The Socialization of Risk

March 16, 2020

Let's talk about socialism - specifically, the socialization of risk. 

We're likely about to be asked to bail out the riskiest elements of the American energy sector. Others - like airlines and cruises - will line up after it.

A lot of human beings are looking down the barrel of job loss because of what's unfolding in markets. In energy, it's already savage. Oil sells for less than break-even production prices for a majority of the American energy market and Saudi Arabia is peacocking, saying it can knuckle-by at these levels for years. From Bloomberg:

The more that American producers pump, the more money they lose. They're leveraged and capital-heavy. To survive, they'll look to fire workers and find ways to roll forward their (hyper-risky) debts.

The easiest - maybe only - way to roll that debt will be through the emergency low-interest federal loans lawmakers are quietly conceiving right now. 

The profits of companies in this space are, of course, privatized, as were the profits of American banks before and following the rescue packages that saved those banks a decade ago.

We're crossing through the doorway of economic crisis and the words adorning that threshold are once again "moral hazard."

We've been here before.

Popular accounts of the bank bailouts insist that tax payers earned a handsome profit on the loans extended to our largest banks. In the strictest terms that's true. We know - thanks to an incredible 10 years of reporting by ProPublica - that the Treasury is on track to collect more than it dispersed to our banks. 

It was just the worst risk-adjusted return in the history of lending.

While the global financial system was seizing, while traders were pulling cash out of ATMs, while the most risk-prone speculators in global finance were sprinting from the markets they'd made, the American tax payer - without so much as a personal finance class in its belt - stepped into the bid-ask breach to keep the banks on their feet.

Nothing would stop the bank bombs from detonating, one after the other, except a statement of total backstop from the American collective. And for our trouble, we received, over 10 years, something on the order of 19% (aggregate, not compounded).

The other side of that ostensible windfall were eight million American households losing their homes. Real median income didn't stop falling for five years. Millenials were rocked permanently from the trajectory of financial security that their parents followed.  

From the Washington Post:

The hot potato of risk that always follows speculation and leveraging and the financialization of a society jumped around American financial firms long enough to make a bunch of people unfathomably wealthy and then, in 2008/2009, landed for the briefest of moments in the hands of people that don't have, and don't want, a damned thing to do with the business of Wall Street. When that moment of screaming hot risk arrived, the owners of privatized profit exited, and people not within shouting distance of the levers of power took the lash.

No one went to jail. Offenders made legendary fortunes. We made an obscure paper 'profit' - on a loan we don't even understand - of 19%. 

The truth is, that loan has not nearly been made whole.

And yet, after all that wretchedness, after all that injustice, I believe that the bank bailouts were necessary. This one may be too.

I am a capitalist, but I am a capitalist that believes we determine the parameters of the toolset that is Our Capitalism. So if we're going to step in to brace industry at its moment of peak risk, again, we need to demand our pound of flesh. Their other options are the wolves of creative destruction.

But what about the virus?

Well, why do critics focus so acutely on companies' stock buybacks and dividends in national moments like the 2018 $1.5 trillion Trump tax cut for corporate America?  Because it is in that behavior that companies forego building a margin of safety and fundamentally disqualify themselves from receiving the sorts of bailouts we're discussing now.

A case study:

Last year the five largest energy firms made a combined $29 billion in profit. In that same period they delivered $36 billion to shareholders through dividends and stock buybacks. 

Sit with that a moment. 
They paid out more money to shareholders than they made. 

Worse, they bought those shares (and redistributed them to executives through option-based compensation packages) at all-time record highs. Debt makes that possible. And corrupt changes to tax policy make that debt possible. This is private equity strategy writ into public markets. 

Such is the crazy-making reality run wild in American corporate finance at this moment, and one of a handful of reasons the Dow is tripping circuit breakers again this morning. Market participants know full well how meager remains the buffer keeping America from a corporate debt catastrophe.

They've left themselves no safety net, because they've seen that the safety net is us. 

Of course a virus has triggered this crisis. Sure.
And the wind is culprit in the demise of all paper houses.

When that crisis wind blows, though, the agents of Our Capitalism that have always insisted on the strict privatization of profits in health insurance and energy become very tolerant of socializing risk.

While our millions-deep ranks of medical professionals lace their best sneakers, it's worth a great deal of brain power from the rest of us to contemplate how and when the socialization of risk and benefit is most appropriate.


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Disclosure:  I have investments that bet against junk-rated debt, including in the energy sector.


Notes & References
1. White House considering bailout, Washington Post;
https://www.washingtonpost.com/business/2020/03/10/trump-oil-bailout/
2. Tracking the bailout, ProPublica; https://projects.propublica.org/bailout/
3. Coporate debt binge, Bloomberg; https://www.bloomberg.com/news/articles/2020-03-10/coronavirus-exposes-the-danger-of-corporate-america-s-debt-binge
4. Let's talk about bail outs before we need them, New York Times;
https://www.nytimes.com/2020/03/11/business/dealbook/coronavirus-bailouts.html
5.  Company net income, buybacks, dividends, yCharts;
 https://ycharts.com/companies/OXY/chart/#/?securities=include:true,id:XOM,,include:true,id:OXY,,include:true,id:CVX,,id:KMI,include:true,,id:EOG,include:true,,id:COP,include:true,,id:SLB,include:true,,id:MPC,include:true,,id:PSX,include:true,,id:OKE,include:true&calcs=include:false,id:gross_profit_margin,,include:false,id:free_cash_flow_ttm,,include:false,id:total_long_term_liab,,include:false,id:revenues_ttm,,include:false,id:eps_ttm,,include:false,id:cash_operations_ttm,,include:false,id:assets,,include:false,id:ps_ratio,,include:false,id:price_to_cash_flow_ttm,,include:false,id:current_ratio,,include:false,id:quick_ratio,,include:false,id:price,,include:false,id:pe_ratio,,include:false,id:ebitda_ttm,,include:false,id:ev_ebitda,,include:false,id:times_interest_earned,,id:net_income_ttm,include:true,,id:stock_buybacks_ttm,include:true,,id:total_stock_dividends_paid_ttm,include:true&correlations=&zoom=3&startDate=&endDate=&format=real&recessions=false&chartView=75604&chartType=interactive&splitType=security&scaleType=linear&securitylistName=&securitylistSecurityId=&securityGroup=&displayTicker=false&title=&note=&units=false&source=false&liveData=false&quoteLegend=true&legendOnChart=true&partner=basic_850&useEstimates=false
6. (Update:  good note from Jesse Felder on buybacks and bailouts, Felder Report;
 https://thefelderreport.com/2020/03/18/why-price-insensitive-buying-is-to-blame-for-many-of-the-major-economic-problems-we-now-face/)