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Coronavirus: Should taxpayers bail-out debt-laden corporates?

How will the coronavirus crisis affect the massive corporate debt overhang that has built up since the 2008/09 crisis? Now that governments are preparing massive fiscal stimulus packages to prevent a wave of corporate defaults, companies that borrowed recklessly in recent years to take advantage of ultra low interest rates are lining up for taxpayer-funded bail-outs, too. Bail-outs will not solve the underlying problem, however: with interests rates likely to remain ‘lower for longer’ the temptation for companies to gorge on cheap debt will be as strong as ever.

A decade of monetary easing across most major developed economies has left the world with unprecedented levels of public and private-sector debt. Since 2007, global debt has soared by more than 50%, from USD 167 trillion to USD 253 trillion. The debt of governments, households and non‑financial companies alone went from USD 113 trillion to USD 191 trillion, an average annual increase of ca. 4.5% since 2007, and nearly twice the rate of growth of the world economy. As of September 2019, the global ratio of debt to GDP stood at 322%.

IMF, BIS, OECD and many researchers and academics have warned of a new debt crisis. This time, the corporate sector is looking particularly vulnerable. Companies across all sectors of the economy replaced expensive equity with cheap debt funding by way of share buy‑backs. Between 2009 and 2019 the leveraged buy-out (LBO) market experienced a boom that took valuation levels close to their 2007 pre-crisis highs while credit quality deteriorated. ‘Covenant lite’ leveraged loans – always a reliable indicator of frothy credit markets and a harbinger of crisis – returned with a vengeance. In September 2018, the BIS dramatically warned of the rise of ‘zombie firms’ that are unable to cover the interest on their debt from current operating profits over an extended period of time.

With the global economy at a virtual standstill due to the coronavirus pandemic many of these companies are expected to run into difficulties servicing their debt. Spreads on sub-investment grade corporate bonds that started to widen already in the autumn have rocketed since the onset of the crisis, indicating that investors are expecting a wave of defaults. Governments have announced fiscal stimulus packages worth trillions of Euros in recent weeks to support companies and households affected by the crisis and to reboot the economy. Will taxpayers now come to the rescue of companies that deliberately, and recklessly, loaded up on debt during the good times, never mind the consequences?

It appears very likely that the proposed stimulus packages will end up bailing out many of these overleveraged firms. Even before the coronavirus crisis hit, the global economy was anything but robust. A major corporate debt crisis on its own, without the added damage wrought by the coronavirus, would have been extremely taxing already. In combination with the fall-out from the pandemic it appears inconceivable that policymakers would risk a systemic crisis by letting debt‑laden businesses fail. Like it or not, ‘zombie firms’ are likely to get a new lease of life – for now.

Helping overleveraged companies to survive this crisis does not solve the problem of excessive leverage, however. Investors and policymaker agree that interest rates should remain ‘lower for even longer’. Central banks are expected to keep policy rates low for the foreseeable future, and to support the economy with monetary easing, e.g. asset purchasing programmes. This may be necessary for some to allow the economy to recover from the unprecedented shock of the coronavirus crisis. But an abundance of cheap debt will continue to incentivise companies to experiment with excessive, and ultimately unsustainable levels of leverage. In its 2018 study, the BIS was very outspoken about the risk of taking monetary accommodation too far. ‘Zombie firms’ are a drag on the economy, even in normal times, and could spell disaster when the economic cycle turns again.

Christian Stiefmüller

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