A few years ago, I was chatting with a neighbor on my front stoop and as we talked he absent-mindedly poked the painted lintel. His finger went right through the glossy paint into the rotten wood underneath. I would never have guessed that the front of my house was so rotten. The paint had done a great job of concealing the decay. That’s kind of how I am thinking about the US economy today. I warn you, however, that I am no economist. I just happened to see the articles cited below in a short window of time and it made me wonder whether we are on the verge of another crash like 2008. Let me know what you think.
The first article I read was in the business section of NYT last Sunday and it was filed by Jeff Somer. He reported something that came as quite a surprise to me and that is that the American stock market has been shrinking. The article observes that in the mid-1990’s there were more than 8,000 publicly traded American companies. By 2016, there were only 3,627. That was surprising. But what was disturbing was that, of the 3,627, only 200 were profitable. The remaining 3,281 lost money.
So how do these money-losing companies survive? I couldn’t find any data on how many of those firms were at balance, meaning they aren’t making money but they aren’t losing any either. Companies can trim staff, avoid capital equipment purchases, etc. But, ultimately, there has to be a source of cash and increasingly that may be borrowing. This brings us to the second article also in the NYT yesterday (8/9) by William Cohan, an investment banker and business writer. His article, “The Big, Dangerous Bubble in Corporate Debt“, is sobering. I will quote some of it, but you should read the entire article because it contains what I think is the core of what will trigger the next recession (if not crash). Just as prior to 2008, a sustained period of low interest rates lead to a weakening of credit standards and the advent of mortgage-backed securities that disguised the true risk of such, so this same mis-pricing of risk is taking place in corporate bonds, in Cohan’s view.
I hope I am not exceeding fair use guidelines but this paragraph is just chilling:
Examples of mispriced risk are strewn across the financial landscape. In June, Asurion, an insurer of cellphones, closed on a $3.75 billion loan package from Wall Street’s biggest banks, with minimal covenants — agreements to protect creditors by notifying them when certain red flags, like a higher than agreed-upon debt-to-cash flow ratio, are waving.The proceeds of Asurion’s “covenant-lite” or “cov-lite” loan were used to pay dividends to the three private-equity firms that own the company. Its debt load has increased to $11.3 billion, seven times its cash flow. For additional irresistible fees, Wall Street then repackaged the Asurion loans into securities and sold them to investors, who now own the debt of a highly leveraged company with far fewer protections.
According to LeveragedLoan.com, which monitors the corporate loan market, the issuance of cov-lite corporate loans has exploded in the past few years and reached a record in May. Cov-lite loans now account for nearly 77 percent of the estimated $1 trillion corporate loan market. And some of these loans are packaged and resold as bonds or as other complicated investments.
It brought back to me the feeling I had in 2007 when I read that 50% of Countrywide’s new mortgages were interest-only, a sense of “this can’t end well.’
Currently, corporate debt is running at about $6.3 trillion. Optimists point out that corporate cash reserves of $2.3 trillion can easily service that debt. The problem is that the Companies with the cash aren’t the Companies with the debt. The cash is with the 200 profitable giants like Apple, Google, Microsoft, and Amazon. The debt is held by Companies that are barely able to service their debt. So, with the increases in interest rates this year, you might expect that it has all got a bit too much for some Companies to handle and the numbers support that view. Chapter 11 bankruptcies, according to Business Insider are up 63% this year.
If you couple this to the fact that the uptick in wages has been canceled out by inflation, you get a picture of an economy that is pretty unhealthy. The surface gloss provided by cheap money can hide the dry rot within for only so long. Maybe Donald Trump is like my neighbor, unwittingly poking through the paint to expose the mess beneath. If this all comes to an end while he is President, then we will have an Administration almost uniquely ill-equipped to deal with the crisis and, even with a sudden surge of competence, will not have the fiscal tools to deal with the crisis.
As I said at the outset, I am no economist. So I would appreciate the insights of those far more knowledgeable than I on the subject.