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> …has drawn attention to the relentless build-up in corporate debt in the US, where companies now owe a record $10tn — equivalent to 49 per cent of economic ou
by cs702 6y ago
> …has drawn attention to the relentless build-up in corporate debt in the US, where companies now owe a record $10tn — equivalent to 49 per cent of economic output. When other forms of business debt are added in, including to partnerships and small businesses, that already extraordinary figure increases to $17tn [83% of GDP, the highest ever].
> Even before the pandemic, the level of corporate leverage was beginning to cause alarm. At the end of last year, the IMF issued a striking warning: as much as $19tn of business debt in eight countries led by the US — or 40 per cent of the total — could be vulnerable if there were a “material slowdown” in the economy, a scenario that, if anything, now seems tame.
I like to think of it this way:
At present, a business that is barely-investment-grade (say, BBB-/Baa3) can borrow for a decade at just over 3%/year. A risky business that is rated as junk (i.e., below BBB-/Baa3) can borrow for a decade for as little as 6% to 7%/year. The interest payments are tax deductible, so the effective annual cost to borrow is around 2.5% for barely-investment-grade and around 5% for junk, give or take. As long as the executives think they can earn more than 2.5% to 5% per year on any money they borrow, why not borrow it? And if they can justify using borrowed money to buy back shares, keeping their stock options in-the-money, why not do it?
Many US companies in mature industries (think energy, hospitality, travel, transportation, etc.) have been doing exactly that, to the point that corporate debt is now the highest ever in relation to US GDP. And it has worked beautifully... that is, until a global pandemic suddenly cut their revenues by 10% to 20% or even more, instantly flipping those expected earnings into losses. People are no longer traveling as much, or going to restaurants as much, or going to the office as much, etc.
All of a sudden, all those businesses are losing money on all that borrowed money -- they are losing so much, in fact, that many have had to borrow even more during the pandemic to be able to continue paying interest on prior borrowing and avoid going into bankruptcy.
- supercanuck 6y ago>As long as the executives think they can earn more than 2.5% to 5% per year on any money they borrow, why not borrow it? Back in the day, people were responsible for their Choices. So if some unforeseen happened, a savings was considered a good thing. Today, a CEO can just shrug and say “meh, pandemic” and the government is suppose to be the lender of last resort. This is the moral hazard that we were all afraid would happen after 2008.
- smabie 6y agoWhat was this day when people were responsible?
- ooobit2 6y agoGood question. But the issue of kicking the can about insolvency played a huge role in the Great Depression. At that time, and having had one major global conflict behind the largest sovereign states in the world, I have no clue why people in power continued placing the same bets with even higher amounts attached. I do think the safety net of shared consequences has made it safer for them to get away with it. Companies will take huge risks because, while the equity holders stand to lose everything, so too do the workers. And they know the downward pressure on those workers forces them into choosing between their needs and their time. I mean, look at gaming companies like Bethesda and Rockstar Games. The downward pressure on having to deliver a billion-selling title because they deliberately limit staff and new IP opportunities, contract more and more labor. It's a framework of continuous stress and instability. Companies optimize for stress all the time. I've seen it firsthand across meetings with Inc. 5000 and Fortune 500 logos.
- N1H1L 6y agoGreat question.
- Ericson2314 6y agoWell, in the great depression and 19th economic mood swings they certainly more of paid a price for irresponsibility. If there's no welfare for the poor, better that there be no welfare for the rich.
- anthony_barker 6y agoDon't you think that companies are just reacting to the fed/bank of england etc keeping rates at 300 year lows? https://www.bankofengland.co.uk/-/media/boe/files/monetary-policy/baserate.xls?la=en&hash=EEB8729ABFFF4B947B85C328340AE5155A99AD0F https://www.bankofengland.co.uk/-/media/boe/files/monetary-p...
- alexpetralia 6y agoYes, the simple fact is that an optimal capital structure in the current environment benefits heavily from debt because a lower cost of debt means a lower cost of capital.
- QuesnayJr 6y agoIf central bank rates were too low, we would see inflation, but we don't. Rates are so low because savers want to save more than borrowers want to borrow. Corporations are just taking advantage of the large pool of savers that's already out there.
- freedaftimagine 6y agoRising asset prices don't count as inflation to you?
- mrep 6y agoNot OP, but I don't see any data suggesting that assets are inflating. For real estate, inflation adjusted price per square foot hasn't changed for most of the US [0] (west coast admittedly has ballooned but that's because their cities are built in valleys with a fixed amount of land and restrictive zoning causing a fixed amount of housing and thus bidding up home prices; not a problem for most of the country though). As for equities, Annualized S&P 500 Return (Dividends Reinvested) from 2005-2020 are 6.738% [1] versus 7.690% for 1990-2005 [1]. Or are you talking about another asset? [0]: https://www.supermoney.com/inflation-adjusted-home-prices/ https://www.supermoney.com/inflation-adjusted-home-prices/ [1]: https://dqydj.com/sp-500-return-calculator/ https://dqydj.com/sp-500-return-calculator/
- gumby 6y agoGreat opportunity to wash these companies through bankruptcy, wipe out the shareholders, leaving the buyer with a profitable, operating business. As a bonus you’ll get the politicians behind you as you’ll be saving jobs — jobs that never would have been at risk except for the excess liquidity still flushing through the system.
- godzillabrennus 6y agoPoliticians only care about shareholders not jobs. Trickle down something or another...