Fed Economists Warn of Debt Overhang Problem From Covid Crisis

The Covid-19 crisis could be worse than the Great Recession for companies that had high levels of indebtedness at the start of the outbreak, according to economists at the Federal Reserve Bank of New York.

Firms in industries most affected by the pandemic such as tourism, travel and hospitality could grow as much as 10% more slowly than in ordinary times if the current crisis plays out in a similar way to the economic decline of 2007 to 2009,Kristian Blickle andJoão Santos wrote in ablog post on Tuesday.

Research from the two economists shows that companies with higher levels of debt experienced 3% slower growth during the Great Recession compared to less-indebted peers. The gap between the two groups is closer to 2% in normal conditions.

The sharper contraction in growth that could materialize during the Covid-19 crisis is due to the combined effect of record levels of corporate indebtedness at the outset of the pandemic and the sharp revenue declines during the course of 2020, the economists said.

“The Covid-19 outbreak has the potential to have an even bigger effect on the economy through the channel of debt overhang than what we identified in the Great Recession,” they wrote.

Many of America’s most iconic companies — from Boeing Co., Carnival Corp. and Delta Air Lines Inc. to Exxon Mobil Corp. and Macy’s Inc. — aren’t earning enough to cover their interest expenses after borrowing billions of dollars over the past few months to help get them through the coronavirus, according to a Bloomberg analysis.

Read more: America’s zombie companies have racked up $1.4 trillion of debt

Large debt loads can hamper the ability of companies to borrow more to finance worthwhile investments, a problem economists call debt overhang.

Fragmented ownership of corporate debt may further increase the cost of the debt overhang during the fallout from the virus, while small companies that are over-levered may find it more difficult to take advantage of the bankruptcy process to ease their debt burden, the economists said.

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