There’s no doubt that coronavirus will plunge the U.S. into recession as economic activity grinds to a halt. The ‘v-shaped’ recovery that pundits were once pointing to is starting to look like a pipe dream as an epic debt bubble casts a terrifying shadow over the U.S. stock market.
Over the past few years, reckless borrowing among U.S. corporations has been no secret. Every quarter economists questioned how much longer businesses could survive on a diet of over-inflated debt and profitless operations. Still, the stock market marched ever higher and warnings about a recession were ignored.
Coronavirus has lit the fuse on a massive debt bomb that could stretch banks to their absolute limits.
Against the backdrop of an unstoppable bull market, banks opened up a host of investment-grade revolving lines of credit. Many were low margin loans and some even lost money. But banks continued to hand them out in an effort to secure future business and reinforce relationships with big clients.
When the world ground to a halt over coronavirus, businesses found themselves suddenly devoid of cash. That prompted many firms to turn to their existing credit lines to shore up their cash coffers.
According to Bloomberg, banks saw a surge in borrowing throughout March as companies tapped into cheap revolving credit lines they’d secured in better times. If everyone were to do that, banks would find themselves high and dry. So bankers started asking their clients to take out new loans instead of tapping existing lines of credit.
Liquidity is key for banks right now as they look to ensure they can meet the growing demand for funds. As Bloomberg Intelligence analyst Arnold Kakuda put it,
The banks are open but if everybody asks at the same time then it’s going to be difficult from a balance sheet perspective.
Indeed, America’s banks are heavily exposed in the face of this sudden recession. A Goldman Sachs analysis showed that JPMorgan’s credit commitments to coronavirus-sensitive sectors like transportation, leisure and energy total $193.8 billion.
The Federal Reserve’s intervention and the potential for money to cycle through the financial sector will help stop some of the bleeding. But equity investors should be prepared for the possibility that this is going to end badly.
This year, $4.1 trillion worth of corporate debt is due to mature and around $1.3 trillion of that is speculative grade.
An estimated one in six U.S. companies didn’t have the cash flow to cover their interest payments at the best of times—imagine what that figure looks like now that most have shut their doors. Now imagine how it will look a few months into a recession.
What we’re seeing now as banks plead with customers to tap existing credit sparingly are warnings signs for what’s to come. Banks are starting to worry that everyone is about to turn on the hot water at the same time—and there’s not enough to go around.
U.S. corporations aren’t the only ones draining banks of their liquidity. Consumers are also sitting atop a nauseating debt pile.
Earlier this year, estimates regarding consumer debt fell somewhere between $14 and $16 trillion. At minimum, that’s $1.78 trillion more than U.S. consumers were carrying during the 2007 financial crisis.
Before coronavirus sent millions of Americans to the unemployment lines, bulls pointed to record-low unemployment rates and one of the strongest economies on record. They argued that debt at those levels isn’t a concern because people can pay it back.
When the impact of coronavirus started to become clear, bulls pointed to a so-called v-shaped recovery. They claimed the current predicament was just a blip on the radar.
Donald Trump recently announced that he’d avoid a national lockdown, but that social distancing measures were to remain in place until April 30.
All signs point to a prolonged period of depressed economic activity around the globe. A recession is all but certain at this point and its length is undetermined. The ability of borrowers—both corporate and consumer—to repay their loans has severely diminished, leaving banks in a precarious position.
For now, the Fed has been able to slow the bleeding but the bank won’t be able to plug the hole forever.