I developed an interest in distressed finance during my time at NYU-Stern, in part due to a very interesting professor, @restructurings, as well as some very cool and smart classmates, with whom I am blessed to remain connected. I have been rereading @elerianm’s The Only Game In Town over the past week and I have found myself thinking about the costs of the coronavirus, vis a vis the Families First Coronavirus Response Act, as well as the CARES Act. It seems to me there must be some limit where federal debt becomes untenable for a state. But, where is that level? And what are aggravating and mitigating drivers of financial distress for sovereign states?
I wondered last night, is there a connection between the experience of shareholders stakeholders of for-profit corporations experiencing financial distress and the experience of citizens of a country experiencing increased volatility, worsened as a result of increased central bank interventions, in particular an expanded balance sheet?
(As I re-read the question I posed above, it is no surprise I didn’t sleep well last night and that I have been feeling a little stressed out… If only the Yankees were playing, I would have a better way to fill time!)
Of course analogies must fail when comparing, broadly speaking, leadership strategies of sovereign nations in contrast with private business. Paul Krugman addressed many of these in a 1996 Harvard Business Review article. I agree that some tactics that are potentially appropriate in business are potentially disastrous in a government context (e.g. threats of default on debt.) But what about a more narrow view?
I am going to think more in a series of posts about this. It seems to me that certain risks must be worsened by a central bank’s expanded balance sheet. It is inarguable that moral hazard is created. Liquidity is impacted as changes to the balance sheet are effected. Perhaps other market distortions and excesses become more likely as a result.
Of course, other risks have grown over time, which may be independent of a central-bank’s policies reflected on its balance sheet; Trends towards (de-) globalisation, commercial market structures, and demographic trends all come to mind. In summary, some questions I am found myself wrestling with last night, and I woke up this morning thinking about, include the following:
- If changes to a private firm’s capital structure (i.e. D/E) increases volatility of equity (E,) while not changing its fundamental business risk (i.e. unlevered Beta,) how does a nation’s capital structure impose comparable volatility?
- How does volatility manifest as a resultant symptom in this context?
- How does one infer an enterprise value (D+E) for a sovereign nation?
- How much of the total value of a nation’s equity is directly observable (e.g. market cap of domestic corporations, GDP) in contrast with unobservable (e.g. US national parks, intellectual property owned by domestic universities, etc.)?
- Is there a monetary means by which to estimate this?
- How does one determine the value of all debt (D) for a sovereign nation?
- How should central-bank assets, state and municipal liabilities (incl. pensions,) and federal contingent liabilities (e.g. FDIC insurance) be incorporated into this analysis?
I think I will take this in small bites over time…