Can We Save Corporate Debt?

What makes this financial crisis so dangerous, is how weak our corporate sector is. Going into the current crisis, American Corporations are more indebted than at any time in history. It was just a couple of weeks ago that total corporate debt outstanding topped an incredible $7 Trillion Dollars. Never before have the corporate sector piled on this type of leverage.

What makes this financial crisis so dangerous, is how weak our corporate sector is.

Going into the current crisis, American Corporations are more indebted than at any time in history. It was just a couple of weeks ago that total corporate debt outstanding topped an incredible $7 Trillion Dollars.

Never before have the corporate sector piled on this type of leverage. And contrary to the fashionable thinking of the day, this is most definitely not a good thing.

But before we look at all of the ramifications of this situation, let's take a moment to look back over the past decade and exactly how we got here.

Like, seemingly all tales about our current economy, this one began with the Great Financial Crisis, of 2008. The GFC began in the Real Estate Sector of the Economy, and quickly spilled over to the financial sector.

There was a dramatic decline in overall economic activity, and the National Bureau of Economic Research dates this recession as having lasted from December of 2007 until June of 2009, a total of 19 months. One of the longest and deepest recessions in our history.

The reaction by the Federal Reserve was equally dramatic, dropping interest rates to a mere fraction and pumping money into the economy through their various stimulus programs such as Quantitative Easing.

This move, by the Fed, opened the door wide  for those corporate managers who wanted to expand their company's financial position through debt. And they did that with aplomb.

From 2008 until now, corporate managers pilled it on: doubling their collective debt in just 10 years.

Now it's true, that at the beginning of this cycle many of these managers needed these funds to stay solvent, and later they would use the funds to expand their operations, and increase market share.

But as time went on, it became apparent that the free flow of cheap money could only go so far in expanding their business. Aggressive managers, who often were compensated by the performance of their company share price, jumped on the latest form of financial engineering: share buybacks.

It was a fad, that carried away nearly every corner of the economy.

Now we should make a distinction here between two methods of share buyback. If a corporation is buying back its shares out of income. I have no real issue with that.

However if a corporation is buying their shares, through borrowing additional funds. That is a problem.In this second method, the Corporation is simply exchanging equity for debt. All the while becoming much more leveraged.

And it is this second, more pernicious form of buyback that has been practiced all too often.

Incidentally, if you want to know if a company you're looking at uses this form of buyback: check their balance sheet. Most often management will say that they are not exchanging debt for equity. But their balance sheet will tell the real story.

So flash forward to today. Here we are collectively with $7 Trillion in Corporate Debt. $7 Trillion upon which the interest has to be paid every month. That's not a good position to be in, when customers are few, because of the Coronovirus. And when supplies from China are short, because of the same virus.

Contrary to all that you may have heard over the last decade. Debt does not make an organization stronger. It makes them weaker.It makes them beholden to those monthly payments. What we on the Street call debt service.

And in hard times can lead to default, and potentially bankruptcy.

Incidentally, many corporations renew their short term financing at the end of each quarter. And that's coming up in a little over 2 weeks.

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