Policymakers and regulators have launched financial relief and rescue programs to promote economic recovery and alleviate household suffering during the COVID-19 pandemic. In doing so, prudential regulation for banks has been adjusted and it remains uncertain if such suspensions are temporary or entail longer-term effects. In our paper ‘Debt Expansion as “Relief and Rescue” at the Time of the Covid-19 Pandemic: Insights from the Legal Theory of Finance’ we examine the emergency measures adopted in the US, UK, and European Union (EU) which involve legal and regulatory suspensions to facilitate debt expansion. Such suspensions would normally have been limited by microprudential regulation for lenders and contractual constraints in debt arrangements. We observed that this relief has been influenced by financialization in developed jurisdictions and the perception of temporary duration by policymakers. This financialized context raises concerns about the long-term consequences of over-indebtedness and the tendency to turn to private sector credit as a panacea for financial needs.
Financial Relief and Rescue Programs in the UK, US, and EU
Temporary debt relief and adjustments in financial regulation have been introduced under loan repayment holidays for households and corporations, salary support schemes, and fiscal support for corporate borrowing. In the UK, the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) suspended the application of certain laws and private contractual obligations applicable to their regulated entities. Specifically, the FCA introduced periods of deferred payments for the consumer products it regulates (mortgages, unsecured personal credit, retail credit, and high-cost short-term credit). Loan repayment holidays are supported by suspensions of lenders’ regulatory obligations, preventing lenders from becoming too risk-averse. Contractual enforcement for business debt can be suspended for two weeks under the Corporate Insolvency and Governance Act of 2020 which also provides for flexible moratoria of up to 1 year with creditor consent. The Bank of England has provided a new Coronavirus Corporate Financing Facility to prevent bank liquidity problems. The UK government passed ‘The Coronavirus Job Retention Scheme’ to protect jobs by alleviating wage expenses for businesses and two loan schemes administered by the British Business Bank, the ‘Coronavirus Business Interruption Loan Scheme’ and the ‘Bounce Back Loan Scheme’ to provide fiscal support for corporate borrowing.
In the US, under The Coronavirus Aid, Relief, and Economic Security (CARES) Act banks are required to provide homeowners with mortgages insured by the federal government with up to six months in deferred payments upon request. The CARES Act introduced the ‘Paycheck Protection Program’, a loan program (with a possibility to forgive the debt) to support small-to-medium sized businesses to maintain workers on their payroll. The Federal Reserve enacted the ‘Main Street Lending Program’ that provides support to small and mid-sized non-financial firms hit by the pandemic.
In the EU, the European Banking Authority has welcomed national regulatory initiatives regarding legislative moratoria on loan repayments, payment holidays, and forbearance. Each Member State provides corporate debt relief through legislative enactments such as mandatory deferred payment periods and moratoria from insolvency proceedings. Member States may borrow from the European Stability Mechanism, a funding facility that provides specific ‘Pandemic Crisis Support’ based on the existing credit lines, but private businesses access national fiscal support schemes.
Regulatory suspensions to facilitate lending permitted banks in the UK, US, and EU to draw down regulatory capital buffers, which are considered ‘flexible’ and responsive to economic circumstances. In parallel, the implementation of the liquidity and leverage thresholds have been relaxed for banks. The relaxation of microprudential requirements to incentivize lending has been accompanied by the suspension of supervisory activities such as stress test exercises. Keep in mind that microprudential implementation after the global financial crisis took about 10 years to complete, and these changes in apparently flexible thresholds are not trivial or likely to be temporary.
Central banks in the UK, US, and EU during the pandemic designed expansive monetary policy measures to support liquidity of sovereign and corporate bonds. The Monetary Policy Committee of the Bank of England decided to increase the bank’s holdings of UK government bonds and nonfinancial investment-grade corporate bonds mainly financed by central bank reserves. In the US, the Federal Reserve used quantitative easing tools which rely on asset purchases to prevent bond prices from systemic collapse. At the EU level, the Pandemic Emergency Purchase Programme has been introduced to allow the European Central Bank and national central banks to collectively purchase private and public sector securities.
The Impact of Debt Expansion
We argue that the upshot of relief and rescue policies is that debt expansion, or the carrying of increased debt burdens for corporations and households, has been a key financial policy response during the pandemic. However, policymakers focus on the temporality of relief and rescue measures too much and seem to not have sufficiently engaged with the potential longer-term consequences of financial regulatory suspensions and the hazards of debt expansion. On this view, we have critically considered whether debt overhang should be dealt with through private solutions or whether public regulatory intervention and structural reforms are necessary. Debt expansion for the corporate economy is likely to bring about radical business changes. Relief policies for consumer credit are likely to raise conduct issues in the lender-customer relationship since clarity is lacking on the mandate of preserving lender prudence while being pro-social and sensitive to borrowers’ conditions in these extraordinary circumstances. Therefore, the deployment of regulatory suspensions should be considered more carefully within the institutional framework so that policy thinking for such suspensions as a tool of crisis management can be more generally developed.
Analysis Under Pistor’s Theory
We have placed the policies for relief and rescue within the theorization of legal elasticity in Pistor’s legal theory of finance.1 This theorization, drawn largely from observations during the global financial crisis of 2007-2009, offers a path for structural reforms in law and regulation as part of post-crisis management. We have examined whether the financial regulatory suspensions are a demonstration of legal elasticity and whether they are temporary or likely to have longer-lasting effects. As a result, we critically question the alleged temporary nature of the legal and regulatory suspensions during the COVID-19 pandemic. The theoretical insight drawn is that legal elasticity is often more structural in nature and will have to continue to apply to mitigate the long-term adverse consequences of debt expansion. This suggests that more lasting and continuing applications of elasticity will be needed to fully address the adverse impacts from first-round applications.
Exploring Long-Term Solutions
The theoretical insights of legal elasticity provided us with a platform to consider more broadly and holistically the problems of debt expansion in the corporate and household sectors in developed jurisdictions, heightened and sharpened during the COVID-19 pandemic. In this context, we have explored longer-term substantive solutions for mitigating the adverse effects of over-indebtedness. In doing so, we articulated how legal elasticity can be enriched in its theorization and provided practical support for advancing policy choice sets for policymakers in addressing post-COVID-19 implications. The set of solutions for policymakers aims to recalibrate legal frameworks that have facilitated increased access to debt and inflexibility in private debt relations in the light of three regulatory objectives: facilitating corporate economic recovery, alleviating household suffering, and preventing systemic risk in the financial system.
The treatment of post-pandemic debt overhand requires a reformulation of prudential regulation objectives towards the financial welfare of household and small and medium-sized enterprises (SMEs) borrowers. Regulatory decision-making should be long-termist, incorporate “scenario planning” and be subject to an inclusive framework to receive different stakeholders’ views. This would allow regulators to be fully informed and avoid regulatory decision-making dynamics that only involve powerful financial actors. Any policy reforms adopted to address the adverse consequences of post-pandemic indebtedness should be subject to ongoing review. Policymakers may also adopt a stronger form of temporality by stipulating sunset clauses to compel review and legislative scrutiny. Further, regulators and policymakers may wish to consider the balance between private sector financialization, application of financial distress laws on a ‘private law’ basis, and desirable levels of deleveraging as a matter of public interest. However, past substantive policy choices in favor of financialization pose questions on the need for a greater public hand in financial welfare consequences for households and SMEs, and on the intensity of these legal reforms.
The time is ripe for policymakers to reflect on the structural implications of addressing these problems. Debt expansion in highly leveraged economies, such as the US, UK, and EU, is a double-edged sword, as adverse consequences may await corporations and households. Regulators must be prepared to work with policymakers more broadly to address the longer-term adverse consequences of excessive corporate and household indebtedness.
The post is adapted from the paper ‘Debt Expansion as “Relief and Rescue” at the Time of the Covid-19 Pandemic: Insights from the Legal Theory of Finance’ published in the Indiana Journal of Global Legal Studies.