How Bad Can It Still Get: Credit Risk, Debt Overhang, and the COVID-19 Recession

This episode of Dead Talks, hosted by Mort Schillerick, brings together experts Megan Greene, Joran Marsh, and Anatol Kaletsky to discuss the pressing question of "How Bad Can It Still Get" regarding credit risk, debt overhang, and the economic fallout from the COVID-19 recession. The panelists explore whether economies are "out of the woods" yet, focusing on the corporate debt market, policy responses, and the broader economic outlook. A central theme is the dependence of the economic trajectory on the path of the virus, with economists acknowledging their inability to predict its course.

The discussion highlights several key distinctions and nuances. Megan Greene emphasizes the difference between liquidity issues, which central banks can address through massive interventions like bond-buying programs, and solvency issues, which monetary policy cannot resolve. Joran Marsh provides data on corporate balance sheets, noting high but not abnormally high leverage, and firm outlooks from CFO surveys, which show product demand as a top concern, not access to credit. Anatol Kaletsky introduces the concept of unprecedented collapse met by unprecedented stimulus, creating a complex predictive environment where past correlations are less useful. He also distinguishes between short-term (collapse prevails), medium-term (stimulus prevails), and long-term horizons (potential for regime change).

Practical insights and recommendations emerge regarding the crucial role of sustained fiscal and monetary policy support. The panelists debate the risk of premature withdrawal of fiscal stimulus, with Megan Greene expressing concern based on U.S. political dynamics and Anatol Kaletsky suggesting that policymakers might have learned from the 2009-10 experience, leading to a more sustained approach. The potential for "creative destruction" versus the risk of "zombie companies" being kept afloat by stimulus is also discussed, highlighting the challenge of sectoral reallocation and asset specificity in a changing economic landscape.

Broader implications include the potential for a "regime change" in global economic policy, moving towards more positive fiscal and monetary expansion, which could lead to either stagflation (like the late 60s/early 70s) or a period of gradual inflation combined with stronger economic activity (like the 50s/early 60s). The sustainability of government debt, the impact of work-from-home trends, accelerated inequality, and the incentives for automation are also considered as long-term consequences of the pandemic and policy responses. The overall sentiment, while cautious, leans towards a belief that a massive financial crisis is unlikely in the short to medium term due to robust policy support, though structural adjustments and the long-term debt overhang remain concerns.

"how bad can it still get credit risk debt overhang and the covet 19 recession"

"are we out of the woods yet or how bad can it still get"

"it actually depends and it depends mainly on the virus which as an economist i can't actually predict"

"central banks are really good at stepping in and addressing a liquidity issue they can't really do anything about a solvency issue"

"I don't think we're going to have a massive financial crisis I think that's very unlikely because policy will be so supportive"

"the situation will be epidemic dependent"

"the most pressing concern that firms have which you can see from the last slide is again understandably product demand and access to credit is actually somewhat low on the list of priorities and the list of concerns"

"what matters is the debt servicing costs and as megan said the debt service and costs have actually come down rather than up because of the easing of monetary policy around the world"

"we have an unprecedented collapse in economic activity much deeper than anything we've ever seen before on the other hand we have an unprecedented monetary and fiscal stimulus much greater than we've seen before"

"this is not a liquidity problem monetary policy can deal with liquidity problems it can't deal with solvency problems but actually fiscal policy can deal with with solvency problems"

"what we are seeing around the world is a regime change and we are potentially on the brink of a new policy environment"

"if you're keeping all these zombie companies afloat then that means that you know they're not moving into new areas you're keeping workers attached to jobs and industries that are just never coming back and that's pernicious for growth going forward as well"