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Record debt risks ‘tipping point’ after pandemic passes

The United States is embarking on a rapid-fire experiment in borrowing without precedent

http://www.stamfordadvocate.com  |  David J. Lynch, The Washington Post

The United States is embarking on a rapid-fire experiment in borrowing without precedent, as the government and corporations take on trillions of dollars of debt to offset the economic damage from the coronavirus pandemic.

The federal government is on its way this year to spending nearly $4 trillion more than it collects in revenue, analysts say, a budget deficit roughly twice as large relative to the economy as in any year since 1945.

Business borrowing also is setting records. Giant corporations such as ExxonMobil and Walgreens, which binged on debt over the past decade, now are exhausting their credit lines and are tapping bondholders for even more cash.
To support such borrowing, the Federal Reserve has dropped interest rates to zero and added more than $2 trillion of loans to its portfolio in the past six weeks – as much as in the four years following the Great Recession.

All this borrowing is required to plug the gaping hole the novel coronavirus has punched in the economy, as unemployment reaches levels not seen since the Great Depression. Few, if any, prominent economists or lawmakers opposed opening the government’s fiscal taps amid the current economic emergency. The Senate last month approved $2 trillion of crisis spending with a vote of 96 to 0.

Yet high debt loads already are straining many corporations, which may be forced to choose between skipping loan payments and laying off workers. Millions of consumers, too, face sizable monthly bills for student loans and credit cards, a burden that could weigh on any economic rebound.

The reliance on so much debt also will leave scars after the pandemic passes, economists say, making it difficult for policymakers to withdraw support and leaving the economy more vulnerable than before this crisis began.

“We should be very worried,” said Atif Mian, an economics professor at Princeton University who has written widely on the subject. “We are talking about a level of debt that would certainly be unprecedented in modern history or in history, period. We are definitely at a tipping point.”

On the eve of the pandemic, the U.S. economy was humming, thanks in part to a jolt from the 2017 tax cut and the subsequent end of congressional spending limits. But Congress took those actions without any plans to pay for them.

Governments and companies often turn to lenders during times of unexpected duress. This new wave is different because it follows an era of heavy borrowing.

For President Donald Trump, debt is a familiar tool. The former real estate executive once bragged that he was “the king of debt” and suggested haggling with holders of U.S. Treasurys over repayment terms using hardball techniques he had honed in the business world.

Treasury Secretary Steven Mnuchin said last month that the government must spend freely to help workers and businesses hurt by official shutdown edicts. “Interest rates are incredibly low, so there’s very little cost of borrowing this money,” he told reporters. “In different times, we’ll fix the deficit. This is not the time to worry about it.”

Some argue that even more spending is needed to save the economy. Economist Joseph Stiglitz, a Nobel laureate, says the government should guarantee workers’ pay and forbid evictions or foreclosures. Larry Fink, the chief executive of BlackRock, a New York-based investment firm, told CNBC last week that an additional $1 trillion may be needed for small businesses.

But once the coronavirus has been tamed and the country regains its swagger, U.S. leaders will need to find an exit from the extraordinary levels of government borrowing.

Building a consensus for the blend of tax increases and spending cuts needed to shrink the mammoth post-crisis debt will be tough to manage. Neither political party emphasized spending limits in recent years. And the presumptive Democratic nominee for president, former vice president Joe Biden, proposed relatively modest tax increases compared with his former rivals. Republicans, meanwhile, reflexively oppose tax hikes.

The Fed, likewise, will face difficulty extricating the economy from today’s elevated levels of financial support. The Fed had only partial success in unwinding its efforts to buttress the economy after the 2008-2009 crisis before the pandemic drew it back into an emergency posture.

Economists typically worry that excessive debt could lead to a crisis triggered by investors’ suddenly concluding that they will not be paid their promised returns and starting a fire sale of government securities, causing interest rates and inflation to soar. That scenario has afflicted numerous smaller economies. But such an outcome seems less likely for the United States, given the primacy of the dollar in the world economy and the country’s long track record of relative economic stability.

Still, for four decades, the U.S. economy has grown steadily more addicted to borrowed money. Total government, business and household debt now exceeds 250 percent of annual output, three-quarters greater than in 1980, according to government statistics.

To Mian, the author of “House of Debt,” which examined the role of household debt in the 2008-2009 financial crisis, the U.S. debt burden will reshape the economy in subtle but powerful ways.

An era of perpetually ultralow interest rates distorts the economy by eliminating the traditional market discipline that discriminates between worthy investments and unprofitable ones. If money is virtually “free” for many years – as it has been since 2008 – even bad ideas can attract financing.

As the United States once again turns to debt to rescue the economy, it is locking in a future of lower growth. The national credit card is being used largely to stop today’s financial bleeding, rather than for investments – in the medical system, infrastructure and education – that would boost future growth.

Japan has been stuck in an endless loop of disappointing growth, low interest rates and mounting debt, and the United States could face a similar future.

The United States is ensnared in a “debt trap,” Mian said.
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In the aftermath of the Great Recession, government debt exploded as the United States ran annual trillion-dollar budget deficits for four years through 2012. But even before robust growth returned, Washington embarked on spending cuts and tax increases that cut the deficit starting in 2013.

This year, the deficit will reach a postwar peak of 18.7 percent, according to the nonpartisan Committee for a Responsible Federal Budget. Only when the United States fought Nazi Germany was Washington bathed in more red ink.

Even budget hawks who warned for years that Washington was courting financial calamity with its unbridled spending concede that the pandemic requires high levels of government borrowing. And indeed, there is almost universal support for the $2 trillion financial rescue package President Trump signed last month with the aim of saving the economy from depression.

But the pandemic’s costs are only beginning. House Democrats are negotiating with the Treasury’s Mnuchin over an additional $250 billion of loans for small businesses as well as $150 billion more for hospitals and state and local governments.

By the end of September, the public debt will be larger than the $21 trillion economy, according to CRFB calculations. The recession’s impact will push the debt past the previous record of 106 percent of the economy, set in 1946.

Today’s low interest rates make the massive federal debt relatively affordable. The government pays less than 1 percent interest to raise money by selling Treasury securities to investors.

But Torsten Slok, the chief economist at Deutsche Bank Securities, says that interest rates are being kept low only by massive purchases that the Fed began last month to settle markets unhinged by the pandemic.

In March, to smooth out dysfunctional trading, the Fed began buying $75 billion worth of government bonds every day.

The Fed has cut back to daily purchases of $30 billion, but that is still a staggering amount of central bank support. At the peak of the Fed’s controversial crisis-fighting efforts in 2010, it was purchasing only $110 billion of government securities each month.

Today, it buys that much in less than four days.

The Fed wants to avoid compromising its traditional independence by financing limitless government spending. Running the monetary printing press at the behest of politicians historically has been a recipe for financial crisis in multiple countries.

The central bank’s desire to bring an early end to its unusual market role may collide with the Treasury Department’s need to sell an unprecedented amount of government bonds to raise money for anti-pandemic spending.

“Who’s going to buy all these Treasurys? Foreigners? Private investors?” Slok asked. “It all adds up to supply growing at levels we have never, ever seen before.”

Such worries are exaggerated, according to Guy Lebas, the chief fixed-income strategist with Janney Montgomery Scott.

“The point at which the size of the U.S. debt is too great for the market to take on is eons away,” he said. “If anything, the covid crisis has increased global demand for U.S. debt.”

Most economists expect inflation and interest rates to remain low for years. But they could be wrong. Rising public debt is “the most important predictor” of future crises, including defaults, sudden increases in borrowing costs or runaway inflation, according to a January study by four economists at the International Monetary Fund.

“Governments should be wary of high public debt even when borrowing costs seem low,” the study concluded.
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For scores of companies that borrowed heavily in recent years, the pandemic is raising borrowing costs just as a fierce economic downturn obliterates their earnings and imperils their ability to repay their debts.

Total business debt topped $16 trillion last year. As the Fed reduced interest rates to zero in 2008 and kept them there for several years, companies took on more and more debt, including to buy back their own stock and raise shareholder dividends.

In recent weeks, corporations have drawn more than $200 billion from their standing credit lines. JPMorgan Chase alone has provided $50 billion to corporate borrowers via revolving credit lines and in March extended $25 billion of new credit.

“This already dramatically exceeds what happened in the global financial crisis,” Jamie Dimon, JPMorgan’s chief executive, wrote in his annual shareholder letter.

In a survey of top banks’ corporate loan portfolio managers, 60 percent said they expected borrowing costs to continue rising for many companies over the next three months. And 90 percent said they expected more corporate borrowers to default, according to the International Association of Credit Portfolio Managers.

“People believe credit risk is going way up,” said Som-Lok Leung, the executive director of the industry group.
Likewise, with almost all Americans covered by mandatory government stay-at-home orders, the economy is in free fall. Earnings for oil and gas companies could be cut in half, according to Capital Economics, a London-based investment analysis firm said.

The grim outlook already has prompted layoffs at companies such as Halliburton and Apache.

Investors, meanwhile, are starting to worry that prominent companies such as Ford and Delta Air Lines may struggle to repay their debts.

The number of companies in danger of having their credit rating lowered is at a 10-year high, according to S&P Global Ratings. Among the companies drawing greater scrutiny are Chevron, Honda and the Walt Disney Co.
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For now, American consumers – whose borrowing played such a critical role in the 2008 crisis – have mostly been affected by job losses, furloughs and wage cuts, not debt.

While household debt hit a record $16.1 trillion last year, it remains much smaller relative to the economy than in 2008.

But those statistics mask underlying vulnerabilities. Even as the majority of Americans firmed up their financial position, 40 percent – nearly 50 million households – have fallen further into debt since the financial crisis, according to Moody’s Investors Service.

The most indebted households also are likely to have family members lose their jobs in the wave of unemployment that’s washing over the economy, according to Asti Sheth, Moody’s managing director for credit strategy. The nation’s four largest banks have set aside so far this year more than $18 billion to cover their anticipated losses on consumer and other loans, a level of reserves not seen since the 2009 financial crisis.

“The distribution of debt and income is uneven,” Sheth said. “And that is something we’re watching.”
Congress has granted some mortgage relief, and Trump has suspended student loan payments for most borrowers through Sept. 30. But that won’t be enough to avoid a debt-driven economic spiral, according to Tomasz Piskorski, an economist at Columbia Business School.

A severe recession that drove the unemployment rate to 30 percent would send nearly one-third of mortgages into default and lead to 1½ times as many foreclosures as occurred after the housing bubble collapsed.
“In a few months, the recovery will not be there,” Piskorski said. “And these households will be saddled with very high debts, and they won’t have jobs, and they will start to default.”

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