In reacting to overwhelming evidence of a devastating blow to corporate earnings, policy makers and investors now have to come to grips with another consequential theme connected to that: the severity and duration of balance-sheet stress and the potential to relieve it.
It’s a theme that will partially determine the severity of the global recession and the amount of pain felt by society as unemployment shoots up to previously unthinkable levels and incomes plummet. It will also differentiate among sectors and companies in a way that will significantly affect investment performance.
As it makes it way through the global economy, the coronavirus has decimated corporate income statements. Signs are everywhere, starting with drastic downward revisions in earnings, with many companies understandably suspending forward guidance entirely. The next rounds include corporate downsizing that will drive unemployment quickly to alarming levels, above even the highs reached after the financial crisis.
The collapse in corporate earnings puts balance sheets into play in a big way. Many companies are experiencing unforeseen large drains on their cash reserves. New financing is expensive, and that’s assuming that debt markets are open for new bonds and loans. Issuing shares would be incredibly dilutive, if not fundamentally destructive to some capital structures. And all this comes after a prolonged period of ultra-loose financial conditions that encouraged all sorts of excesses in corporate borrowing, leverage and financial engineering.
All this translates into a critical situation for companies with little cash and a need to refinance maturing debt. The sweeping measures announced by the Federal Reserve on Monday will help some but will be of limited relief to companies with low credit ratings. The only way out for several of them will be a bailout, either by other corporations or the government. And, in some sectors such as airlines, bailouts are likely to be only domestic given concerns about foreigners exploiting temporary national weaknesses.
It’s no wonder there is a huge demand for government bailouts all over the world. After all, the last thing that a country’s ailing economy needs is a series of corporate bankruptcies that result in even higher joblessness, loss of pensions and more. And while most politicians seem sympathetic, design and effectiveness are complicated by two crucial issues.
First, there is a huge and correct desire not to repeat the mistakes of the 2008 emergency policy interventions, which are seen to have done a much better job in safeguarding the survival of companies and financial markets as opposed to restoring the well-being of people. With that, the resulting post-crisis period was lucrative for investors and corporate executives but less so for the average wage earners operating in an economy that produced low growth and whose benefits accrued disproportionately to the already better-off. This time around, the focus will be on people first.
Second, the infrastructure to relieve balance-sheet stress is underdeveloped for the task at hand. No one had factored in the scale and scope of the sudden stops hitting not just individual countries but also the global economy as a whole. While some sectors can help the federal government, including the banking, pharmaceutical and big technology sectors, this is basically a case of building it and using it at the same time. The likelihood of leakages and unintended consequences add to the already-considerable political complexity that comes from having to make difficult choices and striking delicate trade-offs among so many competing claims.
All of this is of critical relevance to people’s well-being. It will also play an important role in determining whether the already deep sudden recession in the cards for the global economy will evolve into something worse. It wouldn’t be an exaggeration to say that the credibility of the political system in liberal democracies is at stake, as is the fabric of society and the ability to avoid civil unrest.
Then there are the investors in companies with weak balance sheets, including those that were tempted by ample liquidity and repressed volatility to venture well beyond their natural habitat. Their choice is not an enviable one: Sell their holdings after prices have already plunged to avoid an even bigger destruction of their capital, or hold on hoping for a very uncertain generous bailout.
Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. He is president-elect of Queens' College, Cambridge, senior adviser at Gramercy and professor of practice at Wharton. His books include "The Only Game in Town" and "When Markets Collide."
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