While the U.S. economy appears to be booming, so is the country’s corporate debt, which is a historical and stratospheric high. Easy borrowing – or easy paper money, if you will – has allowed companies to ignore their mounting debts in favor of borrowing more. As of the end of the second quarter 2019, non-financial corporate debt was at $5.7 trillion.
This could easily lead to a corporate slowdown or even recession. Investors are beginning to notice and demand that companies pay down their debts and lower dividend payments instead of adding to it. According to a Bank of America survey, 46 percent of fund managers believe that corporations are overextended with debts. In the same Bank of America survey, more than half of those responding expect the economy to weaken. Some believe that the chances of a recession in the next year is at about 30 percent. Eighty percent of corporate financial officers think that the U.S. will be facing a recession within two years. In the event of an economic slowdown, this tsunami of debt would be even more difficult to pay off. Some companies are taking the situation seriously. Since the recent tax cuts, 37 percent of corporations have diverted their efforts to pay off debts. Prior to the tax cut, only 5 percent were making any visible effort at debt-repayment.
While corporations are struggling to pay off their debt, the recent interest rate hikes have made borrowing more difficult. There have been nine interest rate increases over the past decade, and the Federal Reserves’ own balance sheet has decreased by $400 million during that period. The non-financial corporate debt ratio to GDP is the most alarming since the Great Depression. One-third of companies are either not rated or rated as junk.
One major concern are bank loans to risky customers, those who are the least likely to be able to repay their loans. More than $1 trillion risky loans are on the books. What happens in the event of a default?
Investor Carl Icahn has stated that artificial low-interest rates have led to the desperate printing of fiat currency by the Federal Reserve in an effort to keep up. Globally, debt has increased from $100 trillion to $250 trillion during the past 10 years. Icahn likens the Federal Reserves’ easy money policy to a parent tossing more dollars at a child’s allowance instead of teaching the child moderation and discipline. He points out that up to 90 percent of U.S. consumers have no actual net worth due to the bad habit of borrowing money to sustain their lifestyle. Companies are using assets to grow their businesses instead of paying off the staggering loans that are due. His own investment strategy has been to remain as diverse as possible. According to Icahn, there simply is no way of knowing from which direction the ill economic winds will blow.
Investor Steve Eisman, known as “The Big Short,” predicted the collapse of the subprime market in 2008. He has expressed concern about the growing amount of corporate BBB rated debt. These low-rated bonds amount to $2.7 trillion. The problem is not the large amount of these debts, but the fact that during a severe economic downfall, these bonds will only sell at a tremendously discounted rate, costing investors and lenders dearly. In addition, some of these BBB rated bonds are quite likely to turn into junk bonds.
The corporate debt is a serious problem. To paraphrase former Prime Minister Thatcher, “Sooner or later, you have to repay the money you borrowed.” When that time comes, consumers had best be prepared for the economic fallout.