by Brian DeChesare Comments (12)

Are the Coronavirus/COVID-19 Crisis Bailouts and QE Infinity Justified?

Coronavirus Crisis Bailouts

As I publish this on March 25, 2020, the U.S. Senate and White House have just agreed to a $2 trillion “stimulus bill” to counter the Coronavirus COVID-19 pandemic crisis.

We don’t yet have the exact terms in writing, but some of the provisions include:

  • Direct cash payments to individuals and families ($1,200 – $2,400), which scales down above certain income levels.
  • A $350 billion fund for small businesses to reduce layoffs and keep staff employed.
  • ~$200 billion to fight the pandemic.
  • A $600 per week increase in unemployment assistance for 4 months.
  • $500 billion in “corporate aid” that will go toward backstopping Fed loans to big companies, with some “oversight.”
  • And various other emergency funding measures.
  • Any company receiving a government loan is prohibited from buying back stock for the term of the government assistance + 1 year.

The final terms will be different, especially since the House of Representatives has not yet agreed to anything, but these are the basics so far.

Along with that, the Fed has announced “QE Infinity”: Not only will they buy unlimited Treasuries and mortgage-backed securities, but they’ll also purchase corporate bonds.

At this point, I would not be surprised if the Fed started buying equities, private companies, and single-family homes.

In fact, why not just print $10 trillion and distribute the Cash to everyone in the country?

It’s free money!

Technically, the Fed can only spend up to $8 trillion, so I guess that’s not possible, but the rules can always be bent or broken.

Coronavirus Crisis Bailouts, Quick Thoughts: Most of This is a Bad Idea

The amazing thing is that the crisis and the government’s response have not changed my overall market views.

At the start of 2020, I described my switch into Equities and Gold, and now that seems like an even better idea:

  • If the Fed eventually starts buying stocks, sure, stock prices will probably rise… in nominal terms.
  • At the same time, Gold and other precious metal prices should rise as massive monetary expansion and interest-rate repression results in inflation and currency devaluation.

Yes, the USD has been surging so far, but that’s because there’s a global shortage of dollars due to high USD-denominated foreign Debt (plus, everyone is panicking and moving to Cash).

In the long term, the USD has to weaken, especially if other countries print less money.

Oh, and yields on 1-month and 3-month Treasuries are now negative, so the U.S. can join the rest of the world in the “negative yield” party.

The bottom line: Unlimited easy money and negative interest rates and yields will not solve anything.

They only make the long-term problems, such as high corporate Debt and wealth/income inequality, even worse.

If interest rates are negative, why not borrow even more? With those terms, companies might as well lever up to 20x or 50x Debt / EBITDA. Who cares, it’s free money!

Would 80% inflation or a 95% decline in the value of the USD kill the system? Or would it take another pandemic, war, or some other crisis?

Taking bets now…

“Corporate Aid”: What to Do?

It’s easier to discuss the corporate side of this deal because the scope is more limited.

The usual justification for bailouts is that if the government does not act, things will get even worse.

There is some truth to this argument, but it comes with a big caveat: any bailout funds should come with many strings attached.

The strings might include limitations on stock buybacks and executive compensation, requirements to use the funding a certain way, or obligations to retain employees.

I would also argue that if a company accepts a bailout, salaries should be limited to those of government employees at similar levels, i.e., a max of $150K per year for the top ones.

How Do Companies Reach This “Bailout State”?

To quote Charlie Munger:

“The liabilities are always 100% good. It’s the assets you have to worry about.”

Companies tend to reach this state when their Cash balances decline so much that they can no longer continue operating, and they have no reasonable expectation of a recovery.

A bank might reach this state if the value of its assets suddenly declines, resulting in a massive loss and lower regulatory capital, and the firm needs additional equity ASAP to survive.

This time around, it’s a more unusual scenario because it was caused by a voluntary shutdown of the entire economy.

So, any firm that lacks a large Cash balance – enough to cover all expenses for months – is likely to be in trouble.

High leverage makes the problem even worse because the company must keep paying interest and eventually repay or refinance the principal – even if its revenue drops to 0.

You’ve probably seen charts like the one below that show how airlines have spent ~96% of their Free Cash Flow over the past decade on stock buybacks:

Airline Stock Buybacks

And then there’s Boeing, which spent ~74% of its Free Cash Flow on stock buybacks over the past 10 years (~$43 billion).

Most of these firms also kept adding Debt to their Balance Sheets, sometimes to fund these stock buybacks.

Although this behavior was foolish, it’s not entirely the fault of corporations.

It’s also because central banks such as the Federal Reserve suppressed interest rates and kept monetary policy ultra-loose for far too long (and now they’re loosening even more).

Are Stock Buybacks the Root of All Evil?

This situation has led many politicians and commentators to call for a “ban” on stock buybacks.

But the problem isn’t so much that stock buybacks are inherently evil or risky, but that when they are combined with other factors, such as problematic executive compensation, they increase systemic risk.

Look, I just published a video on this topic of stock buybacks yesterday:

In theory, stock buybacks reduce a company’s Equity Value but do not affect its Enterprise Value.

The company repurchases shares, its Cash balance falls, and its Common Shareholders’ Equity falls.

Common SH Equity is down, and Net Assets are down, so Equity Value declines.

Enterprise Value stays the same because Net Operational Assets do not change.

But in real life, stock buybacks often end up boosting companies’ share prices.

Even though it’s heavily manipulated, the stock market is still a market.

Repurchasing shares sends a strong “Buy” signal, and if there’s more buying than selling, the company’s share price will go up.

There’s a reason why stock buybacks were illegal for most of the 20th century!

But the real problem is that executive compensation (options, RSUs, etc.) is often based on share-price targets for the company.

It’s hard to make a company’s core business more valuable, but it’s easy to manipulate the share price.

So, raise Debt, buy back more shares, boost the share price, sell the stock for a profit, and then call in the government as soon as there’s a crisis.

So… What’s in the Actual Rescue Package? Are There Other Options?

If there has to be a bailout, yes, it’s justified to help small businesses/freelancers/self-employed people, hospitals and medical professionals, and low-income individuals.

The mechanics of the loans to companies are unclear, but my guess is that there will not be enough “strings” for the big companies, and the funds will flow too slowly for small businesses.

I prefer Mark Cuban’s suggestions:

  • Have the Treasury guarantee overdrafts so that all businesses can continue writing checks as they always have.
  • If one of these companies fires employees, it immediately loses this benefit.

I have no idea how the government would monitor companies for condition #2 (maybe look at cash outflows week to week?), so that is one big problem with this proposal.

Coronavirus COVID-19 Crisis Bailouts for Large, Public Companies

I have zero sympathies for large, public companies in any industry.

That group includes banks, airlines, hotel chains, Boeing, casinos, mortgage REITs, and many others.

Let them file for Chapter 11 bankruptcy so they can continue operating and paying employees while they restructure.

Not only did these large companies spend their Free Cash Flow foolishly, but they also have far more options available to them than small businesses and individuals.

If a public company wants a bailout instead of Chapter 11, it should come with heavy strings attached:

  • No stock buybacks for ~10 years.
  • Executive compensation extremely limited; the max should be “high-level government employee” levels.
  • All non-executive employees must keep their jobs for at least a year.

It looks like the deal will ban stock buybacks for any company that accepts a bailout, for a period of at least 1-2 years.

But I’m not sure that would fix the problems of high executive bonuses, dangerously low Cash, and very high Debt balances.

Regulators could require public companies to hold a minimum amount of Cash on-hand to cover expenses over a 6-12-month period, and that might help a bit.

But there’s another, bolder solution that might fix many corporate problems: ban stock-based compensation at public companies.

Bonuses and incentives should all be paid in Cash, and they should be based on metrics other than the company’s share price: ROIC vs. Cost of Capital, organic EBITDA growth, or almost anything that’s remotely operational.

Yes, it’s possible to game these metrics as well, but they’re still less terrible than using the stock price as the main number.

If we’re being honest, stock-based compensation is a giant scam for most people:

  • Startups often lure people with meager salaries but promises of future fortunes if the company takes off (hint: it probably won’t).
  • And at big companies, stock-based compensation creates incentives for stock buybacks and results in massive compensation disparities between top executives and everyone else.
  • And self-employed individuals and those at smaller/private companies can’t benefit from stock-based compensation at all.

Anything Else?

To summarize:

  • Bailouts are happening, whether you like it or not, but I do think they’re justified for low-income individuals, small businesses, hospitals, the self-employed, etc.
  • The big companies do not deserve any bailouts; if a large, public company accepts one, it should also accept heavy restrictions on executive compensation, stock buybacks, and employee retention.
  • Regulators should require much higher minimum Cash balances at companies and ban stock-based compensation at public companies. Incentives and bonuses should be paid in cash and linked to business performance, not short-term stock prices.
  • I don’t know about central banks. It seems like the fiat currency system has to collapse at some point, but I don’t know if that means “next year” or “50 years from now” or “whenever the next crisis strikes.”

Like last week, I expect the comments section to be lively on this one…

M&I - Brian

About the Author

Brian DeChesare is the Founder of Mergers & Inquisitions and Breaking Into Wall Street. In his spare time, he enjoys memorizing obscure Excel functions, editing resumes, obsessing over TV shows, traveling like a drug dealer, and defeating Sauron.

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  1. Brian,

    I appreciate the article. It is nice to see level-headed posts on this subject. I know the 1998 Russia financial crisis had numerous causes, but I always focus on their fiscal deficits since that is closest to the situation the USA is in. It seems that we have become so numb to the deficits that there is no way to go back to deficit neutral and even a surplus to start paying some of this back. There isnt a way we can raise that kind of tax revenue to offset the difference (at current productivity) and there is no way a politician will have the willpower to cut the programs and departments that need cut. I guess our best chance is a sort of Industrial Revolution 2.0 and productivity skyrockets. wishful thinking.

    What would a modern day 1998 Russian Financial Crisis look like? i imagine that much greater than 1998 since the countries involved would add up to be a lot greater economic impact than Russia was in 1998.

    1. I think they’ve just given up. They know that there will never again be a balanced budget or a surplus, and until there’s some crisis as a result of the huge deficits, nothing will change. The Fed is probably planning to peg interest rates permanently at 0% just so the government can run its debt into the quadrillions.

      But there will be consequences – and I think it will come down to how much the U.S. prints vs. how much other countries do.

      I don’t think it will look exactly like the 1998 Russian financial crisis. One big difference is that the USD has been the reserve currency for ~100 years, while the ruble never has been. If the reserve currency becomes the RMB or something else, that might signal the end. The Fed will lose control of Treasury yields and will have to induce massive inflation to service the debt.

  2. We’ve been expecting rampant inflation for over a decade and that hasn’t happened so far…

    What do you think about Gary Shilling’s assertion that *deflation* is on the horizon, not inflation?

    1. Yes, but the difference is that this time around, the government is sending money directly to people and businesses rather than just printing it and letting asset prices run up. So I think there’s a decent change of the inflation appearing not just in asset prices, but also in the real economy.

      There will probably be some deflation from the economic shock (look at the Great Depression early years), followed by inflation as the government keeps sending people free money.

  3. Well, what to add, 100% on board. It’s not only a continuous debase of currencies worldwide but there’s always less price discovery permitted on financial markets. There’s a bid on more or less every segment of bond markets, about stocks we know that there isn’t but also you are inclined to think that may be one day.. so an implicit one. Japan has been a precursor on all this and the trillions of fiat money are announced with a minimum impact on rates. Mtm will be suspended on many cases and regulations changed, don’t know what will happen about accounting rules. But do you really think that with Trump as leader these conditions will ever be applied?

    1. Thanks. Who knows. Honestly, I’m surprised Trump has not “accidentally” pressed a “Destroy the world” button so far. It seems like the bailout package will restrict stock buybacks, but nothing is being done about central banks, so these problems are going to get worse and worse. You can’t fix an economy with constant bubbles by re-inflating yet another bubble.

  4. Avatar
    Jason Chen

    Brian, if the US collapses, do you think China will end up being the world’s superpower?

    1. No. I don’t think they want it, and they have too many other internal problems. I think general lawlessness and chaos is a more likely outcome, kind of like most cyberpunk/dystopian stories.

  5. Killer article, love the info… two quick questions.

    Just to clarify are you completely against corporate bailouts, or just require corporate bailouts to come with many many more strings attached? If we did no bailouts at all and had them file Chapter 11, wouldn’t this just have a domino affect where banks would get hit hard due to the credit they have with these companies..

    And second your switch to gold, is this just a short term hedge, I know in 2008-2011 there was a mini bull run for gold once QE really ramped up but it never seems to last? So is gold primarily just a short term hedge? And is there anything terrible with investing in a company like barricks gold vs going out and buying physical gold?

    1. You’re right that it’s not realistic to expect every company to go through Chapter 11 proceedings. So, if a company wants a bailout, sure, it can accept it, but it has to come with heavy penalties and restrictions. Private companies cannot reward top executives with huge bonuses when the firm is doing well and then run to the government when there’s a crisis. Either be government-backed/owned (lower salaries but also less risk), or be private.

      This is why people got so pissed after the 2008 crisis, but this time around, I think people actually hate airlines more than banks because there’s more direct interaction with them. So I don’t think the airline bailout will go over well.

      I think Gold will perform very well over the next 5-10 years, so it depends on whether or not you consider that short-term or long-term. Anything could happen with Equities, but we can be reasonably confident that bonds of all types will not perform well because interest rates are already so low – and there’s something like 99% correlation between initial interest rates and 7-10-year bond performance.

      So… I am using Gold instead of bonds as the “safe” part of some portfolios.

      You could buy individual gold companies as well, but it’s riskier because they’ve traditionally done poorly with generating positive cash flow. Barrick Gold is one of the better individual companies that’s also reasonably priced (note: I haven’t done in-depth research on it, but have read some reports that were convincing). It’s just you’ll have to monitor it more closely than you would if you bought physical gold or a gold ETF.

      1. Thanks Brian for the response. I had one last question, you briefly mention it at the end of this article… that the fiat currency system has to collapse… is this specific to the US? If so is this because of the massive increase in the feds balance sheet over the past decade? Could you actually see the US lose their credibility as the go-to currency?

        Also side question, have you made a recent article about the feds implications of a never ending increasing balance sheet?

        1. All countries now use fiat currencies, so it will happen everywhere. Yes, I could see the USD collapsing – not just because of the massive Balance Sheet expansion, but also because the risks of USD-denominated foreign debts are now so obvious. No one wants to take on massive risk if there’s another crisis and dollar shortage.

          I don’t think there is really much to say about the never-ending Balance Sheet expansion. Ever greater money supply while the real economy stays the same means we’ll get either asset price inflation or wage/goods/services inflation. Over the past decade, it was mostly asset price inflation, but this time it could move into the real economy.

          An expanding Balance Sheet by itself isn’t necessarily the end of the world – the issue is when it grows much faster than the underlying economy.

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