Axios Markets: The world's growing solvency crisis

1 big thing: A growing corporate solvency crisis | Monday, December 14, 2020

Open in app View in browser   Presented By Goldman Sachs   Axios Markets By Dion Rabouin ·Dec 14, 2020 😿 Sorry about the late send! The Group of 30 report on this looming solvency crisis was embargoed until 9am ET today and it felt important enough to delay the send of Markets. Was this email forwarded to you? Sign up here. (Today's Smart Brevity count: 1,300 words, 5 minutes.) 🎙"That which neither weapon nor flame could accomplish will be achieved by a sweet speaking tongue in council." Catch up quick: A bipartisan group of lawmakers is expected to unveil a $908 billion coronavirus relief proposal that will be broken into two pieces, splitting the contentious issues of state and local aid and liability shields off from a larger package that covers less controversial proposals. (Bloomberg) The EU and U.K. agreed on Sunday to continue Brexit talks with no deadline after a telephone call between U.K. prime minister Boris Johnson and European Commission president Ursula von der Leyen. (The Times) TCF Bank will merge with Huntington in a $22 billion deal creating one of the 10 largest regional banks in the country. (Detroit News) After big pops for Airbnb and Doordash in their IPO days, gaming company Roblox and payments company Affirm have delayed their IPOs, with Roblox citing the market moves. (N.Y. Times)     1 big thing: A growing corporate solvency crisis Illustration: Eniola Odetunde/Axios   Around the world companies are increasingly at risk of failure and the size of the problem is growing. That's the message being delivered by two of the world's most respected monetary authorities — former European Central Bank president Mario Draghi and former Bank of India governor Raghuram Rajan — and a flurry of other top economists. What's happening: "There is a growing corporate solvency crisis in most of the world, as balance sheets are hit hard by losses and the resulting need to pile up debt," co-chairs Draghi and Rajan, along with a group of economists, academics and central bankers that includes former chair of the Council of Economic Advisers Jason Furman and People's Bank of China governor Yi Gang, wrote in a report for the Group of 30 (G30). "In addition, many companies entered the coronavirus recession with unusually high levels of leverage." Between the lines: Further, the actions taken by central banks and governments in response to the coronavirus pandemic are masking the true state of the economy — a disguise that cannot last forever. What we're hearing: While central banks could continue to pump money through the financial system for a long time, businesses can't survive on liquidity alone, Draghi told Axios during a meeting with reporters Friday. "You can do a certain amount of what's called evergreening but after a while the corporation will remain unviable no matter how big is the liquidity support." "At this point in time the next issue we've got to be worried about is a surge in nonperforming loans all over the banking system in most parts of the world." One level deeper: Unlike central bank support, which will be in place for quite some time, the massive fiscal support packages from governments will have to come to an end, Rajan told Axios during the meeting. At that point, businesses will start failing and questions will need to be answered about not just the firms that go under, but about the firms that are connected to them, as well as banks and individuals. The bottom line: "We're not yet out of the pandemic but we should start preparing for what comes next," Rajan said. "And what comes next are the consequences of the tremendous amount of support that we have in place."     2. A crisis with no end in sight Illustration: Eniola Odetunde/Axios   Draghi, who famously said the ECB would do "whatever it takes" to support the eurozone economy back in 2012, believes central banks have no alternative but to continue to keep rates low and keep printing incredible amounts of money. "Support, in my view, will continue for quite a long time," he told Axios during the Friday meeting. The big picture: "Originally, some people said this is going to be a V-shaped recession. This is not a V-shaped recession, this is a long recession." The big question: "For fiscal authorities almost everywhere ... we are in a period of time where new [spending] programs succeed old programs without any break, and bigger and bigger numbers come every day." "The main issue is how do you design these programs, how well do you spend this money because ultimately growth will depend on that. In many countries, only on that."     3. A growing debt crisis Data: Institute of International Finance; Chart: Danielle Alberti/Axios A major issue that will complicate any potential recovery is the extreme level of debt corporations and governments around the world have built up, much of it predating the pandemic. By the numbers: To dig themselves out of the hole COVID-19 created, governments and corporations have added significantly to their already heavy debt loads. The Institute of International Finance reported last month that as of the third quarter this year global debt had reached 364% of the world's GDP, having climbed by 30 percentage points between Q1 and Q2 this year. Global debt was 210% of global GDP as recently as 2015. Keep it 💯: "The wrong answer is to turn a blind eye to this," Rajan said. "We know from the experience in places like Japan after their bubble burst that the sooner you fix the problem the more you get back to strong, sustained growth." "And if you don't, the problem just gets bigger." Yes, but: In addition to being an issue that governments have ignored over the past decade — and especially the past four years — it is virtually impossible to know the size of the problem because "it's been disguised a lot by the extensive support that's in place," Rajan added. "But we will see the extent of corporate distress when we come out [of the pandemic]." Why you'll hear about this again: "Many firms have used existing cash buffers to soften the drop in demand," the G30 report noted. "However, many studies have found that the strain of continued lockdowns will quickly exhaust cash buffers for many firms." "A Bank for International Settlements (BIS) study estimated that if 2020 revenues fall by 25 percent and firms are not able to roll over debt, cash buffers and revenues will be exceeded by debt service and operating costs in more than half of the sampled corporates across 26 countries."     A message from Goldman Sachs How COVID-19 accelerated ESG     Soros Fund Management's Dawn Fitzpatrick joins Goldman Sachs' Insights from Great Investors to discuss how the pandemic has shaped her investment outlook and why it has accelerated the focus on ESG. Find out what she had to say on what makes a successful investor.     4. A growing zombie crisis Reproduced from BofA Global Research; Note: Banks included are Federal Reserve, European Central Bank, Bank of Japan, Bank of England, Bank of Canada and Reserve Bank of Australia; Chart: Axios Visuals Fears are mounting that the massive growth in debt and the current policy environment — described as "monetary policymaking on steroids," by Michael Arone, chief investment strategist for State Street Global Advisors, earlier this year — could be producing a new global wave of "zombie firms," the G30 report warned. What it means: "The term 'zombie firms' was coined to refer to firms propped up by Japanese banks during Japan's so-called 'Lost Decade,' following the collapse in 2001 of the Japanese asset price bubble," according to the report. "Multiple studies suggest these firms contributed to Japan's economic stagnation by distorting market competition and depressing profits and investments in healthy firms." Why it matters: "[O]verburdening of the corporate sector with debt in the response to Covid-19 could create a new wave of zombie firms, with harmful consequences for the prospects of economic recovery." "As interest rates stay low and governments continue to support struggling firms, the risk of zombie firms increases." Don't sleep: We may already be seeing this happen. The G30 report comes on the heels of the BIS' latest quarterly review, which noted that a "divergence in the assessments of corporate vulnerabilities may be emerging." The review pointed out that while equity prices were reaching record highs and credit spreads had compressed, banks have significantly tightened their standards and cut back lending. Investors' search for yield and central banks' gargantuan easing programs "appeared to underpin these contrasting developments." The bottom line: The G30 report quoted Piyush Gupta, CEO of Singapore-based DBS bank, who expects the issue of zombie firms to be a particular challenge among small and midsized businesses. He predicts a wave of defaults that will add pressure to the financial sector. Policymakers will soon need to ask themselves a serious question, he says: "Do you keep...using public finances to support companies or do you let creative destruction happen?"     5. A growing disconnection crisis Data: Dealogic. Chart: Danielle Alberti/Axios Giant Wall Street firms are getting lots of the riches from this year's monster stock offerings like Thursday's IPO by Airbnb, Axios' Felix Salmon reports. An analysis by Dealogic for Axios found that IPO investors have made more than $50 billion so far this year, just by being allocated stocks and holding on to them for a single day. That's a new annual record, and the year's not over yet. Case in point: On Wednesday night, Airbnb sold 51,323,531 shares at $68 each to some of the biggest and most powerful investors in the world. The total amount paid for those shares: $3.5 billion. By the close of trade on Thursday, those shares were worth $7.4 billion, representing an overnight profit of $3.9 billion for institutional investors. The bottom line: Repeat that story across almost 200 other IPOs this year, and windfall profits end up totaling $51 billion. That's a larger profit than is made by any company in America, except for Berkshire Hathaway and Apple.     A message from Goldman Sachs What's on the minds of some of the world's great investors?     Each week, Goldman Sachs brings viewers an interview with leading private and public investors. Why it's important: Some of the world's greatest investors will provide insight on their investing philosophies and how they are approaching the new investing landscape. Explore their insights.   Thanks for reading! Quote: "That which neither weapon nor flame could accomplish will be achieved by a sweet speaking tongue in council." Why it matters: On Dec. 14, 1503, French apothecary and reputed "seer" Michel de Nostredame, better known as Nostradamus, was born. He is best known for his book "Les Prophéties," the first edition of which appeared in 1555.   Axios thanks our partners for supporting our newsletters. Sponsorship has no influence on editorial content. Axios, 3100 Clarendon B‌lvd, Suite 1300, Arlington VA 22201   You received this email because you signed up for newsletters from Axios. Change your preferences or unsubscribe here.   Was this email forwarded to you? Sign up now to get Axios in your inbox.   Follow Axios on social media: