The Government Must Protect Strategically Vital Industries from the Shock of Coronavirus
Bailing out airlines and energy companies might be politically unpopular, but in this case it’s necessary.
As markets tanked Monday, President Donald Trump announced plans for a payroll-tax cut to stimulate the economy, as well as potential wage relief for hourly workers affected by coronavirus. Democrats have proposed alternatives, such as paid sick leave for workers staying home due to the virus. While both proposals could marginally increase domestic demand, neither addresses the particular pressure points of this crisis.
The shock from coronavirus is likely to be temporary, if deep, for a quarter or two, but its potential for lasting economic harm centers on businesses that will have trouble servicing their debt due to revenue loss from the crisis. Airlines, cruise operators, and energy companies, in particular, are facing staggering losses as demand for their products tanks. President Trump hinted at potential government assistance of those firms on Monday. But rather than being an ancillary concern, such assistance should be at the forefront of the administration’s response to the coronavirus shock.
Airlines earn razor-thin margins from their operations, so even a temporary reduction in revenue has dramatic effects on their bottom line. They tend to be highly leveraged due to the large capital costs involved in owning and operating a fleet of aircraft. While lower oil prices will reduce their variable costs somewhat, that won’t matter if they can’t sell tickets. American Airlines’s short-term debt-coverage ratio for the last twelve months was 0.8x, meaning it made 20 percent less from operations than it paid to service debt. As cash flow plummets, American Airlines and its peers might not have enough cash on hand to pay back short-term liabilities. Accordingly, the company’s implied cost of funding shot from less than 3 percent in February to nearly 12 percent last week. If airlines default on their debt, it could spell doom for a sector that employs roughly 500,000 Americans. And even if they withstand the crisis, international competitors such as Emirates, which receive lavish government subsidies, will be well-positioned to wrest market share from them in the aftermath.
Shale-oil companies are in a similar position. Since 2016, the price of oil has fallen, due in large part to the abundance of natural gas produced in the United States. Even before the coronavirus hit, the decline in prices had already pushed domestic profits down industry-wide. As demand for energy decreases due to the virus, firms such as Occidental Petroleum will almost inevitably fail to meet debt payments. Exacerbating that harm is the collapse of OPEC+ talks between Saudi Arabia and Russia, whose collective caps on oil output have put a floor beneath oil prices in recent years. A weakened American energy industry is a particularly alarming possibility, because of the national-security implications of losing domestic sources of oil and gas. Indeed, American energy independence has reshaped the geopolitical landscape in the U.S.’s favor.
Corporate-bond yields, which move inversely to bond prices, skyrocketed on Monday as investors sold off the debt of firms threatened by the virus. High-yield spreads — the difference between the rate at which the U.S. government borrows and that at which highly leveraged corporations borrow — surpassed 660 basis points, their highest level since 2016, due largely to sell-offs of energy bonds. With markets expecting insolvency for strategically crucial firms, the federal government now faces the choice of propping those firms up or letting them go into bankruptcy.
Bailouts tend to be unpopular due to the “moral hazard” involved in saving flailing businesses. If firms know the government will step in to assist them in times of need, they have an incentive to take outsize risk. This argument held weight during the 2008 bailouts, because that financial crisis was largely the creation of banks’ taking huge risks on mortgage securities.
But the current shock is a different beast. Airlines and energy firms are not responsible for the havoc wrought by the coronavirus, nor will temporary assistance make them likely to take actions that risk another pandemic in the future. (In fact, such firms couldn’t do so even if they wanted to.) But if every American business had to prepare for the tail risk of a global shock, it would permanently hinder economic growth.
The clock is ticking. If the White House and Congress wait, financial pressures will continue to mount. They must act now to protect the American economy.
© 2020 National Review