No, Corporate Debt Will Not Cripple America

While I often find interesting threads on Twitter/X, I am also in a constant state of annoyance due to completely false ideas that often take off as themes. One of these recent false-idea-turned-theme has to do with increasing rates to 5.25% will result in the End of Corporate America and crash the economy because mass numbers of companies will have to refinance their debt. 

It’s typically accompanied by this chart showing a jump in issuance starting in 2020. Pundits typically then suggest given that corporate debt is 5 years and most refinance this debt as year 4 approaches, the end is near. 

This is sheer and utter nonsense. Let’s talk about all the logical flaws of this argument. 

The first and biggest flaw in the argument: Corporations took out this debt and should not have.

Here is the long term chart on corporate yields, relevant as a proxy to the rates that borrows were conducted at. From 2020 until about the middle of 2022, you had all-time low yields, and essentially, all-time low “cost of capital” for corporations.

During this period you paid almost nothing to take out 5-year debt, often less than 2%. All you had to do was deploy the money in activities that yielded at least 2.5% and you would come out ahead (and if you couldn’t do that, you likely had bigger problems).

Now let’s talk about the second flaw in the argument: This debt is a problem for the corporations because of its size. 

This is wrong for two reasons. 

First, it presumes that the companies took out bad debt and did not grow. There is little to support this. Here is a chart of debt as a % of market value and we can see clearly it is lower from 2020-2022 than previous historical periods. 

Second it ignores the most central concept of corporate debt, i.e. did debt-financed investments end up making money above the cost of capital? Current money market rates are over 5%. Even if the CFO did absolutely nothing with the debt since taking it out around 2.5%, you’d have a spread of 2.5% gain!

The final flaw with the argument is the assertion that companies will have to roll the debt forward. To that, I ask the simple question, why? They could pay it back, take out less, or simply pass on the costs to customers. 

There is simply little to no evidence to support a mass wave of defaults or a liquidity crunch for the vast majority of corporations, except in specific industries like commercial real estate (though the issues facing CRE are more multi-faceted than just higher interest rates).