Expert Commentary

Debt-Deflation Double-Down

Corporate bankruptcies are set to soar as companies double-down on debt.

The Altman Z-score is a formula devised in 1968 by Edward Altman, who was an Assistant Professor of Finance at New York University. The Z-score uses multiple corporate income and balance sheet values to measure the financial health of a company, and it is used to predict the probability of bankruptcy and debt default. That same Edward Altman is now Professor Emeritus at NYU’s Stern School of Business and, according to a Bloomberg report, he is warning that insolvencies in the U.S. are going to explode.

Altman is concerned at the level of new corporate debt issuance since March, which “kicks the can down the road” for many companies simply hoping that the economy and their circumstances will improve. Global corporate debt issuance this year is over $2 trillion, half of that coming from U.S. borrowers. It’s all part of the dash for cash that comes when deflation starts, except in this case it’s borrowed cash used to pay off short-term loans that were drawn in March and April. These companies are simply playing Russian roulette with debt now, praying that the loaded chamber doesn’t stop at their head.

As the chart below shows, non-financial corporate debt as a percentage of Gross Domestic Product was already at record highs in the first quarter this year, and this measurement should rise further as the economy contracts. Indeed, this is the same dynamic that occurred in Japan as its debt bubble burst in the early 1990s. Private sector debt as a percentage of GDP initially went up, before the decades-long debt-deflation (which is still happening) took hold.

Altman is aghast at companies not de-leveraging debt and, instead, doing the opposite. Bloomberg quotes him as stating, “When there is an increase in insolvency risk, what you do not need is more debt. You need less debt.” We couldn’t agree more, but we recognize this for what it is – the final, desperate, overdose shot in the arm for a debt-addicted corporate culture. Comatose beckons.

U.S. Non-Financial Coporate Debt Percent of GDP