Question

Chaos on Virgin’s last flight

Multiple sources within the Virgin advisory team say that Treasurer Josh Frydenberg expressed support for some sort of rescue, as did secretary of the department of infrastructure Simon Atkinson, Treasury secretary Steven Kennedy and other unnamed cabinet ministers.

By the time the board decided to call in Deloitte on Monday night there had been a total of seven rescue packages. The final rescue package put to the federal government last weekend needed a government debt guarantee of about $200 million.

Virgin never went as far as to remind the government of past rescue packages such as the $3.5 million federal government loan to Kendell Airlines to keep it flying regional routes in 2001 and the $4 million federal grant to National Textiles by the Howard government in 2000 to cover workers’ salaries.

Required:

As this article relates, Virgin,  an Australian airline,  got into severe financial difficulty during the COVID-19 crisis due to its high debt levels and has sought government assistance.  

What potential moral hazard problems could arise in the future, at both Virgin and other companies,  if the government “bails-out” Virgin  by providing some government guarantees for payments of its debt? .   Which stakeholder in Virgin would most benefit from these moral hazard problems? .  Who would incur most of the cost of these moral hazard problems?  .

Answer 1

Hello Buddy,

Coming to the question,

1) Potential moral hazards that could arise at Virgin Airlines or other companies would include that the management being laid back and taking unwanted and avoidable risks on the pretext that if anything goes wrong, definitely the government is there to bail them out of the mess they created by taking decisions in their personal interests. It would not take long for other companies to also show and point out how poor their performances have been and why they also deserved to be bailed out.

2) The debt holders first and the stock holders next would benefit the most out of such a bail out if it is received by such company, reason being that they get to receive their payments in full without taking any haircut or without getting into the mess of bankruptcy and liquidation, etc.

3) Unfortunately but most of the cost of such moral hazard porblems which force such bailouts, will indirectly have to be borne by the tax payers, mostly in the form of increased taxes, duties, etc. More such moral hazard problems would lead to more bailouts which the government will try to fill its pockets by collecting more taxes. Hence the persson to bear such bailout is no one else but the tax payer.

I hope the above solution is what you were looking for. For any further queries or doubts in the solution, please feel free to drop a comment. Please do leave a positive feedback, Thank you :)