Bailouts – how do we get it right this time round and set the basis for a new social contract?

Please note Mr Sodha has co-authored this in his personal capacity and is not reflecting the views of his organisation.

As stories emerged this week of hedge funds applying for bailouts and lockdown periods being extended, policymakers have woken up to the need to think long and hard about who should benefit from such funds. When it became clear that the most effective way to contain the COVID-19 outbreak would be to shut down much of the economy, and thus reverse many of the economic gains of the past years, it was a race to see who could unleash the most comprehensive stimulus package.

However, while swift action was merited given the unparalleled damage wrought by the virus, the rush to allay fears over loss of livelihood meant little thought was given to the longer-term impact of bailouts. The question will inevitably be asked whether ordinary people benefited from state intervention. One only has to look to the Occupy Wall Street movement and the emergence of ‘post-truth politics’ to understand why it is important that we get the bailouts right.

While it may be tempting to draw parallels to the Great Recession, the truth is that there really isn’t a playbook for how we deal with the fallout from this specific crisis. The ‘Great Lockdown’ has been largely indiscriminate in its attack on society, rendering systems of production, consumption and ways of life fundamentally changed beyond any previous economic crisis in this century or the last.

Multinational companies and small and medium enterprises (SMEs) alike are looking for government relief. Large swathes of privately-owned and for-profit companies are likely to be ‘saved’ and underpinned by taxpayers. Applying the logic of past financial crises doesn’t seem right. We are facing an entirely different problem, and the scale of funding is of another magnitude altogether.

That makes it all the more urgent to ensure transparent checks and balances are in place. There needs to be a new form of public accountability, reporting on the public return on government bailouts. If we are to learn from the bailouts of banks, it is clear that a new form of governance and regulatory system will need to be developed that can deal with the seismic value of public finance being made available.

Given the ethical and philosophical questions at play –  along with the inevitable increase in taxes on incomes and profits to come – devising a framework to decide on how grants and loans should be distributed to industry and business is imperative. We should start by asking five overarching questions.

Firstly, is the business socially useful? Here, the so-called ‘ESG test’ (environmental, social, and governance) could prove useful. How many people depend on what is provided? What does it contribute to its wider group of stakeholders? Is the remuneration of directors properly aligned with the success of the business and their employees, beyond earnings and share price measures?

Secondly, what is the ownership structure of the company? This could dictate the form in which support is provided (debt vs. equity/loans vs. grants) and its propensity to repay. Surely taxpayers would be loathed to create moral hazard by providing support to a business that is majority funded by hedge funds or ultra-high net-worth individuals (UHNWIs) vis-à-vis one that is made up of pension fund money. Though public shareholding models are politically difficult, in some cases, this will be the least worst option. From the bailout of AIG in the US, we know that, over time, this strategy can yield substantial profit for taxpayers.

Thirdly, would the absence of financial intervention in the market result in increased pricing power for incumbents? What would be the impact on consumers and stakeholders if the firm in question was allowed to fail?

Fourthly, could the bailout lead to a greener footprint? Green conditionality should form part of access to public funds with clear and specific proposals from recipients setting out their move to carbon neutrality.

Finally, will this help reduce inequality? Private entities receiving public funds should demonstrate how they will play their part in tackling inequalities through employment, training and targeted education initiatives.

This framework is by no means failproof, but it will certainly help reassure taxpayers. There will, however, be more complex cases which require a more nuanced approach. Should the state intervene to save moribund cinemas and retailers who were on course for insolvency prior to this crisis? If we chose not to, our high streets might become desolate far quicker than might have been the case without this crisis, with potential negative externalities resulting from the vacant space they leave behind.

There is also the question of whether governments use their own balance sheets to help support businesses or if they should use more innovative methods of risk allocation. They could, for example, harness the record levels of cash reserves waiting to be deployed in the alternative investment universe through private equity, sovereign wealth and private family offices. Private equity alone has around $1.5 trillion in cash to invest, as at the end of 2019, according to data from Preqin.

In this context, the concept and potential of ‘conditionality’ becomes the public guarantee and deal maker for public good, if used effectively. These bailouts can serve as a basis for a green recovery and reduced inequalities.

If the private sector needs a public bailout, then surely, this should mean a very different settlement, and perhaps a new social contract between citizen, state and the private sector.  A social contract that guarantees fairness, equality, a greener future and closes the gap between those that have the most and those that have the least.