Amid an economic catastrophe, a few billionaires are still winning

[NEW YORK] The invisible killer is testing global capitalism as never before.

Some highfliers are getting a long overdue comeuppance. Take, for instance, the Vision Fund, the US$100 billion venture capital fund created by Masayoshi Son, a Japanese billionaire whose mantra is "We only live once, so I want to think big." On April 13, Mr Son's conglomerate SoftBank announced it expects to lose US$16.7 billion on its Vision Fund portfolio for the year ended March 31, after a string of bad bets on dubious Silicon Valley startups.

The Vision Fund invested not just in WeWork, which was a debacle even before the coronavirus outbreak, but also Opendoor, a real-estate startup; Zume, a restaurant robotics company; Compass, an online real-estate brokerage; and Oyo, an Indian budget hotel chain, all of which have fired or furloughed huge numbers of employees in recent weeks. SoftBank has already written off its US$300 million investment in Wag, a dog-walking startup, and is likely to lose its US$2 billion equity investment in OneWeb, a British satellite operator, which filed for bankruptcy protection.

The Vision Fund thrived for as long as it did in part because of a decade of super-low interest rates. Investors desperate for higher yields, like the sovereign wealth funds of Saudi Arabia and the United Arab Emirates, flocked to the Vision Fund because Mr Son promised them a 7 per cent yield on most of what they invested, far higher than could be found investing in, say, Treasury securities. It was the same mentality that attracted other investors to the mountains of risky debt issued in recent years by companies with less-than-stellar credit ratings. (There were US$9.6 trillion in US corporate bonds outstanding at the end of 2019, nearly double the amount of a decade earlier.)

This corporate debt bubble has finally burst - another long-awaited reckoning. Companies with too much debt are in an existential struggle.

On April 15, Neiman Marcus, the luxury retailer, skipped a US$5.7 million interest payment on its outstanding bonds, setting the stage for its inevitable bankruptcy filing. Another large retailer, Macy's, has hired restructuring advisers. Ford has seen its debt downgraded to junk status, as has Kraft Heinz.

The United States will soon be awash in corporate bankruptcies, which means a world of hurt for creditors, shareholders and employees of overleveraged companies or companies that have found themselves in the wrong place at the wrong time.

In fairness, no company could have anticipated the catastrophic effects of the pandemic. But the investors and employees of companies that for years gorged on cheap debt will pay the biggest price. There will be no soft landing for them.

And yet, things are not playing out exactly as one would expect. That's in large part because of the Federal Reserve. It has intervened into the capital markets in a way that dwarfs what it did in 2008, an intervention that has been so big and so fast that it introduces another wild card into America's deeply uncertain economic future.

It started on March 23, when the Fed put together an array of loans and other forms of credit, totaling around US$4 trillion. It was a necessary move, intended to restore calm and liquidity to the financial markets, which had all but stopped providing much-needed capital to businesses and households. The Fed was acting, as it should, in its essential role as the lender of last resort, which happens when financial markets seize up and the usual sources of capital - such as banks and global investors - disappear. The Fed's actions allowed capital to begin to flow again, saving some companies and some jobs.

On April 9, the Fed struck again, by providing an additional US$2.3 trillion in loans to support the economy, bringing its intervention to more than US$6 trillion. For the first time, the Fed said it would also consider buying the bonds of "fallen angels", companies like Ford and Kraft Heinz that are considered so troubled that their debt is now rated by credit agencies as junk after decades of investment grade ratings.

It also said it would be willing to buy high-yield exchange-traded funds. The Fed had never before agreed to buy such risky securities, giving speculators hope it might be willing to buy anything, including equities. Last August, the Fed held around US$3.7 trillion in credit assets on its balance sheet; it now holds more than US$6 trillion.

Thanks to the Fed, the debt markets sprung back to life. They had been shut for a month, but then in one week at the end of March, 49 companies issued US$107 billion of investment-grade bonds, the single-largest week of issuance on record. Then came a parade of junk bonds: Yum Brands, the parent company of KFC and Pizza Hut, raised US$600 million of new debt on March 30. On April 1, the cruise ship company Carnival issued US$4 billion of new debt.

The Fed's actions may have saved some jobs at struggling fast-food chains and cruise ship operators, but they are also warping the financial markets, just as they did in the aftermath of the 2008 financial crisis. By buying junk bonds, the Fed has created a proverbial "moral hazard" for those investors whose risk-taking had got out of control but now may not face the consequences for their profligacy.

This problem is revealed most clearly in a spat that has pitted one group of billionaire investors against another. On one side are private-equity firms including Apollo Global Management and the Carlyle Group, which want some of the Paycheck Protection Program bounty for their struggling, overleveraged portfolio companies. This is an outrage, of course. Private-equity firms have more than US$1.5 trillion of their own capital that they could use to salvage their losers instead of hoovering up money meant for the less fortunate.

On the other side are people like Howard Marks. He is the co-founder of Oaktree Capital Management, one of the largest investors in distressed securities in the world. He made his billions betting that markets will act rationally in challenging times. In recent years, he has been warning that overleveraged companies will fail and that overpriced bonds will return to earth.

In an April 14 letter to his investors, Mr Marks expressed his ire about the Fed's moves that rescued such companies. "Capitalism without bankruptcy is like Catholicism without hell," he wrote, recalling an old Wall Street truism. "Markets work best when participants have a healthy fear of loss. It shouldn't be the role of the Fed or the government to eradicate it."

Mr Marks is correct, in theory. Companies and investors that make poor economic decisions should be penalised for their mistakes. The system won't function properly if, every time there is a major crisis, the bad actors get rescued. The Fed could be inadvertently reinflating another asset bubble right now, although it is comforting that those lucky companies tapping the capital markets are paying investors much higher rates of interest than they have in years. Investors seem to have finally wised up to the meaning of risk.

The Fed's moves, at least for a while, may have saved the pension funds of firefighters, teachers and police officers - which often buy the high-yield securities issued by risky companies - from far worse losses. If in order to rescue those retirement funds and jobs at some troubled companies, we have to live with the Fed's moves, then that's a trade-off worth making. The Fed was created for moments such as this one, and it's a blessing that it has acted forcefully.

In such times, there are always a few who somehow see trouble coming and find a way to profit from it. Take, for instance, Bill Ackman, the hedge fund manager. In mid-February, he started buying insurance on various bond indices - a bet that the debt bubble would burst - based on his hunch that investors would abandon the riskier securities in those indexes as the pandemic spread from Asia to the West. His US$27 million hedge was completed on March 3, and he sold his positions on March 23, the day the Fed announced its first major new intervention, for a profit of US$2.6 billion.

Mr Ackman played the Fed's moral hazard, betting correctly that until the Fed and the Congress acted, the markets would tank. And that once they did, that the markets would start to recover. (He has since ploughed his winnings back into stocks.) For speed and accuracy, Mr Ackman's bet may be the single best trade of all time.

For the rest of us, there is more painful uncertainty. Until Americans feel safe - really safe - there isn't going to be much good news from this economy. And there isn't a whole lot that Congress, or the Fed, can do about that.

NYTIMES