Since the Great Recession in 2008, the economic growth of companies in America has taken a turn and corporate debt levels higher than ever. You may ask, “Why should we be worried if companies have debt? It’s not my debt to worry about.” The economy is built on the profitability of both businesses and individuals. If one is doing well and the other is not the economy will be negatively affected.
To help boost the economy after the Great Recession in 2008, the Federal Treasury made it easier for corporations to borrow money by lowering interest rates and reduced the rates on bonds to the lowest in history. This allowed companies to borrow funds for less and they were also able to qualify for loans much more easily than before. This was done to boost the economy and help businesses spend more to make more.
How is all this measured?
Since the Great Recession, the level of corporate debt has gone up to about 50% of the overall debt in America according the Gross Domestic Product (GDP.) GDP measures the value of economic activity in a country, by measuring the values of services and products sold in that country.
What is the concern?
Although it was an important step to allow companies to take out more loans in order to allow them to build and help grow the economy, a large concern is how the funds are being used and if they are being applied in a way that is positive for economic growth. Many companies are turning to stock buybacks rather than purchases for capital expenditures.
What is the difference between stock buybacks and purchases for capital expenditures?
This happens when companies buy their stock shares back from investors. Although this does free up spending money for the corporation, it also heavily benefits the stockholders rather than the profits going directly to the growth of the company. The remaining stockholders will then own a larger portion of the company and therefore profit more from future business.
Purchase for capital expenditure:
This is future planning for the company’s growth. It is used for major purchases that extend into the future accounting periods, rather than just the current one, short-term cost for long-term benefit.
What happens if interest rates go up?
The biggest risk for companies taking advantage of low interest rates and easier access to funds, have variable interest rates on their loans. They are making payments on their loans now for what they budgeted to pay, but if the interest rates go up for any reason they may not be able to make the payments. If too many companies with high-risk loans can’t make payments and loose their collateral, it will have a negative affect on the economy long term.
So what is the overall main concern for the economy long-term?
The main concerns for the economy overall are:
The debt levels themselves, companies debt levels are breaking records and many feel it will be too much for them to handle over time.
Varying interest rates: If they rates go up, many companies will not be able to pay and it will hurt business and the economy.
What type of borrowing are companies doing, and how are they using the funds? Is it beneficial or detrimental to the economy?