> Even before the pandemic, the level of corporate leverage was beginning to cause alarm. At the end of last year, the IMF issued a striking warning: as much as $19tn of business debt in eight countries led by the US — or 40 per cent of the total — could be vulnerable if there were a “material slowdown” in the economy, a scenario that, if anything, now seems tame.

I like to think of it this way:

At present, a business that is barely-investment-grade (say, BBB-/Baa3) can borrow for a decade at just over 3%/year. A risky business that is rated as junk (i.e., below BBB-/Baa3) can borrow for a decade for as little as 6% to 7%/year. The interest payments are tax deductible, so the effective annual cost to borrow is around 2.5% for barely-investment-grade and around 5% for junk, give or take. As long as the executives think they can earn more than 2.5% to 5% per year on any money they borrow, why not borrow it? And if they can justify using borrowed money to buy back shares, keeping their stock options in-the-money, why not do it?

Many US companies in mature industries (think energy, hospitality, travel, transportation, etc.) have been doing exactly that, to the point that corporate debt is now the highest ever in relation to US GDP. And it has worked beautifully... that is, until a global pandemic suddenly cut their revenues by 10% to 20% or even more, instantly flipping those expected earnings into losses. People are no longer traveling as much, or going to restaurants as much, or going to the office as much, etc.

All of a sudden, all those businesses are losing money on all that borrowed money -- they are losing so much, in fact, that many have had to borrow even more during the pandemic to be able to continue paying interest on prior borrowing and avoid going into bankruptcy.