MAY 14, 2018
Asking that corporations not take on too much debt, when that debt costs them almost nothing in interest, is unrealistic. Asking that the Fed not leave interest rates at emergency-condition levels for 10 years is not.
In the myopic mad dash that is quarterly earnings-obsessed Wall Street, you have about 90 days to prove yourself, over and over again. If you can access borrowed money at near-zero up front cost and get a return on investment above that near-zero, you’re going to pad your bottom line over the short term.
And, exactly like an elected government official, that’s all CEOs care about. Positive quarterly results mean keeping their jobs and getting fat bonuses. When investors are obsessing about beating estimates for the past three months, worrying about incrementally higher interest payments next year might make academic sense but is about the least pressing concern for public company executives.
The Greenspan Fed pushed rates abnormally low in the late 1990s even though the then-booming economy needed no stimulus. That was in part to provide liquidity to a Y2K-wary public and partly in response to the 1998 market turmoil, but they were slow to withdraw the extra cash.
Bernanke was again generous to borrowers in the 2000s, contributing to the housing crisis and Great Recession. We’re now 20 years into training people (and businesses) that running up debt is fun and easy… and they’ve responded.
But over time, debt stops stimulating growth. Over this series, we will see that it takes more debt accumulation for every point of GDP growth, both in the US and elsewhere. Hence, the flat-to-mild “recovery” years. I’ve cited academic literature via my friend Lacy Hunt that debt eventually becomes a drag on growth.
Debt-fueled growth is fun at first but simply pulls forward future spending, which we then miss. Now we’re entering the much more dangerous reversal phase in which the Fed tries to break the debt addiction. We all know that never ends well.
If some of this sounds like the Hyman Minsky financial instability hypothesis I’ve described before, you’re exactly right. Minsky said exuberant firms take on too much debt, which paralyzes them, and then bad things start happening. I think we’re approaching that point.
The last “Minsky Moment” came from subprime mortgages and associated derivatives. Those are getting problematic again, but I think today’s bigger risk is the sheer amount of corporate debt, especially high-yield bonds that will be very hard to liquidate in a crisis.