The U.S. Might Get Screwed by the $1.2 Trillion Leveraged Loan Market

The coronavirus. The economy. Unemployment. Toilet paper shortages. These are what most United States citizens are worried about today.

But there’s something else Americans should be deathly worried about: Debt. Specifically, the leveraged loan market.

The $1.2 Trillion Leveraged Loan Market

On the Apr. 1 episode of The Journal podcast, host Kate Linebaugh talks with Matt Wirz of The Wall Street Journal, who calls attention to the $1.2 trillion market of high-risk corporate debt, much of which is in danger of defaulting.

As if we need anything else to worry about right now. We have a lot of reasons to be pessimistic about the future.

• U.S. coronavirus testing is still inadequate.
• Too many people are acting as if the coronavirus is a short-term problem.
• The post-coronavirus economic data coming out of China is discouraging.
• Stock buybacks will halt as a condition of the $2 trillion stimulus package.

One day, I will bet on American capitalism — but not today.

I’m not even close to going all in yet.

And one pretty big reason is the mountain of leveraged debt corporations have irresponsibly piled up over the past half decade. Per Wirz: “These loans have permeated every aspect of the U.S. economy. … The market has actually increased by 50% in size over the past five years.”

What. The. Fuck.

It’s junk debt like this that got us in trouble in 2008, and now this country once again is overexposed to leverage, except now it has nothing to do with real estate. Per Linebaugh: “It’s like a corporate version of a subprime mortgage.”

Same song, different verse. Same album, different song. Same shitty band, different album.

However you want to conceptualize it: The ghost of 2008 is coming back to haunt us.

We didn’t learn our lesson as well as we should have.

It’s easy for companies in good times to want to access the leveraged loan market: They can’t imagine that the good times will end, and by using this levered debt, they can bulk up, like baseball players on steroids.

But when bad times come around, they’re screwed: Their revenues drop, and then they can’t pay back the loans. And when that happens — and when it happens to enough companies — the economy gets hit. Per Wirz:

That can trigger something like a house of cards falling down, where the company is immediately in default, they can be put into bankruptcy, they have to cut staff, they may be forced to shut down completely and liquidate, and that has a cascade effect throughout the company. That unfortunately is what we’re headed into.

When companies default, it’s not just the corporations that suffer. The banks — the lenders — suffer as well, and then everyone suffers.

And why are the banks making these horrible loans anyway?

“Neither a Borrower Nor a Lender Be”

In Act I of William Shakespeare’s Hamlet, Polonius (the counselor to King Claudius) gives his son, Laertes, some advice: “Neither a borrower nor a lender be.”

Here’s the thing: Polonius is an idiot. His stupidity eventually gets him killed. His mouth is a never-ending fount of mundane pseudo-truisms — until Hamlet permanently shuts it.

But Polonius is more or less right in his advice about borrowing and lending.

If you borrow — especially in a leveraged way — you become overly vulnerable. And if you lend in a reckless manner, you increase the odds that your capital will be lost.

In The Black Swan, Nassim Nicholas Taleb says this about debt.

It makes you fragile, very fragile under perturbations, particularly when we switch from the assumption of Mediocristan to that of Extremistan. … All Mediterranean cultures developed through time a dogma against debt. Felix qui nihil debet goes the Roman proverb: “Happy is he who owes nothing.” Grandmothers who survived the Great Depression would have advised the exact opposite of debt: redundancy; they would urge us to have several years of income in cash before taking any personal risk. … Had banks done that, there would have been no bank crises in history. …

Debt implies a strong statement about the future, and a high degree of reliance on forecasts. … So debt is dangerous if you have some overconfidence about the future and are Black Swan blind, which we all tend to be. And forecasting is harmful since people (especially governments) borrow in response to a forecast. … Borrowing makes you more vulnerable to forecast errors.

Could companies with leveraged debt have foreseen the coronavirus? No. But that’s the point: No one is all that good at predicting the future. That’s why cash is a virtue and debt is dangerous.

It’s bad enough that companies didn’t save money in anticipation of some unknown eventuality. It’s even worse that they went into debt. And it’s the stone-cold worst that this debt is leveraged.

I know that the leveraged loan market might seem fairly insignificant right now, given the very real trauma the coronavirus is causing. People are dying. They’re losing their jobs. Their pets’ heads are falling off!

There’s something to be said about leaving tomorrow’s wars for whenever tomorrow actually comes.

But we shouldn’t forget that after today there will be more wars to wage.

I’m not a financial advisor, and I don’t suggest that you make any decisions based on anything I say or write … but I expect that the leveraged loan market is something Americans are going to hear much more about over the next year.