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Non-Financial Firms Borrowing Surged During COVID-19 Shock

August 18, 2020 By Mircea Vasiu

Years from now, when the business cycle has changed, and economic growth picks up consistently, we can sit back and analyze how the policymakers reacted to the health crisis. Innovations are everywhere.

From the joint debt issuance in the European Union to the American Congress sending people checks – all taboos have been broken. Just like in ESG considerations, where the stakeholders’ interests expand the shareholders’ ones, central bankers expanded their role and the meaning of fulfilling their mandate.

Businesses Loading Up on Debt

Debt is viewed from different perspectives by financial market participants and households in general. For instance, businesses issue debt to expand their assets base, despite the fact that they do not actually need to issue debt. Apple is the best example – it sits on piles of cash, yet it issues debt and loads up on cheap loans.

On the other side of the story, households are often told by financial advisors to stay away from debt as much as possible. However that has its role in building wealth – if managed correctly, it brings leverage.

The fact that borrowing in debt markets had boomed relates to the ultra-cheap conditions available. Businesses look beyond the current business cycle and prepare for the next decade or even more. As such, low interest rates act as a reason behind the fixed-income market’s debt issuance. After all, companies rearrange their long-term cost of debt by taking advantage of the environment created by central banks.

However, if debt is used in non-productive ways, it will end up seen as bad debt. In time, it will affect a company’s profitability as higher cost of debt leads to higher weighted average cost of capital.

The previous Fed press conference explained it perfectly. The Fed (and other central banks in the world) cannot send people checks. That is something for the government to do – the central bank sticks to its role as the government’s banker. But the central bank can increase its lending abilities. For instance, by lowering the eligible conditions for granting a loan, more businesses have access to finances.

This is exactly what sets this crisis apart from others. Previously rejected projects suddenly have access to funds. The only job of a business is to not appear as a going concern for investors. Once that aside, the crisis offers big opportunities for those willing to take some risk.