The full impact of the coronavirus pandemic may take years to play out. But one outcome is already clear: Government, businesses and some households will be loaded with mountains of additional debt.
The debt surge is set to shape how governments and the private sector function long after the virus is tamed. Among other things, it could be a weight on the expansion that follows.
Many economists believe low interest rates will help the nation manage the soaring debt load. At the same time, they say high levels of private sector debt could lead to a period of thrift, slowing the recovery if businesses and individuals try to rebuild their savings by holding back on investment and spending.
“People and firms and government are facing a negative shock, and the classic textbook prescription for a temporary shock is to do some borrowing to smooth that out,” says Alan Taylor, an economist and historian at the University of California, Davis, who has studied the economic effects of pandemics going back to the Black Death of the 14th century.
Borrowing now amounts to a transfer of economic activity from the future to the present. The payback comes later. “You do have something to worry about in terms of the recovery path,” Mr. Taylor said.
Past crises and buildups in U.S. government debt led to changes in the tax code and sharp fluctuations in inflation. In the private sector, debt loads could become a dividing line between firms that fail and those that emerge more dominant in their industries.
Because states generally run balanced budgets to avoid large debt, they are likely to dip into rainy day funds in the weeks ahead and could turn quickly to cost cutting to keep their budgets in line in a downturn, squeezing the economy.
Moody’s Analytics sees $90 billion to $125 billion of such cuts or tax increases coming and says the hits will be unevenly spread around the country. New York, Michigan, West Virginia, Louisiana, Missouri, Wyoming and North Dakota are especially vulnerable, it said.
The Federal Reserve, the nation’s central bank, will play the critical role of navigating the nation through the rising tides of debt. It sways the cost of debt service, whether inflation emerges and whether banks and other financial institutions can bear the burden of lending that the nation demands.
So far the Fed is getting high marks from President Trump and many economists and investors for moving quickly to make credit widely available, though it faces challenges and uncertainties deciding how far to extend itself and when and how to pull back. On Thursday, it announced more programs to support $2.3 trillion in lending.
During and after the 2007-09 financial crisis, the Fed expanded its own portfolio of securities and other holdings from less than $800 billion to $4.5 trillion. The Fed unwound some of that as the expansion took hold. Now, in the initial stages of the coronavirus crisis, it has stretched its holdings from $3.8 trillion last September to $5.8 trillion as of April 1, and is on track to increase them by trillions more in the months ahead.
“Had the Fed not come in these past few weeks, we would have had a combination of the Great Depression and the 2008 financial crisis,” said Mohamed El-Erian, chief economic adviser at Allianz, the Munich-based financial firm.
The U.S. government currently has $17.9 trillion in debt held by private investors and other governments—the amount it has borrowed from others to fund its annual budget deficits. That works out to 89% of U.S. gross domestic product, the highest since 1947. Before the coronavirus crisis, debt and deficits were pushed higher by ramped up government spending on military and other programs and tax cuts enacted in 2017.
Government borrowing will soar in the months ahead due to the $2 trillion economic rescue program, higher spending on programs like unemployment insurance and an expected fall in tax revenues amid lower incomes and corporate profits.
Mr. Trump is pushing for an additional Washington stimulus program focused on infrastructure spending. House Speaker Nancy Pelosi said another round of stimulus could exceed $1 trillion. That could include an expansion of small business loans and grants by another $250 billion.
Past crises accompanied by swelling government debt led to dramatic changes in the government’s role in economic life. Alexander Hamilton, the nation’s first Treasury Secretary, consolidated state debts at the federal level after the Revolutionary War, one of the nation’s first steps toward centralizing power. The vast expansion of lending from Washington today could further increase its sway over the economy.
Abraham Lincoln’s Revenue Act of 1861 imposed import taxes and a 3% tax on high incomes to fund the Civil War effort. An income tax created in 1913 was expanded to finance World War I. The Treasury Department started tax withholding during World War II, when the tax rate for high income households surged over 90%.
Mr. Trump has likened the virus crisis to another war.
“After the dust settles in the U.S. there will be arguments over who should pay for all of this spending and absorb the burdens of the debts, which will be political arguments,” said Ray Dalio, founder of Bridgewater Associates, the large hedge fund company.
Many economists believe that for now the U.S. can manage the surge in government borrowing, in part because the Fed is likely to buy a lot of the debt itself.
The U.S. Treasury funds government deficits by issuing Treasury bonds. In normal times the Fed isn’t a player in the Treasury market, but after the 2007-09 financial crisis it started buying government bonds itself. Its “quantitative easing” program was meant to hold down interest rates to help the recovery by reducing the supply of Treasury securities in public hands.
With the Fed’s abrupt restart of bond buying, government debt held by the public actually went down in March, according to Louis Crandall, an economist at Wall Street bond broker TP ICAP. He sees the Fed’s overall portfolio reaching $10 trillion by year-end.
In theory, large scale purchases of government bonds by the Fed should cause inflation, because it involves pumping money into the financial system in exchange for the securities. That money eventually finds its way to households whose purchases drive consumer prices higher.
Such price spikes did occur after World War I and World War II, and the U.S. could head for such a repeat.
But inflation didn’t budge during or after the Fed’s purchases in the 2007-09 crisis. Despite warnings by critics that the moves would destroy the purchasing power of dollars, inflation has remained below the Fed’s 2% target for most of a decade. Interest rates also stayed low.
Japan, the world’s third-largest economy, offers additional evidence that inflation might not surge. Japanese government debt is even larger than U.S. government debt, at two-times GDP. The
has been buying Japanese government bonds for years, but inflation there has been subdued throughout.
Many economists see a repeat of those patterns now. With inflation and interest rates expected to remain low, they see reason for the central bank and federal government to respond aggressively to lift the economy, even if it drives government budget deficits higher.
“The much greater danger on the part of governments is that they may choose to under-respond rather than over-respond, based on a notion of fiscal rectitude that’s carried over from a generation or two ago,” said David Wilcox, the Fed’s former chief economist.
As long as the economic growth rate returns to a level higher than the interest rate, government debt is manageable, some economists argue.
As in Japan, the Fed was fighting deflationary headwinds before the health crisis, stemming from an aging population that sapped consumption, and increased saving that tamped down inflation.
The pandemic might amplify these trends. Mr. Taylor, the University of California economic historian, said interest rates tended to remain low for years after past pandemics as businesses and households saved to rebuild lost wealth.
Households pared back their mortgage debt after the 2007-09 crisis, slowing the recovery while they rebuilt their savings. Individual borrowing shows signs of rising now as some households look for funds to ride out the economic storm.
Better.com, an online lender, says it has seen a 500% increase so far this year in applications by households for mortgage refinancing that involves taking cash out of the equity held in homes. Fed data show a modest pickup in household borrowing from bank home equity lines in March after an extended decline following the 2007-09 crisis.
Student debt has become a heavier burden for households, and since 2007 it has tripled to $1.5 trillion, with large exposures among young individuals, according to Fed data.
“We were talking about, when this is over, we want to downsize, maybe move into a townhome, being way more conservative in terms of major purchases and spending and start building savings,” Heather Schmiege, 41 years old, said of a conversation she recently had with her husband.
Both have student loans, in addition to a mortgage and two car payments. The Tallahassee couple makes enough with two jobs to cover the bills with a bit left over, but the crisis and recent Florida hurricanes have made them wary of risk.
Congress, concerned that delinquencies could rise if unemployment skyrockets—as happened after the last economic downturn—granted a reprieve for student-loan borrowers as part of the recent economic-rescue package.
The law will allow most of the 43 million Americans with federal student loans to suspend their monthly payments, interest free, for six months. Since the federal government is the nation’s primary student lender, the program effectively shifts the student debt fallout from the crisis to Washington.
Business debt was high and rising before the crisis, as firms took advantage of low interest rates and steady growth. Now debt is increasing as firms scramble for funds to keep themselves running while profits evaporate.
Issuance of investment grade corporate bonds reached $194 billion in March, $138 billion more than the month before, according to Dealogic.
The boom in bond issues contrasts with the 2007-09 crisis, when credit dried up. In the month after Lehman Brothers collapsed in September, 2008, for example, investment grade bond issuance fell 72%, according to
Businesses are also tapping bank credit lines. In the weeks between March 11 and March 25, bank commercial industrial loans rose $365 billion, according to Fed data.
Mark Kiesel, chief investment officer of Pimco, the large bond investment firm, said he expects many companies to respond to all of this borrowing by investing modestly after the crisis ends and paring back dividends and share buybacks.
“Priority number one is going to be to pay down debt,” he said. “We are not expecting a V-shaped recovery. We are expecting a U-shaped recovery.”
Debt is already proving to be a dividing line for firms racing to adjust to the crisis, and a crucial factor in a competition of survival of the fittest. Companies that came into the crisis highly indebted will have a harder time continuing.
That line is especially stark in the energy sector, which is being pummeled by falling oil prices. Many U.S. oil drillers face pressure to meet hefty debt obligations they took out from banks and bondholders to make America into the world’s largest oil and gas producer. One of them,
Whiting Petroleum Corp.,
filed for bankruptcy protection in late March.
“People will want to get into bankruptcy quickly in order to beat the rush,” said Buddy Clark, a partner and co-chair of energy practice group at Haynes & Boone.
Occidental Petroleum Corp.
took on tens of billions in debt to buy Anadarko Petroleum Corp. last year, leaving its cash flows tied up servicing bonds and loans. Its share price is down around 60% since Feb. 1. Two bigger competitors with cleaner balance sheets,
Exxon Mobil Corp.,
have seen much smaller share price declines.
The Fed, some analysts note, could amplify the debt divide, because it is opening credit programs to borrowers with investment grade credit ratings and just below that level, but not others with junk bond ratings.
“If you emerge from this, you will emerge to a landscape where a lot of your competitors have disappeared,” Mr. El-Erian said.
—Josh Mitchell and Rebecca Elliott contributed to this article.
Write to Jon Hilsenrath at [email protected]
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