A plummeting economy, a dangerous addiction to debt and investors who won't listen: The scary reality of a post-corona world

This problem started before Covid-19, but as even Boeing's bonds head towards junk, the markets seem unable to stop themselves from making it worse

All is not well on Wall Street (Getty)

About a year ago, when Corona was a beer and face masks were reserved for fancy dress parties, one of the world’s most important credit rating agencies published a report in which it admitted that it was getting nervous about the state of the economy.

Moody’s — whose job it is to determine the likelihood of individual countries and companies going bust — said in the May 2019 note that sky-high corporate debt levels were starting to look troubling and that they could spell disaster when corporate earnings, robust for years, started to cool off.

John Lonski, the economist who authored the piece, said he was particularly concerned about the proportion of corporate debt as a share of gross domestic product — about 46.6 per cent at the time — and that he was worried about the swiftly shrinking piles of cash companies were sitting on.

“The dangers implicit in today’s record-high ratio of nonfinancial-corporate debt to GDP will not become manifest until core profits’ yearlong average shrinks by more than 5 per cent from its current zenith,” Lonski wrote.

You might think that businesses would’ve taken Moody’s advice on board, particularly as stock markets started to wobble towards the tail end of 2019. They didn’t.

You’d be forgiven for thinking that corporates would’ve at least stopped taking on new debt when the price of oil crashed dramatically and Covid-19 shuttered swathes of the economy indefinitely. But they didn’t.

And even as reality dawned that the world economy was hurtling towards its most bruising recession since the Great Depression, companies still flocked to the debt market, gobbling up billions from willing lenders with little apparent concern for what Lonski might be thinking.

So what’s driving this bumper borrowing binge? The short answer is central banks.

Interest rates were cut in the wake of the 2008 collapse of Lehman Brothers with the hope that the move would encourage borrowing and stimulate an economic recovery. But growth proved lacklustre, so rates stayed where they were and companies started gorging on the cheap money available to them.

By the time this current crisis got under way, US non-financial companies had accumulated a combined debt load worth about $10 trillion dollars — a historic record — and it’s growing by the day.

Servicing all that money is absolutely fine when profits are dependable, but the earnings reports due to be published over the coming weeks almost certainly show us that everything is definitely not OK.

When cash flow dries up, interest payments can become prohibitive. Debt that was issued a decade ago and is now due to be repaid is also likely to be just about the last thing you need when you’ve already been forced to furlough staff and scrap your dividend. Unless, of course, you simply issue more cheap debt to pay off that old debt. And suddenly it becomes obvious why so many businesses are hooked like addicts.

It’s hard to say if, when or how this will all end. A prospect of interest rates rising any time soon would of course be worrying as that would make refinancings and servicing debt more expensive. But considering just how wrecked the economy is, that’s off the table for now. A lot of the debt being issued isn’t due to be paid back for years — in some cases decades. Much can happen in that period. But a corporate landscape that’s leveraged up to the hilt is simply much more vulnerable to future crises and shocks than one that’s not.

We’ve still not seen the full repercussions of Covid-19 for businesses and the economic ecosystem. We don’t know how severe the damage will be on a financial and human scale. It’s impossible to tell exactly how many companies will be forced to file for bankruptcy, how many jobs will be lost and the role that excess debt will play in this whole sorry saga.

Agencies like Moody’s assign credit ratings to corporate debt with “Aaa” denoting the safest. Debt is considered to be investment grade if it’s rated “Baa3” or above (or “BBB-” by rating agencies Standard & Poor’s or Fitch), but below that it’s known as “high yield” or “junk” which prevents some funds from holding it in their portfolios. Agencies downgrade debt as companies become more indebted, or levered. If a lot of debt suddenly slips into junk territory, the forced selling could be spectacular.

What’s troubling at the moment is the amount of debt that’s on the cusp of high yield: it’s a huge amount and it’s growing. That being junked at a time of immense economic weakness could set in motion a domino chain of doom for global markets. And it's not just more debt that can lead to slashed ratings. Within reason, downgrade decisions are made by agencies at their discretion and can be triggered by a whole host of factors: poor earnings, macroeconomic pressures beyond a company’s control or something far less pedestrian.

So far this year, companies have raised over $1 trillion of debt. That includes a $25 billion bond priced by Boeing, the US’s largest exporter and a company that has been so severely burned by the economic lockdown that it’s been forced to turn to the government, cap in hand. Boeing’s shares, which were trading at about $330 a piece in January are now changing hands at close to $130 and yet investors feasted on the deal, putting in orders worth some $75 billion. In rating terms, while still investment grade, Boeing’s bonds are on the brink of junk and two of the three major agencies have already signalled that a downgrade could be on the cards.

Regardless of what Corona has come to mean, the party in markets is raging and everyone seems a bit drunk on debt. At some point, though, someone’s going to push it too far, and we’ll all go home to sulk and sleep off the hangover.

As we’ve learned from the past, periods of irrational exuberance are difficult to spot when you’re in the midst of them. Perhaps the best we can hope for is that once this one passes, we’ll remember it for a very long time.