An innovative approach to supply credit during the financial crisis that is recommended to be a part of the tool kit when combating future crises. That’s the summary of researcher Gustav Martinsson’s study of a unique government lending program, presented in the Finance Panel seminar arranged by the Swedish House of Finance in cooperation with SNS.
“This lending program is now a part of our toolbox for mitigating a financial crisis”, commented Karolina Ekholm from the Ministry of Finance.
Watch a video from the seminar (in Swedish) or read the summary below (in English).
You can also listen to the seminar as a poddcast (in Swedish).
In Spring 2009, mid financial crisis, the Swedish Government launched a tailor made lending program. The policy allowed companies to voluntarily postpone paying all of their labor-related taxes and fees, typically due at the end of the month. For companies choosing to use the program, the suspended payments were treated as a loan from the Swedish government. Gustav Martinsson, visiting research fellow at the Swedish House of Finance and associate professor in financial economics at KTH, has studied the effects of the lending program and published the results in a recent paper.
“At the time of offering the lending program, there was no time to test it before hand. So the government decided to offer what I would like to call an innovative lending opportunity. AS practically all Swedish limited companies were able to postpone payment of some of their tax debt, it could mean considerable liquidity”, said Gustav Martinsson.
Profitability no requirement for loan
Companies were able to postpone the equivalent of 9 percent of their annual salary costs. By targeting a firm’s labor taxes rather than profit taxes, firms did not have to be profitable to gain liquidity from the program. The interest rate was set so as to not crowd out other kinds of loans. The annual interest rate was set at around 5,3 per cent.
The fact that the loan did not require any paper work and did not involve an approval process, made it attractive and easy to utilize.
In the study, Gustav Martinsson and his coauthors included Swedish companies with a minimum of 5 employees and a turnover exceeding 1 million euro. The study showed that 5 per cent of these companies used the program of government liquidity.
But how can we know if these companies really needed the liquidity? Gustav Martinsson and his coauthors tested this by checking whether he companies that took the loan, increased their debt accordingly. This would mean that the loans were not utilized to substitute previous debt.
“Accepting a government loan does not in itself indicate that you are liquidity constrained. We tested whether the companies were liquidity constrained by seeing how the loan affected their net debt levels. What we found was that the increase in the companies’ debt-to-assets was equal to the liquidity gained from the government loan.”
An important advantage of this particular program, compared to other lending programs, is that it was speedy and that the companies did not need to await approval before receiving liquidity, stressed Gustav Martinsson.
The study shows that the credit obtained from the lending program was used to invest in working capital and fixed assets.
“We find that the loan program was a valuable measure. Though some larger companies took the loan, it was mainly smaller and younger companies that used the lending program. This has likely contributed to mitigating future economic costs of the financial crisis”, said Gustav Martinsson.
He recommends the lending program to be utilized again in future crises.
Risk of moral hazard
Karolina Ekholm, State Secretary at the Ministry of Finance, elaborated and commented on the work of Gustav Martinsson. She mentioned the risk of moral hazard, which might lead companies to take more risk when the government offers credit that banks are unwilling to extend.
“One suggestive factor is that the companies that participated in the program had higher debt than other companies. So typically, the companies that participated already had rather high debt”, she said.
Karolina Ekholm also commented that the cost of the program, which in the study is mentioned as 200 million SEK, might have been higher in the end. In the spring of 2010, around 400 of the companies that participated in the lending program had become bankrupt, and several more were in risk of becoming bankrupt, before paying back their debt.
“Though no exact cost has been calculated, we are probably still talking hundreds of millions of SEK rather than billions”, said Karolina Ekholm.
Policy needs to be implemented faster
Despite this cost, Karolina Ekholm argued that implementing the program was a good measure, and stated that it remains in the toolbox of the Ministry of Finance to potentially be used in future crises.
“It’s about risk evaluation. If you take measures whereby tax payers fund an increase in the credit supply, but find that there is no credit crisis and therefore that the measure was unnecessary, there will be a certain cost related to credit losses and potentially moral hazard. But if you do not take these measures, and find that there is indeed a credit crises – then the cost will be very large because of a large downturn in the economy. So the conclusion is that such measures should be taken.”
One lesson learnt is to put the policy in place faster next time.
“Most of the measures taken during the financial crisis were started a bit too late, and they were also terminated a bit too late. At the next crisis I believe that we need to find a way to put measures in place very early, and also to avoid keeping them in place too long”, said Karolina Ekholm.
Want to know more?
Read the paper “Can Policy Mitigate Liquidity Constraints? Evidence from a Temporary Lending Program” by Gustav Martinsson, Christian Thomann, and James R. Brown.