Existing fiscal and monetary policies are powerless to restore firms’ revenues during this health emergency. Many firms will soon begin having trouble meeting their interest payments and recurring fixed obligations. Two programs, whose cost would be $348 billion, could enable businesses to keep their lights on during the health emergency so they can rapidly reopen afterward.
The Covid-19 pandemic and the extraordinary public health measures needed to slow its spread have triggered a sudden stop in global economic activity. Due to this unprecedented drop in consumption and production, the revenues of many firms have fallen dramatically.
The vast majority of smaller, privately-owned businesses in the US, as well as many larger, publicly- traded firms, do not have the financial reserves needed to survive this large, temporary decline in revenue.
Furthermore, existing fiscal and monetary policies are largely powerless to restore firms’ revenues during this health emergency. Many firms will soon be, or have already been, forced to lay off many of their employees.
In short order, firms will also begin having trouble meeting their interest payments and other recurring fixed obligations.
A large expansion of unemployment insurance and other forms of direct cash assistance to households are clearly needed to cushion the impact of the sudden stop on US workers.
However, we believe that the second key goal of economic policy must be to ensure that the sudden stop does not lead to a mass of business bankruptcies that will hobble the economy’s productive capacity for years to come.
Two Complementary Approaches
We propose two complementary approaches—Business Continuity Insurance (BCI) and Business Continuity Loans (BCL)—that should be included in the US government’s response to the Covid-19 pandemic and the resulting sudden economic stop. These approaches share the same underlying principles but differ in program implementation and administration to allow policymakers to adopt the most feasible path forward.
Both approaches feature a one-time government program, with the goal being to prevent the sudden stop from triggering an unprecedented wave of non-financial business bankruptcies, which would greatly amplify the economic contraction and inhibit economic recovery once the health emergency passes.
Put simply, the goal is to enable businesses to keep their lights on during the health emergency so they can rapidly reopen afterward. These new programs, in combination with other programs, maximize the chance of a rapid economic recovery and minimizes the chance of a deep, prolonged recession.
Under BCI, the government would provide payment assistance to enable affected businesses to meet their recurring fixed obligations—including interest, rent, lease, and utility payments— during the health emergency. A key advantage of our plan is that it can be easily implemented and administered.
Firms would apply for grants up to a maximum limit determined by their recurring fixed obligations, measured using items on the front page of the firm’s 2019 corporate tax return. Both to protect taxpayers and for reasons of fairness, firms—especially the largest firms—that receive temporary BCI assistance would be required to gradually repay most of these benefits over time.
Large firms that receive assistance would also face temporary restrictions on their ability to pay dividends and repurchase shares, as well as limitations on executive compensation.
In the companion note, we outline the economic policy challenges posed by the COVID-19 pandemic and discuss the motivation for BCI. Our diagnosis is inspired by the proposals recently sketched by Emmanuel Saez and Gabriel Zucman and by Glenn Hubbard and Michael Strain and shares some similarities with the expansion in Small Business Administration lending authorized by the recently passed CARES Act.
The Cost of BCI: $348 billion
We quantify the size of firms’ recurring fixed obligations using tax data, an exercise that motivates the design of our program. We then summarize how the US government could set up a broad-based BCI program and provide details on how the program could be implemented. We estimate that our BCI proposal would cost taxpayers $348 billion, a smaller sum than other similarly-motivated proposals.
Our estimate of aggregate annual fixed obligations for all non-financial private firms in the US is approximately 150–200 percent of aggregate annual profits for these firms. Moreover, there is significant heterogeneity across firms and industries, meaning that recurring fixed obligations are a much larger percentage of profits for some firms.
Thus, a first key principle in designing a BCI program is that any repayment terms for firms must be “soft”: BCI should not take the form of traditional loans or debt. For many firms, recurring fixed obligations are so large that it would be uneconomical for them to borrow to cover these costs.
Even if firms were willing to borrow, providing BCI assistance in the form of traditional loans is likely to leave firm balance sheets impaired, creating significant drag on the recovery once the pandemic ends.
To the extent that recurring fixed costs are interest payments on debt, our program indirectly provides support for firm’s debtholders, including banks and other financial institutions. In the absence of economic and financial amplification effects, the program will provide business debtholders with less than one year of interest payments, which is a small amount in a low interest rate environment.
The key purpose of the BCI program is to avoid these amplification effects from missed interest payments, which have the potential to create much larger losses for society.
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More Generous for Small and Medium-Sized Businesses
A second key principle in designing a BCI program is that it should be broadly available to and widely used, by a wide set of non-financial firms that are facing financial distress due to the pandemic.
Since the goal is to avoid economic amplification effects and congestion in bankruptcy courts, assistance must reach a large number of affected firms.
In particular, the terms of the program should be most generous for small and medium-sized businesses, which are unlikely to benefit from other government programs aimed at stabilizing financial markets. This principle implies that program simplicity is critical. Otherwise, administrative issues will severely limit program take-up.
Our proposal deliberately does not cover the costs of employment because we believe that the existing infrastructure for unemployment insurance (UI) is a more effective vehicle for delivering aid to US workers during the Covid-19 pandemic. We also attempt to fill in some key details of this kind of BCI program.
Specifically, we discuss how policymakers can:
1) Target BCI assistance towards more financially vulnerable businesses whose revenues have been most adversely impacted by the pandemic;
2) Ensure beneficiary firms repay the assistance they receive in a fair way overtime; and
3) Ensure beneficiary firms face appropriate restrictions on their use of BCI assistance.
Under BCL, the Treasury and Federal Reserve would create a program that makes junior debt investments designed to enable impacted non-financial businesses to meet their recurring fixed obligations. To maximize taxpayers’ bang-for-buck, this program would be targeted toward firms that have been most affected by the pandemic.
Junior Subordinated Debt
Crucially, as we detail below, it is desirable to structure BCL investments as junior subordinated debt with deferrable interest payments. This is a “softer” form of debt than a traditional unsecured bond or loan.
There are two advantages to structuring the investments this way. First, much like preferred stock investments, these BCL investments would help program participants avoid solvency concerns and the associated “debt overhang” problems once the health emergency has passed. Second, making BCL investments “soft” debt claims would increase take-up among firms facing financial distress due to the economic stop.
Large firms that receive BCL should face temporary restrictions on their ability to pay dividends and repurchase shares, as well as limitations on executive compensation.
This BCL program would complement the direct business lending programs previously announced by the Treasury and Federal Reserve, including the Primary Market Corporate Credit Facility and the forthcoming Main Street Lending Program.
The goal of these more conventional lending facilities appears to be—and should be—to provide unsecured bridge financing, ensuring that affected businesses can refinance maturing debt as it comes due.
The announcement of this “backstop” has already had a positive impact on the investment-grade credit market. While it is necessary to ensure that the pandemic does not lead to a debt rollover crisis, to further avoid financial distress and business bankruptcies, we believe the government must also help affected businesses meet their recurring fixed obligations—i.e., interest, rent, lease, and utility payments—during the sudden stop.
Thus, our BCL proposal should be viewed as a complement to the facilities that have already announced.
Samuel G. Hanson is a Marvin Bower Associate Professor in the Finance Unit at Harvard Business School. Jeremy C. Stein is the Moise Y. Safra Professor of Economics and Chairman of the Department of Economics at Harvard University. Adi Sunderam is a Marvin Bower associate professor of business administration at Harvard Business School. Eric Zwick is an associate professor of finance at the University of Chicago Booth School of Business.
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