It’s enough to have free-market purists reaching for the complete works of Karl Marx.
When the banks were bailed out at a cost of hundreds of billions of dollars during the 2008 crisis, it was supposed to be a one-off intervention by governments and central banks, designed to save the financial system and prevent a collapse in the world economy.
Barely a decade later and we have another “black swan”. As coronavirus wreaks havoc on people’s lives and global business, mass bailouts are again being announced almost every day. Last week the US Congress approved a $2tn package of stimulus measures and the Federal Reserve promised an unlimited programme of bond-buying. Other developed economies are taking similar action.
In contrast with 2008, the banks are not the root of the problem this time. They, and other parts of the financial sector, may yet be burnt badly along the way. But as policymakers embrace some of the principles of a control economy, large chunks of the bailouts — from state-guaranteed loans to central bank bond investments — are going directly to “real” companies to stop them running out of money.
The prospect of mass defaults, as companies are forced to close for months on end, may be averted — except in one increasingly important corner of the market: companies that rely on non-investment grade or “junk” bonds for finance are not part of bailout plans. As their plight worsens, the junk label looks more apposite by the day.
Witness the travails of WeWork. The trendy short-term office letting business already had its own particular problems: a governance dispute that led to the ousting of its former chief executive; a failed initial public offering; and a new reluctance on the part of top shareholder SoftBank to press ahead with a planned $3bn equity investment.
Now, in addition, the global economic shutdown threatens WeWork’s fundamental business model — and in a way that has startling echoes of the failure of Lehman Brothers, Northern Rock and other high-profile casualties of the last financial crisis.
The reason those institutions failed was because they had relied on high volumes of very short-term finance, when their own lending commitments were far longer-term. This “duration mismatch” killed them when short-term finance markets froze. As this column pointed out in 2017, WeWork relies on a similar sort of mismatch, making its money by charging proportionately more for small short-term leases than the large long-term ones it commits to. When the short-term lease market freezes, it is left with a potentially dire problem.
Anyone who has passed any WeWork buildings in recent days could see there might be a problem. They might be open, with receptionists or security in the lobby. But there is little sign of anyone working. The small companies and self-employed staff that make up the bulk of its clientele will struggle for at least as long as coronavirus grips the world — probably far longer. And so will WeWork.
That certainly seems to be the bond market’s view. When the Fed announced its bailout last week, it committed to buy corporate bonds for the first time but specifically excluded junk bonds. The result was that, in common with other companies with low credit ratings, WeWork’s bonds plunged in value. Its 2025 bond is now trading at barely a third of its face value.
The scale of policymaker interventions in this fast-moving crisis dwarfs that of 2008 — and with good reason. Virtually every sector of the economy, in virtually every country, is affected simultaneously. And at the same time the level of debt in the world — and thus the scale of default risk — has ballooned. According to the Institute of International Finance, the tally of global debt hit a record of more than $250tn last year, up by almost a third in a decade. Corporate debt makes up nearly half the total.
If the new bailout schemes are well implemented, they could go some way to averting disaster. But the mounting risks within the WeWorks and other low-rated debt issuing companies of the world could yet be destructive. Such businesses accounted for a quarter of all corporate debt issuance last year, according to Dealogic.
Standard & Poor’s warned last week that default rates on junk debt could triple, topping 10 per cent, within a year. Whether the world can stomach that, or whether another dimension of free markets will need to be nationalised, remains to be seen. Marx would be riveted.
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