Fiscal policy moral hazards
Bottom Line Although we’re bracing for what undoubtedly will be brutally negative second-quarter reports on both GDP growth and corporate earnings in July, we have started to see a few green shoots in recent weeks. Michigan sentiment, both the Empire and Philly Fed indexes, the NFIB small business optimism index and the NAHB housing market index were all surprisingly better than expected. And just yesterday, we got an updated look at initial weekly unemployment claims, which are a critically important leading indicator for the labor market. From a record peak of nearly 6.9 million initial claims for the week that ended on March 28, claims have fallen by two-thirds to about 2.4 million for the May survey week that ended on May 16.
Why the improvement? In our view, social policy initiatives have helped peak the trajectory of coronavirus infections here in the U.S. during mid-April, while the Federal Reserve’s aggressive monetary policies have provided the economy with a crucial backstop. Fiscal policies—the essential third leg of our strategy stool—also have been directionally positive, but there are several potential moral hazards in both existing and proposed legislation that we should manage to successfully facilitate a rapid economic recovery from recession.
Extended unemployment insurance bonuses To slow the spread of the virus and save lives, President Trump made the difficult decision in mid-March to switch off the U.S. economy for nonessential workers and order them to shelter in place. According to the Federal Reserve, 62% of workers with a college degree or higher have been successfully working from home since then, but only 20% of those with a high school diploma or less have been able to do so. As a result, 40% of households earning less than $40,000 per year experienced at least one job loss versus 19% of households earning between $40,000 and $100,000, and 13% of those earning more than $100,000.
In order to make these lower-wage workers whole during the pandemic, the administration included a $600 weekly cash bonus (on top of regular average weekly unemployment insurance of about $400 per week) for a period of 17 weeks through July 31. That came in the $2.2 trillion CARES Act, signed into law on March 27. At an annualized run rate of $52,000 per year ($28.50 per hour), these $1,000 weekly benefits allow laid-off and temporarily furloughed workers to pay their rent, buy groceries and medicine, and make car payments while they wait for the economy to reopen.
The potential problem is that House Speaker Nancy Pelosi’s proposed $3 trillion new stimulus proposal would extend the $600 bonus through January 2021. The possible moral hazard, then, is that the lower half of U.S. workers will earn more staying home than returning to work, which will retard the pace of the economic recovery. An alternative suggestion by Sen. Rob Portman is to replace the $600 weekly unemployment bonus with a $450 employment bonus for a period of time, to incentivize employees to return to work when it’s safe to do so.
Restrictions on corporate loans and grants The CARES Act also extended loans and grants to companies to keep them afloat and keep their workforce employed. But Congress restricted these funds from being used for executive compensation, share repurchases and dividend payments during the loan and for a year after they are fully repaid. Congress is unhappy that public companies rewarded their shareholders over the years with dividends and share repurchases, rather than squirreling the money away into a rainy-day fund. Beggars can’t be choosers, of course, and if companies don’t like those terms, they are welcome to find alternative sources of capital, such as bank borrowings or the financial markets. Boeing, for example, raised $25 billion on May 1 in a bond underwriting, rather than accept stimulus money from the government with strings attached, including an equity stake.
Corporate immunity from liability Senate Majority Leader Mitch McConnell has said that any new stimulus bill must include measures to shield companies from pandemic-related liability. While it’s prudent to protect companies from frivolous lawsuits, that also presupposes that companies have already done the right thing by their employees and customers. For example, has the employer taken the necessary safety precautions to protect their employees? If the company is calling the employee back to work, is the employee healthy and able to work? With schools and daycare closed, does the employee have any child-care issues? Is the employee caring for a sick family member infected from the coronavirus? So if companies took the appropriate steps, then they should be eligible for immunity from junk lawsuits. But we shouldn’t be shielding bad actors.
Restrictions on state and local bailout money Pelosi’s proposed $3 trillion plan includes $1 trillion of unencumbered aid for states and municipalities. Trump has said that he certainly is open to allocating more money for states and cities hit hard by the coronavirus, but he is looking to restrict that money from bailing out underfunded pension obligations. For example, Illinois and New Jersey have pension systems funded only at an estimated 38% and 36%, respectively, according to the Wall Street Journal, compared with Florida at 84%. How did these two states get into these untenable financial positions? In exchange for strong union support at the polls, local politicians typically rewarded workers with big raises and generous pensions (with annual increases targeted at above-inflation rates), regardless of whether these cities and states could afford the contracts. The possible moral hazard here is if coronavirus-related funding bails out cities and states for poor budgetary decisions made over the past half century. A more responsible approach is for these governments to make the hard decisions necessary to restructure their pension obligations—perhaps shifting from a defined benefit to a defined contribution program—to put themselves back on firmer financial footing.