Just 12 years ago, during his last days as the President of the United States, George Bush signed off the $700 billion Troubled Asset Relief Programme (TARP) aimed at insulating the companies affected by the financial crisis from immediate collapse.
The primary beneficiaries were the financial institutions that had exposure to toxic assets and later on, the automobile companies who found themselves drowning against the tides of China, NAFTA and globalisation.
The immediate social dilemma emanating from such an intervention by the government, was the question of whether it amounted to a socialisation of capitalism. The rise in risk appetite and risk-taking across Wall Street in the years leading up to the crisis, had seen record profits generated and compensation packages commensurate with this boom in capitalism.
In the bailout, however, the state intervention amounted to the socialisation of the costs in order to fix the consequences of private actions. The bailout created tensions when after the dust had settled, the companies were stabilised and reclaimed their position on the treadmill of global capitalism. This came with increased profits and yet again – increased rewards for the insiders in the system.
The criticism that policymakers have had to accept since then, centred on the question of whether the process had been too generous to the bankers that had engineered the crisis.
Were the terms too accommodating? Was the risk-sharing between the state and the banks and automakers fair and balanced? Could the bailout be used to facilitate structural reforms in industries that traditionally loathe regulation? And if the intention behind the bailouts was to save the broader economy, could another transmission mechanism prevail that injected capital directly into the economy rather than through the tainted banking system?
The same questions return
Twelve years later, the same questions are once again confronting policymakers. The coronavirus pandemic, and its resultant economic lockdowns, have led to companies across all sectors and industries facing the crisis of the banks and carmakers of 2008. The question of the bailout – thanks to the 2008 precedents – is unavoidable.
Countries across the world have introduced multiple interventions at both fiscal and monetary policy level. But as luck would have it, the banks are also affected, and given their transversal role in the economic value chain, cannot be excluded from the relief interventions implemented by any state.
The monetary policy moves – particularly in South Africa – are limited in reach and scope. Firstly, the delayed transmission mechanism associated with the time-lag between interest-rate decisions and the impact on the broader economy, feels even longer when contrasted against the urgency of the crisis.
Additionally, a feature of downward interest rate adjustments is that they have an impact primarily on those already within the credit system. For a country with such low unemployment levels, far too many people exist outside the formal credit system anyway. And in cases where low-credit-quality clients are within the system, poor individual credit risk profiles lead to a lower benefit – if any – from such rate adjustments. Monetary policy measures are therefore not going to be the fix on their own.
SA’s loan guarantee scheme
The fiscal policy interventions are a critical variable in solving the health and economic crisis. In a world of limited resources – and the hard reality that little is actually known about the virus and its long-term profile – getting them right is important.
A unique intervention launched in South Africa this week is the loan guarantee scheme. The scheme seeks to promote the granting of credit by banks in the time of crisis. The terms of the agreement, however, may create unintended consequences.
As expected, risk appetite from banks shrinks during times of crisis. The guarantee scheme seeks to reduce the freezing of the credit lines. The responsibility to lend responsibly however, remains important in order to avoid reckless lending. The qualifying enterprises – those generating up to R300 million in revenues – will be able to borrow at prime interest rates.
It is in the conditions of the scheme that new tensions emerge. The scheme rules prescribe that the loan cannot be used for paying dividends, bonuses or pre-existing loans. These limitations – noble as they may be – sound rather difficult to justify commercially.
The genesis of the loan notwithstanding, it remains a commercial arrangement advanced to the recipient on the strength of their business profile and credit profile. The imposition of conditions relating to the utilisation thereof, may be regarded as an overreach by the recipients.
A key feature of managing an SME is the need to manage and prioritise cash flow movements on an ongoing basis. An SME that has pre-existing loans at interest rates higher than the rate offered in this scheme, for example, would be exercising rational decision-making in settling the expensive loan and remaining exposed to the cheaper one. The scheme prohibits this. The prohibition on dividends and bonuses has political appeal, but also creates an arbitrage opportunity. It may well be that a business utilises its existing cash flows to fund such dividends and bonuses. The depleted cash profile, however, actually bolsters the business case for borrowing from the scheme.
Whilst the commercial rationale of the prohibitions may be dubious, the political appeal is quite obvious. The backlash faced by regulators in the aftermath of 2008 when bonuses were paid to bankers by institutions that benefited from the bailout, left a bitter taste that lingers on today. To avoid a repetition of this problem, the European Central Bank issued a directive prohibiting the payment of dividends and share buybacks by European banks.
In response, the UK’s Prudential Regulation Authority persuaded British banks to adopt the same approach in cancelling planned dividend and executive bonus payouts.
The question of whether – in the absence of a bailout – such a recommendation was binding on the banks is a matter of academic interpretation. But given the history of benevolent persuasion between Threadneedle Street and the banks, the recommendation was grudgingly accepted by the British banks.
In South Africa, the Prudential Authority issued a non-binding note recommending that no dividends and executive bonuses be paid out in 2020. If adopted, this will simply mean that in the next reporting cycle, we will be spared the hysteria associated with the bankers yet again being seen as winning from a crisis.
But whether such a step merely delays the payouts remains to be seen. For an industry that has a lot to do to restore its place within the social compact, the banking industry needs to tread carefully around this matter. Taking the wrong step at this stage would not only alienate society but also the regulators who – as history tells us – will soon enough be called upon to fix yet another crisis in the world of finance.