Coronavirus Shutdown and the Worldwide Corporate Debt Crisis
Corporations Are Broke. It’s Time to Cut Up Their Credit Cards. This time, any industry bailouts must place corporate investment under public control.
After a decade-long, worldwide corporate debt binge, the bill has come due: huge swaths of the corporate world are now at risk of default, with only governments able to save them. This time, any bailouts must place corporate investment under public control.
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Already, US financial markets are on public life support. The Federal Reserve has committed to unlimited purchases of all sorts of assets: US Treasuries, mortgage-backed securities, car loans, municipal debts, and, in a historic step, both short term and long-term corporate debt. But the crisis will require more than a financial rescue.
The key political question now is: What sort of controls will come with the state intervention? Corporate greed and self-dealing need to be checked not merely in the name of fairness but also to make sure public bailout money is actually invested in the real economy rather than just gambled away, as it was after the 2008 crash and rescue.
The Rise of Corporate Debt
Total global corporate debt, including bonds and loans, is approximately $66 trillion; more than double what it was a decade ago. For comparison, the combined gross national product of all economies was estimated at $80.27 trillion in 2017. About a quarter of that is the US economy.
What They Did With the Money
Corporations have been borrowing for a variety of reasons that range from shrewd arbitrage to stupid and reckless asset stripping. For a struggling and unprofitable company, for example JCPenney, debt can be a lifeline. For a profitable firm, borrowing money can be a way to raise capital without diluting existing shareholders’ claim on the company’s profits, which would happen if the firm issued stock.
Even some profitable firms with piles of cash borrowed rather than spend their cash, in part for the firepower effect: letting other competitors and market entrants know that the firm has enough money on hand to buy out any threatening start-ups, and showing the world the firm is ready to ride out any economic crisis.
Some firms used their borrowed money to buy other firms. This helped fuel a post-2008 wave of mergers and acquisitions (M&As). Deloitte reported “more than $10 trillion in [M&A] domestic transactions since 2013.” Targeted companies borrowed to stockpile cash as a defense against such takeovers.
Firms also borrowed to fund CEO compensation, distributions to investors via dividends, and stock buybacks. Companies buy back their own stock so as to boost its price. A rising stock price is useful in many ways: it can keep away hostile raiders by making a targeted company too expensive to take over, but it can also draw in friendly suitors because (with some creative accounting) a rising stock value can make a weak firm appear more profitable. Corporate executives like a rising stock price because compensation packages are both tied to stock performance and almost always include some payment in company stock, so the higher the stock price, the higher the executives’ payout.
Sometimes, firms even invested their borrowed money in actual production. The capital-intensive oil and gas industry did that, but as we explain below, it still faces a crisis, perhaps more salient than other sectors.
Bad Credit as Perverse Incentive
Corporate debt and stock prices entered into a twisted dialectic, each driving the other. As the stock market continued to inflate over the last decade, it provided the confidence investors required to continue their purchases of risky corporate bonds.
Keep in mind that many of the lending banks and asset funds were actually or essentially borrowing from Uncle Sam at inflation-adjusted rates close to zero, then lending to companies with triple-B and triple-B minus ratings at 5 percent interest. Profits like that meant there were always banks and asset funds eager to lend to debt-burdened corporations.
Investors could directly purchase specific corporations’ bonds, or, as is more often the case, invest in mutual funds or exchange-traded funds (ETFs) that target an array of corporate bonds. High-risk loans were also sliced and diced and repackaged into bundles called “collateralized loan obligations” (CLOs), a class of securities backed by an underlying portfolio of corporate loans.
Zombies and Others
Zombie firms are defined by the Bank for International Settlements as heavily indebted, well-established companies that have failed to be profitable over an extended period and have low expected profitability in the future. In other words, heavily indebted start-ups do not qualify as zombies. The most threatened sectors are energy, automotive, insurance, capital goods (meaning equipment and machinery), telecoms, aerospace and defense, and some parts of retail.
The bull market of rising, often overvalued, stock prices allowed many uncompetitive and unprofitable companies to appear healthy based solely on their stock’s performance. Even before the markets started to crash on March 9, some analysts were prescient enough to call the market’s bluff at the beginning of the year.
But in this rapidly developing crisis, firms all across the economy may soon find it impossible to meet their liabilities. With the coronavirus breaking supply chains and forcing massive constrictions in consumer demand, corporate earnings are contracting fast, which in turn will badly hurt corporate debt servicing.
Like a hypertrophied organ rupturing, the putrefaction of unsustainable corporate debt now threatens to create a generalized economic sepsis that will hurt even healthy firms.
Profiles in Debt
Now the coronavirus shock is pushing firms over the edge. Occidental Petroleum — which has $40 billion in debt, while its market value (the value of all of its stocks combined) is less than $11 billion — recently had its debt downgraded to junk.
Energy mutual funds reveal the crisis in the energy sector as a whole. Vanguard Energy Fund, considered one of the top four oil mutual funds, has lost over 41 percent of its value since the beginning of the year. Of course, the biggest oil companies, the “Oil Majors” (such as BP, Exxon Mobil, and Royal Dutch Shell) have enough resources, market power, and government support to survive the crisis. But the effects on the less established firms stretch beyond the energy industry itself.
Lenders. As the oil and gas firms go into crisis, the banks that extended them credit may also face defaults. Loans outstanding to the petroleum sector from regional banks in North America exceed $100 billion. Banks financing oil companies in Texas and Oklahoma saw their share prices drop nearly 30 percent. In oil-dependent states, public budgets will hurt as tax revenues decline sharply.
Retail. A number of important retailers carry net debt to EBITDA ratios that are too high to be sustainable under current conditions. For example, Rite Aid owes $15.80 for every dollar it earns. For JCPenney, the ratio is $8.30 to $1; for Walgreens Boots Alliance, it is $5.80 to $1. Office Depot owes $4.60 compared to every dollar earned.
Beyond Bailout
Oil, airlines, and cruise ships — these are high-emission industries that, in the face of climate crisis, must be radically transformed or cease to exist. With government ownership and planning, these industries could be unwound and their resources redeployed.
Although COVID-19 set off our current recession, it was the indulgence of the 1 percent built into the 2008 rescue that is responsible for the depth and severity of our current economic crisis. Without guidance, money was poured into the financial system. Not surprisingly, it blossomed alongside the mutually reinforcing dynamic of artificially inflated stock prices and ballooning corporate debt.
Capitulation to the gluttony of financiers is deeply unjust. But it is also unworkable in purely technical terms. Without constraints on greed, there will be another bubble and crash and a longer slump, more suffering, greater inequality, and more social instability. We have to force government to use its legal and financial power to steer the American economy toward more egalitarian, socially rational, and environmentally sustainable purposes. We have to make this bailout work for the majority of us.
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Christian Parenti is associate professor of economics at John Jay College, City University of New York. His most recent book is Tropic of Chaos: Climate Change and the New Geography of Violence (2011). His forthcoming book is Radical Hamilton: Economic Lessons from a Misunderstood Founder (Verso, Summer 2020).
Dante Dallavalle is an adjunct professor of economics at John Jay College, City University of New York.