In the 80s, we were borrowing money for mortgages (secured by houses with tenants and 20% downpayments) at rates over 15%.
I don’t find yields over 10% given the current economic climate to be unreasonable or evidence of “desperation” on the part of sellers. I would probably find rates of under 10% as evidence of desperation on the part of buyers...
Real interest rate depends on inflation which is an invented phenomenon of the 20th century. Inflation wasn't relevant in the preceding century and might not be relevant in 21st century either.
At least not in the current form it is measure as a CPI while ignoring asset price inflation in real estate and stock markets.
Whether that is a bug or feature remains to be seen, but for most people a psychological effect of large inflation has been present at least since the last big ceisia in 2008. Banks keep flooding the economy with new QE money and asset prices and rent payments keep increasing. Many people are not able to afford housing and birth rates plummet for not being able to have stability necessary to raise a family.
Whether somebody adds a patch to the inflation theory such as the concept of Biflation (inflation in asset prices, deflation in cheap goods manufactured by robots and imported from China at the same time) or throws thr concept of inflation out of the window completely is the question for economists for this century.
> while ignoring asset price inflation in real estate and stock markets.
Do you have any data to back this up? Some quick math shows annualized S&P 500 Return with dividends reinvested from april 2010 to april 2020 are 9.694% [0] which is entirely in line with historical returns [1]. Housing price per square foot hasn't really changed for most people either [2].
Your premise is quickly disprovable with reference to historical inflation data from many countries. Maybe try the Bank of England, they have data that goes back a ways.
OTOH perhaps we should give the author of The Wealth of Nations more credit for having anticipated the phenomenon of inflation back in 1776.
Well, the economy is deflating fast, which means the riskfree rate is in the toilet. The current 10% is equivalent to closer to 30%-35% in the early 80s.
The fact that the economy is "pretty bad" doesn't necessarily imply that all rates should be low or high. They can be either very high (inflation) or very low (deflation), and both are not good signs.
I don't know about the 30%-35% number exactly, but the idea they're getting at is what is the "real" interest rate. Interest rates are all relative. If you can take a loan out at a 15% interest rate is that bad? Well if a bank is offering you a savings rate of 20% - congratulations you just made a lot of money.
Take a look at the T-bill rates in the 80s. To straight-faced say "I'm not concerned about these rates," and make a comparison to interest rates in the 80s is ignorant at best. There was an intentional effort by the government to raise rates in order to fight inflation. We are so far removed from the interest rate environment of the 80s...
Real interest rate are ususally defined as Nominal Rate-Inflation, so with inflation at virtually zero, the real rate is 10% for them. To be 35% we would need deflation of roughly that much. Though a 10% real rate is bad enough.
My dad built our house in 1971 and the rate for his mortgage was 6% but less than ten years later it was 21.25%, crazy! Even the 6% was a stretch he has to join a co-op. It was kind of like an early Habitat for Humanity but your group did it all yourself.
Companies were over-leveraged and didn't have cash stockpiles. They're trying to get liquid cash so they don't have to divest of assets in a market that isn't buying or go into chapter 11.
All the same, people are willing to extend loans because they are long on the economy, recovery, and return to normalcy. The engines are starting again.
The biggest issue was that companies were over-leveraged with debt. Maybe we'll learn a lesson from this, although I suspect opportunity cost will prevent many from being more prudent.
To play devil's advocate, how are companies over-leveraged during an environment of such low interest rates? Companies will optimize their capital structure for the lowest cost of capital, and if the cost of debt decreases, companies should rationally leverage accordingly.
That's why we see Apple issuing $8B of debt (at ~135bps over 30 year Treasury bonds!) despite having over $200B of cash on hand. If your hurdle rate is 2.5%, surely your profitable business can return more to shareholders than that, so you should binge on this capital source? (Or even, as Apple claims it will do, distribute this directly to shareholders via buybacks & dividends.)
Also, I would qualify your statement that people are not necessarily long the economy in the short-term, which is where credit markets have miraculously thawed; they're long the fact that they will undoubtedly be able to get credit from yet someone else (namely, the lender of last resort).
Apple’s move is more about tax optimization. Yes they have all this cash but it’s sitting in accounts all around the globe. They’d have to pay hefty taxes to repatriate it and then pay it out as dividends. It’s “cheaper” for them and better for shareholders to take out a loan (bond) in the US and then take that cash and give it to shareholders than it is to bring the money from around the world into the US and pay it to shareholders.
This is why Apple keeps asking for a “tax holiday” to bring all this money back home to the US.
GP said "leveraged and didn't have cash stockpiles". Your example of Apple may fit the first criteria, but not the second.
And this is exactly why you should have a cash stockpile, either as a company or an individual: You can never tell when a random event will completely wipe out your earnings for 6 months.
I'm no corporate financier, but I've certainly heard arguments in favor of borrowing money during times of low interest rates in order to have a cash stockpile. But borrowing to do stock bybacks when you don't have a stockpile is just skating further out onto thinner and thinner ice.
If you're creating the cash buffer as a way to stay afloat during hard times, that's a bad strategy, since the market for shares (including yours) will be weak precisely when you need the cash.
Yes, I agree with you. I am sure shareholders saw piles of cash and demanded: "better in our pocket than yours." (Carl Icahn famously tried this with Apple.)
Don't these yields suggest that people actually aren't willing to extend the loans which is why the yields are spiking. Double digit yields in a deflationary economy should indicate that these loans are being made with a high expectation of default.
It's loan to own! I did high yield Oil & Gas investment banking in the late 90's and a lot of investors had the thinking - Heads I get 12%, Tails I wind up owning a good chunk of the equity and the firm has limited debit.
The rental car market is strongly tied to the travel (both business and leisure) which has crashed. Why would it be surprising if a rental car company is in financial trouble?
No one, they dont even have enough parking for them to all be idle simultaneously. The airport rental agencies near me have been renting out all the stadium parking nearby to use as overflow storage.
On the capital side, one of the biggest assets for rental companies are their fleets. The sell them as used cars. With nobody buying cars at all and the glut of unsold new cars packing lots, those fleets are being revalued at much lower prices. It’s a double whammy.
Yeah, I saw on reddit last month a possible insurance scam in which 3500 rental cars caught fire in an overflow parking lot in florida because they are all sitting around unused [0].
The engines are always on, when prices/yields are allowed to appropriately reflect risk, without interference or intervention. One of the most important functions of an unobstructed free market is price discovery.
Bankruptcies or stock offerings at crisis prices would help too. For instance, the airline Norwegian just accepted 95% dilution of existing shareholders in order to qualify for a government emergency loan. If they'd refused this, they would have gone bankrupt.
Some shareholders were expecting a government bailout, and got a real beating. They're going to think twice about expecting a government bailout the next time.
I don't know that I see 95% dilution as totally reasonable terms for a bailout (though I know absolutely nothing about the details of that example), but making it clear that bailouts come with a cost seems like a good development ... so good on the Norwegian government for doing that.
Why do you consider that unreasonable, when the free-market option is bankruptcy? They got to keep 5%, rather than 0!
The terms of the emergency loan was a certain debt:equity ratio, so in order to qualify, their very high debt load had to be reduced.
This could be accomplished in any way the company desired, and it turned out that the only viable pathway was to allow bondholders to convert their loans to new shares at a favorable price. This led to a 95% dilution for existing shareholders.
If they hadn’t done this, proper bankruptcy would have been the next step.
I wonder why this mechanism (converting potentially derelict bonds into equity) isn't more widespread. In cases where the underlying company reasonably could be expected to continue operating were its debt ratio lowered, apart from legitimate resistance of bondholders expecting debt+interest payments why wouldn't this outcome be preferred to bankruptcy?
Well now that I know it was a binary choice, yes taking the 95% dilution seems like the best option without knowing anything else about that company's financials.
Nah, the Fed will bail them out. They are already holding a lot of corporate bond indexes and more will follow. We have a system now where companies were borrowing money at 0% to do buybacks to keep executive compensation rolling. This is one change that must happen. C-suite, VPs and board members should not be allowed to receive compensation based on stock price. It creates a perverse incentive. They should be building strong companies that allow them to stay employed. Give them bonuses based on growth or profits or whatever, just not stock price.
You are misunderstanding. The GP is not talking about you lending money, but about you borrowing it. As it stands if you borrow $1m and pay $50k in interest as you pay back the loan, that $50k is considered a business expense and reduces your tax liability.
Off the top of my head, two simple arguments why excluding interest from business expenses does not make sense, there probably are a bunch more:
1. Double taxation - if I my operating profit is $100 but I pay all $100 in interest, then that $100 gets taxed twice; when I receive it and when the lender receives it. Such double taxation is bad because it arbitrarily changes depending on where you put the "legal entity boundary" - if the "earner" and "lender" were a single entity, then they would pay much less taxes; so such a double taxation regime would result in large financial incentives towards vertical integration of conglomerates and artificially punish fragmented businesses, which is generally opposite from what we'd want to facilitate.
2. Introducing asymmetry between owning and renting assets. Rent is considered a business expense (if the proposal wants to change that as well, then it's a much bigger change with other considerations), so any current scenario where a company is borrowing money and using it to buy capital assets (buildings/cars/land/machinery/whatever) can be replaced with an equivalent deal where the "lender" is buying the assets and leasing them. If interest does not reduce taxable income but rent does, then a huge portion of commercial credit would be restructured overnight to leasing for an arbitrary artificial reason, so you would not really gain that much extra tax revenue but would introduce all kinds of bad economic incentives (it's generally better for all the business domain-specific assets such as custom machinery to be on the balance sheets of the companies where they're useful, not belonging to generic lenders, especially in various economic crisis situations) for no good reason.
If you want to tax companies more, just raise the tax rate. Adding various artificial rule differences just adds complexity and all kinds of perverse incentives to structure transactions in weird ways so that they fit the arbitrary distinctions created by these rules.
Saying "today, interest is a special kind of expense that's taxed more" is effectively a subsidy to law and accounting firms to restructure all the corporations so that they do the same business without having transactions that technically are "interest". Case in point, Islamic banking system where interest is prohibited as such - lenders still earn the same money from lending (e.g. Murabahah gets you almost the same end situation as "normal" western loans), it just has to be structured in complicated ways.
It doesn't directly. The central banks have lowered "safe rates" down to zero and sometimes below, but desperate businesses still have to offer high yields over 10% to find willing lenders.
Is this a buy signal for some of these travel or travel related companies I wonder? I can see them having a issue with cashflow now, but its not always going to be like this, people will need rental cars, maybe not as many, but they will need them. Potential consolidation first to reduce capacity and then price rises.
Curious how all of these crazy interest movements will affect the housing market. Deflation sounds bad for housing values, but then again, it means interest rates will stay low, propping up values. And then there's the generally-crazy bay area market.
I don’t find yields over 10% given the current economic climate to be unreasonable or evidence of “desperation” on the part of sellers. I would probably find rates of under 10% as evidence of desperation on the part of buyers...