Moral hazards ahead? Moral hazards ahead?\images\insights\article\hazard-construction-site-small.jpg March 22 2021 March 22 2021

Moral hazards ahead?

The $1.9 trillion stimulus bill is too large and not targeted well.

Published March 22 2021
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Passing in Congress strictly along party lines, President Biden’s $1.9 trillion American Rescue Plan (ARP) comes on the heels of $4 trillion in fiscal stimulus already dispersed in 2020 by Congress on a broadly bipartisan basis. The ambitious size and scope of ARP is reminiscent of FDR’s New Deal in the 1930s and LBJ’s Great Society in the 1960s. It further reminds us of Rahm Emanuel’s sage political advice that, “you never want a serious crisis to go to waste.”

Critics contend ARP is too big and not well targeted, with significant pieces largely unrelated to relief from the coronavirus pandemic. Supporters point to its 70% approval rating, according to a recent Pew Research Center survey, but that’s consistent with the percentage of the U.S. population that is getting “free money” from the federal government. There’s no such thing as a free lunch, of course. The 30% who will ultimately be paying for the new stimulus package are much less supportive due to the longer-term impact it may have on the federal debt and deficit, inflation and interest rates, economic growth and corporate profits, and stock and bond prices. As such, we’ve identified several moral hazards embedded in this new legislation.

Did we need a fiscal stimulus package quite this big? Austan Goolsbee, an economist at the University of Chicago and an advisor to the Biden administration, warned last month that “there is a real prospect of slipping into a double-dip recession.” In a New York Times op-ed piece, he said that, because Covid-19 is not under control, “the economy needs help desperately.” In addition, White House Press Secretary Jen Psaki said in early March that, “we’re still at the height of a pandemic. We are not going to recover from this pandemic tomorrow. The economic recession will not be recovered tomorrow.”

Malarkey. While the National Bureau of Economic Research has yet to officially date it, we think the recession ended in May or June 2020, marked by a spectacular V-bottom economic rebound in the third quarter.

Importantly, at this week’s policy-setting meeting, the Federal Reserve raised its full-year GDP estimate for 2021 from 4.2% to 6.5%. That would be the strongest economic growth since 7.2% in 1984. The Fed also lowered its forecast for unemployment, at 6.2% now, to 4.5% by year-end 2021.

Moreover, Larry Summers (President Obama’s Treasury Secretary) calculates that the output gap for the U.S. economy at present approximates $600 billion, which we believe will be fully recovered by the end of this year’s second quarter. Biden’s legislation at $1.9 trillion was roughly triple the size of what we needed. While ARP will certainly provide a sugar high for an economy that has been recovering strongly over the past 10 months or so, that incremental growth comes at a price.

With the federal debt now at $29 trillion and a total debt-to-GDP ratio at an astounding 145%, nominal inflation and interest rates have increased sharply in recent months. Benchmark 10-year Treasury yields, for example, have soared from 0.90% at the end of last year to 1.75% this week, which will certainly impair our ability to service that growing debt level.

Aid not targeted enough We’re still dealing with a K-shaped labor-market recovery, despite a 6.2% unemployment rate for the overall economy (U-3), down sharply from 14.7% at the cycle’s peak last April. The unemployment rate for individuals (25 years of age and older) with less than a high school diploma rose to 10.1% in February, while that of people with a bachelor’s degree or higher declined to 3.8%, as higher-skilled employees have been able to work from home.

Employees with less education typically work in leisure & hospitality, retail, education, health care and government. We need to help these unemployed workers remain afloat until we achieve herd immunity. That will allow the economy to fully reopen, at which point we can rehire or retrain them. So, we support the $1,400 per person stimulus checks, which complete the $2,000 check former President Trump proposed last December. Congress only agreed to pay $600 at that time. However, we believe ARP’s annual income threshold of up to $75,000 ($150,000 per couple, fully phased out above $80,000/$160,000) is too generous. A $50,000 income level—roughly the midpoint for wages in the U.S.—was more appropriate.

We’re pleased that the weekly unemployment bonus was lower ($300 instead of a proposed $400) and expires in September instead of the proposed end of October. But we would have been happier if its expiration was the end of June, when we expect that adult herd immunity will be finally in place. Biden also exempted the first $10,200 in unemployment insurance from federal taxes. This collectively could slow the labor market’s pace of recovery, as unemployed workers may be reluctant to return to work if their benefits are still flowing.

State and local bailouts and restrictions unnecessary ARP allocated $360 billion in state and local government aid. But Strategas calculates that 21 states generated revenues during 2020 that are above their pre-Covid levels due to the strong economic rebound in last year’s second half. Moreover, a recent Moody’s study concluded that cities and states needed only a collective $55 billion or so nationally to make everyone whole from the budget crisis. So $360 billion is more than six times the funds needed. In addition, ARP plans to allocate more funds to cities and states that locked down their economies earlier and longer, which contributed to their larger deficits.

Part of the concern is that cities and states with significant underfunded government union pension obligations, such as Illinois, New Jersey, Connecticut and New York, will use these alotments to bail out their bankrupt pension funds. The pandemic didn't cause these bankruptcies—they’ve been a half-century or more in the making, due to poor management, irresponsible budgetary decisions and a lack of discipline. We prefer a more responsible and sustainable approach. These cities and states need to make the hard decisions necessary to restructure their pension obligations, among them should be reducing benefits and shifting from defined benefit to defined contribution programs.

ARP also prevents states that accept their share of the $360 billion from cutting their taxes through 2024, lest they be required to return their funds to the federal government. Twenty-one states have sent a letter to Treasury Secretary Yellen seeking clarification on this. Ohio has already filed suit against the Biden administration on the constitutionality of the law, questioning the invasion of state sovereignty by Congress. This dispute could evolve into a class-action lawsuit in coming weeks.

Earmarks…they’re baaaack! A decade ago, Congress ended the politically toxic process of earmarking legislation—pork-barrel spending ripe with waste, fraud and abuse. But Congress is hoping to resurrect earmarks as a potentially crucial sweetener to entice a wayward member to vote along with the majority on a narrowly divided piece of legislation. This reviled, radioactive process involved corruption and backroom deals that wasted taxpayer dollars, and our elected members of Congress should just say no.

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Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.

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