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 best-known companies, including AT&T, Ford Motor 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 dealmaking, rather than new plants and equipment, according to the IMF.
Amid the avalanche of debt, the sharp growth in lower-quality corporate bonds, just one notch above junk, represents a special concern. Investors hold nearly $4 trillion in these bonds, including $2.5 trillion from U.S. companies, according 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 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. If downgrades occurred at the same rate as during the 2009 crisis, the volume of debt hitting the market could be well above the normal daily sales, the Bank of International Settlements in Basel, Switzerland, warned earlier this year. Last month, in its twice-yearly financial stability report, the Fed warned about the potential consequences of the market’s failure to police the rapid increase in risky corporate debt. During the 2009 crisis, “BBB-rated” companies – the lowest rung of investment-grade – faced borrowing costs almost 7 percentage points higher than higher-quality companies. Today, the difference or “spread” is just 1.4 percentage points. The risk of fire sales by institutional investors is real. Mutual funds have tripled their corporate bond holdings over the past decade. At $1.5 trillion, they now amount to about one-sixth of all corporate bonds on the market, according to the Fed. “It’s going to amplify everything,” said Krista Schwarz, a finance professor at the University of Pennsylvania’s Wharton School. “It’s going to make everything happen faster, larger, worse. The recession would just be that much deeper.”
