Only the Fed Can Save Us

In large part, the explosion of debt issuance has been driven by central-bank policies that have kept interest rates at historically low levels, in effect rewarding entities for issuing more and more debt. Interest payments on corporate debt are tax deductible, in most jurisdictions.

We live in a world awash in debt.

But that’s the risk we can see. There is plenty of additional risk hiding in the undisclosed obligations of private companies and in the “shadow banking system,” nonbank financial institutions that have sprung up in the past decade to hold the risk that the Federal Reserve insisted, after the 2008 financial crisis, that Wall Street avoid.

So what would happen if interest rates did increase slightly, or if the economy dipped into a recession, and some of those overleveraged companies could no longer meet their interest payments? It wouldn’t be pretty.

We got a taste of that, briefly, last December, when interest rates ticked up just a bit, and there were suddenly no buyers for high-yield debt. Not a single high-yield debt deal got done in that month. When companies with the poorest credit can’t get financing, it sends a chill throughout the credit markets, but it also means that hiring slows, factories don’t get built and innovation stalls.

It’s easy to dismiss those fears. After that December freeze, the Fed again moved to keep interest rates low. And the capital markets revived. The party resumed. Many other economic indicators look stable — G.D.P. growth, unemployment, wages — and the Dow, while volatile, remains just 1,000 points below the high it reached in July.

READ  Global stocks drop with Trump expected to hit back at China

But while we look to the stock market as a barometer of our economic health, it’s increasingly less relevant. In the late 1990s, the number of publicly traded companies peaked at around 7,300; today there are around 3,600. With more companies in private hands, and the market for private finance growing, we know less and less about the hidden risks these companies pose to the economy.

For calm to return to the capital markets, we must pop the debt bubble, the sooner the better.

Mr. Powell could pivot back to a posture of raising short-term interest rates. He’s been trying to hang tough. He has publicly defended the Fed from meddling by the president, who continues to pressure Mr. Powell to lower interest rates, believing incorrectly that it will accelerate economic growth.



Please enter your comment!
Please enter your name here