Helping Companies and Helping Taxpayers

Since the coronavirus pandemic reached our shores, the US government has taken a series of essential steps to bolster our public health and economic response. Most recently, the CARES Act, signed into law on March 27, includes massive relief for distressed companies large and small as part of a $2.2 trillion relief package. Nestled within that legislation is a series of important provisions which provide the US taxpayer with equity stakes in companies getting government support.

What types of conditions can be put on government financing?

As the federal government injects massive amounts of capital into the economy, there are a number of ways that it can condition its support for publicly-traded companies in order to get “paid back” for this assistance. Three common ways are summarized below:

• A warrant is a security given to the US Treasury by the distressed company. It includes the option for the US Treasury to buy stock in the distressed company at some later date but at a price determined now. During the financial crisis of 2008-09, the US Treasury received warrants from the banks that were given assistance. In two years’ time, most of those warrants were converted to stock in the banks and sold in the markets to other investors. The proceeds from those stock sales were used to essentially “pay back” the government assistance.
• An equity stake would be an outright transfer of stock in the distressed company, marked at the current market price of the stock. For example, Boeing’s stock price closed at $162.00 per share on March 27. If the US government received, say 1 million shares in Boeing, this equity stake would be worth $162 million. The US government could sell this equity stake at a later date (and hopefully at a higher price) to be paid back for the government assistance.
• A corporate bond is a debt instrument sold by companies to investors. The proceeds of these bonds are typically used to finance capital spending. Over time, the company pays investors interest on this borrowing and ultimately also pays back the principal. In an arrangement such as this, the US Treasury could be an investor in a company and receive regular interest payments to recoup their government assistance.

The latest rescue package shows how these methods can be used in practice. The airline industry, for example, was allocated $50 billion of support in the legislation, split evenly between loans and grants. The CARES Act includes a provision directing the Secretary of the Treasury, on behalf of the US taxpayer, to receive a warrant or equity interest or a senior debt instrument of the distressed company receiving support. Over time, as the company recovers, it is likely that its stock price rebounds, or bond values grow. After about two years or so, the federal government can sell this equity stake or bond and lock in likely positive proceeds which can be given back to the US government—in essence, paying back US taxpayers for their assistance.

At the very least, as the CARES Act specifies, the airline companies must retain employees at the levels they had as of March 24^th “to the extent practicable” until the end of September. The companies would not be allowed to reduce worker wages either. But after September, the conditions and requirements change. If the recession persists, the companies will have flexibility to pare back employee levels. While these worker retention requirements are helpful, they are not iron clad.

Looking Ahead

What about future stimulus packages? While the massive $2.2 trillion rescue package provided critical help for workers and businesses, it is widely expected that more help will be needed. The financial health of companies is deteriorating quickly, and it will be important that future relief packages include stimulus to prevent a collapse in the labor market. The CARES Act opened a template on equity, warrants, and bond holdings to benefit US taxpayers in the post-crisis period.

Going forward, any additional relief and stimulus for publicly-traded companies in subsequent legislation should consider including provisions and a quid pro quo for warrants, equity, or bonds. That allows the US government to receive an adequate return for financial support. As Congress debates this legislation, it must be clear that the US taxpayer is respected. A US government ownership stake in these companies is much more appropriate than a “no strings attached” bailout.

Ensuring equity ownership in return for bailouts helps mitigate the moral hazard problem for future crises. A failing company may still expect to be bailed out—but the shareholders and executives won’t get off scot-free. The US government will be protected, helping the economy and taxpayers at the same time.