Short sharp shock or Great Depression Mark II?

By Tim Farrelly, 23 March 2020.

Or somewhere in between? How this crisis unfolds and where we end up depends hugely on government policy. If we see a large, well targeted response to the crisis, a short sharp shock is the most likely outcome – a deep V shaped recession. On the other side of the valley there will be economic casualties but, for the most part, businesses will come roaring back.

In assessing the long-term impact of this crisis, we should be looking out for policies that allow businesses to go into hibernation rather than liquidation. If the governments of the day get this right, we will get a relatively benign long-term outcome for sharemarkets. If they get this wrong, we risk the Great Depression Mark II.

Here are some things we should be looking for. It is written with a strong Australian bias – but the same applies everywhere.

Firstly, businesses must be able to lay off staff without losing them for ever. This means staff need to be able to go into hibernation too. Yesterday, the Australian government effectively doubled unemployment benefits to $28,600pa and made it payable immediately – absolutely spot on. But there needs to be more support. The higher unemployment benefit supports a basic level of expenses but will not help higher income earners with substantial commitments such as mortgage repayments, rents, school fees and medical costs.

There is more good news here. The banks have come to the party with holidays on mortgage repayments – again exactly what is required.

With respect to other expenses, a scheme such as that proposed by former RBA board member Warwick McKibbin needs to be rolled out. This entails interest free government loans to individuals to meet defined expenses that would relieve a huge amount of financial stress. The loans would be repaid using the HECs student loan principles – pay when you can via the taxation system.

If businesses can hibernate their staff, their next problems are meeting debt service and rent obligations. Again, the banks appear to be stepping up to the plate on the debt servicing issue. They deserve applause – for once. Business rents remain an issue. The nuclear option on rents would be for the government to use Emergency Powers to over-ride any contractual rental obligations and mandate that rents be halved where a property has been substantially untenanted for the period of the Emergency. It would then provide an interest free loan to the business to cover the remaining rent. The landlord gets a 50% income haircut for 6 or more months. Probably better than losing a tenant and having a vacancy. It’s all about sharing the pain and reducing the costs to re-open businesses when the Emergency is over.

If the government decides not to use the nuclear option, there are be many in-between measures that can be employed from a simple appeal for a fair-go with naming and shaming of those landlords that choose to play tough to a policy where loans will only be made to tenants where the landlord has agreed to a 50% cut for the term of the emergency.

Again, any interest-free government loans to businesses would have to be repaid on a pay when you can basis with the corporate tax rate remaining at 30% with a loan repayment surcharge of, say, 15% for those firms with interest free loans outstanding.

The interest free loans have many policy advantages; they are precisely targeted; the majority will be repaid and therefore are at a modest cost to the Treasury; and, because of that, can be much larger amounts can be deployed than unfunded government handouts.

As an aside, we need to worry about rorts – when there is a lot of money flying around, the crooks will be drawn like moths to a flame. A number of measures can be introduced to combat this issue.

  • · Draconian penalties for abusing the system – say, a minimum 3-year jail sentence for any convicted of doing so
  • · Part IV A style definitions of abuse. (Part IV A is a brilliant part of the Australian Tax Act which says that even if what you do is completely legal under the Tax Act, if it is primarily done for tax reduction reasons then any tax reductions are reversed)
  • · If such measures are adopted globally, aggressive extradition agreements
  • · All benefits are only available to individuals and companies with existing Tax File Numbers that can demonstrate substantial activity pre-crisis that has since slowed down.

We are not claiming that this forms the blueprint for getting through the crisis or that all of these measures can or will be adopted in Australia or anywhere else. What we can do is look at the total shape of the packages that governments are putting in place and using those to form a view as to how long this downturn will play out and how much damage it may cause.

From what we have seen to date there is cause for confidence that the governments appear to be getting it more right than wrong. But there is a long, long way to go yet.