Debt as a millstone around our economic necks

 

We've spoken on several previous occasions about the danger of debt, and how it's dragging down our entire economy.  Debt is not just private (you and I);  it's also corporate and state, with not just the federal government, but a large number of states deeply indebted to lenders, and struggling to repay and/or refinance that debt in the face of higher interest rates.

The new, higher interest rates threaten to cripple many major corporations - and those who work for them.

Interest rates are MUCH higher across the board than they were two years ago.

Residential mortgage rates have climbed from 2.75% to 7.32%. The US 6-month Treasury was just 0.03% last summer. Today it’s 4.75%.

And corporate “junk bonds” yielded as low as 3.8% last year. Today those junk rates are nearly 10%.

That last point is really important, and I’ll give you an easy example. We all know how the cruise industry struggled once the pandemic hit, and those struggles continue today.

Carnival Cruise Lines is hurting so badly that the company’s ‘gross profit’ is negative, meaning that it costs the company more to operate their cruise ships than they generate in revenue.

In Q2, for example, Carnival generated $1.2 billion in cruise revenue. But they spent $1.7 billion on fuel, food, crew salaries, etc., resulting a NEGATIVE gross profit of -$500MM. And that’s BEFORE paying for corporate management, administrative expenses, etc. (which totaled another $400 million).

And it’s also before Carnival paid a single penny of interest or principal on its debt.

They’re clearly in a tough spot. And it was even worse last year and the year before.

Yet Carnival has been able to keep the party going by taking on debt; its total debt is now nearly $30 billion, up from less than $10 billion in 2019, pre-COVID. That’s a lot of debt, given that Carnival’s total equity is only around $8 billion. So it’s ‘debt to equity’ ratio is nearly 4:1.

When rates were still low and their business was somewhat healthy, Carnival was able to borrow money at just 1%.

But now that their business is in the dumps, and interest rates have increased substantially, Carnival is borrowing money at 10.5%.

Remember, the company doesn’t even make enough money to pay its 1% debt, let alone 10.5% debt.

And what’s worse is that these bonds will eventually need to be paid back; in the next 12 months alone, Carnival will have to repay nearly $1 billion in debt. And they simply don’t have the money.

This is a classic distress situation. And it’s no wonder that investors have been dumping Carnival bonds.

But it’s not just Carnival, or even the cruise industry. You’d be surprised at how many companies are in a similar situation — heavily in debt and unable to pay. They’re basically walking dead, which is why they’re commonly referred to as ‘zombie companies’.

Zombie companies have been with us for years; they’ve only been able to survive thanks to cheap interest rates and government bailouts.

But, again, financial conditions have changed dramatically. And if interest rates stay high (or go higher), I think it’s likely that we’ll see a wave of bankruptcies and asset sales, possibly over the next 12 months.

There's more at the link.

As the author notes, "it's not just Carnival, or even the cruise industry."  There are probably thousands of companies who are currently finding it difficult to refinance debt they originally incurred at much lower interest rates.  There are tens of thousands of home owners who took out adjustable rate mortgages, and who are now staring down the barrel of massive increases in the interest rate they're paying.

If you work in a company or organization affected by this, pay careful attention to how it might affect you.  If your state has to pay much higher installments on its debt, what might happen to state workers?  If a company has to pay much higher installments, what might happen to at least some of its employees - perhaps entire plants or production lines?  Will your job be safe?

Of course, there's also the personal angle.  Are you carrying a high credit card debt load?  Credit card interest rates are already usurious, several times higher than a typical bank loan.  I've heard that some credit cards, particularly for those with poor credit ratings, are now at 30% or higher.  If you can't afford to pay them, that's your problem.  The credit card issuer is going to sue for his money, and you're in his crosshairs.

(Oh - and if you've booked a cruise on Carnival or any other cruise line over the next year or two, keep a careful eye on the company's financial situation.  You don't want to be stranded at sea or in a foreign destination, because the company can't afford to get you back home again!)

This is a really serious issue.  Do, please, pay attention to the many ways it might affect you personally.

Peter