Rising loan levels cast shadow over US economy
What is it about the Ameri can economy that keeps hedge fund luminaries awake at night? A couple of weeks ago I put that question to Ken Griffin, head of the Citadel group.
His answer was illuminating: “Recession.” This is not because Mr Griffin is braced for a downturn right now; like most executives, he expects moderate growth this year, partly because he is excited about President Donald Trump’s reflation plans.
But Mr Griffin worries about maths — and history. Over the past century, the average length of an American recovery has been six years. However, the current expansion has lasted eight, so the charts imply that a recession is overdue.
Of course, there are many reasons why these historical charts might be wrong. Mr Trump’s reflation plans are one. Another is the fact that the postcrisis “recovery” has upended history by being unusually weak.
But what is also striking is that there are hints in the data of an impending cyclical peak. Consider the issue of debt. Almost exactly a decade ago, American consumer debt exploded, sparking the financial crisis when that bubble burst.
After that drama, consumers delevered. But this week, the New York Federal Reserve revealed that consumer debt balances have risen again, touching $12.73tn at the end of the first quarter of this year, above the 2008 peak of $12.68tn.
There is no reason to panic about this: most American consumers are servicing this debt well, not least because unemployment has fallen to a mere 4.4 per cent. The ratio of household debt to gross domestic product is still well below the peak.
And if you look at the issue central to the last crisis — mortgage debt — the picture is very benign: only 3.5 per cent of home loans went into arrears in the first quarter, compared with 10 per cent a decade ago.
But what is alarming is student debt: this has exploded in recent years to unsustainable levels, and “serious delinquency” rates are already 10 per cent, shattering the confidence and spending power of one segment of the population. If interest rates rise or growth slows, these problems could spiral.
Corporate leverage presents worries too. This has not grabbed many headlines this decade, partly because it did not play a role in the last crisis. But in recent years companies have been stealthily loading up on debt. The Securities Industry and Financial Markets Association, for example, says that corporate leverage is $8.52tn, or 57 per cent above the last 2008 peak, with a particularly dramatic increase in risky borrowing in the last year.
Right now, this is not creating any drama; or not with interest rates at rock bottom levels and the US economy growing. Indeed, investors are so relaxed about the outlook that the Bank of America Merrill Lynch US High yield index tumbled to 5.56 per cent this week, its lowest level since 2014, and leveraged lending covenants are being ripped up.
Meanwhile, Goldman Sachs and Morgan Stanley also revealed this week that there is so much fevered demand for leveraged finance that it is a key factor driving their profits.
But that news should, in itself, ring alarm bells. A decade ago, banks were making big profits by slicing and dicing mortgage loans. And, as the International Monetary Fund warned in its recent Global Financial Stability Report, this borrowing boom could be fragile if interest rates suddenly rise, or growth slows down.
The IMF calculates, for example, that companies accounting for 10 per cent of US corporate assets are already struggling to meet interest payments out of current earnings. More striking still, 22 per cent of companies would be “weak” or “vulnerable” if borrowing costs rose. “[US] Corporate credit fundamentals have started to weaken, creating conditions that have historically preceded a credit cycle downturn,” the IMF notes.
It is important to stress again that neither the IMF nor Mr Griffin is actually predicting a slowdown in growth or sharp rise in rates. On the contrary, the mainstream view is that growth will stay benign.
But the key point is this: with so much growth already baked into financiers’ forecasts — the sunny assumptions of the corporate executives who keep raising all this debt — a sudden recession would create a nasty shock. Investors ignore this at their peril, particularly in a week when the world is confronting more uncertainty about Mr Trump and whether he can actually implement any of his bold plans to stave off any recession.
With so much growth baked into forecasts, a sudden recession would create a nasty shock