Anat Admati on the Perils of Corporate Debt and How COVID-19 Relief Efforts Have Gone Wrong

Anat Admati is a professor of finance and economics at Stanford University, and is well-known for her work on leveraging debt in our financial system and how it makes our economy more susceptible to shocks. She’s also a co-author of the popular book, *The Banker’s New Clothes: What Went Wrong with Banking and What to Do About It*. Anat joins Macro Musings again to talk about the COVID-19 crisis from the debt perspective, how the Fed and Congress have responded so far, and how their relief efforts should have been focused differently.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Anat, welcome back to the show.

Anat Admati: Thank you.

Beckworth: Well, it's great to have you on. You were on the show about three years ago, you were one of the early guests, one of the big name folks who came on and gave this show a bump, so we were grateful when you came on at that time. Back then we were talking about the Great Recession, now we're talking about an even greater recession, a greater contraction, the COVID-19 crisis. Happy to get you back on, we're near the end of our series, the COVID-19 series.

Beckworth: And today what I would like to do with you is look at this from two tracks. One would be what was the economy like coming into the crisis in terms of leverage, and then secondly, how is the policy response interacting, amplifying, or mitigating, if it is, the challenges created by leverage and debt in our economy? Why don't we begin by talking about leverage is, and maybe do so by looking at a household.

What is Leverage and Why Does it Matter?

Admati: Yeah, I like to start through a mortgage, because people can understand it better. So the mortgage is an example everybody encounters where you spend a little bit of your own money and a lot of money that you borrow in the form of mortgage to buy a much bigger house than you could have bought with your own down payment equity. This is a way for people to buy houses, and obviously the house serves as a collateral.

Admati: Then, of course, all kinds of things change after that, including your ability to pay because of your job and other things, but also the housing crisis, and that is obviously part of what happened in the last financial crisis and housing bubble and crash and all of that. Now, what happens when you buy a house? Say you buy a house for $400,000, but suppose you did that with $20,000 in down payment, 5%.

Admati: Then, of course, it all juices up your returns on the upside, because every dollar of the house going up, every percentage of it is a huge number of percentages on your dollar investment, so even the house goes up by 5%, you might, like, double your investment, if it just did so in a snapshot and I'm ignoring interest. But on the downside, it looks really ugly, because what this leverage does is it makes you very, very sensitive to, your investment goes down by a lot of percentages and gets wiped out very easily with shocks.

Admati: And so, say you invested $20,000 and the house went down by $20,000, you're out of your equity, and a little more decline than your equity, or equity plus what you owe in interest, it makes you what's called underwater. So in a corporate context, which we're going to go to soon, that is the notion of insolvency. Insolvency, and we can talk later about zombies and these sort of persistent insolvencies and the differences between default and dispense and insolvency and all these terms really matter here.

Admati: So there's an issue of paying your mortgage, and you might, even if you are insolvent, you're underwater, you might still want to pay your mortgage because you want to stay in the house, you don't want to foreclose. You might renegotiate it on the downside, so all kinds of things are happening, which, of course, the economy's all constructed on contracts, not just mortgages, but even rent agreements that are not to buy a house but even to rent a house, there's an agreement. There's an IOU that was made, and again, now what happens if you don't pay and how do we renegotiate any kind of contract? A car loan, a mortgage, a rent agreement, and then we get to all kinds of other agreements in the economy that are less formal or less imposing, like labor agreements, which employees can be more easily dismissed than some other planes in the economy.

Admati: So that's really the space that we're now at. With shocks, contracts become kind of, people violate contracts, basically. And so a debt contract is a basic IOU contract, and that's where the problem of what happens when somebody doesn't pay or can't pay or might not pay in the future, that's the space that creates all the impacts of overhangs, defaults, bankruptcies, and everything else that, unfortunately, with the shock that we have, happens to throughout the economy.

Beckworth: Okay. Just to summarize, then, leverage is the amount of funding used for particular-

Admati: Leverage is what you create by using the debt to invest.

Beckworth: Yeah. So whether I'm a household, I borrow money to buy a home, I'm a business, I borrow money to run the business. I'm a bank, I borrow funds to fund my lending activity. I'm using borrowed funds as opposed to using my own money, put my own skin in the game.

Admati: The way they invest here is mostly equity funded. If you remember, the big internet bubble burst, a lot more paper profit, a lot more profits that were anticipated and didn't materialize when the internet bubble burst in the early 2000s, there was much more losses, actual losses of companies going under and all of that than the actual amount of defaults on housing, and yet, it didn't cause a worldwide global crisis, because it was just all equity being wiped down, and there was a price adjustment in the stock market, and that's it. It was a collection of sort of overhyped internet bubble that was going on in the late '90s that sort of crashed in the early 2000s, but it wasn't a financial crisis of the type that some defaults on mortgages created in 2007-8 that were sort of spread around the world because of the chains of debts and through the securitization and all these other ways in which it got magnified throughout the system.

Beckworth: Okay, so a key takeaway from this discussion is, the more leveraged you are, the more you've relied on debt-

Admati: The more fragile you are.

Beckworth: The more fragile you are. So if you want to be resilient to a shock, whether, if I'm a house owner or if I'm a bank or if I'm an economy, the US economy in large, as you mentioned, 2001 recession was weathered much better because the decline was in equity, was in stocks, it wasn't related to debt. Whereas 2008 was much more tied to leverage and debt. So we want to have more equity financing I think is one of your big points, right?

Admati: Especially the corporations, because corporations actually have access to debt in their own profits, are ... to equity, sorry, to equity. So the whole point of a corporation is that it can sell equity shares and raise money that way if it has a viable business. And that's true all the time, even if you are indebted. You still have retained earnings that are basically the shareholders' money. Warren Buffett never pays dividends, he just keeps reinvesting. Stock price goes into the stratosphere, he can split it or whatever, but he always invests and wants his investors to trust him.

Admati: So a manager in a corporation invests shareholders' money, and whether they pay it or not, we literally have irrelevancy results on that. If they put it to good use, then investors are happy and the stock price goes up. So the notion that you have to pay dividends is only really there because of the tax code and because of shielding the money, it's like taking the money out away from creditors and borrowing more. So it's really about leverage, the dividend payout.

Admati: Of course, if you don't have investment, the money does belong to shareholders, and you should pay it. But the notion that you must pay dividends to invest is wrong, because there's access to markets, that you have to have dividends to pump up the stock price. You have a good investment, that pumps up the stock price. I always tell my students, "Worry about the asset side of a balance sheet of a corporation, find good investment." The liability side, if it matters, it matters because of the wrong reasons, because of some control issues, because of some tax issues. But that's not a socially optimal thing, to have debt just because you can get more tax subsidy.

But the notion that you must pay dividends to invest is wrong, because there's access to markets, that you have to have dividends to pump up the stock price. You have a good investment, that pumps up the stock price. The liability side, if it matters, it matters because of the wrong reasons, because of some control issues, because of some tax issues. But that's not a socially optimal thing, to have debt just because you can get more tax subsidy.

Beckworth: Okay, so again, we want to see households, businesses, banks, the economy, less leveraged, less reliant upon debt for funding, rely more on capital equity-

Admati: But instead we've got the opposite.

Beckworth: Okay, so there are structural reasons why banks in our financial system will tend to be over-leveraged, and unless we have some wholesale change in banking, it's probably going to persist. Relative to 2008, though, coming into this crisis, where we saw most of the growth in leverage would be in the non-financial corporate sector, is that fair? Relative to banks and households.

Admati: Yeah. I mean, the banks remained extraordinarily leveraged and extraordinarily fragile, but they were muddling along, were very profitable, they have a lot of ways to…

Beckworth: Right.

Admati: ... they have credit card loans, they have fees, they have investment banks, so they behave like hedge funds, they still have a lot of trading and market making and brokerage and all of this other… especially the big banks, but small banks were muddling along. There weren't big losses, everything was fine.

Admati: So they can remain highly leveraged and nobody will know it because they won't default and will go on. In the rest of the economy, there was a huge chase for return. Interest rates were very, very low, and so everybody wanted to leverage. So you started having this market for what's called a covenant-lite leveraged loans, basically lending to already indebted corporations. And it just grew and grew, and the Fed was saying "Oh, we're concerned about that, banks can do that." So then they'll go to shadow banks, and they're going to shadow banks, and through the chain of the entire financial system, they kept having more and more and more debt building up in the corporate sector with money just slushing around looking for a little bit more return, including pension funds and endowments and everybody else just averting their eyes from that risk, and just investing in risky and riskier and riskier debt claims that were promising a little bit more yield.

Beckworth: Okay, so banks are still highly leveraged, but they weren't adding a lot of leverage. They shrank a little bit.

Admati: They just stayed where they were.

Beckworth: But it was the corporations, the non-financial corporations, the traditional businesses you think of that added all the leverage. Household debt to GDP actually fell after the crisis. So that's the one private sector would be corporations, the other sector would be government also expanded debt a lot.

Admati: Right. And I'm not talking about government debt right now, because I want to talk about private debt, and then we can get to central banks. Central banks are very fragile…

Beckworth: Yeah, and one point to bring up in this discussion of debt and leverage, and I saw that Martin Wolf column in the Financial Times where he talks about all the leverage in the global economy now, one part of that, or a big part of that is that there's been this demand for government debt, safe assets, from different parts of the world. For demographic reasons, for emerging markets, for a number of reasons, and that is something I think it's hard to contain, to control. We're kind of endogenously responding to that, so I don't hold that in much concern as I do with the private sector debt, is that fair?

Admati: The notion that you're going to respond to this need for collateral in all of that, if you unpack that, if you peel that, it's also very problematic. But the Treasury borrowing is kind if in a class by itself. The problem right now, when we get to the Fed and the central bank, and of course the Fed is particularly privileged because of the dollar's importance in the world, but once we get to the Fed today, we will be pretty much erasing the fiscal/monetary barrier by now.

The notion that you're going to respond to this need for collateral in all of that, if you unpack that, if you peel that, it's also very problematic. But the Treasury borrowing is kind if in a class by itself. The problem right now, when we get to the Fed and the central bank, and of course the Fed is particularly privileged because of the dollar's importance in the world, but once we get to the Fed today, we will be pretty much erasing the fiscal/monetary barrier by now.

Admati: Because in the CARES Act, you have these really new weird things that are going on in terms of, the Treasury giving, essentially, backstops to the Fed and allowing the Fed to sort of lever, but the Fed doesn't have a real balance sheet like corporations, so the Fed does not default itself. It can go to negative equity, but that's all just make believe, it's all, it gives the profits to the Treasury, it's all in cahoots with the Treasury, but ever more so now than before.

Admati: Let's not get ahead of ourselves. Going into this situation, what really happened was, there was a kind of corporate leverage. And the rest of the economy is built on all these other debt contracts that we don't quite call leverage, which is basically just the standard economy with all the commitments people make, who make all kinds of payments to their landlords and to their employees and to suppliers and all kinds of contracts that are going on that we wouldn't say are financial leverage per se, but just contracts, just their transactional relationships.

Admati: Then you have the hit, you have the shock. And here's where the shock was large for everybody, but we do have to recognize exactly what happens when you enter a shock like that with this financial leverage in place, because when the shock hits, then the question is what happens to all the contracts, and which contracts get prioritized over others? And which contracts does the Fed and the government make sure are fulfilled, versus which contracts and people they let flail around.

Beckworth: Okay. So we live in a world with lots of leverage. There are structural features that make that happen in banking laws, regulations. Let me ask a broader question, stepping back from these points you've been making. So I looked at a paper by Oscar Jorda, Alan Taylor, and some others. They have written several papers on this, and they show a hockey stick of debt or leverage in advanced economies that really took off with globalization. With globalization opening markets, the spread of finance around the world, you see kind of like a hockey stick, kind of like with climate change, except this is with total debt. And it creates the impression that this is almost inevitable, that all this debt is a byproduct of further and deeper financialization of the global economy.

Beckworth: And given that's the case, and I don't want to sound defeatist here, but let's just take it as given, what solutions can we impose on a global economy, particularly advanced economies that are highly leveraged? One solution I've seen that came out of the last crisis is to have more state-contingent debt contracts, so debt contracts that pay out in different states of the economy. So for example, a mortgage where I would make mortgage payments based on the state of my local economy. If the economy's doing really well, I pay more, if it's doing poorly, I pay less. And that kind of turns a debt contract into something more like equity. That's one solution. Are there any other solutions or any other approaches you would suggest, given that we do have a leveraged economy?

Solutions for Highly Leveraged Economies

Admati: Okay, so I will not take this leverage as a given, for one thing, because there's one immediate fix to the corporate leverage part of it, and even to the mortgage debt part of it. Stop the tax debt subsidies. I mean, the Economist Magazine called it the biggest distortion, man-made, person-made distortion. This tax deductibility of interest is a historical accident. There is absolutely zero justification for it. And in my, I can't get into the technical detail of the paper on leverage [inaudible] that I wrote with three colleagues, it's a theory paper in the Journal of Finance in 2018, that talks about all the [inaudible] mortgage, and one of the reasons when you have debt, no matter how high, that if I let you choose another leverage level, you would always go up, never down. So you are really addicted to it, and more so the more you are leveraged, the first-order effect is the tax kick you get from borrowing.

There's one immediate fix to the corporate leverage part of it, and even to the mortgage debt part of it. Stop the tax debt subsidies. This tax deductibility of interest is a historical accident. There is absolutely zero justification for it.

Beckworth: Let me ask this question. If you repealed those tax advantages, do you think there'd be a big change in the amount of leverage in our economy?

Admati: There have been some studies in the IMF about that. It is not clear that this is ‘the’ thing, but it certainly is an immediate help there, okay? So just like, why not? There's absolutely no reason not to change it. Every tax-

Beckworth: Sure.

Admati: ... bipartisan committee on changing taxes, and even in the last, that's been, actually, one of the most outrageous things that's happening right now is that buried in the CARES Act is more tax bonanza to debt, specifically, and to certain wealthy people. I mean, it is really, truly outrageous what gets buried in the details of some of this. It has nothing to do with what the real needs of the economy are right now.

Admati: Now, you brought up global, and that is true. One of the things that you have is that when you have, a lot of the action in corporate taxation and even individual taxation is just tax evasion and tax havens. If you're still reading about that, you will know we are nowhere in being able to just collect taxes, and we're collecting so inequitably, that there's so many tricks that can only be used and are only sued by corporations, by certain particular kinds of corporations in terms of locating subsidiaries and doing all kinds of tricks to avoid taxes, to set up one jurisdiction against another.

Admati: It even happens in this country. The state of Delaware is a tax haven, all kinds of other things like that. So we need to rethink tax collection per se if we're going to have corporate taxes. We have to remove the incentives for debt. There is major tax overhaul that would help us kind of get a better system that would not feed as much into this leverage problem that we routinely suffer from and just say "Oh, we got to live with it," like you did. I do not accept that.

Admati: Markets are failing here, because investors, you get through the layers of, it's a governance problem, layers of the financial sector where you have a lot of institutional investors owning and everybody is just checking off boxes and wanting short term returns. And so it's a kind of fundamental structural problem in our financial sector, and the other thing I would only mention in terms of multinationals and especially multinational banks is the process of default and insolvency once you're a multinational.

Admati: Take the Lehman Brothers bankruptcy. People are saying "Oh, they shouldn't have let Lehman fail, because look what it did." Let's just talk about that bankruptcy process, whether we should or shouldn't be afraid of that legal process called bankruptcy, where a corporation seeks protection from their creditors. And airlines have gone through it for years and we wouldn't even know it, because the planes keep flying and they just restructure some of their contracts.

Admati: Look at the Lehman bankruptcy. Lehman was a medium-sized investment bank, this is in the context of too big to fail. It was a 640 whatever before failing, balance sheet, billion dollar investment bank. Bigger then Bear Stearns, which wasn't allowed to fail, just six months before that, and was swallowed by JP Morgan Chase, to which it owed a lot of money, by the way, in a sweetheart deal, and then Lehman is allowed to fail. Maybe a mistake, maybe not, but what you could see is the following in terms of the legal process: that bankruptcy process, last I looked, which was, I think a year or two ago, was still going on. More than a decade later.

Admati: It involved, first of all, like at least 80 countries doing different bankruptcies and in this country, all these subsidiaries and all these creditors and obviously the lawyers celebrating, a lot of…

Beckworth: Right.

Admati: ... and whatever was the kind of assets to liability, however much their equity was negative, they basically ended up with, I don't know what, 20 cents to the dollar or something. In other words, the process itself was so incredibly messy. Now, it's really messy when it's a multinational, because a multinational lives globally and dies locally. So we don't have bankruptcy procedures that are for a multinational. When Lehman Brothers failed, we saw that play. Because Lehman Brothers, on the eve of declaring bankruptcy, moved all the money from London to New York. When the London subsidiary came on a Monday morning, there was no money there for their bankruptcy process to turn on the lights. So what you see is the ability of the corporation to move money across the globe, and then the process of fail is always a legal process in which you have to divide up and stand in line and all of that.

Admati: And by the way, another distortion in the financial sector specifically, and another thing to change for sure, and this, you can interview at some point, people like David Skeel or Mark Roe in particular, law professors who have been talking about that excessive safe harbor exemption of repos. Basically, and a repo transaction is a secured borrowing transaction. So what it is is instead of me lending you against a collateral, so my name is on that asset, you actually sell me the asset, I have it in my possession, and you promise to buy it back from me at a price, okay? At the end of the term of this loan.

Admati: Now, if you default, if you go into bankruptcy in the middle, I just walk away with the asset. I'm safe, I don't have to wait on line in a bankruptcy court, I don't have to wait eight years until it's all resolved and we see where I stand relative to other secured creditors. The collateral is mine. I walk away, I don't care. I have an exemption from what's called the stay in bankruptcy, bankruptcy freezes all the assets. And so that has been written up multiple times by people in the law, saying that exacerbated fragility in banking that increased the use of repos, and also derivatives, because now you want to call every transaction a derivative, because again, the collateral and the margin are all protected from all bankruptcy, and now you can scale up that kind of leverage, because your creditors, again, feel safe, because they own the collateral.

Admati: In other words, built into the tax code and the bankruptcy code are enablers of this leverage, especially in the financial sector, but more beyond as well. And so we have to correct this. And even in our financial reforms, we never revisited the bankruptcy code, we never revisited the tax code. And these are fundamentally counterproductive. In a recent presentation, I showed you shoot your foot. In other words, we just shoot ourselves in the foot. Nothing good about it, increases fragility. So there are things we can do to reduce the aggregate dependence by the private debt in the market.

Built into the tax code and the bankruptcy code are enablers of this leverage, especially in the financial sector, but more beyond as well. And so we have to correct this. And even in our financial reforms, we never revisited the bankruptcy code, we never revisited the tax code. And these are fundamentally counterproductive.

Admati: Softening some of the terms might make sense as well for mortgages, for student debt, for some other debt. So there's a lot of different things we can do not to find ourselves in this position again and again. Now we have an immediate problem, which is there's going to be a lot of zombies, a lot of insolvencies, and the way we're giving support to the economy right now, especially to the corporate sector, which got itself into this leveraged position.

Beckworth: Okay, so just to summarize, you're saying we shouldn't take for granted the amount of leverage in our economy. We should reform our tax code, reform regulations that incentivize more debt, more leverage. Would you be open, also, to state-contingent debt contract use as well?

Admati: Of course. The debt contract is not always the most optimal, it's just a question of how to structure that contract. What Mian and Sufi proposed was, for example, student debt. Take that. Why should students bear with the incredibly harsh collection terms, you can't even dispose of this debt in bankruptcy, that their college turned out to be for-profit bad college or that the economy tanks and they can't find a job. Why are we subjecting them to that risk with incredible harsh overhang? You can make student debt more income-dependent. You can structure it so they don't just start paying right away. You can make it so that it goes more with their life cycle, rather than so harsh as we have it, and you can also decide who to give it and for what purposes.

Admati: For-profit colleges now are thriving on excessive student borrowing, and the students are too naïve. So now you are in a world, so there are all kinds of places in which we have harsh debt that's subsidized, that's enabled by all kinds of guarantees, without looking at whether it's put to good use. And certainly the harshness of a debt overhang on a household is exacerbating recessions, and that's the *House of Debt* book, and we definitely should revise the way risk is allocated in the economy.

Beckworth: Okay, so we want to move to a world where we finance everything more with equity, with our own funds as opposed to borrowed funds, and we need to go in that direction.

Admati: And we find ways to subsidize things that we care about, not by subsidizing debt to do them.

Beckworth: Okay. So we have a lot of work cut out for us, and a lot of reform and changes that are needed. And I understand your disappointment, it's been a decade since the previous crisis and not much was done on this particular front in terms of reforms. Let's look now at the current crisis in more detail. So we have COVID-19, it's a huge shock, probably larger, in fact, we know it's larger than it was in 2008.

Beckworth: Yeah, so it's going to mean bankruptcy and insolvency for many organizations. And I guess my question to you is, start off with first, what is your sense of the policy response from Congress and the Federal Reserve, and then maybe we can get into specific programs, but just as a bird's-eye view, have we taken the right approach, wrong approach, or somewhere in between with what Congress and the Fed have been doing?

Assessment of the Current Policy Response to COVID-19

Admati: It's somewhere in between, and leaning towards really bad.

Beckworth: Okay.

Admati: And really wasteful and poorly-targeted, and unfair and unjust and a lot of other adjectives I can give you. It favors corporations, it favors investor class, which is not the economy. It favors large corporations, it favors those who are in the financial market, which is why the stock market is high but the rest of the economy is in terrible shape. The stock market stopped reflecting the economy, it’s so propped up because they buy junk bonds, because they do all these windows and alphabet soup that you were talking about last week or whatever. I mean, it is crazy.

Admati: I mean, now, there are a lot of people suffering in the economy that were just living paycheck to paycheck, and that includes small businesses. So the way they target the support even for small businesses is so cumbersome, is so inefficient, is so misused and abused and is so poorly governed, it's really, for somebody who's interested in governance in general for all institutions, private and government, I was shocked and dismayed by the level of accountability and by the way it targeted throwing money at places that less need it and not spending it on places that do need it or in the most direct ways. If you want companies not to fire employees, you can look at examples in Europe like Denmark or England or Germany. You take over the payroll. You do not say to a hotel chain "Oh, do me the favor and don't fire the people." Just say "You know what? You can go and renegotiate your debt contract, you can renegotiate your rent," which is what every small business has to do anyway, "We will pay your employees right now, because they can't work, okay?"

There are a lot of people suffering in the economy that were just living paycheck to paycheck, and that includes small businesses. So the way they target the support even for small businesses is so cumbersome, is so inefficient, is so misused and abused and is so poorly governed, it's really, for somebody who's interested in governance in general for all institutions, private and government, I was shocked and dismayed by the level of accountability and by the way it targeted throwing money at places that less need it and not spending it on places that do need it or in the most direct ways.

Admati: In other words, the economy took a shock, we want people to stay home, and that applies to the restaurant down the street, to the audiologist office of my friend and all of that. They are not getting help, they don't have junk bonds in the market for the Fed to just go snap up, okay? The Fed now bought, in the financial crisis it bought mortgage-backed securities. The ECB ended up buying or taking its collateral, Greek government bond, became a huge creditor. Now the Fed is buying everything and anything, risky and backed up by Treasury. This is a completely unheard of way to think about what is needed and how to get there.

Admati: Now, I understand that you need the banking system to transmit things, and not all of us have Fed window access and all of that. But the way, even in the last financial crisis, fat bailouts were given to banks in order to lend, but because they came with few restrictions, basically the government behaved like a creditor, they said "Oh, don't pay too much salaries and don't pay common dividends until you pay me back the bailout," and then they declared victory. But they motivated it by the banks' lending, and the banks that got help did not want to lend, because they had an overhang and the loan is kind of risky and boring, and so they wanted to just go return the money and move on.

Admati: Now they're saying "Oh, you can't increase," they're just asking politely, there's no clear mechanisms for all of that, "Please don't increase the pay of your incredibly well-paid executives. Don't increase it." It's already tens of millions of dollars, and you're not imposing any pay cuts. In other words, the stakeholders of the corporations, between employees and contract workers and whoever else, and the executives and the investors at the top, who gets favored by all these policies?

Admati: So some colleagues and I organized a letter, signed now by over 230 academics from law, economics, and finance, saying that this targeting to large corporations is completely misguided, okay? And this is the way it's playing out. Even when they get to small business loans, you see all these stories in the paper about how big chains and big clients were getting them, and when a hotel chain like Marriott gets funding, they can use it for the franchise, to pay franchise fees to the top of the company at the head, and meanwhile they let the employees go through this incredibly inefficient unemployment system, and it's so inefficient and so cumbersome because the unemployment insurance system gets overloaded and people are separated from their jobs.

Admati: If you instead said "Okay, I have some IRS, I have some Social Security, I know what people are making, I'm just reversing the taxes and I'm just giving them their pay for a while," 75%, or whatever was taken in Denmark, and then you remove that expense, and then the people are paid. Instead of paying through the unemployment insurance. In other words, on and on and on you can go through how inefficient the system has been. You sent [inaudible] and then who does it go through and how [inaudible] and all kinds of nonsense like that. But in other words, I think there were a few good elements in it, but I think it's poorly-targeted, wasteful, and really dismaying in terms of accountability.

Beckworth: I've had a number of previous guests on the show who share some of those views, in particular the point that shareholders and creditholders are the ones seemingly getting more help than the actual enterprise itself or the employees, and I think one of the reasons that's the case is because Congress is leaning heavy on the Fed. It wants the Fed to do a lot of the heavy lifting.

Admati: Yes. The Fed is the transmission mechanism, and what the Fed was allowed to do was here's $454 billion, the Treasury is basically backing up your losses, and you can lever that up to 10 times or something and go on a shopping spree of things that you have access to, which is not the rent of my friend with a small business, is only in these financial markets, and it props up these same markets. When the Fed becomes a creditor of a large corporation because they own their junk bonds, what happens if that corporation goes bankrupt? I want to know, what kind of creditor will the Fed be? It's probably going to be the nicest of creditors. It's going to say "Oh yeah, we got the Treasury backing me up, let's let other people have it. We're going to make the Treasury money then point to that," and all of that.

Admati: All of that, for people who love markets and advocate markets, to have the market so distorted, to have people say "Oh, government should go away, government is evil, government is the enemy, except government now help me, me, me, me, me," is really dismaying. So let's not talk about how it's a market economy anymore when this is how it plays out. People on the ground, small businesses have no access to that, except with conditions. They are the ones that get stringent conditions on any money they get, and often it comes in loans that they might not be able to pay, okay? It's forgivable and all, but it takes them a month to even get in queue, whereas all the big lenders.

So let's not talk about how it's a market economy anymore when this is how it plays out. People on the ground, small businesses have no access to that, except with conditions. They are the ones that get stringent conditions on any money they get, and often it comes in loans that they might not be able to pay.

Admati: So in other words, again, all the transition ... Meanwhile, by the way, the banks are getting huge windfall from this. Because when I looked at the SBA lending, at Small Business Administration lending when it was first came out in the $349 billion allocated which was, just vanished in two weeks, mostly with all kinds of big loans, and a lot of small businesses couldn't even begin to reach it, what were the conditions for the banks? The banks were told "You go make these loans, here's money at zero interest rate. Go lend it. People have to fill some forms, but you're exempt from having to really be liable for any of that, so it's too much work for you to check the forms and you might not know the client or maybe you go for your top clients," or whatever else.

Admati: Meanwhile, you can charge them 1% interest. We pay all the fees, Small Business Administration, and it's fully guaranteed by SBA. So it's a windfall, no risk. They get the fees, they get the interest, and they can just decide who to give it to. And that's just the way we transmit help to the economy? I mean, through the banking system? It's really incredible.

Beckworth: Well, let me take the side of the Federal Reserve here and play devil's advocate just for a minute. I think part of the challenge the Fed has is that Congress is asking the Fed to do so much, but the Fed itself is not designed to do what Congress wants it to do. I mean, the Fed's designed to help out in liquidity crisis and to bridge troubled waters, not to-

Admati: And it was made into, this phenomena of central banks taking over the economy, we already see it in Japan somewhat, but in Europe, an ex-student of mine wrote a book called *Collateral Framework*, he's in Zurich. And it was about the ECB, just strategy, just policy behind the dark door that hides all the things that they do, and this is one of my complaints about the Fed, it's so opaque, and we can get back to that for the last crisis and now. Central banks were not meant to own the economy, to grow to have $10 trillion of just about everything.

Admati: In Europe it started where basically there's no markets anymore, the ECB decides who lives and who dies by now. Whoever they take as collateral, governments or corporations, lives, and whoever they decline will die. When they didn't want to give liquidity supports to Greek banks, the Greek banks would die. Meanwhile, they're a creditor of the Greek government, et cetera.

Admati: Here, now, the Fed is doing more and more and more, and it was not meant to be that way for central banks. And so it sort of, the idea got planted in the last financial crisis that central banks can do ever more and ever more, I mean, it maybe started in Japan or whatever with these QEs, and now they're going to buy the treasuries, which sort of sounds weird at first, and Ben Bernanke said "Well, it doesn't work in theory, but it worked in practice." Sure. You're a central bank, you can print it, you can buy whatever, and you can go in this loop where everybody loves treasury and you're going to be the one buying them and reducing the yield curve and all of that.

Admati: So now the Fed is in really dangerous territory, because even in the last, it just expands more and more, the risk-taking that it does. And it covers it all with this narrative of propping up market and enabling market and liquidity, liquidity, liquidity that they call everything, but instead, they're taking on risk and passing it on to Treasury, and by now the notion of an independent central bank there to save us from runs on bank is long gone, and there's no difference anymore. And who knows who they lent to and which junk bond they decide? They hire Blackrock, then, to do that. By now you have a blending of the private sector, the central bank, the government, all of that.

Admati: To go back to the last financial crisis, the Federal Reserve in the last financial crisis committed something like $7.7 trillion to loans to financial institutions and other central banks. And if you look at that and if you read Adam Tooze’s book *Crashed,* you can look at the details of all of that. First of all, the Fed refused to give details on that. Refused in court, refused Freedom of Information Act request two, three years after the crisis when everything was calm again. Bloomberg had to go to court, Bloomberg News, to sue for that information. And those loans were not disclosed in financial statements of these banks and were not disclosed to Congress at all, when Congress enacted even the Dodd-Frank Act, nobody knew what actually the Fed did. So accountability was very poor then, and the Fed remains shrouded in mystique, okay, of exactly what they do. And so it's not an accountable institution in the detail, and when the details become $8 trillion, that's even scarier.

Beckworth: Let me ask this question in the time we have left. How would you have made the rescue reliefs different? What would you have done if you were the benevolent dictator here planning how the aid were to flow to households, small businesses, those who need it, what would you have done differently?

How Should the COVID-19 Relief Package Been Structured?

Admati: Well, I started outlining it. I would have gone as much as possible directly to households. Directly to households means using IRS and Social Security Administration, which have the information, and not always going through the banking system in a sense.

Beckworth: Okay.

Admati: So that's one thing you would do. And of course if the IRS wasn't as depleted from resources from this administration as well, and so that's a problem, I would have institutions that you could rely on. The fact that, if we can't do it, that's a sad commentary on the kind of government that we have, that can't spring to action except to throw everything at the Fed.

Beckworth: So more funding directly to households. How about greater use of bankruptcy for larger corporations?

Admati: Even direct to corporations, just direct to the workers, if you want to…

Beckworth: Yes. So what about greater use of bankruptcy? So some of these bigger corporations-

Admati: Yes, definitely.

Beckworth: Okay.

Admati: So in fact, I think Skeel and Roe wrote an op-ed about flattening the curve of bankruptcies, saying that we need more debtor in possession and we need the government to maybe step in within the bankruptcy system to just kind of make the restructuring kind of work if you have a surge of bankruptcies.

Admati: But I think the worst thing for the economy coming as we go with this crisis, which might last both in acute, in some kind of acute term, another year or more, and coming out of it will be evermore, is to avoid the situation in Japan and in Europe of zombies, of leaving the zombies. You need to go through insolvency procedures and get a corporation that's functioning and that's not just operating in an insolvent state, because insolvent corporations are incredibly unhealthy corporations. They don't make good investments, they gamble for resurrection, they are the symbol of sort of a sick corporation.

You need to go through insolvency procedures and get a corporation that's functioning and that's not just operating in an insolvent state, because insolvent corporations are incredibly unhealthy corporations. They don't make good investments, they gamble for resurrection, they are the symbol of sort of a sick corporation.

Admati: And I put a stethoscope, as a corporate doctor, to the banks and say that they are permanently on life support, because they couldn't live a minute in markets, the way they are. The opacity that they have, the little equity that they have, if they were separated from all the safety nets, they couldn't breathe as a business, okay, in the economy. So let's not talk about markets working.

Admati: But for the rest of the economy, propping up zombies is not a good strategy and we should really be careful to ... Let's face it. The economy will change and some businesses won't last. We may not travel for a while. Some industries, including the shale oil industry, probably should have died. You read Bethany McLean, and it was never a good business anyway, and it just was propped up by debt, by the way. So that whole energy business is really awful, okay? If they died, that would just be for the better, okay? In many ways, the environment as well as not supporting zombies with more and more and more debt.

Admati: And so certainly there will have to be restructuring. Some of the sectors will thrive and some sectors will have to slow down. I don't know how many restaurants can survive, we'll have to see how it all settles down. We'll have to redirect some resources to use the space a little differently or to have more of these businesses and less of these businesses. So there'll be and adjustment for the economy, okay? And we have to do that. Sectors, we had VHS and then we don't have VHS. Blockbuster was here, and now we have streaming.

Admati: And then the book stores get reduced and we have more online, et cetera. We have that process always happening, destructive innovation and all this stuff. And that will happen more because of the adjustment to this sort of new normal, whatever that looks like. And so we have to manage that enormous debt that we got into this crisis with wisely. And we have to avoid propping up zombies because they're politically powerful and all of that.

Beckworth: Alright, well with that, our time is up. Our guest today has been Anat Admati. Anat, thank you so much for coming on the show.

Photo by Chris Li