An article in the March 14, 2020 issue of the Economist (a conservative British magazine) caught my attention. The piece makes the case that the high level of corporate bonds and loans are a major concern because of the new financial scare brought about by the Coronavirus.
Some of the facts and figures cited in the article are instructive.
- Worldwide corporate debt is about $74 trillion. Global Corporate debt (excluding financial firms) was 92% of GDP compared to 84% in 2008 at the time of the last financial crisis.
- In the US, the figure is 47% now compared to 43% in 2008.
- Corporate debt today is “riskier” than it used to be. About two-thirds of the non-financial corporate bonds are rated “junk” or “BBB”, the category just above junk.
- It is well known that “naughty habits have crept in” and that underwriting standards have slipped.
- This leaves business more vulnerable to the shock not only from the Coronavirus but also from the recent oil price slump.
- The immediate concern is that certain industries such as airlines and hotels are vulnerable. However, many firms in various industries could face a cash crunch if temporary shutdowns and quarantines spread.
One can make the argument that the present situation could, in theory at least, lead to a more difficult economic situation than 2008 and even 1929.
One can make the argument that the present situation could, in theory at least, lead to a more difficult economic situation than 2008 and even 1929. Why is that? Today we are talking about a crisis that can paralyze and even destroy many businesses depending on how long the pandemic lasts. This is not an economic crisis. This is a crisis equivalent to a war where we are being attacked but this time by an “invisible enemy” as the President has stated. The situations in 1929 and 2008 were financial crises which we now know how to counteract.
Were a 1929 situation to occur today, we would not make the mistake the Federal government and the Federal Reserve made then. At that time the Hoover Administration tried to balance the budget and the Federal Reserve cut credit which converted a stock market crash into a world wide depression. The lessons were learned so that in 2008 the government and the Federal Reserve opened the spigots and prevented another 1929.
None of us are in a position to predict how dire the Coronavirus will be and how long it will last. I do know this however: we live in a world where debt is good, the more the better. As a result, we have unwittingly put ourselves in a more vulnerable position. In recent months I have been attending conferences relating to credit issues and risk management issues. All the experts have been warning that the level of corporate debt is dangerously high; and furthermore, borrowing corporations are able to extract easier terms than in the past. This seems to be due to the fact that worldwide savings have grown as populations age. In effect, there is too much money chasing too few projects and borrowers. This gives power to the borrowers and they have of course taken advantage of it.
The article addresses some positive elements especially as relates to the U.S.
- Institutions that make loans and buy bonds in the U.S. are resilient. A majority of American bonds for example are owned by pension funds, insurers and mutual funds that can easily cope with losses.
- Cash rich firms and private equity concerns have a good deal of liquidity.
- American banks are in good shape with solid profits and capital positions.
- In addition, we now know that the government and the Federal Reserve will do whatever it takes to ameliorate the difficult economic and financial situation resulting from the Coronavirus.
This leads to another interesting point. Back in the 1980’s Ronald Reagan declared that government is the problem. Now we see a Republican Administration taking fiscal steps (with almost unanimous approval) which will greatly increase the role of government. The Federal Reserve has also been very accommodating.
One is reminded of what happened during the last crisis in 2008. Lehman Brothers collapsed and the stock market started on a downward spiral. President Bush called a meeting at the White House on a Thursday which included his aides, various Cabinet Members and also Ben Bernanke, the Head of the Fed. Bernanke grimly told the meeting that if no action were taken there would be no economy by the next Monday. In attendance also was the Secretary of the Treasury Henry Paulson. According to reports later, practically all of Bush’s cohorts were against the “bail out” programs advocated by Paulson and Bernanke because they were ideologically opposed to them. Bush listened, turned around and left the room stating: “I am not going to be the next Herbert Hoover.”
What is cause for optimism is that Donald Trump feels the same.
Since the days of Ronald Reagan, we have had two major crises and, in both cases, a Republican President has taken the cue from Franklin Roosevelt.
There is enough to worry about because of the Coronavirus. We no longer need to worry about the lack of resolve on the part of the U.S. government to do what is necessary in terms of fiscal and monetary policy. On this Republicans and Democrats are on the same page. In times of crisis as they say “we are all in this together.”
James A. Kyprios