Bailout: No Money for “Junk” Debt-Laden Businesses?

Companies who have massive, unsustainable debt burdens will not qualify for bailout money.

Indeed, the Federal Reserve believes that its $4 trillion loan program should be reserved for companies with “safe” credit ratings.

Lobbyists are actively trying to convince the Fed and the Treasury Department to reconsider their position and avoid what they predict will be a wave of corporate defaults. With retailers in several states ordered to close, cash flows are drying up and the threat of bankruptcy is looming.

It is estimated that over half of the companies who borrow through the corporate bond markets don’t quality for Fed help because they are not “investment-grade” classified. To classify as investment-grade, a company needs a Standard & Poor’s credit-rating of ‘BBB’ or higher. If a company is rated ‘BB’ or lower, then it is classified as junk due to a high risk of default.

The Fed’s position is that it should not bail out companies doomed for bankruptcy due to bad management. Rather, it sees the emergency fund as way to guarantee a backstop to private lending markets.

The issue is that the economy is creeping towards a recession and more and more companies’ credit rating will get cut, which will make it even more difficult for them to receive funding. Since the economic outlook is bleak, is is estimated that almost 50% of investment-grade companies’ could see their debt status downgraded to junk level. This means that currently solvent companies will not be able to secure funding based on the assumption that they may encounter financial difficulties in a few months.

As I write, lobbyists are pulling all the stops to ensure that their respective industries are included in the bailout. Given the Fed’s current position, corporations with poor credit ratings are extremely concerned about being excluded from the deal altogether.

Thus, major corporations – including households names of American industry – are at risk of not receiving anything at all: Gap and Macy’s, two companies in structural decline with long-standing debt problems, may be cut from the eligibility list, along with many others.

Their only hope is that the Treasury and Fed agree to expand the scope of the emergency lending to corporations with sub-par credit ratings.

Allegedly, the Fed is willing to accept a compromise: Businesses with poor credit can receive bailout money but the worse the credit rating of the business, the more money the Treasury provides to mitigate the risk.

The credit rating agencies are also facing a serious conundrum: Should they downgrade companies based on temporary circumstances? If the crisis is resolved quickly then business will return to normal; is it fair to jeopardize a business’ future based on this assumption? Or should they ignore the hypothetical “return to normal” scenarios and rate the companies based on the current situation, available data and corresponding risk?

In any case, the deeper question is would the really bailout money help distressed business with long-standing issues? Some companies have been facing structural decline for years and the bailout would only provide temporary relief. JCPenney, for example, is in serious decline. Would a bailout magically reinvent their business model and allow them to compete with modern innovative retailers? This seems highly unlikely.

The reason why the Federal Reserve is being so cautious is because it is preparing to navigate uncharted territory: In addition to making credit available through banks, it has also announced its intention of directly purchase corporate debt. Businesses who wish to benefit from the emergency program must register and pay a fee.

However, this increased Fed interventionism is setting a new precedent. Historically, the Fed’s role has been limited to printing money in order to keep it flowing in the economy. It is not supposed to engage in fiscal stimulus and decide which specific industries and companies to bail out. Traditionally, that is the role of Congress and the Treasury.

However, Congress is expressly asking the Fed to fulfill this role and the Fed is, understandably, unwilling to take on too much risk.

Ultimately, the extent to which the Fed and Treasury extend their emergency program will depend on the severity of the crisis. For now, it is difficult to predict what will happen in the next few weeks.

The only certainty is that businesses are in trouble and need help urgently. If the Fed and Treasury get it wrong and fail to provide sufficient stimulus, the U.S. will enter a severe recession and we could see Mnuchin’s prediction of 20% unemployment – or even worse the Fed’s own estimate of 30% unemployment – become a reality in the coming months.

Let’s hope they get it right.

Like this article to show your appreciation.
Follow me to be informed of my latest publications.
Comment below to start the conversation.

Leave a Reply

Your email address will not be published. Required fields are marked *