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The US must take equity stakes in the companies it rescues

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Via Financial Times

The writer is a law and finance professor at Cornell Law School

We are in crisis again — all of us, worldwide. But this time it’s not just financial or a demand shock, as in 2008. It is those things and more — a combined supply-side, demand-side, public health “perfect storm”.

Existing supplies of hospital beds, pulmonary ventilators, face masks and test kits were already too low. And now they will be lower — as will supplies of most other essentials — thanks to those social distancing measures we are all taking. Social distancing is necessary, but it is a necessary evil. It is antithetical to the production we now urgently need, because so much productive work is done together.

The fact that our challenge is partly a supply-side crisis means we have to rehabilitate production itself. We can start to do this by adapting some processes to off-site collaboration. But also by ramping up production of the material we need to speed our return to on-site collaboration.

One important way to do this, our history shows, is by having our public sectors partner with — and take stakes in — our private sector producers and distributors. Consider the American experience in the second world war.

After Pearl Harbor was bombed in late 1941, US president Franklin D Roosevelt summoned manufacturers to the White House and asked how to multiply the country’s capacity to produce and distribute steel, fuel, rubber, B-29s, tanks and — intriguingly for present purposes — gear for soldiers and civil defence. After those discussions, Roosevelt established a War Production Board to oversee the temporary repurposing of factories, the establishment of new distribution channels and other tasks needed for rapid productive mobilisation.

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The WPB built on and worked with the which had helped finance the New Deal. Its remarkable array of tools included outright grants, inexpensive credit or loan guarantees, and — most critically — equity stakes in some companies.

At the beginning of the Depression, for example, the RFC purchased preferred shares in more than 4,000 private sector banks, recapitalising them while ensuring the public retained a voice in their internal decision-making. In the war years, the RFC wholly or partly owned such companies as the Defense Supplies Corporation, the Defense Plant Corporation, the Metals Reserve Company, the Rubber Development Corporation, and a host of other strategically sensitive companies.

The government’s equity stakes were crucial for two reasons. First, many firms ravaged by the Depression were not well positioned to take on more debt — even cheap debt. And second, equity investment ensured that the public kept “a seat at the table” of each company that its money was rescuing. That allowed the public sector to provide internal guidance on every systemically important private production decision in a time of crisis.

Fast-forward to the present. President Donald Trump should take charge and form what I will call a National Pandemic Production and Financing Board, with distinct but co-ordinating production and financing units.

The production unit would determine where the national shortfalls are — hospital space, medical equipment, test kits, protective clothing and masks — and what production capacity is available. It would then decide which existing production facilities are best able to ramp-up and what else might be needed.

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Meanwhile the financing unit takes care of the money. This isn’t a question of making funding available but rather of directing those massive financial taps the US rescue package will start to open. The unit would have to cut the cheques for every specific project decision the production unit makes.

To make this work, the financing unit would likely have to take equity stakes in some companies, as the RFC did before it. It would be “bailing out” some strategically sensitive firms and would want the internal governance rights that come with those equity injections to ensure good money is not thrown after bad. It will likewise be aiding companies in their production planning and ramp-ups, which makes that involvement in internal decision-making both necessary and fair.

Intriguingly, Mr Trump himself recently spoke of taking equity stakes in the firms the US will be aiding (although later he hedged). Meanwhile, nations across the Atlantic — Britain and France, for example — are contemplating doing the same thing for the same reasons. Similar measures were proposed or taken in 2008-09. The UK took stakes in Royal Bank of Scotland and Lloyds Banking Group and the US did the same for the auto industry. None of this, then, is exotic. It’s merely exigent.

Right now, the US needs a body to mobilise a coherent productive response to the Covid-19 crisis and work with counterpart agencies worldwide to save the day. Over the longer term, though, I believe we will also need something more permanent.

When the immediate crisis is past, the US should develop a freestanding national investment authority, operationally situated between Fed and Treasury, to develop and regularly update a coherent national development strategy, then assist with co-ordinating and financing its execution by public and private sector agents alike.

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That will ensure that America is never caught on the back foot again.

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