They then asked for $50 billion from the government to avoid bankruptcy. Executives buy back their stock as a means of returning money to shareholders; doing so increases earnings per share, and drives up stock prices in the process. Executives typically receive much of their compensation by way of stock grants, with incentives tied to increasing stock prices.
With the money they received from the government, these airline buybacks have effectively been subsidized by the taxpayer. Essentially, what you have is another form of the Bob Rubin trade: Activity was taken to increase share price and remuneration, that activity has now put the company at risk of bankruptcy, and the risk of this behavior is being socialized with federal money.
Fixing this is straightforward.
We can end this moral hazard through onerous financial punishment. Executives and board members that took undue financial risks that left their company requiring federal aid must be made to bear a Scarlet Letter. These repercussions will serve as adequate deterrent for almost never going to the government for help:
- Ban executives who approved risk-taking policy that necessitated government bailouts from leadership positions in public and private companies.
- Ban the board members who approved these policies from serving on a public board again.
- Claw back all cash bonuses for executives and board members that were awarded during the time these risks were taken.
- Disgorgement of all company stock for board members and executives. This is often the majority of executive compensation.
The policies that lead to bailouts are usually the culmination of years of imprudent risk and self-enriching behavior, done by those who have since left the company. Executives often pick up pennies in front of a steamroller for years before the damage actually happens. These consequences should apply retroactively, with an audit made into each bailout-receiving company to determine the entirety of those responsible.
Companies don’t make decisions. People make decisions. Names must be named, and symmetrical financial costs imposed. The Bob Rubin trade and golden parachute need a reckoning. The socialization of corporate risk-taking must end.
Jason Orestes (@market_noises) is a former Wall Street financial analyst who focuses on contemporary political developments affecting economics, markets, and culture. His financial commentary can be found on Jim Cramer’s TheStreet, where he is a regular contributor.
