Risks in financial markets that were ignored during long expansion are being exposed
The mammoth debt bulge includes a significant increase in borrowing by firms with the lowest-quality investment grade — those rated just one level above “junk.” More than $1 trillion in “leveraged loans,” a type of risky bank lending to debt-laden companies, is a second potential flash point.
Watchdogs including the Federal Reserve have warned for years that excessive borrowing by corporations, including some with subpar credit ratings, might eventually blow a hole in the U.S. economy. Now, as Wall Street wrestles with a global epidemic, the debt alarms show how investors are reassessing risks they overlooked during the long economic expansion.
“It is a big concern,” said Ruchir Sharma, chief global strategist for Morgan Stanley. “We’re dealing with the unknown. But given the enormous increase in leverage, the system is fragile and vulnerable.”
Energy companies that have borrowed heavily in recent years may be the first to suffer, as a result of the oil price war between Saudi Arabia and Russia. Falling oil prices, while good news for consumers, may reach levels that will make it impossible for companies in the U.S. shale industry to cover their costs.
On Monday, investors battered some energy companies that have big outstanding obligations. Shares of Halliburton, which has more than doubled its total debt to $11.5 billion since 2012 despite sliding revenue and earnings, lost 38 percent of their value.
The oil field services company last week raised $1 billion by selling investors 10-year bonds paying interest of 2.9 percent. Halliburton said it plans to use the proceeds to pay off existing debt. Over the next six years, it faces $3.8 billion in debt payments.
Today’s debt woes originated in the months that followed the September 2008 Lehman Brothers collapse.
In response, the Federal Reserve cut its benchmark lending rate to zero and kept it at or near historic lows for a decade. The aim was to heal a wounded economy, but the era of easy money bred excesses that only now are coming into view.
Access to low-cost credit helped many companies grow and hire. But it also enabled some that weren’t profitable to survive by repeatedly refinancing their debt. These “zombie” firms, which do not earn enough to cover their interest payments, account for 1 in 6 publicly traded U.S. companies, Sharma said.
About half of the total debt of nonfinancial companies is rated “BBB,” just slightly better than junk or high-yield debt. Companies such as eBay and Martin Marietta have sold bonds this month to investors with such ratings.
Using a broad measure of business liabilities, the ratio of debt to assets is at its highest in 20 years, according to the Federal Reserve. One potential trouble spot lies in the rapid growth of “leveraged loans,” made by top banks such as Goldman Sachs and JPMorgan to scores of cash-short companies.
Until recently, such loans typically were made to companies that were not already deeply in debt. But in the past two years, the biggest borrowers were the nation’s most indebted companies, according to the Federal Reserve. In the first half of last year, about 40 percent of leveraged loans went to companies with a debt-to-earnings ratio of 6-to-1 or greater.
Businesses have been able to bear their extraordinary debt burden only because borrowing costs have been historically low. If that changes for any reason, cash-strapped companies probably would resort to layoffs and slash their spending on new factories and equipment to conserve money for interest payments.
The danger now is that the economy’s sudden stop — with conferences and other public events canceled, travel discouraged and consumers staying home — will cut revenue for many companies and make it harder for them to repay their creditors.
Even before the full effects of the coronavirus hit the United States, analysts were cutting their earnings forecasts. As of Feb. 28, more than twice as many companies in the Standard & Poor’s 500-stock index had issued negative guidance on their first-quarter earnings as had issued upbeat assessments, according to FactSet, a financial data company.
At the same time, nervous investors are becoming pickier about which borrowers they fund, cutting off the flow of cheap money to companies that need it to stay alive.
“It’s a pandemic of fear that’s spreading faster than the virus,” said Ed Yardeni, the eponymous head of a research firm.
In recent days, signs of bond market stress have been multiplying. After years of barely distinguishing between good credit risks and bad, investors are growing more discerning.
The “spread,” or additional yield, that investors demand to hold junk bonds compared to risk-free U.S. Treasurys has increased by more than two percentage points since mid-February — about four times the increase investors required from more creditworthy borrowers, according to Bloomberg Barclays data.
Fearing the higher interest charges — and hoping for additional Fed rate cuts — some corporate borrowers have delayed issuing debt.
New corporate bond issues were falling even before the coronavirus upset Wall Street over the past few weeks. In January, U.S. corporations sold $63.4 billion worth of bonds to investors, down more than 10 percent from the same period one year earlier, according to the Federal Reserve.
“Corporate bond issuance has petered out quite a bit,” said Kathy Bostjancic, a U.S. financial market economist at Oxford Economics. “There were a few days last week we didn’t have any. … There’s just so much fear.”
Ratings agencies, including S&P Global Ratings, also are scrutinizing corporate borrowers for evidence of weakness. On Monday, S&P Global placed Ryman Hospitality Properties, which owns hotels and resorts including the Gaylord Opryland, on a negative watch, citing “significant coronavirus-related cancellations.”
If the economic outlook darkens quickly, a large number of borrowers might become “fallen angels,” downgraded from the lowest investment grade into the speculative junk market. Along with higher borrowing costs, some of them might struggle to find creditors because many pension plans, insurers and mutual funds are permitted to buy only investment-grade securities.
“We’ve had so many years of cheap and easy money with little differentiation in credit quality,” said Sonja Gibbs, managing director with the Institute of International Finance. “What happens if you start seeing downgrades?”
The current bond market turmoil is not as severe as that experienced during some previous recessions, Sharma said. Overall financial conditions are about as tight as they were during the 2011 European debt and currency crisis, although not as bad as during the global financial crisis, according to Deutsche Bank Securities.
“The likelihood that we’ll have a full-blown liquidity crisis is pretty limited,” said Michael Stritch, chief investment officer for BMO Wealth Management. “The banking sector is much less leveraged than in the past, so that’s a positive in terms of credit availability.”
Still, with investors expecting the Fed to return its key lending rate to zero in the next few months, some Fed officials are calling for the central bank to take additional extraordinary action. Eric Rosengren, president of the Federal Reserve Bank of Boston, said on March 6 that the Fed should consider buying assets other than government securities to buttress the economy.
Rosengren didn’t offer any specifics, but acknowledged that Congress would need to authorize any Fed purchase of stocks or corporate bonds.
Corporate debt excesses are not limited to the United States. Corporate zombies also roam the European Union and Japan, where borrowing costs have been low for years and are now negative. In a 2018 study of 14 advanced economies, the Bank of International Settlements said the share of zombie firms had risen from 2 percent in the 1980s to 12 percent in 2016.
The International Monetary Fund and the Fed have warned about reckless corporate borrowing for several years. In a global downturn that was half as severe as the 2009 crisis, corporations in eight major economies, including China, Japan and the United States, may be unable to repay $19 trillion worth of debt — nearly 40 percent of the global total, according to the IMF’s most recent global financial stability report.
“These debt levels truly are troublesome, any way you measure them within the U.S., China and Europe. But you need some kind of catalyst to get people to worry about it,” Gibbs said. “This kind of position we find ourselves in is the type of catalyst that can create a contagion.”
Donald Trump Is Not a Sinister Genius
His race-baiting is impulsive and unpopular, not a brilliant strategy to win white votes.
Some columns spring from inspiration, some from diligent research. And some you’re prodded into writing because of what the other columnists are arguing about.
This is the third kind. With the Democratic debates in the spotlight, there has been a lot written on this op-ed page about the Democratic Party’s ideological evolution, its leftward march on many issues, and how this might help Donald Trump win re-election. Which in turn has prompted a recurring argument from certain of my liberal colleagues that anyone writing about the supposedly extremist Democrats should be writing about Trump’s extremism and unpopularity instead.
So this will be, as requested, a column about Trump’s extremism and unpopularity. But it’s not going to be a mirror image of the columns about the Democrats’ move leftward, because I don’t think policy substance matters as much to Trump’s prospects as it might to the party trying to unseat him.
It matters less because Trump in 2020 won’t be a change candidate. Instead, like every incumbent, he’ll be a candidate of the policy status quo — only much more so in his case, because his legislative agenda dissolved earlier than most presidents and the prospects for continued gridlock are obvious.
That means Trump probably won’t be campaigning on what he promised across 2016 — the kind of infrastructure-building, “worker’s party” conservatism whose ambitions vanished with Steve Bannon. But he also won’t be campaigning on the Paul Ryan agenda that the Republican Congress pushed in his first year, or reviving unpopular Ryan-era ideas like entitlement reform on the 2020 trail.
Instead Trump’s policy argument in 2020 will be, basically, let’s keep doing what we’re doing. That status quo includes a
- deregulatory agenda,
- a tariff push and a
- harsh border policy that are all unpopular.
But it also includes:
- free-spending budgets,
- easy money and a more
- anti-interventionist (for now) foreign policy than past Republicans, all of which are relatively popular.
And in the context of a strong economic expansion, a Trump re-election effort that rested on this record while warning against Democratic radicalism could be plausibly favored.
Except that this isn’t the kind of campaign that Trump himself wants to run. He wants the
- racialized Twitter feuds, the
- battles over Baltimore and Ilhan Omar, the
- media freak-outs and the
- “don’t call us racist!” defensiveness of his rallygoing fans.
He feeds on it, he loves it, and he’s as obviously bored by the prospect of a safe, status-quo campaign as he is obviously uninterested in the conservative intellectuals trying to transform Trumpism into something intellectually robust.
And here I agree with the left that there’s a media tendency to give Trump’s race-baiting impulses more credit as a strategy than they actually deserve. After each Twitter outburst his advisers try to retrofit a strategic vision, to claim there’s a master plan unfolding in which 2020 will become a referendum on Omar’s anti-Semitic tropes or the Baltimore crime rate. And the press gives them credence out of an imprinted-by-2016 fear that the president has a sinister sort of genius about what will help him win.
But this is paranoia, and the retrofitting is Trumpworld wishful thinking. There was, yes, a sinister genius at work when Trump used birtherism to build a primary-season constituency in 2016. But since then, his race-baiting has clearly contributed to his chronic unpopularity, and his re-election chances would almost certainly be far better if he talked like George W. Bush on race instead.
Second, in 2016 Trump won many millions of voters who disapproved of him. But in recent 2020 polling, Trump is performing below his job approval rating in many head-to-head matchups, which suggests that voters who would be responsive to the “policy status quo” argument keep getting turned off by the president’s rhetoric. The supposedly-brilliant strategy of racial polarization, then, is probably just a self-inflicted wound.
None of this means that Trump cannot be re-elected. But it means that if he wins again, it will likely be in spite of his own rhetoric, not as the dark fruit of a white-identitarian campaign.
In this sense both NeverTrump-conservative and liberal columnists can be right about the basic situation. The liberals are right that Trump is defiantly outside the mainstream — that every day, in a particular way, he proves himself extreme.
But this is a fixed reality for 2020, and the NeverTrump side is right about the variable: The campaign may turn on how successfully the Democrats claim or build an anti-Trump center, as opposed to appearing to offer an unpalatable extremism of their own.
Why We Should Fear Easy Money
Cutting interest rates now could set the stage for a collapse in the financial markets.
To widespread applause in the markets and the news media, from conservatives and liberals alike, the Federal Reserve appears poised to cut interest rates for the first time since the global financial crisis a decade ago. Adjusted for inflation, the Fed’s benchmark rate is now just half a percent and the cost of borrowing has rarely been closer to free, but the clamor for more easy money keeps growing.
Everyone wants the recovery to last and more easy money seems like the obvious way to achieve that goal. With trade wars threatening the global economy, Federal Reserve officials say rate cuts are needed to keep the slowdown from spilling into the United States, and to prevent doggedly low inflation from sliding into outright deflation.
Few words are more dreaded among economists than “deflation.” For centuries, deflation was a common and mostly benign phenomenon, with prices falling because of technological innovations that lowered the cost of producing and distributing goods. But the widespread deflation of the 1930s and the more recent experience of Japan have given the word a uniquely bad name.
After Japan’s housing and stock market bubbles burst in the early 1990s, demand fell and prices started to decline, as heavily indebted consumers began to delay purchases of everything from TV sets to cars, waiting for prices to fall further. The economy slowed to a crawl. Hoping to jar consumers into spending again, the central bank pumped money into the economy, but to no avail. Critics said Japan took action too gradually, and so its economy remained stuck in a deflationary trap for years.
Yet, in this expansion, the United States economy has grown at half the pace of the postwar recoveries. Inflation has failed to rise to the Fed’s target of a sustained 2 percent. Meanwhile, every new hint of easy money inspires fresh optimism in the financial markets, which have swollen to three times the size of the real economy.
In this environment, cutting rates could hasten exactly the outcome that the Fed is trying to avoid. By further driving up the prices of stocks, bonds and real estate, and encouraging risky borrowing, more easy money could set the stage for a collapse in the financial markets. And that could be followed by an economic downturn and falling prices — much as in Japan in the 1990s. The more expensive these financial assets become, the more precarious the situation, and the more difficult it will be to defuse without setting off a downturn.
The key lesson from Japan was that central banks can print all the money they want, but can’t dictate where it will go. Easy credit could not force over-indebted Japanese consumers to borrow and spend, and much of it ended up going to waste, financing “bridges to nowhere” and the rise of debt-laden “zombie companies” that still weigh on the economy.
Today, politicians on the right and left have come to embrace easy money, each camp for its own reasons, both ignoring the risks. President Trump has been pushing the Fed for a large rate cut to help him bring back the postwar miracle growth rates of 3 percent to 4 percent.
At the same time, liberals like Bernie Sanders and Alexandria Ocasio-Cortez are turning to unconventional easy money theories as a way to pay for ambitious social programs. But they might want to take a closer look at who has benefited most after a decade of easy money: the wealthy, monopolies, corporate debtors. Not exactly liberal causes.
By fueling a record bull run in the financial markets, easy money is increasing inequality, since the wealthy own the bulk of stocks and bonds. Research also shows that very low interest rates have helped large corporations increase their dominance across United States industries, squeezing out small companies and start-ups. Once seen as a threat only in Japan, zombie firms — which don’t earn enough profit to cover their interest payments — have been rising in the United States, where they account for one in six publicly traded companies.
All these creatures of easy credit erode the economy’s long-term growth potential by undermining productivity, and raise the risk of a global recession emanating from debt-soaked financial and housing markets. A 2015 study of 17 major economies showed that before World War II, about one in four recessions followed a collapse in stock or home prices (or both). Since the war, that number has jumped to roughly two out of three, including the economic meltdowns in Japan after 1990, Asia after 1998 and the world after 2008.
Recessions tend to be longer and deeper when the preceding boom was fueled by borrowing, because after the boom goes bust, flattened debtors struggle for years to dig out from under their loans. And lately, easy money has been enabling debt binges all over the world, particularly in corporate sectors.
As the Fed prepares to announce a decision this week, growing bipartisan support for a rate cut is fraught with irony. Slashing rates to avoid deflation made sense in the crisis atmosphere of 2008, and cutting again may seem like a logical response to weakening global growth now. But with the price of borrowing already so low, more easy money will raise a more serious threat.
By further lifting stock and bond prices and encouraging people to take on more debt, lowering rates could set the stage for the kind of debt-fueled market collapse that has preceded the economic downturns of recent decades. Our economy is hooked on easy money — and it is a dangerous addiction.