Is Record Corporate Debt the Next Ticking Time-Bomb?

There’s been a lot of good news about US companies over the last few years, news that has driven stock prices to new record high after new record high – at least until recently. Corporate profits were record high last year and are expected to be strong again this year.

Yet there is a dark side to this equation. US corporations have amassed record large debt, even as we’ve enjoyed the second longest best economic recovery in decades. Like the federal government, corporations should have been paying down debt during this period of strong economic growth and historically low interest rates.

Unfortunately, they’ve done just the opposite. US corporate debt now stands at a record of over $9 trillion. The question is: Could this be the catalyst for the next US financial crisis? The answer is, we don’t know for sure, but you need to know about this in any event. That’s what we’ll look at today.

Let’s start with “the” chart below – showing the meteoric rise in US corporate debt since 1980, and particularly since the end of the Great Recession in early 2009. As you can see, US corporate debt has exploded from around $6 trillion in 2011 to over $9 trillion today.

Ultra-low corporate bond yields have encouraged US public corporations to borrow heavily in the bond market since the Great Recession. Total outstanding (non-financial) corporate debt has increased by over $2.5 trillion or 40% since its 2008 high, which was already at a dangerously high level in its own right.

US corporate debt is now at an all-time high of over 45% of GDP, which is even worse than the levels reached during the Dot-com bubble (2000) and the US housing and credit bubble (2008).

Corporations have been using the proceeds of their borrowing to boost their stock prices via share buybacks, dividends and mergers and acquisitions, instead of making long-term business investments and expansions that were typical in the past.

The chart below shows the boom in share buybacks and dividends paid after the Great Recession. Share buybacks are expected to top $1 trillion this year after the passing of President Donald Trump’s tax reform plan unleashed a record number of share buyback announcements.

In the spirit of full disclosure, I was wrong about this when President Trump cut corporate tax rates in 2017. I thought US corporations would take advantage of the large tax cuts to make long-term business investments and add jobs. While they have added jobs thanks to the strong economy, they have also used a good deal of that tax savings to fund share buybacks, just as the critics of Trump’s tax cuts warned.

That admission aside, the question is whether the explosion in corporate debt will lead to another financial crisis just ahead. As always, that depends on several factors – chief among them is whether the Federal Reserve will continue hiking short-term interest rates.

Historically low interest rates the last decade are what led to the corporate debt bubble in the first place, so the ending of those conditions would very likely end the corporate debt bubble. Significantly higher interest rates could cause stock buybacks to come to a screeching halt, which could also pop the stock market bubble, creating a downward spiral.

This is why more and more analysts worry that the corporate bond bubble could ultimately be the trigger for the next financial crisis. Maybe that’s why Fed Chair Jerome Powell hinted last week that the Fed can be “patient” about hiking rates further this year (more details on this in Tuesday’s Forecasts & Trends). There’s no question the Fed is keenly aware that a huge corporate bond bubble exists.

There are serious consequences from central bank market-meddling and we are about to learn this lesson once again. Will the record large corporate debt be the catalyst for the next financial crisis? For now, most forecasters believe the current corporate debt level is manageable. But of course, no one really knows.

What we do know is that having over $9 trillion in corporate debt, and growing, is a dangerous trend. Is it as bad as the housing bubble of 2007-2008? Most analysts agree, not yet. But again, no one knows for sure.

I’ll stay on top of this and keep you posted in the weeks and months to come.