Rising corporate debt raises red flag

Little more than a decade after consumers binged on inexpensive mortgages that helped bring on a global financial crisis, a new debt surge — this time by major corporations — threatens to unleash fresh turmoil.

A decade of historically low interest rates has allowed companies to sell record amounts of bonds to investors, sending total U.S. corporate debt to nearly $10 trillion, or a record 47% of the overall economy.

In recent weeks, the Federal Reserve, the International Monetary Fund and major institutional investors such as BlackRock and American Funds all have sounded the alarm about the mounting corporate obligations.

The danger isn’t immediate. But some regulators and investors say the borrowing has gone on too long and could send financial markets plunging when the next recession hits, dealing the real economy a blow at a time when it already would be wobbling.

Some of America’s bestknown companies, including AT&T, Ford Motor Co. and CVS Health, have splurged on borrowed cash. This year, the weakest firms have accounted for most of the growth and are increasingly using debt for “financial risk-taking,” such as investor payouts and Wall Street deal-making, rather than new plants and equipment, according to the International Monetary Fund.

In the avalanche of debt, the sharp growth in lowerquality corporate bonds, just one notch above junk, represents a special concern for economists. Investors hold nearly $4 trillion in these bonds, including $2.5 trillion from U.S. companies, accord

ing to the credit rating agency Standard & Poor’s.

Since Oct. 1, familiar names like Hasbro, Nordstrom, Marriott and Hyundai all have tapped investors for cash by selling near-junk bonds that S&P labels “BBB.”

This low-quality corporate debt bulge, by itself, is unlikely to cause a recession, according to economists and investors. But it could make the next one much worse.

“We are sitting on the top of an unexploded bomb, and we really don’t know what will trigger the explosion,” said Emre Tiftik, a debt specialist at the Institute of International Finance, an industry association.

The corporate worries darken an otherwise bright economic picture. On Wednesday, there was a flurry of upbeat reports, including rising orders for big-ticket items and a decline in firsttime claims for unemployment aid.

With abundant jobs and rising wages, Americans seem to have dodged the summer’s recession fears. Growth is steady, if far short of the dramatic uptick President Donald Trump promised.

The root cause of the debt

boom is the decision by the Federal Reserve and other key central banks to cut interest rates to zero in the wake of the financial crisis and to hold them at historic lows for years.

The low rates were needed to encourage companies to invest and hire as the nation recovered from the worst economic collapse in 70 years.

Cutting interest rates is the standard answer to a troubled economy. But rates have never been this low for this long, and the side effects from too much easy money are becoming clear as central bankers struggle to return interest rates to traditional levels.

“This is part of a much bigger issue: an increased amount of collateral damage and the unintended consequences of an excessive reliance on central bank liquidity,” said Mohamed El-Erian, chief economic adviser to Allianz, the German financialservices giant.

Rather than reducing their risky debts, companies are adding to them. With the Fed having cut rates twice since July, companies continue to tap investors for enormous sums. In September, U.S. corporations issued $220 billion in new bonds, the largest single monthly figure in more than two years, according to the Fed.

Lured by low rates, companies have splurged on debt to repurchase their own shares, pay higher dividends to investors and fund acquisitions, the International Monetary Fund noted last month, contrasting those increases with what it called “subdued” capital investment. Corporations have spent more than $3 trillion over the past five years buying back their own stock, according to S&P.

The United States is outperforming other advanced economies in Europe and Japan. But over the past four quarters, the economy grew at just a 2.1% annual rate, virtually unchanged from its 2.2% average since the recession ended in mid-2009.

El-Erian and others worry that an artificial environment of near-free money is masking serious underlying ailments and may be storing up problems for a future reckoning. This era of perpetually cheap money has kept alive some debt-ridden “zombie” companies that would have failed if rates were at traditional levels; widened the wealth gap between rich and poor; and distorted financial decisions, he said.

Indeed, today’s environment remains an alien world for financial market veterans. Low-rated companies can borrow at rates that only the most financially sound corporations enjoyed just a few years ago.

That could change quickly if the economy unexpectedly deteriorates. Though most economists now expect the U.S. to continue growing through next year, an unexpected shock — from a breakdown in U.S.-China trade talks or perhaps a military conflict in the Persian Gulf — could derail those forecasts.

Credit rating agencies likely would react to a slowing economy by downgrading companies that have issued the lower-quality bonds, turning those suspected of being unable to cover their interest payments into “fallen angels.”

That would force some mutual funds, insurance companies and pension officials — which are allowed to hold only investmentgrade bonds — to unload their holdings.

In a flash, as all those fallen angels fell into junk territory, there would be too much speculative-grade debt for the market to absorb. Companies that already would be seeing profits shrivel from the downturn would suddenly face higher interest rates, chilling investment, forcing layoffs and spreading pain throughout the economy.