What happened to the rainy day?

Photo by Katherine Moran on Unsplash

Moral hazard is one of those highbrow topics that proper, heavyweight publications like the FT and the WSJ love to write about, especially within the context of private enterprise. We wanted to have some fun with this topic, if indeed it is possible to have fun talking about shameless rent-seeking, tax-payer funded bailouts on an epic scale, profound long-term economic distortion and other very bad things. 

“Privatise the gains and socialise the losses” has been the mantra for publicly owned companies in strategically important sectors for donkeys’ years. Banks have been at it for years. So too have Airlines. As the guys at Epsilon Theory have pointed out:

“The CEOs of the Big 4 airlines received $430 million in stock-based compensation over this period, separate from their cash compensation, deferred benefits, etc [...] They received $430 million in stock-based compensation over this period, separate from their cash compensation, deferred benefits, etc.

You have to admire the temerity of these people. They spend most of their free cashflow on share buybacks, lining their pockets in the good times. Then, when the proverbial excrement hits the fan, they ask tax-payers to bail them out.

Of course, this is to be expected. There will always be rent-seekers in any economy. But what we are seeing here in the maelstrom of the Coronavirus crisis is different. Moral hazard is now en vogue for individuals, too. 

This time it’s personal.

The first raft of government support packages focused on bailing out businesses. But they are quickly being expanded to help individuals with tax breaks, state-sanctioned mortgage holidays and in some cases, fat cheques shoved out of helicopters. If the crisis continues for much longer, we might expect to see utility bills scratched and underwritten by state treasuries. Their endgame? Free Deliveroo and Netflix to keep the masses safely isolated in their homes. Stranger things have happened (please excuse the pun), and will continue to do so.

To be clear, we are not talking about people who cannot afford to save. We are talking about those who can afford to set money aside, but instead choose prioritise lifestyle over financial prudence. Let’s call them the “just-in-time generation”.

The rainy day of folklore has well and truly arrived, and unlike our stoical post-war parents (who say no to £8.50 avocado-on-toast and other lame lifestyle signifiers in order to save for armageddon), we have been left hopelessly exposed. We are yet to see a bank run during this crisis, but we have seen a run on umbrellas. It’s fair to say there’s a global shortage of the things, since the government has stepped in to manufacture them on a hitherto unseen scale.

The signalling impact of these top-down interventions is huge. Saying to people (or whispering softly in their ears), “Don’t worry about saving for a rainy day, we’ve got your back no matter what”, might seem the “right” thing to do on a certain time horizon, but on another, it might be something else entirely. It might be the wrong thing to do for our children, and their offspring. It might profoundly distort the sacred relationship between people and money. 

A dumb trade.

“Moral hazard” is one way of describing what is going on right now – another is selling the future. 

If the state writes free insurance policies for all, everyone now has a put option on tomorrow – whatever it may bring. If you don’t like what the world has become, if it doesn't work for you and your family, you can simply sell it back to the government and get your money refunded (or at least some of it). This is, of course, completely farcical and unsustainable. Right now, Prime Ministers and their compliant next door neighbours might be superheroes in the mode of Batman and Robin, but they will sure enough be villains on a par with the Dr. Victor Von Doom when they are (almost inevitably) forced to raise taxes in a deep and scouring recession.

We’re not saying we wouldn’t act as policymakers have acted. We’re simply saying that the genius “free money” strategy has consequences. It could have significant monetary effects, since encouraging everyone in society to spend what they have right now (rather than putting money aside in case the world goes to hell) isn’t exactly going to help when everyone returns to work and there’s trillions of dollars of freshly printed money washing around financial markets. We plan to explore the endgame of this monetary abundance in our newsletter next week!

The real economy. 

However much we might want to believe that the world is a simulation, one that can be manipulated in our favour by benign policymakers and central bankers, the fact remains that the world is real. It exists on its own terms. It is not fair. It can be a horrible place to live, just as it can be beautiful. We need to build this uncomfortable truth into our models so we can plan for the future. We need outputs that make us panic now, so we don’t have to panic later. 

Many years ago we attended a business school lecture (which is not to say we attended business school, simply that we attended a business school). The topic was something along the lines of “the dangers of over-optimisation” and how it can do great damage to supply chains. Today we are seeing this in technicolour, with “just-in-time” retail supply chains and healthcare systems that operate dangerously close to the cusp of failure in order to promote short-term profitability.

One area of the global economy where this doesn’t happen is farming. The EU’s Common Agricultural Policy provides financial support to farmers in member states by paying over-market rates to ensure self-sufficiency in food production. Critics love pointing out that the creation of excess capacity in the sector distorts supply and demand signals and inhibits the efficient functioning of the market – not to mention undermining the global push towards environmental sustainability. But excess capacity comes in pretty handy during a pandemic of epic proportions.

The big question.

The big question at the end of this crisis (which might never end, since it surely represents a paradigm shift in our thinking and behaviour), will be “how big should the buffer be?” 

Answering this has implications for the way we make, consume and pay for things. Ultimately, building redundancy into our economic model will make it less efficient – but it turns out life (especially very little pieces of life called “COVID-19”) don’t care much for efficiency. So, like all good sapiens, we must adapt.

The global economy, which we thought was so robust, diversified, resilient to change, turns out to be hopefully fragile. Technologisation (if that is even a word) has driven prices down and offered one-click convenience to billions of people, but it’s made a small number of people very wealthy and created an economy that is over optimised and over centralised. 

With large retailers offering free same-day delivery and rock-bottom prices, the local guy can’t get a look in. Which means that when global retailers have to furlough their staff and close down their operations, there are no local guys to step in and service the community. The ecology of the market has been destroyed in favour of a homogenised global marketplace, which is in fact not a marketplace at all – it’s an oligopoly of tech-enabled, highly scaled behemoths that gobble up every threat and opportunity in their wake, increasing the concentration of risk in the system. 

A new version of progress. 

Tomorrow looks different from where we are standing. This pandemic is accelerating the future, throwing us forward to a place where everything is virtual and instant. Of course, this process was already well underway – it has been since the invention of the personal computer. But there is a danger that the very over-optimisation that’s exacerbating this crisis will lead it to happen again, over and over, throughout time. 

We are going to learn a lot from what is happening to us. Human beings are good at that. But there will be things we miss. And things that we simply cannot bear to be parted with, however dangerous they might be to our health and our finances. In order to build and maintain a robust safety net, global economic growth would have to take a hit – permanently. And how do you begin the process of under-optimising something? How do you persuade people that not all progress moves forward? That progress might mean moving backwards to a time when things were less clever, less efficient, less good? 

If you can answer this question, please drop us a note. In fact, drop us one anyway. We’d love to hear how you’re navigating this crisis – and the questions that you want answering.