May 2020 - The Great Debt Bubble Has Finally Burst

It’s over. We think we can finally call the end of the game. It has been one heckuva run, but we think that the end has come for the World’s Great Debt Bubble. It has fueled some truly unbelievable economic scenarios, but the day of reckoning appears to finally be upon us. This is the beginning of a new chapter that will be focused on lower leverage, debt restructuring, more conservatism and possibly even some austerity. Even if the balance sheet of the Federal Reserve Bank and the U.S. Treasury are limitless – a theory which they appear to be attempting to prove with each passing day – the rest of us are left to accept the fact that we are going to have to live with more prudence and less availability to debt.

We have officially entered the first phase of a long-term trend of deleveraging. Many market participants may be dragged kicking and screaming toward this eventuality, but nonetheless, whether heading there willingly or unwillingly, most municipalities, corporations and families will be deleveraging over the next several months and years. The days of continually and ceaselessly solving our debt problems with more debt have come to an abrupt end.

Does this mean that borrowers are out of luck? Of course not, logical, sensible deals will continue to get funded. However, it will be back to basics for borrowers and lenders. Real underwriting, real due diligence and sensible loan structures will be the order of the day. No super-rush deals with high leverage and lite covenants. Sorry, those days are gone and we don’t expect them back any time soon. The old school lending axioms are back and they are here to stay.

Low interest rates are also here to stay, but not for any good reasons. As we are being reminded in real-time fashion, low interest rates not only hide broken business models, they also can mask broken and over-levered deals. Those deals will need to refinanced, restructured and replaced with new loans, new lenders and possibly with new business models.

The world economy is in a very precarious position. In the future, and possibly soon, there will be buying opportunities and there will be plenty of new investment in new and revamped industries. However, there remains much destruction and uncertainty to come in 2020. Big new waves of unemployment claims are coming. The true devastating effects and economic fallout from the shutdown of huge portions of the economy is just now starting to be felt. The economic reports during the summer and fall months of 2020 will begin to reveal with shocking clarity the depth of the economic collapse and they will continue to tear away at a fragile and weak consumer, whose confidence has been shaken to its core over the past 60 days.

This isn’t really much of news flash, but the higher education industry is on high alert. Consumers (aka students and their families) have figured out that maybe, just maybe it’s not a great idea to rack up massive piles of debt to get a college degree. We believe that nearly half of the colleges and universities in the U.S. could be gone in the next 20-25 years with the advent of technology, unfavorable demographics and the complete obsolescence of their business model. Colleges are businesses and businesses cannot assume that they can raise prices every year for an inferior and failing product.

The massive and dramatic Federal Reserve intervention is propping up the credit markets and many failing companies. Emergencies call for necessary emergency action. There isn’t a lot of time to analyze and assess the unintended consequences of these dramatic actions. We do not agree with some of the actions currently being taken by the Fed and the U.S. Treasury. But they are here and they are skewing the markets. We think that many of these programs will end like most of them always do – with controversy, fraud, waste and huge excesses. The Machiavellian tactics will be praised once the U.S. economy begins to grow again, but we aren’t sure the ends will ever justify the trillion dollar means.

And despite all of the neutron bombs that the Fed is launching at the credit markets, everyone that we speak with is focused on survival, maximizing and preserving liquidity, using leverage much more prudently and only doing deals that they are absolutely sure are going to work. The bar has been raised about 20 notches higher than it was at just a couple short months ago. There is a lot of talk of a new normal or even a new, new normal that looks a lot like old-school underwriting tactics that most of us learned in days gone by. Everyone has portfolio issues and is focused on capital preservation and that includes lenders and investors who are still actively making new investments and new loans.

Much of the way we live and do business with each other has been altered forever. Whole sectors of the economy are being displaced and literally could be changed or gone for good. This will take years to sort out and coinciding with this sea change is going to be an era of lower multiples, sober capital structures and real risk pricing. The bubble has burst and now it’s time to move forward into a new era of sanity and sensibility. How long will this era of cautiousness last? That is anyone’s guess at this point, but we are going to assume that it is going to be here for a while, given the severity of the circumstances, the unprecedented amount of change and disruption that is happening all at once, the continuing uncertainty around the longevity of the virus outbreak and shutdowns, as well as the likelihood that the recovery is going to be long and slow in nature.