The Wall Street Journal ran a nice editorial earlier this week — “The Federal Resurrection Board” — arguing that the strange phenomenon of Hertz seeing its stock price rise despite the company’s having filed for Chapter 11 bankruptcy protection could be laid at the door of the Federal Reserve Board, which has doubled-down and doubled-down again on easy-money policies that will keep many zombie firms walking the world long after they should have been put out of their misery. The Journal speculated that in the case of Hertz the problem could be day-traders bored to distraction now that betting on pro sports is largely limited to wagering on when exactly they will return. Since Hertz is sitting on something like US$19 billion in debt, shareholders would be at the back of a very long queue, even if it weren’t social-distanced. (Hertz Global Holdings suspended the sale of new stock Wednesday after the Securities and Exchange Commission, perhaps having read the editorial, said it wanted to ask it some questions.)
But you never know in markets. My respect for them began with the very first stock I bought, which was also pretty close to the last stock I bought. My broker — this was in the days of brokers — told me it was “poised to move.” Unfortunately, he didn’t specify in which direction. You know the rest: He was right. It did move. About as sharply downward as airline bookings this March. I tried individual stocks about twice more and then switched permanently to the broadest possible indexes.
As an economist, I’ve got to believe that, in general, markets incorporate all the information that’s relevant to whatever it is they’re pricing. But there will be times, even economists allow, when that may not be the case. It’s interesting that the Bank of Canada has just published research on one such case where markets may provide suspect information.
The staff working paper in question is “Trading for bailouts,” by Toni Ahnert of the Bank’s Financial Stability Department and two Chilean academics, Caio Machado and Ana Elisa Pereira. You can’t tell a book by its cover and you can’t really tell a paper by its title. But some titles, like some covers, insist that you read what comes next. “Trading for bailouts” is one of those.
The paper looks at what can happen to market information when a large enough block of shares in a firm is owned, or a high enough proportion of its debt held, by a player who therefore has an important interest in whether or not the firm gets bailed out. In a world of imperfect information, i.e., Planet Earth, such a player, the potential “bailee,” may try to influence the decision of the potential “bailer,” which is normally a government, often its central bank. The problem arises if the bailer is trying to judge the firm’s prospects by relying on what’s usually a good index of its future, namely, its stock price, but the bailee is big enough to move the stock price by buying or selling or not doing either. In particular, when things are in fact looking up for the at-risk firm the player may be able to dull the emerging shine by either selling shares it wouldn’t have sold or not buying shares it would have bought were a bailout not on the table.
The three researchers set up a simple game-theory model that pretty quickly gets hairier than non-specialist readers will want to deal with and then they use it to derive and prove 11 theoretical propositions (including two lemmas) about how different results change according to changes in the model’s parameters. For instance (“Proposition 4”): the greater the block of shares owned by the player, the lower its market informativeness and “the higher the ex-ante probability of intervention,” though the probability is “non-monotonic in the block size.” It’s the sort of thing economists gobble up but that leaves ordinary folk — one’s tempted to say reasonable folk — mystified.
The derivations and conclusions are very instructive but this is one of those papers where you’d like to see real names instead of alphas and betas — especially when the authors turn their attention to “a simple model of liquidity support to a distressed bank.” Might they have any particular potentially distressed bank in mind? And which players in the real Canadian world are big enough to move the stock price of a distressed bank if they were to put their self-interested minds to it? And what “intervention cost” does the Bank of Canada perceive in providing such liquidity support, since it’s this economy’s principal fount of liquidity?
There’s a long-standing and on balance probably good tradition of Bank of Canada economists following up interesting research avenues mainly because they are interesting. And writing, thinking and vetting lags are such that this research project almost certainly began well before the name “COVID-19” was coined. But it’s very interesting to see the country’s chief potential bailer-outer thinking out loud and in public about how some of the institutions it might be called on to bail out could be tempted to try to influence the bailing in ways that, though not illegal, might seem a little underhanded.