In Case You Missed It: The Corporate Debt Bubble


Ariel Santos-Alborna

Summary

Corporate debt to GDP is at its highest level in all of recorded history.

50% of that debt is BBB, or one level above junk.

Decreased cash flows and less corporate debt demand in a recession will stop buybacks and lead to insolvency in the junk bond market.

This may lead to another wave of bail outs and increased sovereign debt.

Increased sovereign debt will lead to Japanese and European-like economic malaise unless the U.S. creates inflation.

As wages have remained relatively stagnant for decades, credit has become the engine of economic growth in the U.S., and excess credit and leverage the primary driver of recessions. The two charts below demonstrate this process. Real wages have remained stagnant since 1973. Around that time we begin to see increases and violent swings in consumer credit change. The reason? Without wage growth, the credit economy must be pumped up to increase consumption (and therefore GDP).

(Source: Economic Policy Institute)

(Source: Trading Economics)

Home ownership, created with debt, increased drastically before the savings and loan crisis of the 1990s and the subprime mortgage crisis of 2008. When homeowners began defaulting, the crisis shifted to banks. Then credit froze as banks held worthless mortgage backed securities until the government stepped in. Government balance sheets assumed most of the banks’ debt and the Fed provided easy credit and ample liquidity through low interest rates and Quantitative Easing to spurn lending. Thus, the seeds were sewn for the excesses we see today in corporate and sovereign debt.

This article demonstrates how an economic slowdown will likely burst the corporate debt bubble. With limited room for increasing sovereign debt levels, the crisis may shift to currencies.

The Corporate Debt Bubble

This bull market’s excess is undoubtedly in the corporate debt sector. Corporate debt has doubled since the 2008 crisis. Corporate debt to GDP is at its highest level in all of recorded history. Naturally, too much debt lowers your credit quality. This is evident by the fact that roughly 50% of the corporate debt market is BBB, or just one level above junk. The explosion of BBB debt can be seen in the second chart below. AT&T has amassed $191 billion of total debt. Ford has $157 billion of debt but a much less manageable 450% debt/equity ratio. General Electric and General Motors are two other companies with debt levels putting them at risk of downgrade…….more here

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