In the spring of 2020, as the COVID-19 pandemic shut down economies around the world, pressure arose for governments to respond to the growing threat of pandemic-related market distress. In addition to responding to the direct public health emergency, governments were expected to stabilize markets—both financial and economic—and provide relief to those harmed by the pandemic’s market effects.
In the United States, the initial proposals for government action varied in nature and focus. Some proposals targeted the financial system, while some targeted small businesses and individuals. Others were intended to bail out large businesses and specific industries. Still other proposals took a more institutional focus. In the context of bankruptcy law, many imagined building up the bankruptcy system as a primary bulwark against a seemingly imminent wave of economic and financial distress.
With the exception of measures related to financial markets, the actual responses formed a chaotic mix of disconnected half measures that neither stabilized the economy nor provided meaningful relief to those most affected. While that failure may be attributed in part to general government dysfunction and legislative gridlock, a large part of the problem arises from the lack of a clearly identified purpose and framework to guide government responses.
To prepare for the next crisis, we must use this failure to better understand the toolset available to governments dealing with economic and financial threats. The main lessons to take away are that the choice of tools deployed by governments to alleviate a crisis should depend on the nature of the specific problem at hand and that scattershot approaches are unlikely to work.
As obvious as those lessons may seem, they were largely ignored in 2020. Much of the confusion in pandemic responses is attributable to attempts to use the wrong tools and to implementation of measures that lacked any clear purpose. In particular, governments and commentators lost sight of two important distinctions in deciding how to act. First is the distinction between tools appropriate for addressing economic distress and those appropriate for addressing financial distress. Second is the distinction between a systemic crisis where distress is spreading and an instance of firm-specific distress where the harm—though perhaps large—is contained.
These distinctions present four types of market distress: specific economic, systemic economic, specific financial, and systemic financial. Each type is distinct from the others, and for each there is a category of appropriate government responses (respectively): direct subsidies, general stimulus, bankruptcy proceedings, and financial bailouts. We thus have this matrix:
Table 1
Specific Systemic
Economic Direct Subsidies General Stimulus
Financial Bankruptcy Proceedings Financial Bailouts
(Chapter 11)
The importance of understanding these classifications is most evident in the flawed proposals for pandemic-related fixes to bankruptcy law and in the lack of a centralized economic plan to support failing small businesses around the country.
This Article is an attempt to clarify the appropriate (and the inappropriate) government tools for responding to different forms of market distress. In Part I, I provide a brief review of the market-related responses to the pandemic. I discuss actions the United States government has taken, various proposals that have been considered, and some of the economic and financial effects that have resulted. In Part II, I lay out a framework for thinking about government responses to market distress. I describe the four types of distress and explain the fit of each type with a specific category of tools. In Part III, I provide a closer look at and place special emphasis on the interaction between pandemic responses and bankruptcy law because bankruptcy’s role has been the most obviously misunderstood and provides the starkest example of confused analysis.
Authors
