(soft ambient music)
-[Viral Acharya] Good afternoon, everyone.
Welcome back all the students,
alumni, faculty members,
and some of the media who have
kindly joined this session.
We have a slightly
different format
for today's Faculty
Insights series.
It is going to be a
panel on the financial
and economic policy response
to the COVID-19 outbreak
in the United States.
As we saw on Tuesday
in the presentation
by Professor Rob Engle,
the market reactions
to the COVID outbreak
and the social distancing
stringency measures
that have been
taken on since then
have been quite unprecedented,
both in terms of
the correlations
as well as the volatility
of the market moves.
At the same time, this is not
just a financial amplifier.
There is a large shock to the
underlying real economy since,
to some large firms,
especially to the small firms,
and in fact at the level
of individuals themselves,
many of whom are out of jobs,
on unemployment insurance,
and many small businesses
are working their way
to stay afloat
through this episode.
So, unsurprisingly,
the policy response
has also been quite
unprecedented,
and today we have
three experts with us:
Professor Larry White from the
Stern Economics Department,
Professor Kim Schoenholtz,
also from the Stern
Economics Department,
he also heads the Global Economy
& Business Center at Stern,
and Professor Dick Berner,
who co-heads the Volatility
and Risk Institute
at the Stern Finance
Department with Rob Engle.
So, without much ado,
let me hand it over to
the three panelists.
The order in which
the Three Musketeers
will present their show
is Larry first, then Kim,
and finally Dick said he's
going to do a little bit of cleanup
of whatever damage the first
two have done to the panel.
So, let me hand it
over to you, Larry.
- [Larry White] All right.
Thank you, Viral.
So, first, I'm very
pleased to be able
to be part of this
seminar series.
And, really, thanks to
Viral and Batia Wiesenfeld
for setting all of this
up and making it happen.
I'm the opener here.
The stars are going to
be Dick and Kim.
They're going to show you the data,
they're going to show you
more details on policies,
but I want to try to set
the conceptual stage.
Now, like any good
business school professor,
I have to tell you
what I'm going to say,
then I'm going to say it
and tell you what I said.
And here's the overview.
Basically, someone has
to bear the losses.
I'll get into more
detail on that,
then talk a bit
about mitigation,
talk about the mechanisms
for allocating the loss.
And it's important to understand
the position of lenders
and people like
lenders, like landlords,
when a borrower can't repay.
An important part
of that message
is bankruptcy need
not mean liquidation.
So, the losses, and we've
seen a number of metaphors.
I think the best metaphor
is we're experiencing
the equivalent of a
sustained national hurricane,
not a couple of days, not in
a specific geographic area.
And it's targeting people,
not the physical
structures plus people.
And no question, there are
widespread personal tragedies,
premature deaths, new and
exacerbated illnesses,
and large economic losses,
the reduced outputs
of goods and services.
Remember, we are primarily
a services economy,
and that also has the other
side, which is reduced incomes.
And of course, in this
kind of reduction,
there are going to be
the direct effects,
then there are going to
be multiplier effects,
which we all learned in
our macroeconomics courses,
and the dislocation effects
as there's going to
be some expansion,
but in different places
employing different people
from where the
reductions happen.
How deep, how long?
What recovery path?
And the other area
of economic loss
is the diverted resources
to the emergency medical and
related services and goods,
and that's going to show up in GDP,
but it's the equivalent of
the repairs after a hurricane.
Yes, those repairs
show up as part of GDP,
but they're really just
repairing the losses.
All right, one primary point.
Someone, people, are going to
have to bear the losses.
Companies, governments
aren't the real bearers
because they are ultimately
relationships among people.
Governments are elected by
and funded by constituents.
That means us.
So, at the end of the day,
someone must bear the losses,
and they're going to
be substantial losses.
Then we get to the
question of who.
And one can start asking
are there culpable parties?
Nah, I don't think
so, not really.
Should we just let the
chips fall where they may?
And should higher
income individuals,
higher income households
be among the main
bearers of the loss?
All right, when we think
about mitigating the losses,
of course, what
we're experiencing
are the lockdowns,
quarantines, et cetera,
and on an overall basis,
there's this interesting
working paper
by Anna Scherbina at Brandeis.
She was on the President's
Council of Economic Advisers
a year ago, and they
did a practice exercise
a year ago looking at this.
You can see what the benefits
of the kind of
lockdown/quarantine are.
Of course, to think
about the benefits,
you've got to put a
value on saved life
and avoided illnesses.
We could spend the
rest of the afternoon
just talking about
those particular
types of calculations,
but I think Scherbina has
done a reasonable job there.
The costs: reduced
output and incomes.
She may have done a little
bit of double-counting,
but, again, I think,
basically sensible.
And there's also more
intangible costs,
like reduced mobility, like
reduced freedom, if you like.
How many of us would've
liked to have been
at family's homes this
past Wednesday night
for a first night of Passover
or at friends' and
families' homes
this coming Sunday for Easter?
And it's not going to happen.
These kinds of
calculations, of course,
are sensitive to
modeling assumptions
and we always need more data.
In addition to the
overall benefit-cost test,
there's a marginal
benefit-cost set of issues
that are also relevant.
You want to know first on
the intensive margin,
how severe should the
suppression measures be?
And then there's the
extensive margins,
those are at least two: which
sectors and for how long?
And again, we need more testing.
And I show you links
to the Scherbina paper.
You may also want to take a look
at "The Economics of Lockdowns".
Trigger warning:
This was a webinar
that was hosted by the
Cato Foundation yesterday.
There are some things in there
that many of us
don't agree with,
but I think there's an awful lot
of good, clear,
sensible thinking
that gets enunciated
in that webinar.
All right.
So, as we think about
mitigating the losses,
it's important to remember
that economic relationships
are important in the
economy right now
and quite important
for the recovery,
and there are those kinds
of economic relationships.
You might say, "Well,
maybe the eroding
"of some of these relationships
"can lead to more innovative
arrangements in the future."
Maybe, but we need to
remember about relationships.
All right, so, suppose
an enterprise experiences
a downturn in business,
and I give you examples,
and customers don't
want to patronize,
the employees can't or
don't want to show up,
supplies may be hard to procure.
And, of course, suppose
this is widespread.
First, let's suppose the owners,
the employers bear the loss.
They continue to pay
out to their employees,
their suppliers, the
creditors, the landlords.
Well, they're going to have
to draw on liquid assets
or they're going to have to borrow.
And then who's going to lend
to them, on what terms?
And it's important to remember
borrowing doesn't cure the loss,
it just pushes the borrower's
loss-bearing into the future.
Now, this kind of scenario does
maintain the relationships,
but how long can this continue?
Now, you can say enterprise
owners tend to be higher income,
so asking them to bear more of
the burden; okay, I get that.
But you also have to think,
well, pension funds when
it comes to corporations
are major owners and their
beneficiaries are the owners.
What about them?
They probably, on average,
the beneficiaries,
if they are part
of a pension fund,
probably above-average
income as well.
All right.
Next, suppose instead
the employers say,
"No, I can't bear the loss.
"I'm going to close down.
"I'm going to severely retrench."
And then it's the
employers, the suppliers,
the creditors who bear the loss.
And then, of course,
we're into wider
macroeconomic consequences
with multiplier effects,
dislocation effects.
Of course there's
going to be some buffering
from in-place stabilizers,
unemployment benefits,
Supplemental Nutrition
Assistance Program,
what we used to
call food stamps,
Women, Infants,
Children nutrition.
But there's going to be
relationships eroding.
And then there's
this real question:
What about those
contractual obligations
with their landlords, with
their creditors, suppliers?
And the same issues arise when
an individual's obligations
are in question.
Now, in fact, what we're seeing
is the federal government
as the social insurer
that spreads the
loss more widely.
The Fed, and you're going to hear
much more about this aspect
from Dick and from Kim,
but you have to start asking are
other programs going to be cut?
Is the tax system itself that's
going to be used eventually,
sooner or later, to
repay, is it progressive?
How much support?
To whom?
And if it's enterprises,
so as to preserve
those relationships,
should government be
acquiring equity positions
in corporations?
How quickly?
How effectively?
How thoroughly?
Who's going to fall
through the cracks?
And then, should that support
be in the form of
grants or loans?
And again, remember,
loans provide liquidity,
but they just push the
borrower's loss into the future.
What can borrowers do when a--
What can a lender do when a
borrower says, "I can't pay"?
Well, there's going to be some loss
that the lender will
highly likely have to bear.
The lender should be looking
for the least cost outcome.
The lender can
restructure the loan,
and we saw a lot of that
in 2008, but you have to,
the lender has to worry
about moral hazard
or the lender can
foreclose/repossess
or, for commercial borrowers,
they can force a bankruptcy,
but there are going to be
added transactions costs
and there may be some
neglect of social spillovers.
And it's just
important to remember,
when loans are securitized,
we've got extra complications
because there are
multiple lenders
and an extra layer that creates
an additional
agent/principal problem.
The last important
point I want to make,
bankruptcy for large companies
need not mean liquidation.
They can continue to function.
Yes, the owners/shareholders
get washed away.
The lenders take haircuts,
become the equity stakeholders.
Incumbent management may be kept
or new management installed.
And all of the major airlines
have gone through
bankruptcies at least once
and have continue to operate.
Or there can be liquidation.
If
bankruptcy-but-continued-operation
was the alternative,
then you've got to understand
government aid to such a company
is primarily a bailout
of owners and lenders.
And so, there are
my conclusions.
I've gone a bit longer
than I had hoped I would,
but I hope I've set the stage.
Dick, Kim, it's over to you.
- [Kim Schoenholtz] Thank you, Larry.
So, good afternoon, everyone.
Thank you, Viral, for
organizing this panel.
It's really an honor to be here
with Professors
Berner and White.
So, my role today
is really to discuss
the Federal Reserve's
response to COVID-19.
Suffice it to say, the Fed's
actions are breathtaking
in scale, scope, and speed.
In less than six weeks,
the US central bank
already has gone far beyond
its extraordinary actions
in the crisis of 2007-09.
The Fed appears committed
to do whatever it takes
within the law to counter the
impact of the COVID crisis
on the economy and
the financial system.
Put differently,
the Federal Reserve
is now on wartime footing
and is prepared to use
its emergency tools
to support the government's
battle against the coronavirus.
I believe an apt analogy
is to the Fed's role
in World War II,
when it set monetary policy
to ensure the smooth
financing of the war.
Given the circumstances,
it is very good news that
the Fed is finding ways
to support the
government's efforts.
There is much that it
has done and can still do
as the lender of last resort,
market maker of last resort,
and as monetary policy maker.
At the same time, I am concerned
that the Fed's new role
as a key allocator of credit
to nonfinancial entities,
a role as a state bank,
is one that will be
difficult to shed
when the challenges currently
facing private markets fade.
Why is this important?
Over the past 35 years,
Federal Reserve monetary
policy independence
has been vital to securing US
price and economic stability.
Going forward, however, the
deep engagement of the Fed
in politically sensitive
distribution issues,
like the allocation of credit
to non-financial firms
and municipalities
raises doubt about the
sustainability of independence.
Put simply, independent banks
do not make fiscal policy.
That is for elected officials.
With this in mind,
let me highlight the
Fed's aggressiveness.
Compared to the crisis of
2007-09, when it took 16 months
to lower interest
rates close to zero,
the Fed did so last
month in two weeks.
It also announced unlimited
quantitative easing,
QE infinity, something
that was introduced
only years after the
financial crisis was over.
And it revived an alphabet soup
of so-called expired policy
tools from the crisis,
including dollar liquidity
swaps with foreign central banks
and various lending
facilities to non-banks,
like the Primary
Dealer Credit Facility
and the Money Market
Lending Facility.
These actions already have
swelled its balance sheet
to a record $6 trillion.
That's the April 8
black dot in the chart.
The increase is driven
by massive gains
in lending to
financial institutions
and in Treasury holdings.
Going forward, the
announcement of new programs
for allocating credit
to nonfinancials
portends a further large
increase in the balance sheet.
Indeed, rather than using the
government's own balance sheet
for such fiscal purposes,
the CARES Act calls
on the Fed to do so
and it provides a
taxpayer backstop.
It's worth contrasting
this new state bank role
with the Fed's
historical approach.
Traditionally, the
US central bank
aimed at asset neutrality,
setting the interest
rate on safe assets
while allowing private
firms and markets
to allocate risky credit.
While the Fed can
accept the liabilities
of nonfinancial
entities as collateral,
even in the crisis of 2007-09,
its direct role in credit supply
to these nonfinancial
entities was limited.
For example, the
Fed's Commercial
Paper Funding Facility
supported a market
which, at that time,
only about 20% 
of the issuance
was from nonfinancial firms.
Following recent
Fed announcements,
including those from yesterday,
asset neutrality is no
longer a key objective.
A new alphabet
soup of facilities
will provide about $2 trillion
in credit against collateral,
including loans and
bonds to corporations
and small businesses, as
well as municipalities.
And the Fed already is
extending the riskiness
of the acceptable collateral
to sub-investment-grade
instruments,
presumably backstopped by
taxpayers through the CARES Act
or through the Treasury's
Exchange Stabilization Fund.
To be clear, the Fed ought
to be on wartime footing.
It should ensure that
the financial system
is able to perform
its critical functions
of facilitating payments
and delivering credit
to healthy borrowers.
Moreover, as in World War II,
it should be prepared,
if necessary,
to limit the cost of financing
the governments' battle
against COVID-19.
At the moment, however,
Treasury funding costs
are at or close to record lows.
So, the question
is why the CARES Act
uses the Fed's balance sheet
to allocate credit to
the nonfinancial sector.
As an alternative, Congress
could have given Treasury
the authority and
the budget resources
to implement all
these mechanisms
for delivering credit to
nonfinancial entities.
Under that approach,
the credit provided
would appear transparently
on the government's
balance sheet.
Instead, under the
current arrangements,
it could take many
years for the Fed
to put its new politically
sensitive emergency tools away,
even after they are
no longer needed.
Indeed, it took six
years for the Fed
to gain a modicum of
independence after World War II,
even when the Fed was
primarily financing
just the federal government.
Let me close with a few words
on whether the Fed's
actions will work.
Based on recent labor
market developments
and on private forecasts,
the current recession
will be the deepest
US economic downturn
since the Great Depression.
With long-term interest
rates already so low,
the impact of forward guidance
and quantitative easing
is likely to be more
limited than it was
in the crisis of 2007-09
or in the subsequent recovery.
Consequently, discretionary
fiscal policy,
which Professor Berner
will now discuss,
is front and center
in this crisis.
Ultimately, however, the
impact of both monetary
and fiscal policy depends
on the effectiveness
of our public health efforts.
Economic policy can help us
while the economy is
in suspended animation.
But the longer that
period extends,
the greater the
wave of bankruptcies
that could swamp the financial
system and impede recovery.
So, while the Fed is doing
its part to fight this war,
the real battle for
the nation's wellbeing,
including its financial
and economic wellbeing,
remains with our
healthcare workers.
To them, we will be
forever indebted.
- [Dick Berner] Okay.
So, thank you, Viral and
Batia for setting this up.
And like Kim and Larry,
I'm honored to join
my esteemed colleagues
on this panel.
So, like Larry, as a good
business school professor,
I'm going to give you the
punchline right up front.
In terms of fiscal policy,
we've gotten fiscal relief.
We've gotten a down payment
to support the economy
and preserve essential services.
But it is merely that,
and more is definitely
needed and on the way.
- [Viral] Dick, I'm sorry to interrupt.
There is some
disturbance coming in.
I don't know if
it's your cell phone
that's interacting with the
microphone or something,
but there's some static
that's coming in.
If you are able to just push
it aside, it might help.
Thank you.
Sorry, everybody.
-[Dick] All right, let me
know if that persists.
So, one of the things that
Viral alluded to at the start
was the work that we are doing
to show the tracking
of cases and volatility
in financial markets.
And you can see that on our
website, which I depict here.
This is from yesterday.
And you can see how that spread
and which markets
are being affected.
And that's important
when we think about this
on a global perspective or
in a regional perspective
when it comes to fiscal policy,
which coordinates between
the federal government
and state and local governments.
Now, Larry set the stage
in terms of talking about
what we have in front of us.
First and foremost, obviously,
we have a dramatic
healthcare crisis
that involves shutting
much of the economy down,
not just here in the
US but also globally.
And that creates both
supply and demand shocks.
And it's important to take
a moment to look at those
because they drive the policy
responses that we're getting.
The supply shocks I think
you're pretty familiar with,
with the spillovers
the loss of employment,
the spillovers through
global supply chains,
and, not incidentally, the
provision of essential services
which can be threatened.
On the demand side, I
think it's important
to think about the lost income,
the focus on necessities,
whether or not there's
access to credit,
as Larry and Kim both indicated.
But I think it's also important
to talk about the uncertainty
and risk aversion in this crisis
because while
currently it appears
that we may be approaching
a turning point,
that's highly uncertain,
and so people are,
that risk aversion
gets amplified.
And it gets amplified
on a global basis
because we have a
highly connected,
interconnected global economy.
In addition, the shock
from COVID, I think,
exposed a number of
vulnerabilities and amplifiers.
Economic vulnerabilities: a
frail economic safety net,
a global slowdown,
an oil price war that
dragged down production,
the impact of an
ongoing trade war,
and whether or not our
emergency responses
were coordinated or not.
And the financial amplifiers
that Viral alluded to.
But in particularly, I
want to talk about the fact
that corporate America,
nonfinancial corporate America
had embraced high
corporate leverage
and we saw weak credit quality.
And the other kinds of
financial amplifiers are there.
Just to illustrate
on the safety net,
when we look at our
state unemployment
insurance trust fund,
they are clearly, depending
on which state you look at,
even on the eve of this crisis,
they clearly were
not adequately funded
and the infrastructure
for distributing unemployment
insurance benefits
was also fraught and still is.
And in terms of corporate
leverage and defaults,
we have seen a dramatic
increase in corporate leverage,
measured here by
nonfinancial corporate debt
relative to nonfinancial
corporate GDP in the black line.
And you see two
default rates here.
One is for commercial
and investor loans,
which so far has been benign.
But second is the default
rate for high-yield debt
from our colleague Ed Altman,
and that has already shown
signs of deterioration.
You look back in history and
you see the kinds of defaults
and bankruptcies that we
had in past recessions,
particularly the
most recent one.
So, I think that frames
for us the policy goals.
And as Kim and Larry
have both indicated,
we're trying to balance
fighting the virus
and limiting the economic damage
with an assessment to
the extent we have data
of the benefits and
costs of doing each.
So, it's essential
that we have policies
that build confidence
in health outcomes
and preserve essential services.
And on that latter point,
it's important that
we get critical aid
to state and local governments,
to do that, and equipment,
and maybe use wartime powers,
not just at the Federal Reserve
but elsewhere as appropriate.
And we need to help
people stay at home,
and Larry talked
a lot about that,
by funding sick leave,
replacing lost income,
and deferring
obligations to pay bills,
including rent and
loan obligations,
and providing loans and grants
to support people
and businesses,
to help the Fed to support
market functioning,
as Kim discussed, and,
as Larry also indicated,
to preserve our
economic infrastructure
and relationships for recovery.
So, what have we gotten?
We've gotten three
phases of fiscal relief:
first, in very modest terms,
to help state and
local governments;
second, tax credits
for employers offering
paid sick leave;
and then third, which you
probably read a lot about,
a $2.2-trillion
tranche in phase three,
which was enacted at
the end of last month
that provided a lot of
relief in broad terms.
As for the Fed's response,
this has been breathtaking.
It's been bold.
It's been relatively speedy,
given the political process.
And it's been widespread.
And the numbers
here that you see
in terms of the distribution
of outlays look large.
$500 billion to help
big corporations,
$377 to help small
businesses, and so on.
Relative to a $21-trillion
US economy, however,
these numbers are
not all that large.
It sounds big.
It sounds 10% of GDP.
But when we think about the aid
that is going to individuals,
it is really only
sufficient to maintain them
for a relatively
short period of time.
So, when we ask whether these
actions meet these goals,
I think it's
important to recognize
that this is not fiscal
stimulus in the usual sense.
It's really a down payment
for health providers,
for state and local governments,
and for income support.
And the need has been amplified
by the deficiency
in the safety net
that I talked
about a little bit.
Further, when we think
about reaching people
who are low-income,
that is challenging
because either they
don't file tax returns
or they don't get Social
Security benefits.
And last, the official resource
infrastructure that we have
is being overwhelmed
and that slows down the
speed of the payments.
The good news is that there's
likely more relief on the way.
There's been talk of
an extra $250 billion
for small business loans.
That got held up in
Congress just yesterday.
And additional aid for hospitals
and for state and
local governments.
And then, to preserve our
prospects for recovery,
there are going to be more
stimulus that's needed.
I want to mention at this point
that there's also an
international development here.
When we think about the
spread of the coronavirus
and its impact on
the global economy,
it's particularly acute for
emerging market economies.
We've seen $100 billion in
outflows from those economies,
depriving them of
resources needed
to support their populations.
Now, the IMF is
standing by to help
and lenders are also
proposing a standstill
along with official
support for that,
a standstill in loan payments
by emerging market economies.
And I think that fits the script
that Larry was talking about
in terms of who has to pay.
And in that case, the
lender and the borrower
share in the pain.
So, a couple of comments
that reflect what
Kim was talking about
with coordination of
monetary and fiscal policy.
Kim talked about
the Fed programs
that are being backstopped
by the Treasury.
We've seen a number of those,
both in the CARES Act
and even before that
to back some of
the Fed facilities.
And if there are
more facilities,
it's clear that
they're going to require
more Treasury backstop.
In the Fed minutes,
we saw mention of the
Term Auction Facility,
which will provide
term liquidity.
And there are questions
about facilities
for mortgage servicers,
a point Larry raised,
for our government-sponsored
enterprises in housing,
namely Fannie and Freddie,
for insurance companies
who may need liquidity
in order to make
good on payments.
And it may be necessary
to expand the range
of financial counterparties
in existing or new facilities.
All these will
involve coordination
between the Fed and the Treasury
either in terms of backstop
or direct assistance.
And I think it's
important also to note
that indirect
coordination is occurring
because the Fed and
other regulators
have been encouraging banks
to draw down their capital
and liquidity buffers.
And if the banks are not
as resilient as we think,
then some recapitalization
of the banks may be required.
It would be great if they
could do that on their own,
but it may be that
they're going to need
some assistance
in certain places.
Other regulatory relief, I
think, has also been helpful.
And the question
is whether or not
that leaves the banks
resilient enough
to survive what
we're going through.
And then, when we
get to recovery,
there will be questions about
coordinating what the Fed does
with debt management policies.
My suspicion is
that won't be like
what we saw in the
global financial crisis.
There's probably going to
be more coordination.
So, I share Kim's concern.
And a couple of ways
that we might think about
alleviating that concern,
Congress authorized the
Treasury to backstop the Fed.
Congress could equally
authorize the Treasury
to take back some
of those facilities
onto the national balance sheet
and make them Treasury
rather than Fed facilities,
which would alleviate
some of those concerns,
and that might be helpful.
So, I will stop there.
- [Viral] Great.
Thank you so much,
Larry, Kim, and Dick,
for providing this both
summary conceptual framework
as well as some
sort of a guide path
as to where we are
likely to end up
as the economic fallout worsens
and more economic data comes in
over the next few
months and quarters.
Let me take some questions
from the audience.
I had a question in my mind,
but it's very close, Larry,
to a question that Jason Smith
from the NYU EMBA
program has asked.
And the question is, "Doesn't
bailing out zombie companies
"like airlines empower
CEOs and boards
Òwho have sort of not run
their balance sheets too well?"
The precise term he has used,
the precise adjective
he has used is 'crappy'.
"Shouldn't they go through
the bankruptcy process?
"It's not like bankruptcy
"will lead to companies being
shut down in the short term.
"Sophisticated investors
know the risks they take
"when they make an investment."
And I think the final question
is really a very deep one.
"Is capitalism dead?"
Over to you, Larry.
- [Larry] Ah, yes.
All right, crappy, a
technical term in finance.
Isn't that right, Viral?
Look, there are serious issues.
Should the airlines have
maintained more liquid assets
on their balance sheets so as
to be able to at least handle
part of the losses that
they are experiencing?
But this is so massive that I
don't think it was reasonable
to expect them to have
had so many liquid assets
that they could survive
without anything else.
So, then the question is,
should they go
through a bankruptcy?
And if they have a viable
future, presumably the lenders,
maybe the lenders with
some encouragement
from the federal government,
would be able to figure
out a way forward.
Again, bankruptcy
typically washes away
the existing creditors and
the lenders take a haircut,
become the owners.
They decide about what
management team they want.
How you think about
whether there should
be a bankruptcy or not,
you've got to remember,
if there is a bankruptcy
and the alternative
was that they would've
remained in operation,
like the airlines have done
over the last 20 or 30 years,
then what the bailout does is--
Sorry, what the support
does is bail out
the existing shareholders,
the existing creditors.
You've got to decide what you
think the right outcome is.
I just think it's
important to recognize
that bankruptcy does
not mean liquidation,
at least for a
publicly-traded company.
- Just follow up on that,
Larry, with a related question
that has come from Omara Ali
from the Langone program,
and this refers to, in
addition to bankruptcy,
whether you see M&A activity
as being the potential way
that the industry
might sort itself out
as firms which have
cash constraints
and likely unable
to weather the storm
are perhaps sort of acquired
or merged into firms
that have run extremely
prudent balance sheets
or are sitting on large
stockpiles of cash.
How do you see this playing
out during and post-COVID
as a potential
alternative to bankruptcy
for some of these firms.
- [Larry] No question, there will
be some acquisitions.
As many of you know, I come
from an antitrust background,
and so I sure hope that
the Antitrust Division
of the US Department of Justice
and the Federal Trade
Commission will be,
they will have the legal powers
to review such acquisitions
and they ought to be maintaining
strong, competitive frameworks
for deciding, is this a
sensible acquisition or no?
But of course, if the
alternative is that
the business fails
and doesn't, can't go on,
then, gee, that business is
going to disappear anyway,
and so maybe an acquisition
is the best outcome.
There's no question there
are going to be lots of M&As
or certainly proposed
M&As on the landscape
in the near future, no question.
- [Viral] Great.
Thank you, Larry.
Let me turn to Kim now.
There's a question
that was on my mind.
I think it's on minds
of a lot of investors.
Rob Engle has proposed
it in the Q&A as well
and so has Pret,
which is, typically,
the kinds of public debt growth
and central bank
balance sheet growth
that we are already witnessing
and, as Dick Berner pointed out,
we are likely to
see more of this,
historically, these have
been followed by episodes
of either severe repression
in which you have to channel
savings of the economy
through restrictive
policies into public debt
or they have been
sort of dealt with
through monetization
by the central bank
or what economists have
called as fiscal dominance,
where the central bankers
who start worrying about
the public debt getting
rolled over without problems
rather than worry about
inflation and other mandates.
So, the question is what do
you think is the likely path
over the next decade or two
on Treasury rates,
inflation, taxes,
once we are out of this
scenario in which almost surely
both the central bank
balance sheet size
as well as the public
debt to GDP programs
in all developed economies
are going to be at
unprecedented high levels
other than sort of
wartime scenario.
Kim, do you want
to take this on?
And, Dick, please
feel free to chime in
once Kim has responded.
- [Kim] I hope that Dick
has a crystal ball
that goes out two decades.
Mine doesn't quite go that
far, but I'll do my best.
Look, I think it's
a great question,
and it is true that we
have seen in the past
when there are massive
increases in debt,
for example, for
wartime finance,
that wartime finance
typically leads ex post
to periods of either higher
inflation or to repression.
That happened after World
War II, as a good example.
However, I think we
have to be careful
in the current episode
and think back to a period
more like the Great Depression.
We don't yet know the
extent to which this shock
or the shocks that
we're experiencing
are going to be dominated
by supply or demand shocks.
And the longer that the
isolation process goes on,
the social distancing goes on,
the likelihood is
that we will see
a larger and larger
wave of bankruptcies
that will have an
impact on demand
and on the structure of
the economy going forward.
So, frankly, I'm not surprised
that Jay Powell said yesterday
that inflation is not
the critical issue
that they're focused on
at the Fed at this time.
They're trying to make
sure that the economy
doesn't fall into such disrepair
that it's not reparable.
And so, while--
And I would also say that
if you look at markets
around the world,
long-term bond markets,
they're not flashing red
signs about inflation.
Quite the opposite.
They seem to be warning us
that the risks of a
deflation are greater.
So, I don't want to
sound complacent.
I think it's a good
question to ask
and we should remain
alert to the risks,
especially, for example,
if central banks
are stuck in the role of
playing fiscal policymakers
for a long time to come.
In that world, they could
do damage to economic growth
and ultimately someone will
have to bear those losses,
either in higher taxes or in
inflation as a substitute tax.
So, we should be alert.
I don't think that's the
key issue at the moment.
- [Dick] Let me just add
to that if I could--
- [Viral] Yes, please,
Dick, yeah, yeah.
- By and large,
I agree with Kim.
I think the near-term
risk, and by that,
my crystal ball is no
less cloudy than his,
so I think the near-term
risk for the next few years
is probably lower inflation
and maybe even deflation
for a short period of time.
So, I'm not worried about that,
and so I share Jay
Powell's concern.
And I think the analogy
to the Depression
is more apt than it is apt
to the Second World War.
But it's mixed because
there is going to be
a great shift in resources
and we don't know exactly
how that's going to play out.
There will be massive
changes in business models,
particularly in the service
parts of our economy
that we are all aware of that
are being hammered right now.
We don't know the extent to
which technology will help us
with some of these things
because we haven't seen the
innovation that may occur
that will keep inflation down.
And we don't know the
extent to which this shock
and its consequences
will ripple through
to affect investment
and productivity
and the infrastructure
of our economy.
Now, Larry talked about
maintaining those relationships.
It's pretty clear to most of us
that some of those
relationships need to change.
And, in fact, there may
be a tiny silver lining
in this crisis that
some of them will change
in a way that is positive.
We're not quite sure.
But we need to be
wary and vigilant
about exactly how those
things are going to play out
and whether or not over time
they will promote inflation.
As far as the fiscal issues
and the debt issues
are concerned,
I'm a card-carrying member
of the school that says
when you start approaching
debt that's 200% of GDP
or whatever we're headed
for, you should watch out.
And we need to have a fiscal
policy that is sustainable.
However, I'm also mindful
of the lessons from Japan,
where they do have
200% of GDP debt
and many people have tried to
talk about inflation in Japan
and to short the Japanese
government bond market,
and neither of those two
things have materialized.
So, we're in uncharted waters
and, frankly, our crystal balls
don't really give us a
lotta guidance right now.
We need to watch those
supply and demand shocks
that Kim and I talked about.
- [Viral] Great, thank
you, Kim and Dick.
Just as an aside, having
grown up in an emerging market
and having spent some time
at a central bank there,
my experience has been
that there are sort
of two trajectories
that tie public
debt to GDP levels.
One is sort of
outright monetization
by the central bank.
The dominance leads to some
loss of inflation credibility
and then any shock could
lead to an inflation spiral.
The alternative is one of
sort of very high levels
of repression for
long periods of time,
in which case you get
sort of low-growth,
low-inflation sort
of environment.
And so, I just wanted
to put that on the table
that lack of inflationary
signals in the market
may not necessarily be good news
because that might
reflect in part
the expectation that
we are likely to be in
a crowding-out repressive zone
for a long period of time,
not so bad for bond-holders,
but not that great for
growth in the economy.
Let me turn now to--
- [Larry] Viral, Viral?
Viral, can I just
jump in for a second?
- [Viral] Absolutely, absolutely, yes.
- [Larry] As Kim and Dick know,
I am wary of that
parallel with Japan
because the US dollar has
been a reserve currency
for the last 70-plus years.
The Japanese yen is not.
And so, it may be a lot easier
for the Japanese economy
and government to have
a 200% debt-to-GDP ratio
than it would be for the US
if it wants to continue its
role as a reserve currency
with the benefits, soft power
and monetization, et cetera,
that goes along with that.
- [Dick] And, Larry, I couldn't
agree with you more.
If anything, this
crisis underscores
the fact that there is no
alternative to the dollar.
And what Kim has described is
essentially not just the Fed
being lender and market-maker
of last resort and state bank
but it has become the
global central bank,
the lender to the
world as a whole.
And so, we all come
down to confidence
in the Federal Reserve
when it's appropriate
to shift from what it's doing
now to its traditional goals
of making sure that we
have price stability.
- [Kim] If I might jump in that,
Viral, there was a
question, I thought, earlier
about whether the Fed's
actions are taking account
of what's happening
outside the United States.
And I think they definitely
are very much aware of it.
They're very much
aware of spillover
and spillback into the US.
And one of the best
examples of that
is the central bank
liquidity swaps
that were introduced
aggressively last month
and have already gone a
long way to diminishing
some disruptions in
short-term financing markets.
So, remember, it's
worth keeping in mind
what I call the
global dollar system,
the system of
dollar-based financing
outside the United
States, is actually larger
than the commercial banking
system inside the United States.
So, the need for dollar
funding is enormous.
And the central bank
of the United States
has stepped into that role again
as it did in the
crisis of '07-'09
to be the lender of last
resort in that market.
So, the other
question that came up
I thought related to that
is what about coordination
with other central banks?
So, in this area, they
obviously are coordinated,
but it's worth keeping in mind,
if the Fed's
ammunition is limited,
meaning long-term bond yields
here are already quite low
and there's a limited
effect they can have,
the limits that
face central banks
in much of Europe and
Japan are even greater.
They already start with a zero
or negative long-term
interest rates.
So, the ability that they have
to influence their economies
is even less than the Fed's,
and so the reliance
on fiscal policy there
will be even greater than
it is in the United States.
-[Dick] And if I could
conclude this dialogue
with two brief points.
One is that the Fed is
not the only central bank
that is setting itself
up as the state bank.
Other central banks are doing
similar kinds of things,
notably the Bank of England
in its own lending operations.
And the second point is that,
to the coordination point.
It would give
markets and, I think,
investors and business
people and consumers
a lotta confidence if we saw
in response to this global
pandemic, global coordination
not just in monetary policies
but also of other policies
that were aimed to
solve the health crisis
in a coordinated way.
- [Viral]Great.
Thank you, everyone.
Just in interest of time,
let's squeeze in two or
three quick questions
with sort of very
brief responses.
I'll try and channel
them to one of you.
Larry, the first
question is for you.
You discussed about the
virtues of bankruptcy
in the sense that it doesn't
necessarily mean liquidation.
Would you carry
over that concept
also for micro, small, and
medium-sized enterprises?
If yes, why so?
And if not, what do you
recommend be done for the MSMEs?
- [Larry] Sure.
With smaller enterprises,
the real issue is
do you have enough confidence
in the current management
that you're willing to
restructure the loan
in your position as
lender or do you say,
"You know, I just don't think
this enterprise has a future
"and I'm better off
foreclosing, liquidating,
"getting what I can, rather
than restructuring the loan
"and hoping this enterprise
is sometime in the future
"going to be able to pay me back"?
Those are difficult decisions.
Lenders have to do
them all the time.
Again, back in
2008, '09, and '10,
real estate lenders, mortgage
lenders had to be making
those kinds of decisions
vis-a-vis homeowners.
It's a standard
issue for any lender
when the borrower
says, "I can't pay."
So, it just has to be
that kind of issue.
If we do have
government assistance,
yes, it's going to
help the borrower,
it's going to help the owner.
That may well be
what we want to do.
These are tough decisions.
- [Viral] Next question,
over to you, Kim.
It seems that increasingly
the Federal Reserve
is playing the role of
a lender of last resort,
not to specific
depository institutions
but to markets at large,
markets for corporate bonds,
markets for commercial paper,
markets for municipal
debt, et cetera.
Do you think this is a
step in the right direction
as the economy becomes more
sort of market-financed
rather than bank-financed
or do you see
substantial moral hazards
in sort of casting
the safety net
across even to market investors?
- [Kim] I think we have to be careful.
I think lender of
last resort efforts
really are focused
on making sure
that liquidity is
available for institutions
and in particular in
some money markets
where those institutions
might finance themselves.
So, past interventions in
short-term financing markets
fit that definition.
They would've fit
Bagehot's definition
back in the 19th century.
But when it comes to
allocation of credit,
I don't view that as
lender of last resort.
And I think that
up until recently,
the Fed did relatively
little of that,
even in the great
financial crisis.
They did, of course, intervene
in the mortgage market.
That was, in some sense,
the biggest effort
at allocating credit,
but they were buying only assets
that had federal government
full-faith-and-credit
guarantees.
So, the new state bank approach
involves them actually
allocating resources
to default risky institutions,
and that's a very
different pattern, I think,
than we've seen
generally in the past.
That's what I think,
as Dick suggested,
would probably be better located
on the Treasury's balance
sheet than on the Fed's.
- [Viral] That's great.
Thank you, Kim, for that
really crystal clear response.
Last question,
over to you, Dick.
It's a combination of questions,
but I'll make it into one.
How do you see all this,
the COVID-19 response
play out in a couple
of years down the line
in terms of two outcomes?
One, the relationship
between US and China,
notably the US government
debt ownership by China
which relates a little bit
to the reserve currency issue
that we discussed earlier.
And second, how do you think
companies are likely to plan
for such pandemic stress
tests going forward?
- [Dick] Two very weighty questions.
I'm not a China expert,
but I would venture to say
that the answer to that lies,
to some extent, in politics.
In the post-World War II period,
we have built up
alliances around the world
in the United States,
and we've shown global
leadership in that regard.
We've tried to do that
in a number of ways
with respect to China as well:
encouraging China to
join, for example,
the World Trade Organization
and other arrangements in
which China is a participant
and has a seat at the table
rather than is on the outside.
That has proved to
be very difficult.
I think it will continue to
prove to be very difficult.
And frankly, I think that
a risk in this crisis
is that we will see more, not
less, nationalistic policies
and more assertion by China
to assert a global
leadership role
in the world economy
and in world politics.
So, that's going to be
a real challenge,
not just for economic
relationships
but for strategic and political
relationships as well.
And it bears on a
whole range of issues
that we will be grappling with.
The second question is
how will businesses,
and for that matter I
think we should extend it
to governments and all
members of our society,
be prepared to deal with
pandemics in the future
and for other kinds of risks?
And I think the answer we
have to build resilience,
we have to be prepared.
Clearly, we did
not have resilience
in our healthcare systems.
And comparatively,
Viral, as you know well,
emerging market economies
have even less resilience
than we do in that regard.
We have to think about all
the things that can go wrong
and how, in a globally
interconnected economy,
we can see shocks transmitted
from one part of the
economy to another.
So, this is going to
be this huge tension
between a world that is
still globally interconnected
and national policies or
nationalistic policies
that tend to move that apart.
And coordination, I'd maintain,
is always the answer here.
It's difficult to achieve.
But we need to think about
what our global
relationships look like.
How resilient are
our supply chains?
How prepared are we
for the next pandemic?
Because it does seem to me
they've become
increasingly frequent.
And how are we prepared to
meet other challenges out there
that are still important,
challenges from climate change,
which may be related
to pandemics,
challenges for geopolitical
risks and cybersecurity risks?
All those things are things
that I don't think
we're prepared for
and we need to start doing that.
- [Viral] Thank you very much,
Larry, Kim, and Dick,
for a really
stimulating session.
Thank you as well to
all the participants
from faculty,
students, alumni, media
for your excellent questions.
As we get back to the sobering
reality of our current lives,
I'm glad to see that
the Stern faculty
who were on the panel today
seem extremely resilient
to stressful questions.
(laughing)
So, very well done.
All the best to all of you.
Stay safe and take care.
- [Larry] Thank you, Viral, thank you.
- [Viral] Thank you, bye.
- [Dick] Thanks to my colleagues.
- [Kim] Thank you, everybody.
- [Larry] Yes, thank you;
thank you, everybody.
- [Viral] And thank you to
all the admin staff
for helping us run the Zoom
session really seamlessly.
- [Dick] Agreed.
- [Viral] It was excellent, thank you.
Bye.
(soft ambient music)
