Money, money, money (or the lack thereof)

We've had a lot to say about debt in these pages, most recently earlier this month.  If anyone's unclear as to why excessive debt is a bad thing, for individuals, corporations or governments, see here.

The magnitude of corporate debt has now become so great that it's causing alarm among international banks and financiers. This may sound boring, nothing that affects you personally, but it does - because almost every company with whom you deal, or from whom you buy your daily needs, uses corporate debt to finance itself.

Global issuance of corporate bonds has doubled to $US13 trillion over the last decade and standards have deteriorated dramatically, raising the risk of "fire sales" and a self-feeding chain reaction in times of stress.

The OECD is raising alarm over corporate debt levels, warning the easy money climate of recent years may have given investors a false sense of security.

"In the case of a downturn, highly leveraged companies would face difficulties in servicing debt, which in turn, through higher default rates, may amplify the effects," said a detailed report by OECD's corporate finance division.

"Any developments in these areas will come at a time when non-financial companies in the next three years will have to pay back or refinance about $US4 trillion worth of corporate bonds.

"This is close to the total balance sheet of the US Federal Reserve," it said.

. . .

Borrowing costs soar and "default contagion" spreads. It becomes even harder to refinance debt. This can lead to a vicious circle.
Regulations and internal investment mandates restrict insurance companies, pension funds and mutual funds, among others, from holding junk bonds (bonds rated below BBB-).

They have to offload their portfolio into a falling market if there is a downgrade. "Investors will have a hard time finding potential buyers," it warned.

. . .

The report warned that companies must increasingly compete for capital in a world without the succour of central banks.

The Fed, the European Central Bank, the Bank of Japan and the Bank of England were together buying $US2 trillion of bonds each year at the peak of quantitative easing in 2016. This dropped to zero late last year and is now turning negative.

. . .

Emerging markets must repay or roll over 47 per cent of their outstanding liabilities over the next three years, double the percentage in 2008 ... It is striking that debt securities now make 57 per cent of all international credit ... . Tough new Basel rules may have made banks safer, but these anachronistic lenders are no longer the core of the global system.

The risk has migrated elsewhere, to investment funds crowded into illiquid assets and above all into corporate bonds.

There's more at the link.

The problem, basically, is that companies have issued bonds - IOU's, in so many words - to fund current operations.  Those bonds must be repaid out of future earnings, which permanently hobbles those earnings and prevents them being applied to then-current needs.  (The "drawing on the future" conundrum was explained here.)

When those bonds fall due, companies can pay them if they have the funds available to do so;  or, alternatively, they can issue new bonds to replace the old (a process known as "rolling over" debt).  This assumes that the holder of the existing bond will be willing to accept a new bond to replace it, instead of money;  or that new buyers will emerge for the new bonds, so that the money they pay for them can be used to pay off the old bondholders.  If there are no new buyers, or existing bondholders are unwilling to roll over the debt, then the company is in a very precarious position.  (This is known as the "refinancing risk").  It's very similar to our situation if we're heavily indebted on a credit card, and the card issuer decides that we're a poor credit risk.  It demands that we repay the amount owed;  but we don't have sufficient funds to do so.  If it calls in the total debt due to non-compliance with its terms and conditions (for example, we've routinely exceeded our credit limit, or something like that), we're neck-deep in the dwang.

The article is pointing out, in so many high-falutin' financial and economic terms, that this is what many companies are facing in today's market.  (The most recent - and very public - example is the Sears bankruptcy.)  If financing is limited due to its being tied up in so many other investments (government bonds, stocks, natural resources, futures, etc.), then companies that in the past have been able to draw on that investment pool will find themselves on barren ground.  That can lead to all sorts of "interesting times", in the sense of the apocryphal Chinese curse.

Peter