Corporate Debt Could Trigger the Next Recession

The UCLA Anderson Forecast and the UCLA Ziman Center for Real Estate is sticking to its 3-2-1 economic calculation. According to the most recent forecast, the school is consistent that there will be 3% growth in 2018, 2% growth and 1% growth in 2020—increasing the risk of a recession. The forecast has maintained this outlook since March 2018, but the latest forecast shows concern about the leveraged loan market. In fact, corporate debt, which the forecast says is not as “over-extended” as the mortgage market in 2008, could trigger the next recession.

David Shulman, the author of the forecast, is not surprised that a problem in the financial market is the likely culprit for the next downturn. “If you go back to the last three recessions, they were all financial induced recessions, or if not induced, they were exacerbated by problems in the financial market,” says Shulman, senior economist for the Ziman Center and UCLA Anderson Forecast. “In 1990, it was the S&L crisis, which brought down a bunch of banks and insurances companies. In the 2000s, it was the excesses in the dot.com financials, which led to too much capital spending. Then, in 2008, it was the excesses in the residential mortgage cycles. To me, it seems like we have financial cycles more than we have traditional economic cycles having to do with inventories.”

To be clear, the forecast is not predicting a recession. Rather, it is predicting slow economic growth through 2020, which will increase the risk for a recession, and has pinpointed corporate debt as one of the potential triggers. “I think corporate debt is an excess that we have building up,” explains Shulman. “A lot of the debt has been used to for merger and acquisition activity, which has been buoying the stock market, and a lot of the debt has been used to buy back corporate shares. A lot of corporations are worried about their credit rating, and if share buy-backs drop, that could have a negative effect on the stock market.”

Still, the next downturn, when it does come, won’t look anything like the 2008 financial crisis. “I don’t think that we are going to look at another 2008. That was a once in an 80-year event,” says Shulman. However, one lasting effect from the financial crisis is the recovery slow recovery out of a recessionary economy. Shulman says that the growing federal deficit will serve to exacerbate the recovery period. “We may, however, take more time to come out of a recession because of all of the problems with the Federal Government running monster deficits when times are good. That could create a real problem when times are bad,” he explains. “The $1 trillion deficit that we are going to have next year for the government will easily be over $2 trillion in the next recession, maybe even $3 trillion. That is going to be an issue in how we recover.”