The Stimulus Package and the Meaning of ‘Too Big To Fail’

We are departing briefly from issues affecting the satellite sector specifically to look at the general economic conditions affecting our sector and all others. The 2003-2004 rebound of the satellite sector was led by the entry of private equity debt leveraged investments and acquisitions. The current crisis, led by a credit crunch combined with historically low interest rates, means that new investment and acquisition finance as well as restructuring existing debt is going to be difficult. That affects us all.

The $825 billion fiscal stimulus package unveiled by the Obama administration in its first week is a reflection in part of the depth of the current financial crisis and in part of the lack of other tools at hand to apply to the crisis. Past recessions often have occurred at times of high interest rates, and a monetary policy of loosening the money supply by lowering interest rates has provided stimulus either alone or in tandem with fiscal stimulus measures. This time, with interest rates effectively near zero, monetary policy has no way to stimulate the economy, and government spending is the only measure available.

The crisis was brought on by overly liberal bank lending in the form of mortgages and credit cards (the next looming crisis) and has led to a near freeze in lending both to individuals and businesses, which are sensibly hoarding cash. However, the economy will not rebound unless consumers and businesses resume spending.

In an economy now, unlike in past recessions, driven by debt-financed consumer and business spending, the crisis brought on by the credit crunch is self-perpetuating. In addition to the scarcity of tools available to provide stimulus, the crisis presents a paradox: if Americans’ profligate personal and business deficit spending habits, enabled by bankers’ trafficking in cheap credit, led to the crisis, and the only way out of the crisis is to encourage further consumer and business spending, how is the vicious cycle ever going to end?

We all have heard the phrase "too big to fail" in recent months. In the context of financial institutions and industrial concerns requesting taxpayer dollars, it means the company is so large and embedded in the overall economy that allowing it to fail would risk unacceptable macroeconomic effects. "Too big to fail" is an exception to what economists call "moral hazard," which means the danger — by relieving a person or company from the effects of bad economic decisions — of causing them to think that future behavior is risk-free, since a bailout will always be there at last resort. In that case, a rational decision is to engage in future similar or other high-risk behavior, since the possibility of excess gains on the upside is there (reward follows risk), and the downside is protected.

In fact, it is worse than that; since the bailout is only on offered if the company is at risk of failing, it is the most risky behavior that is encouraged, since that is the behavior that creates the risk of failure. Moderately risky behavior may risk only bad returns, not failure, and therefore is relatively discouraged by acknowledging that an institution is too big to fail. If institutions can assure themselves of bailout on the downside if they are too big to fail, they are encouraged both to become too big to fail and to engage in the riskiest behavior possible, since it is only under those conditions where, if their bets go wrong, the bailout will be available.

That is the situation we have bought over the last couple of decades and which came to fruition last year. The path to remedy is narrow and unforgiving of drunken wobbling. The stimulus package must be enacted with a level of targeted specificity unheard of in our legislation. It must at once stimulate lending by financial institutions but limit that lending to credit-worthy businesses and individuals though the strict imposition of debt-to-equity ratios, guarantees, "quick" ratios, default covenants and limited (and monitored) permissible use of borrowed funds, among other measures. All of these conditions and covenants are well known to bankers; it is their will to enforce them that is suspect and which must be enforced by legislation and regulation.

And one other thing: the only rational response to "too big to fail" is to acknowledge that anything "too big to fail" is "too big to exist." A new era of "trust busters" may be dawning. While the satellite sector may not pose the macro economic risks of financial institutions, it will need to adapt to a world of less leverage and less ready acceptance of the logic of consolidation and economies of scale.