by From Dean Baker The folks who remain determinedly ignorant about the financial crisis and Great Recessioncontinue to look for another crisis where it isn’t. Much of the latest effort focuses on corporate debt. There are four big reasons why corporate debt does not pose anything like the same sort of problem that mortgage debt did during the housing bubble years. First, many companies took on large amounts of debt for a simple reason, it was very cheap. The debt was not a necessity for them, but the opportunity to borrow for thirty or even fifty years at very low interest rates looked too good to pass up. As a result, many entirely healthy companies have large amounts of long-term debt on which they have very low interest payments. The ratio of corporate debt service payments to
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from Dean Baker
The folks who remain determinedly ignorant about the financial crisis and Great Recessioncontinue to look for another crisis where it isn’t. Much of the latest effort focuses on corporate debt. There are four big reasons why corporate debt does not pose anything like the same sort of problem that mortgage debt did during the housing bubble years.
First, many companies took on large amounts of debt for a simple reason, it was very cheap. The debt was not a necessity for them, but the opportunity to borrow for thirty or even fifty years at very low interest rates looked too good to pass up. As a result, many entirely healthy companies have large amounts of long-term debt on which they have very low interest payments. The ratio of corporate debt service payments to after-tax profits is at a relatively low (as in the opposite of high) level.
Second, the crisis mongers apparently missed it, but stock prices are very high right now. This means that most companies have the opportunity to raise more money by selling stock if they feel the need. Of course, the stock market could always plunge by 50 percent, but this one doesn’t factor into most crisis mongers’ predictions. As long as the market stays high, or even if it falls 20 percent, most companies would be able to sell shares to raise capital if they were facing trouble meeting their debt service payments.
The third reason corporate debt does not pose the same problem as mortgage debt is that even in a bankruptcy, debtors usually collect the bulk of their debt. It’s rare for a company facing bankruptcy not to still own valuable assets, such as a profitable subsidiary or land and buildings that can be resold. As a result, debtors might have to accept 70 or 80 cents on a dollar, which is a substantial loss, but far more than zero.
By contrast, in the housing bubble years, many homeowners were able to borrow an amount that equaled or even exceeded the full value of their home. In the most inflated markets, prices fell by 50 or 60 percent. Given the costs of carrying through a foreclosure and reselling the house, many mortgage holders were looking at pretty much a complete loss on their mortgage when a homeowner stopped paying. That is a very different story with corporate debt.
Finally, corporate debt will not have the same sort of feedback story as was the case with mortgage debt and the housing market. If GE finds that it can’t make its debt payments (not my bet, but the issue raised in the article), it will not make it more difficult for a software company or an airline to make its interest payments.
By contrast, when people began defaulting on their loans and foreclosed houses were placed on the market, it put downward pressure on the prices of other homes, making more homeowners underwater. That increased the risks of default and led to more foreclosures. There is nothing like this dynamic in the corporate debt market.
With these four minor qualifications, the corporate debt market is just like the mortgage market in 2007. So, if you want to believe in an imminent crisis go ahead, but this is not something serious people should worry about.
Addendum
Robert Salzberg reminds me of another difference, corporate debt is much less likely to be securitized than mortgage debt. This mattered in the collapse of the bubble since the servicers of the mortgages in mortgage backed securities were not set up to arrange write-downs. As a result, in many cases they carried through with foreclosures that were not only worse for the homeowner, but also worse for mortgage holder.