At Financial Sense economist Norman Mogil provides some explanations for why companies are taking on debt:
- Profits are inadequate to fund capital expenditures
- Pressure to increase dividends.
- Rising operating costs.
- Corporate stock buy-backs.
There’s another explanation I’m surprised he doesn’t submit. It may be that for large companies with international operations money is stranded, i.e. they may have money overseas but don’t want to bring it to the United States where it will be taxed again and at a higher rate.
Additionally, low interest rates make taking on debt more attractive. In other words, the Fed’s strategy is working.
The owners of the companies may be surprised to hear that some consultant has decided what they should do with their financial affairs, scolding them for not investing. I remember when I was in business school and exactly the opposite issue was in vogue. Corporate managers were criticized for “empire building” when they didn’t have worthy places to invest in the business, but did, and failed to return capital to owners. What should they be investing in now? Maybe Mr Mogil should open up his own wallet and show the way. But I digress.
You knew this guy had an ax to grind when he told us corporations “have been on a debt tear” while “consumers have been wary” even though the two lines are essentially parallel the last four years.
Worse, and pure sophistry, becomes apparent by looking at the numbers. (From Treasury Direct’s database) From 2000-2005, 2008-2013 and 2010-2015 government debt increased by pretty similar dollar amounts per year (maxing in the 2008-2010 range), but the denominators (the base amount of debt) increased from 2000-2005 to 2010-2015 by about 2x. That would halve the percentage growth rate right there.
Further, the elephant in the room is the much, much bigger number (multiples bigger) of unfunded entitlements. A set of government programs, funded by taxes to be paid by government………for which they have not established sinking funds but largely spent the money away. Waive your hands and don’t call it government debt if you like, but economically its government debt. Probably soon to be increased by more Obamacare subsidies and Medicaid support.
To Mr. Mogil I say, “who ya crappin’?”
“You knew this guy had an ax to grind when he told us corporations “have been on a debt tear†while “consumers have been wary†even though the two lines are essentially parallel the last four years.”
They start at the same baseline and business debt ends up at least twice as large. I don’t think parallel means what you think it means. It is interesting that corporations are taking on debt while not investing. Wonder where all of the money is going? The Fed’s plan is clearly not working.
Steve
I’m most familiar with Google’s decision to start issuing bonds in 2011, and the stranded cash hypothesis was a huge part of it: Google had (and still had) oodles of cash, but most of their cash is tied up in tax-advantaged overseas subsidiaries. Borrowing against stranded cash in order to raise domestic cash gives them the ability to spend money freely on acquisitions and large-scale capital projects (mostly buying land and building offices and datacenters) while continuing to wait for a more favorable tax environment to repatriate their stranded cash.
Another factor is that Google’s cash isn’t literally cash — Google’s finance division contains a fairly sophisticated “cash management” department, which is practically a private bank. Google’s huge cash-equivalent position, positive cash flow, and (even with the newly-issued bonds) very low leverage ratio makes their bonds a very safe investment, so they can lock in very low interest rates on medium-term bonds and invest the money profitably in moderately-risky financial positions. In part, this is regulatory arbitrage: there are many financial institutions which are required to invest much of their assets in “safe” investments (which have artificially-low interest rates because of this requirement), as which Google bonds qualify, while Google makes the riskier investments the banks would make if they were allowed to and takes a middleman’s profit on the deal.