For several years now, I have expressed concern about the accumulation of debt by governments, corporations and households. Some folks seem to recognize that – across the board – total debt levels are on an unsustainable path. Others have argued that the only thing of importance is the ability to service existing obligations, and that each group is quite capable of paying back the interest on their loans.
Unfortunately, the naysayers argument ignores several unpleasant realities. First, borrowers at all levels – family, company, government – continue to increase their total debt as well as increase their interest expense. Borrowing costs would have to drop further to maintain a favorable picture for debt servicing. Secondly, it is unlikely that borrowers at all levels will have permanent access to lower and lower rates. “Subprime” was not merely a 2008 struggle, nor was the euro-zone sovereign debt crisis isolated to 2011. Both the domestic credit catastrophe as well as the European version involved an inability to pay when bond prices fell as corresponding yields climbed.
Not surprisingly, corporations will be heavily pressured in 2016. Many will see more and more of their cash flow being diverted to the repayment of obligations. Some will fend off default concerns, while others will succumb.
Back in mid-October, Bloomberg presented an article on the epic debt binge of “Corporate America.” The author chronicled the alarming deterioration of American balance sheets, from total debt excesses resulting in the highest interest expense ever to the lowest capacity to service obligations (i.e., a.k.a. interest coverage) since 2009. More recently, Deutsche Bank’s Chief U.S. Economist described corporate balance sheets as being worse off than household balance sheets. Corporate debt as a percentage of national income has been pushing levels that remind us of the past three recessions.
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