Corporate debt will not be the basis for another financial crisis/great recession
from Dean Baker
The folks who remain determinedly ignorant about the financial crisis and Great Recessioncontinue to look for another crisis where it isn’t. Much of the latest effort focuses on corporate debt. There are four big reasons why corporate debt does not pose anything like the same sort of problem that mortgage debt did during the housing bubble years.
First, many companies took on large amounts of debt for a simple reason, it was very cheap. The debt was not a necessity for them, but the opportunity to borrow for thirty or even fifty years at very low interest rates looked too good to pass up. As a result, many entirely healthy companies have large amounts of long-term debt on which they have very low interest payments. The ratio of corporate debt service payments to after-tax profits is at a relatively low (as in the opposite of high) level.
Second, the crisis mongers apparently missed it, but stock prices are very high right now. This means that most companies have the opportunity to raise more money by selling stock if they feel the need. Of course, the stock market could always plunge by 50 percent, but this one doesn’t factor into most crisis mongers’ predictions. As long as the market stays high, or even if it falls 20 percent, most companies would be able to sell shares to raise capital if they were facing trouble meeting their debt service payments.
The third reason corporate debt does not pose the same problem as mortgage debt is that even in a bankruptcy, debtors usually collect the bulk of their debt. It’s rare for a company facing bankruptcy not to still own valuable assets, such as a profitable subsidiary or land and buildings that can be resold. As a result, debtors might have to accept 70 or 80 cents on a dollar, which is a substantial loss, but far more than zero.
By contrast, in the housing bubble years, many homeowners were able to borrow an amount that equaled or even exceeded the full value of their home. In the most inflated markets, prices fell by 50 or 60 percent. Given the costs of carrying through a foreclosure and reselling the house, many mortgage holders were looking at pretty much a complete loss on their mortgage when a homeowner stopped paying. That is a very different story with corporate debt.
Finally, corporate debt will not have the same sort of feedback story as was the case with mortgage debt and the housing market. If GE finds that it can’t make its debt payments (not my bet, but the issue raised in the article), it will not make it more difficult for a software company or an airline to make its interest payments.
By contrast, when people began defaulting on their loans and foreclosed houses were placed on the market, it put downward pressure on the prices of other homes, making more homeowners underwater. That increased the risks of default and led to more foreclosures. There is nothing like this dynamic in the corporate debt market.
With these four minor qualifications, the corporate debt market is just like the mortgage market in 2007. So, if you want to believe in an imminent crisis go ahead, but this is not something serious people should worry about.
Addendum
Robert Salzberg reminds me of another difference, corporate debt is much less likely to be securitized than mortgage debt. This mattered in the collapse of the bubble since the servicers of the mortgages in mortgage backed securities were not set up to arrange write-downs. As a result, in many cases they carried through with foreclosures that were not only worse for the homeowner, but also worse for mortgage holder.
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Real-World Economics Review Blog 
The article does mention the leveraged loan market that both the IMF and BIS have warned about. These junk rated bonds are also being securitized, with institutional investors the main buyer. Certainly not as large as the mortgage bubble, but trouble just the same.
https://www.businessinsider.com/the-imf-is-latest-to-warn-about-13-trillion-in-risky-leveraged-loans-2018-11
It can be difficult to separate cause from effects in a crash like we had in ’08. Just prior to the crash the Fed went on a debt selling spree, taking money out of the economy. That could have been a prime cause of the crash.
Does all this apply to the lovely retirement homes of Paradise, or have the fire bobbles reduced house prices slightly? Perhaps US-based colleagues can elaborate a little further as to the future prices, plus the contractual agreements for any reconstruction involved. We could also ask for new formula to calculate the perfectly predictable costs of global warming which started decades ago, was sourced out and has now engulfed the whole universe beyond redemption.
GE was largely a shadow bank more than an industrial products manufacturer. When the GFC hit the finance arm, GE Capital became insolvent and GE sold assets to service debt while keeping the financial liabilities on its balance sheet. Bond rating agencies took notice and downgraded GE paper but not enough to exclude them from institutional investors. Now their debt is rated at junk risk so any borrowing will carry a high interest rate. Meanwhile the industrial products arm is in poor competitive shape and needs to modernize its products and its plants but competition is fierce. So equity values are depressed by the weak balance sheet and new bonds will be junk rated. There are lots of similar hybrid shadow bank/manufacturing companies in China. If China goes into recession or a credit crisis they buy a lot of locomotive parts and new equipment from GE. The snowball likely will start rolling in China.
Yes, that’s a rather easy call seeings how China is simultaneously the world’s largest export platform and importer of capital goods, and even though they have a pragmatic attitude toward debt they’re still an elite run country and also reside within the current monetary paradigm of Debt Only. However, I’ve been getting a lot more hits on my blog from China. If a powerhouse like China adopted the policies and structural changes I recommend here they would immediately end their debt problems and just as rapidly democratize their money system. Then they wouldn’t have to rely solely upon being the an export platform and could also invest in capital goods production as well thus becoming a much more balanced economy. And if we don’t do the same we’ll get caught with our pants down with an industrially hollowed out economy and financial domination to boot.
The policies, structural changes and regulations of the paradigm changing theory of Wisdomics-Gracenomics has so many resolving benefits.
The last recession was not brought about by corporate debt because corporations have only profited from the stock market which has hit ever new highs and from stock buybacks. Corporations are drowning in their own profits. The financial crisis and recession was brought about by the banks who make their profits by providing loans (to buy mortgages) and the more loans they made, the more profits they earned, and the more mortgage-backed securities they can sell. For the next financial crisis and recession, follow the money again which means look at the banks and the loans that they make and the powers and controls they have over finance and you will see it.
Banks must increase their loans exponentially in order to have sufficient money in the economy to pay interest on the loans. The only other sources of money to pay loan interest is senioriage spending by the government which has been systematically reduced over the past five decades and open market operations by the Fed, buying debt to place money into the economy. Just prior to the ’08 crash the Fed SOLD debt, taking money from the economy and there by instigating the crash.
“The only other sources of money to pay loan interest is senioriage spending by the government which has been systematically reduced over the past five decades and open market operations by the Fed…”
Presently, yes….and that’s the problem because deficit spending still won’t resolve the problem….only a new monetary and financial paradigm that intelligently, insightfully and specifically applied at the point of retail sale inverts the realities of chronic price inflation, systemic austerity and individual monetary scarcity into abundance and painless and beneficial price deflation.
Elizabeth Warren is worried about CLO (collaterized loan obligations). See here: https://www.warren.senate.gov/imo/media/doc/2018.11.14%20Letter%20to%20Regulators%20on%20Leveraged%20Lending.pdf
I agree with the sentiments and would add that a major structural difference between loans (such as mortgages) or corporate debt issued through the bond markets is that loans increase the money supply and their repayment or write off contract it whereas bonds are genuinely an intermediated liquidity preference (although there may be secondary impacts on the money supply). Therefore a bond market crisis is not immediately a liquidity crunch per se.
I’d also add that this preference exists in no small part due to the outsize share of profit distributions in favour of existing capital. So the scale of the corporate bond market is little more than a re-investment of a proportion of that excessive share of accumulated profits (especially in the post-GFC policy world), crowding out ‘traditional’ lenders.
Further I’d make the added point that for (too many?) companies, borrowing against a healthy balance sheet has been an indirect factor in the wider process of enabling level records of share buybacks and pushing share prices to record highs.
However, in the detail I would push back with the following observations:
Any reduction in aggregate corporate profitability (which an increasing number of commentators feel is implied) would reduce the profit aggregate and it’s hard to see how the exponential rate of distributions to capital could continue. That implies a supply problem to the corporate bond market at some future point. If the increase in the level of supply can’t be maintained, then while defaults don’t have the same direct impact as defaults on bank loans, it’s hard to imagine that they don’t create a feedback loop that is almost as damaging. Finally, while Dean focuses on the limitations to macroeconomic impacts, the capital market impacts would be severe – imagine companies whose share prices have been ramped almost 4.5 X from trough to peak in the SPX suddenly selling shares again in an environment of bond market mark downs and defaults….
Dean, with all due respect, recession, maybe a bad one or even a depression is on the way. It’s the only thing the current crop of economists and “policy makers” do well. Sometimes it’s the only thing they do, period! The dominating economic system the last three generations can be characterized as “Cowboy Economics”: When you have depleted and devastated the current place, you simply break up and go west, for the next place to deplete. Other names are extraction economy, predator or casino capitalism, economics of greed, disaster economics, or unsustainable economics. The main message is that there are no limits to growth, and the only issue that matters is to make profits. Development is defined as increased growth without limits, increased consumption, increased waste production and conversion of natural resources to financial. Increasing the human ecological footprint is regarded as necessary and valuable. In this world, the more leveraged loans lenders make the more successful they are.
Minsky nailed it with “stability is destabilizing.” He described how he reached that conclusion in words and the factuality of his theory can be described mathematically. All you need to do is calculate the total amount of bank loans needed vs time to maintain a fixed amount of money in the economy. What it shows is that a period of steady economic growth, a time of stable growth, leads inevitably to a crash.
I don’t know Minsky or his work. But I agree with his points. They are square on. Andrew Pickering explains it this way in his book, “The Mangle of Practice: Time, Agency and Science.”
In a broader sense, though, throughout the book I will take the mangle to refer not just to the practical, goal-oriented, and goal-revising dialectic of resistance and accommodation, and the transformations it effects, but to the overall scheme, as I just called it, to the overarching image of practice that encompasses the dialectic-to the worldview or metaphysics, if you like, which sees science as an evolving field of human and material agencies reciprocally engaged in a play of resistance and accommodation in which the former seeks to capture the latter.
The world of the mangle lacks the comforting causality of traditional physics or engineering, or of sociology for that matter, with its traditional repertoire of enduring causes (interests) and constraints. I must add, though, that in my analysis brute contingency is constitutively interwoven into a pattern that we can grasp and understand, and which, as far as I am concerned, does explain what is going on. That explanation is what my analysis of goal formation as modelling, the dance of agency, and the dialectic of resistance and accommodation is intended to accomplish. The pattern repeats itself endlessly, but the substance of resistance and accommodation continually emerges unpredictably within it.