Month: March 2020

Stock Buybacks are Fine

Ted Frank writes:

Let’s start with what a buyback is, since even many financial journalists do not understand this: A corporation purchases stock from its shareholders. It’s economically indistinguishable from a special dividend, where a corporation pays out money to every shareholder, except it permits shareholders to elect their own tax consequences, unlike a dividend that creates a tax event immediately.

…Proposals to ban buybacks are effectively proposals to demand corporations hold such huge stockpiles of cash, depriving shareholders of investment choices. Such proposals will backfire by slowing down the economic recovery when money that could be invested is instead held in corporate bank accounts, doing nothing.

I agree. Buybacks are just not a big deal.

Suggest regulatory pauses

Suggest Regulatory Pauses

Is there some government regulation or rule that is keeping you from helping manage the COVID-19 crisis?

Maybe you’re a frontline healthcare worker, an administrator, or work in manufacturing, and believe you could make medical supplies. Whatever your position or industry, perhaps you have ideas that could help.

We want to hear from you. Please fill out the form below.

An initiative from the Booth School of Business at the University of Chicago.

Tuesday assorted links and non-links

1. Some mask production is being deregulated.

2. “Using country-, subnational-, and individual-level data, we show that Facebook has had a significant and sizable positive impact on citizen protests.”

3. Open source ventilators?

4. Automated contact tracing without giving up privacy?  And explanation.

5. What the SuperForecasters think.

6. A useful thread on mutation.

7. Scott Alexander on masks.

8. “People exhibit overconfidence in their ability to calculate exponential growth.

9. The Spanish flu rebellion against masks.  And how the Spanish flu shaped trust.  And 1919 Science piece on the lessons of the Spanish flu.

10. From my email: “One major issue for SMBs is that many owners are on the hook *personally* for lines of credit and other business loans and also for business credit cards. For example, my business has a line of credit that I had to personally guarantee and it is with the same major bank that holds my mortgage. Bankruptcy would probably mean I discharge the line of credit AND lose my house at the same time. I suspect other SMB owners are in similar situations.”

11. Aurlus Mabele, coronavirus victim (NYT) obit), RIP (music video here).  And Manu Dibango too.

12. “Based on the proposed methodological procedure, we estimated that the actual cumulative number of exposed cases in the total population in Lombardy on March 8 was of the order of 15 times the confirmed cumulative number of infected cases. According to this scenario, the DAY-ZERO for the outbreak in Lombardy was the 21st of January 2020. The effective per-day disease transmission rate for the period until March 8 was found to be 0.779 (90% CI: 0.777-0.781), while the “effective” per-day mortality rate was found to be 0.0173 (90% CI: 0.0154-0.0192). Based on these values, the basic reproduction rate R0 was found to be 4.04 (90% CI: 4.03-4.05). Importantly, by reducing the transmission rate by 90% on March 8 to reflect the suspension of almost all activities in Italy, we run the simulator to forecast the fade out of the epidemic. Simulations show that if the measures continue, the complete fade out of the outbreak in Lombardy is expected to occur by the end of May 2020.”  Paper here.

13. Why Germany is not doing as well as you think.  It is about the exponential function, yet again.

14. An overview on possible drugs and their status.

FDA Stops At-Home Tests

TechCrunch…the U.S. Food and Drug Administration (FDA) has updated its Emergency Use Authorization guidelines to private labs that specifically bar the use of at-home sample collection. This means startups, including Everlywell, Carbon Health and Nurx, will have to immediately discontinue their testing programs in light of the clarified rules.

The FDA issued the updated guidance on March 21, and though some of the companies had already begun to ship their sample collection kits to people, and even begun to receive samples back to their diagnostic laboratory partners, even any samples in-hand will not be tested, and will instead be destroyed in order to comply with the FDA’s request

The tests are collected at home but the tests themselves are done in certified labs under quality-control standards (CLIA). It is of course possible, even likely, that tests collected at home are not as accurate as those collected by a trained nurse. But we don’t want trained nurses to be testing everyone–they have other things to do right now. Furthermore, some of these errors will be detected at the lab and can be fixed with a retest. False negatives are possible but going to a hospital or standing in line to get a test also comes with risk. False negatives will also become apparent to the extent that symptoms worsen at which time patients can seek medical assistance. Yes, of course, delay and false reassurance are also not without risk. Welcome to the world of tradeoffs. But at this point in time we need to unleash American ingenuity and enterprise and evolve our way to the frontier as conditions improve.

We need to learn now, regulate later.

The Forgotten 1957 Pandemic and Recession

The 1957 Asian Flu Pandemic killed around 70 to 100 thousand people in the United States (the 57 flu was not as infectious or deadly as COVID-19). In the last quarter of 1957 the growth rate (on an annualized basis) was -4% and in the first quarter of 1958, -10%, the largest such decline in post WWII history, bigger even than in the financial crisis. By the third and fourth quarters of 1958, however, the growth rate had surged back up to nearly 10% and for the year as a whole GDP declined by less than 1%–a bad recession, 3rd worst by depth in post WWII history, but not unprecedented.

Here’s what is interesting. Many sources don’t even list the pandemic as a cause of the recession (e.g. here, here, here, Wikipedia lists it as one among several causes). Indeed, the pandemic was soon forgotten. James Patterson’s Grand Expectations: The United States, 1945-1974 doesn’t even mention the pandemic or the recession, just the boom years of the 1950s. I am not entirely surely what to make of this. The recession was worldwide which makes me think it was the flu (deaths were low but many more people would have been sick) but this FED review from August of 1958 doesn’t mention the flu either.

Lessons from the “Spanish Flu” for the Coronavirus’s Potential Effects on Mortality and Economic Activity

That is the subtitle of a new paper by Robert J. Barro, José F. Ursúa,  and Joanna Weng, here is the abstract:

Mortality and economic contraction during the 1918-1920 Great Influenza Pandemic provide plausible upper bounds for outcomes under the coronavirus (COVID-19). Data for 43 countries imply flu-related deaths in 1918-1920 of 39 million, 2.0 percent of world population, implying 150 million deaths when applied to current population. Regressions with annual information on flu deaths 1918-1920 and war deaths during WWI imply flu-generated economic declines for GDP and consumption in the typical country of 6 and 8 percent, respectively. There is also some evidence that higher flu death rates decreased realized real returns on stocks and, especially, on short-term government bills.

I wonder if the economic cost isn’t higher today because we know more about how to limit pandemic spread and we also value human lives more, relative to economic output?

Kudos to the authors for such swift work.

Also from NBER here is Andrew Atkeson on the dynamics of disease progression, depending on the percentage of the population with the disease.  Here is an excerpt from the paper:

Even under severe social distancing scenarios, it is likely that the health system will be overwhelmed, which is indicated to happen when the portion of the U.S. population actively infected and suffering from the disease reaches 1% (about 3.3 million current cases).7 More severe mitigation efforts do push the date at which this happens back from 6 months from now to 12 months from now or more, perhaps allowing time to invest heavily in the resources needed to care for the sick. It is clear that to avoid a health care catastrophe as is currently being experienced in Italy, prolonged severe social distancing measures will need to be combined with a massive investment in health care capacity.

Under almost all of the scenarios considered, at the peak of the disease progression, between 10% and 20% of the population (33 – 66 million people) suffers from an active infection at the same time.

A not entirely cheery prognosis.

A new idea for small business lending and support

From my email, from Amanda Brown, she is developing this plan with Ben Laufer:

I am a master’s student at Stanford in Management Science & Engineering and a fan of your blog Marginal Revolution. I have been following it more closely in the midst of COVID-19, especially the conversations about small business financing during the crisis (e.g. today’s post about bridge loans).

I was hoping to get feedback on an idea for a new small business lending platform which would allow community members to fund fractional amounts of a business loan. The thesis is that fractional loan contributions from local supporters would give institutional lenders confidence to fund the full requested loan amount (and that the total amount contributed by peers would supplement traditional measures of borrower creditworthiness, such as FICO score, cash flow, etc., when setting the interest rate). For example, 10% of the principal might come from all the peer investors combined, and the remaining 90% from a single big lender. To my knowledge, nothing quite like this exists. In the wake of COVID-19 shutdowns, it seems especially important for small businesses at the heart of our communities to be getting access to low-interest financing based on peer endorsement.

Adding the “peer staking” element to a small business loan signals to investors that the local community believes in the future success of the business and the borrower’s likelihood of repaying (and peers would also be able to earn the same interest rate return on the principal as the majority funder… so it’s not like crowdfunding, where you contribute but won’t see your dollar again…). The design also increases accountability without the need for a collateral since borrowers would feel a personal responsibility to repay their peer debt-holders, who may be friends, family or customers.

I am wondering what your thoughts are on the idea (and its relevance at this time). If you think it is worthwhile, perhaps you would consider sharing this 5-minute survey with your followers to collect feedback on the idea:

https://forms.gle/Tk2Gweqa5frTacid9

Amanda Brown ([email protected])

Ben Laufer ([email protected])

Joshua Angrist has written a tribute to Alan Krueger

Alan Krueger died a year ago this week. I think of him often, and would like to mark the anniversary of his death by sharing a story of my time with Alan. Alan and I had a lot in common. First, we were both born in the third quarter; that is, we’re QOB3s. In fact, Alan was only one day older than me. We used to joke that this explains his relative success: it’s an age effect!

There is much more at the link, moving throughout.  And here is the Joshua Angrist introduction to econometrics course on Marginal Revolution University.

Ex post social insurance

Greg Mankiw has an idea:

Let’s send every person a check for X dollars every month for the next N months. In addition, levy a surtax in 2020 (due in April 2021) equal to N*X*(Y2020/Y2019), where Y2020 is a person’s earnings in 2020 and Y2019 is a person’s earnings in 2019.

Under this plan, a person whose earnings fall to zero this year returns none of the social insurance payments. A person whose earnings fall by half keeps half of the payments. A person whose earnings remain the same returns everything: They will have just gotten a short-term loan. And those lucky few whose earnings rise this year will return more than they got.

Of course, there is an implicit marginal tax rate in this scheme. Every dollar of earnings in 2020 faces an additional marginal tax rate of N*X/Y2019.

There is more at the link.

Let the Markets Work

Many people are calling for the President to use the Defense Productions Act (DPA) but the reality is that the DPA is neither especially useful nor necessary. The markets are already redirecting resources in a rapid and sophisticated manner. For the most part, the shortages were due to temporary increases in demand. The shelves are now filling. Food is plentiful. Hand sanitizer and soap is on the way or available. We are not going to run out of toilet paper. Now that the CDC and the FDA have gotten out of the way, we are producing more tests.

Honeywell and 3M are already ramping up production of N95 masks. We should arrange with China to buy more. The Federal Government is playing a useful role by buying surgical masks from companies like Hanes. Ironically, we will be importing them from Latin America.

Winston-Salem Journal: The company went from negotiating a contract with the federal government to beginning production in less than a week, according to the spokesman.

Using U.S.-grown cotton, the masks are being produced in Hanesbrands’ sewing factories in El Salvador, Honduras and the Dominican Republic.

These factories would normally be producing T-shirts, underwear, socks, sweatpants and sweatshirts.

(Note the stupid requirement to use American Cotton.)

A price is a signal wrapped up in an incentive, as Tyler and I write in Modern Principles. Compare the price system with command and control. We need ventilators. The federal government could order ventilator firms to make more but they are already doing so. The government could order other firms to get into the ventilator business but does the Federal government have a good idea which firms have the right technology or which firms have the right technology that could be repurposed to ventilator production at low cost, that is without causing shortages and disruption in other fields? Can they do better than a decentralized process in which millions of entrepreneurs respond to price signals. No.

A word here on “price gouging.” There are two kinds. The first, which has gotten some attention, is when the manufacturer/retailer holds the price constant despite increased demand and an enterprising fellow buys up stock to sell at the true market price–the ticket scalping model. “Ticket scalping” has some good features and I would not make it illegal but it has one big problem–the benefits of the increased price are not going to the producers. It would be better if the manufacturer and retailer raised their prices, the scalpers would then be eliminated and the benefits of the higher price would flow to producers giving them an incentive and resources to expand production. We shouldn’t worry too much about ticket scalping, however, because its temporary. Typically what happens is that the manufactures and retailers hold the price low for a short period of time to avoid consumer backlash, output ramps up, and then the price rises but given the increased supply by not as much as it would have in the short run. This also works fine. The bottom line is that it’s very important that manufacturer prices be allowed to rise to reflect true scarcities and to get resources flowing in the right direction. So far, we are doing that and the system is working well.

If all the trucks are fleeing from the front, we want the army to be able to requisition vehicles to move in the opposite direction. Private and social incentives do not always align and when time and certainty are of the essence command and control may be superior (as Tyler and I discuss in Modern Principles in the chapter on externalities). For the most part, however, that is not the situation we are in now. Private incentives are all pushing in the right direction of greater production. Let the market respond. The federal government is not good at command and control but it does have a role to play in redistribution for need.

America’s great strength is decentralization and markets, and right now we need our strength.

Monday assorted links

The Fed is not asleep — open season on asset purchases and more

Here is the press release.  And:

In addition to the steps above, the Federal Reserve expects to announce soon the establishment of a Main Street Business Lending Program to support lending to eligible small-and-medium sized businesses, complementing efforts by the SBA.

Are those last five words Straussian satire?  If so, bravo.

Dog-walking markets in thwarting the Spanish lockdown

4 people in Alicante were ticketed for violating the State of Alarm for walking the same dog. Seems there were trying to get out of their apartments to walk their dog, only it wasn’t theirs. I’d like to know if the owner of the dog was pimping it out for walks. Update: People are pimping out their dogs for walks Going rate seems to be between 20 and 25 Euros per walk.

That is from a reader (Marty O.) email, in turn from a contact in Spain, here is an associated article those dogs are pretty tired by now.

Zachary Booker on bridge loans and bankruptcy

This is an email, all from him, I won’t add in any other formatting:

“Like you, I have an extraordinarily deep concern about the capacity for businesses – not only SMBs, but also larger, capital-intensive firms – to weather this path of suppression. I was quite surprised to hear Russ take a lighter note.

…I am deeply sceptical of the efficacy of bridge loans that you spoke about early this morning. While Brunnermeier, Landau, Pagano, and Reis have laid out the best transmission mechanism, I can not possibly envision it will move the needle enough for the majority of those businesses while also not leaving a wake of loss provisions for future generations. I suppose you could say I am partial to point two in your piece.

I also simply can’t understand the legal logistics of bridge loans in this scenario. Most companies will have a capital structure of some kind (perhaps without the most sophisticated lenders). How are you cramming down those who you are priming in the capital structure? You need consent. Who will be managing this incredibly laborious process of gaining consent and creating the terms? Cash grants are one thing, but bridge loans that aren’t unsecured at the bottom of the capital structure are an entirely different matter.”

“While the benefit of hindsight can be a hindrance to pontificating on novel circumstances, it strikes me as unequivocally true that the GFC had a much simpler – intellectually, if not politically – solution. Namely a solution that at its core involved taking known, marketable securities out of the system at haircuts or depressed valuations to abate panic, settle markets, and of course eventually sell at a profit.

In short, I’m partial to the view that mark-to-market accounting was both a central impetus for why the crisis was so severe and why action could be taken so decisively without burdening tax payers for generations to come (see Ball’s very good book here and Fragile by Design, both of which you’re likely familiar with). This crisis provides no such “simple” solutions that can be concentrated against a singular sector of the economy by taking decisive action.

I, of course, have no grand unified theory to share with you. However, I did want to pass along some thoughts I had upon reading your bridge loan piece that came to mind.

Like you, I am also worried about how broad the demand shock is currently and will be moving forward. Affecting not only every industry severely, but also every locality in the economy (e.g. leaving no state or municipality without deep, painful bruises). This raises the question of how the economy – when this is all said and done – reconstitutes itself in an orderly, efficient fashion.

While I’m partial…I believe one of the incredible strengths of the United States is its bankruptcy code. In particular, the out-of-court and Chapter 11 processes.

I would perhaps mull over how the United States can leverage the bankruptcy code to provide support, both out-of-court (e.g. before filing) and to expedite the process while in-court (e.g. by utilizing pre-packs, which are very popular, very quick, and incredibly effective at providing sustainable balance sheets).

The United States could explore offering – or backstopping – DIP Financing for firms that file Chapter 11 (see explainer on DIP financing from Davis Polk here). DIP Financing has been around for many decades, is incredibly safe, and deeply effective.

  1. The US could offer DIP Financing at favourable terms directly and automatically under preset conditions (e.g. a firm that was FCF positive in 2018 with EBITDA +$[10]mln, but needing to file Chapter 11 in 2020, would immediately get a facility at L+[100]). This would also give the US the highest seniority in the cap stack with very favourable terms upon a potential future Chapter 11 (Chapter 22) or a future Chapter 7 (liquidation). For firms that have not been in distress prior to the crisis, this would have the US assuming very little real credit risk. 
  2. The US could backstop private DIP providers – to get credit rolling again – by guaranteeing [95] cents on the dollar for any facility extended within the next [X] months. Historically, DIPs have returned much more than this so this is reasonably safe from a credit perspective. Note: this could also be done for TL1s or revolvers out-of-court. Same principle applies regarding seniority, lessened credit risk, etc. although you’d need consent down the capital structure.
    1. The United States could explore offering participation in pre-packs whereby:
      1. The US would inject $[X]mln in senior secured notes if;
      2. Existing Senior Secured take a [5]% haircut
      3. Unsecured take a [15]% haircut
      4. Equity take a [50]% haircut
      5. Again, the idea would be for pre-packs to be, well, pre-done. The idea would be that if your business is hurling towards bankruptcy, it may be best to bite the bullet and recapitalize (via the US notes) while re-working your balance sheet right now. If your firm meets the FCF, EBITDA, or whatever criteria is determined then the US would offer this package automatically. Contingent only on those within the capital structure consenting to taking at least [X]% haircuts (as consent is required by law). Note: you may want to say that any financing put in – or backstopped by – the US will not be additive to the covenant ratios underpinning the rest of the capital structure (or these covenants can just be amended, if necessary, to allow for this new capital injection as is commonplace anyway).

One would hope that if The United States does something like this it could serve three useful functions:

  1. Providing confidence to market participants that there will be a financing backstop – for otherwise healthy firms blindsided by COVID-19 – by the United States, which will likely have the paradoxical affect of freeing up credit from private participants and stopping the explosion in credit spreads and the halting of credit extension we’re currently seeing.
  2. Allowing firms, without much relative credit risk to the United States, to obtain a runway through the fresh injection of capital along with a modest restructuring that will help them weather the storm if it is to be prolonged.
  3. Providing an automatic, guaranteed solution that is widely accessible to firms as all qualifications and terms would be preset and thus remove any uncertainty as to what firms would be able to qualify for or ultimately obtain.

Using the bankruptcy code in this way would allow the United States to help firms (albeit, likely slightly larger ones than mom-and-pops) in a predictable, known, guaranteed way while also protecting tax payers from taking significant downside risk positions in an ad-hoc and convoluted matter via bridge loans (if they are feasible at all, which I doubt). In short, the United States would leverage the incredibly strong institutional and intellectual framework of its existing bankruptcy code.

I believe – as I believe you do as well – that we are in for a much lengthier protraction than many anticipate…I do not believe Goldman’s forecast…that we’ll see 13% GDP growth in Q3. I do not believe demand will return so quickly or in such force, because I do not believe we will return to normalcy as quickly as we have just departed it.

As I said previously, I have no grand unified theory to get American business through this crisis. However, we both agree in the general goodness of Big Business as a driver of America. What I’ve just laid out is perhaps the most politically palpable solution (because it involves bankruptcy, even if only in name only) that can give a strong life line to those currently in need while not exposing taxpayers to absurd (albeit still large) credit risk. This solution also can be worked to protect pension liabilities and other essential worker benefits.

I think it’s inevitable that we have mass insolvencies, dislocations, and mismatches moving forward. For small businesses, there are solutions around the edges, but I simply cannot comprehend how the United States would be able to figure out and then extend the appropriate levels of credit via bridge loans en masse to these folks. It is surreal to imagine it possibly working and I worry deeply about what such a program – if tried, almost certainly with less dollars than would be required – would do to the social fabric and psyche of the American people when firms inevitably still buckle and break.

I haven’t given much thought to how to leverage the institutional framework of America to best ameliorate this crisis, but I’ve seen no one speak much about how out-of-court or in-court restructuring could be a partial solution. So I figured I’d pass this along as something to keep in the back of your mind and mull over.”

Zachary tells me you can reach him at [email protected].

Pooling to multiply SARS-CoV-2 testing throughput

Here is an email from Kevin Patrick Mahaffey, and I would like to hear your views on whether this makes sense:

One question I don’t hear being asked: Can we use pooling to repeatedly test the entire labor force at low cost with limited SARS-CoV-2 testing supplies?

Pooling is a technique used elsewhere in pathogen detection where multiple samples (e.g. nasal swabs) are combined (perhaps after the RNA extraction step of RT-qPCR) and run as one assay. A negative result confirms no infection of the entire pool, but a positive result indicates “one or more of the pool is infected.” If this is the case, then each individual in the pool can receive their own test (or, if we’re getting fancy [read: probably too hard to implement in the real world], perform an efficient search of the space using sub-pools).

To me, at least, the key questions seem to be:

– Are current assays sensitive enough to work? Technion researchers report yes in a pool as large as 60.

– Can we align limiting factors in testing cost/velocity with pooled steps? For example, if nasal swabs are the limiting reagent, then pooling doesn’t help; however if PCR primers and probes are limiting it’s great.
– Can we get a regulatory allowance for this? Perhaps the hardest step.

Example (readers, please check my back-of-the-envelope math): If we assume base infection rate of the population is 1%, then pooling of 11 samples has a ~10% chance of coming out positive. If you run all positive pools through individual assays, the expected number of tests per person is 0.196 or a 5.1x multiple on testing throughput (and a 5.1x reduction in cost). This is a big deal.

If we look at this from the view of whole-population biosurveillance after the outbreak period is over and we have a 0.1% base infection rate, pools of 32 samples have an expected number of tests per person at 0.0628 or a 15.9x multiple on throughput/cost reduction.

Putting prices on this, an initial whole-US screen at 1% rate would require about 64M tests. Afterward, performing periodic biosurveillance to find hot spots requires about 21M tests per whole-population screen. At $10/assay (what some folks working on in-field RT-qPCR tests believe marginal cost could be), this is orders of magnitude less expensive than mitigations that deal with a closed economy for any extended period of time.

I’m neither a policy nor medical expert, so perhaps I’m missing something big here. Is there really $20 on the ground or [something something] efficient market?

By the way, Iceland is testing many people and trying to build up representative samples.