
How companies became addicted to debt - bertdc
https://www.ft.com/content/c732fded-5252-4333-a3f8-80b767508bbc
======
cs702
_> …has drawn attention to the relentless build-up in corporate debt in the
US, where companies now owe a record $10tn — equivalent to 49 per cent of
economic output. When other forms of business debt are added in, including to
partnerships and small businesses, that already extraordinary figure increases
to $17tn [83% of GDP, the highest ever].

> Even before the pandemic, the level of corporate leverage was beginning to
> cause alarm. At the end of last year, the IMF issued a striking warning: as
> much as $19tn of business debt in eight countries led by the US — or 40 per
> cent of the total — could be vulnerable if there were a “material slowdown”
> in the economy, a scenario that, if anything, now seems tame._

I like to think of it this way:

At present, a business that is barely-investment-grade (say, BBB-/Baa3) can
borrow for a decade at just over 3%/year. A risky business that is rated as
junk (i.e., below BBB-/Baa3) can borrow for a decade for as little as 6% to
7%/year. The interest payments are tax deductible, so the effective annual
cost to borrow is around 2.5% for barely-investment-grade and around 5% for
junk, give or take. As long as the executives think they can earn more than
2.5% to 5% per year on any money they borrow, why not borrow it? And if they
can justify using borrowed money to buy back shares, keeping their stock
options in-the-money, why not do it?

Many US companies in mature industries (think energy, hospitality, travel,
transportation, etc.) have been doing exactly that, to the point that
corporate debt is now the highest ever in relation to US GDP. And it has
worked _beautifully_... that is, until a global pandemic suddenly cut their
revenues by 10% to 20% or even more, instantly flipping those expected
earnings into losses. People are no longer traveling as much, or going to
restaurants as much, or going to the office as much, etc.

All of a sudden, all those businesses are losing money on all that borrowed
money -- they are losing so much, in fact, that many have had to borrow _even
more_ during the pandemic to be able to continue paying interest on prior
borrowing and avoid going into bankruptcy.

~~~
anthony_barker
Don't you think that companies are just reacting to the fed/bank of england
etc keeping rates at 300 year lows?

[https://www.bankofengland.co.uk/-/media/boe/files/monetary-p...](https://www.bankofengland.co.uk/-/media/boe/files/monetary-
policy/baserate.xls?la=en&hash=EEB8729ABFFF4B947B85C328340AE5155A99AD0F)

~~~
QuesnayJr
If central bank rates were too low, we would see inflation, but we don't.
Rates are so low because savers want to save more than borrowers want to
borrow. Corporations are just taking advantage of the large pool of savers
that's already out there.

~~~
freedaftimagine
Rising asset prices don't count as inflation to you?

~~~
mrep
Not OP, but I don't see any data suggesting that assets are inflating. For
real estate, inflation adjusted price per square foot hasn't changed for most
of the US [0] (west coast admittedly has ballooned but that's because their
cities are built in valleys with a fixed amount of land and restrictive zoning
causing a fixed amount of housing and thus bidding up home prices; not a
problem for most of the country though). As for equities, Annualized S&P 500
Return (Dividends Reinvested) from 2005-2020 are 6.738% [1] versus 7.690% for
1990-2005 [1].

Or are you talking about another asset?

[0]: [https://www.supermoney.com/inflation-adjusted-home-
prices/](https://www.supermoney.com/inflation-adjusted-home-prices/)

[1]: [https://dqydj.com/sp-500-return-
calculator/](https://dqydj.com/sp-500-return-calculator/)

------
pixelmonkey
Something I have never seen a good answer to or explanation of: what is an
"appropriate" debt or leverage ratio for a healthy company?

Obviously, a private company with hundreds of millions in stable recurring
revenue shouldn't operate debt-free -- debt can be a useful tool, even if only
as a rainy-day tool for situations such as the recent pandemic.

In other words, corporate debt -- and especially low-interest and covenant-
free debt that is secured using recurring revenue -- seems like a capital
allocation (corporate finance) tool with a set of trade-offs relative to cash
and venture investment. But, how much debt is "too much"? I feel like those of
us who work in software can sometimes forget that for most industries, venture
capital isn't even an option, which means debt can be one of your only growth
financing sources of capital -- and even for those in software, some companies
are not venture-fundable but might still be debt-fundable.

It's clear that the PE firms that load up billion dollar companies with
billions in debt are just playing a speculative finance and asset strip-mining
game. But, it would be a shame if we invested all of this time, money, and
regulation into a robust "financial capital banking sector", and we can't even
rely on it for capital that businesses can use to create jobs, service
customers, and smooth the rough patches in the economy.

~~~
ciconia
> Obviously, a private company with hundreds of millions in stable recurring
> revenue shouldn't operate debt-free -- debt can be a useful tool, even if
> only as a rainy-day tool for situations such as the recent pandemic.

Why obviously? Seems to me when a crisis hits the last thing you want to have
is debt you need to pay back. For example, should Apple, with their huge
mountain of cash, have debt? Do they need debt?

I guess one can also ask the same about countries. Do they really have to
maintain some level of debt in order to have a healthy economy? Why not just
have a big bunch of cash put aside for a rainy day? How is this "obvious"?

~~~
pixelmonkey
Also, re: your question about Apple:

> For example, should Apple, with their huge mountain of cash, have debt? Do
> they need debt?

Obviously not. Debt is for companies that have already utilized most of their
cash, right? Or have future cash flows that they want to access now before the
cash actually materializes. Apple, by contrast, should probably become an
investor or lender, since it doesn't know what else to do with its excess
cash. It certainly serves no purpose being hoarded on their balance sheet.

~~~
zxcmx
You can create debt in jurisdiction A collateralised with assets (even cash!)
in jurisdiction B... potentially without any tax implications. I expect Apple
can borrow money basically for free, so there's probably a bunch of financial-
engineering type reasons that debt would be useful to them.

------
daniel-s
That period in the 70s also corresponds with the moment that US dollars lost
any ties to gold.

There is a natural rate of interest in an economy. When the central bank
artificially lowers interest rates you get malinvestments. This is only
possible with fiat currencies because you can't print gold.

None of this would be possible if interest rates were at (say) 5% which is
about the historic average, or at early 90s (double digit) levels.

This ends dramatically. I'm guessing with a less dramatic version of Zimbabwe
or the Weimar republic.

~~~
neilwilson
"There is a natural rate of interest in an economy."

Yes, and the base rate is zero. Since reserves are costless to produce and
banks can't get rid of them in aggregate the base rate should always be zero.

It is rates above zero that are unnatural since by definition they are a
market intervention that reduces the price of all other assets and drives up
yields artificially.

The state shouldn't be paying a Basic Income to banks in the form of interest
on reserves. Banks should earn their crust by lending productively.

Beyond that the rate of interest is the one estimated by the lender to be
sufficient to cover the risk of discounting your collateral into the state's
liquidity.

Banks are really just pawnbrokers with shinier suits and better PR.

~~~
AbrahamParangi
The base rate is non-zero because capital has non-zero cost. Interest is just
the limit of the cost of capital. If you don’t have a fed, or if the fed does
nothing then interest rates will converge on their own to a positive value.

~~~
neilwilson
Banks have a capital cost. The central bank does not. I was talking about base
rates. Banks mark up on base rate to cover the risk to their capital

------
woodandsteel
This is a very informative article, but it has one major deficiency.

I have a general rule that when we are looking at something going bad in our
country, one of the things to do is look at how the issue is handled in other
countries, like are they doing it better or worse, and what can we learn from
that that might help us decide what to do here.

With that in mind, the article should have covered how this whole corporate
debt issue is handled in other countries. Are they doing better or worse?
Perhaps someone who has some knowledge here could make a comment.

~~~
smabie
Well, Japanese companies used to have a lot of debt in the 80s and when the
crash came, a lot of them got hurt. Now, they're mortally afraid of debt and
cant for the life of them ever expand their revenue. Japan is a cautionary
tale of what happens when people save too much money, are too risk-adverse,
and are unwilling to borrow.

The BOJ has been trying to get inflation up for decades with some of the
lowest rates around and it hasn't worked. The country has been in a recession
for a good 30 years and no amount of monetary policy manages to make things
any better.

Debt is a really powerful force, both positive and negative. I think for some
businesses, like real estate, it makes sense to have a lot of debt, and
others, like brick and mortar retailers, where debt can very easily destroy
your entire business.

~~~
woodandsteel
Thank you, that's a very interesting comment.

------
dsukhin
Perhaps an unorthodox way of looking at things, but it's very intersting take
a step back to consider what 0 to low interest rates might accomplish for
society:

\- Low interest rates mean it makes no sense to simply keep cash, it's better
to invest in _something_ productive. For companies that's new projects/ideas
which create jobs, for individuals that might be spending on goods to
stimulate the economy or buying a house.

\- High interest rates are a considered a way to reduce "risky" investments.
But in reality, interest is rent seeking on capital which benefits (1)
lenders/banks (2) capital holders. Cheap capital enables more projects with
positive ROI (above cost of capital) to be persued. And this is good for
society as it drives innovation and allocates capital to innovators instead of
locking it under stagnant rent seeking. Lest you worry, this doesn't hurt
capital holders, as they can instead proactively invest in companies and make
the same or larger returns, but now capital is allocated by merit of the
project being invested in instead of by simply who can afford it because it
meets some threshold. This unlocks the "long tail" of innovation. This is what
is referenced in the article: 1970s Hertz took a risky bet using debt which
paid off to record profits.

\- Higher interest really means higher long run inflation. If you can just let
money sit in a bank, doing nothing directly productive for society, and there
is suddenly more of it, prices will adjust accordingly. With low interest
rates, money supply will adjust with GDP growth from innovation and prices
might even be reduced by higher competition and discovery of efficiencies. As
long as innovation (enabled by access to capital) stays on pace with money
supply, inflation stays low.

This is of course a very optimistic way of looking at things which doesn't
consider the effect of things like wage growth which has all but stopped. One
could argue in a non-inflationary environment that might be ok, but this is a
larger topic having to do with social mobility goals rather than just the
economics.

~~~
pjc50
> Higher interest really means higher long run inflation.

In orthodox macro, higher interest rates -> reduced investment -> reduced
demand -> reduced inflation. This is pretty much empirically proven by how
central banks have been able to control inflation in the West.

The way I see it is the "search for safety", especially where negative
interest rates are concerned. There are two huge concentrations of safety-
seeking money in the modern economy: pension funds and oligarchs. The pension
funds more or less have to buy government bonds in a certain ratio, regardless
of the price. Whereas the oligarchs have hundreds of billions they need to
keep anonymously in a stable economy - ie dollars, pounds, and euros.

Things like the Apple "cash" pile of $245bn represent a lot of floating wealth
too.

Ultimately, if we don't get real wealth taxes, interest rates will be forced
negative simply by the market and the huge volume of safety-seeking money.

~~~
dsukhin
It's always strange to see the "orthodox" macro realtionship take precedent
over emperical results (see article and figure 1 scatter plot:
[https://www.stlouisfed.org/publications/regional-
economist/j...](https://www.stlouisfed.org/publications/regional-
economist/july-2016/neo-fisherism-a-radical-idea-or-the-most-obvious-solution-
to-the-low-inflation-problem)). In the short term, the orthodox thinking might
be correct and an effective lever for the economy, but long term, it's clear
that high interest leads to higher inflation AND less innovation which are bad
outcomes IMHO.

I agree with your observation for the demand to keep money "safe". We should
define what that means. Historically, if you choose to keep wealth in a stable
cash with real interest rate (nominal interest rate minus inflation rate) that
is positive or zero, it's safe as it retains or grows its buying power. The
"or zero" part is important as it allows for a zero interest environment if
that also means low inflation.

Some may even argue that a reasonable negative interest rate is "safe" and
it's just like a "wealth tax" which is the cost of service for keeping large
sums of money at the bank. Shouid safety be free (no negative rates)? I would
say maybe yes, but safety shouldn't also reward you... and positive interest
rates do exactly that.

------
jariel
The 'Elephant in the Room' here is the chart they did not show, and it's
interest rates, which have been steadily declining. You can't fight the
impetus for the system to want to give you free money because in the race to
equilibrium, your competitor will do it, which leaves you with little choice.

Imagine that some industries are 'thin margin' and naturally going to be
competitive, and a little prone to failing if there is a hiccup.

What 'low interest rates' do is exacerbate that quite a lot - so that only a
little hiccup is needed to blow you up.

There is a really, really interesting national parallel between the fall of
Spain in the 2008 crisis and this story. The 'accepted narrative' is that when
the Euro came along, Spain acted 'irresponsibly' and borrowed too much. But a
more careful analysis (from an FT interview no less!) showed that they
actually acted rationally given the very cheap money flowing in from 'Rich
Europe' at the time.

So the overarching issue is real: there's a lot of corporate debt. But it's a
financing instrument like any other, it might actually make sense for
companies to be leveraged to some extent. Credit runs the economy, this is a
form of credit.

I think a much bigger 'meta' look at this from the FT Economists would be
warranted - instead of looking at this as more of a 'corporate activity' kind
of thing, look at it from an economic equilibrium perspective in terms of
defining 'how much debt' is actually good, or bad, and why.

------
woodandsteel
From what I understand, the basic problem is this. The way things are supposed
to work is corporations take their profits and divide them up in two ways.
Part goes to paying the owners, like dividends to stockholders. Part goes in
investing in the future, like research and building factories.

The problem is that for a long time a large proportion of companies have been
paying out an increasing portion of their profits to pay off massive and ever
increasing debts. They still keep paying profits to the owners, and so they
have ever less left for investing in improving the company. That in turn means
poor growth and being less competitive in world markets.

And even worse when the economy goes through a bad period, many thousands of
companies can no longer pay their huge debts and go bankrupt, with great
damage to the economy.

------
shitgoose
Instead of free market finding the proper risk-adjusted yield for a bond, we
are swinging between over-regulated squeeze (shut down non-blue chips
companies from access to capital) and free-for-all central bank buying bonanza
(carpet-buying of corp bonds). It is either very hard for business to get
access to capital, or CB makes it excessively easy.

Somehow FT makes is look like it is some "financial engineering" fault that
companies are "addicted to debt". How about letting willing debt buyers get
into transaction with willing debt sellers? That simple.

------
lapcatsoftware
"Pension funds and insurance companies bought the debt in bulk"

Is it fair to say that pension funds are largely to blame for this?
Corporations can't acquire debt if nobody offers them money. Insurance
companies too, of course, but pension funds in particular are at least
theoretically supposed to be protecting the workers. Hard to see how debt-
funded corporations (I'll mention Uber as an egregious example) are in
alignment with the interest of the workers.

~~~
em500
> Is it fair to say that pension funds are largely to blame for this?
> Corporations can't acquire debt if nobody offers them money.

About as fair as it is to say that people who wish to receive some income
after retirement are to "blame" for this. Nobody can save without some other
party (households, companies or the state) acquiring debt.

~~~
lapcatsoftware
Junk bonds are hardly the only form of investment, and certainly not the
safest, if your goal is to ensure someone's retirement. Moreover, corporate
debt is at high risk of mass default in a market downturn such as the current
one.

~~~
em500
Any large pension fund has a large portfolio of bonds of all grades and
yields. Most will still have the bulk allocated to investment grade government
and corporate bonds. But the yields on safe investments have been so low for
so long that they all see themselves forced to choose between riskier
investments (leading to cheaper and cheaper debt as per article) or telling
their participants that they need to save way more for their retirements.

~~~
lapcatsoftware
That is true. But I'd say it's better for the funds to be honest with the
participants than to try to pretend everything is fine and paper over lower
returns with higher risk, because ultimately it won't be fine. Over-leveraging
is a strategy that can bring short term results but is destined to fail in the
long term — catastrophically.

~~~
em500
Good luck telling your state workers that they all need to take a pay cut
(which is what lower pension returns really are) and/or your local citizens
that they'll face a tax hike (if you don't want the state workers to take the
hit), because you read in the FT that "companies are addicted to debt", and
that we have this hunch that all this debt will collapse at some unknown time
in the future.

~~~
lapcatsoftware
"because you read in the FT" is a not a fair response. The linked article is
not breaking news, it's an analysis of a well known phenomenon.

With great power comes great responsibility. If someone can't be honest, they
have no place managing other people's money.

------
davidjnelson
The economy has been based on credit for a loooong time. I learned about how
it works from Ray Dalio’s excellent video on how the economic machine works
[https://m.youtube.com/watch?v=PHe0bXAIuk0](https://m.youtube.com/watch?v=PHe0bXAIuk0)

------
simonCGN
No, not companies. Investors who rather get dividends or share buybacks than
having the company pay down debt

------
neonate
[https://archive.is/r1js6](https://archive.is/r1js6)

------
tomerbd
Just print the money

------
dwighttk
is it different from governments or individuals?

~~~
neilwilson
Depends which sort of government: sovereign or otherwise (US state, Scotland,
Eurozone member). Sovereign government don't really have debt in the sense you
would recognise as debt.

~~~
smabie
Government debt denominated in foreign currency looks pretty much identical to
corporate or individual debt.

~~~
neilwilson
Indeed. That's part of the "otherwise" \- the reason why a Eurozone country
struggles. They denominate in a currency issued by a foreign entity they don't
control.

