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Bankruptcies Loom As Fed Spells Out Economic Gloom

Economic Gloom

Anyone who was bold enough to follow the positively depressing economic and financial news stories back in 2008 received a crash course on a wide variety of arcane subjects such as naked short selling, subprime loans, Ponzi schemes, mortgage-backed securities, and, of course, the $62 trillion global credit default swaps market. 

By any account, 2008 proved to be a banner year for bank and brokerage-house failures as well as commercial bankruptcies after 136 public companies filed for Chapter 11 bankruptcy protection, a hefty 74% increase from the previous year.

This year already, companies both large and small have been succumbing to the effects of the coronavirus, including household names like Hertz and J. Crew as well as comparatively anonymous energy companies such as Whiting Petroleum and Diamond Offshore Drilling.

But now experts are warning that the growing momentum of Covid-19 bankruptcies will make 2008 appear tame in comparison.

Speaking to CNBC, former Federal Reserve governor, Randy Kroszner, has warned that a lot of small-and medium-sized businesses (SMBs) have been badly crushed by the pandemic and simply won’t be able to bounce back once the short-lived stimulus wears off.

Krozner’s dire warning comes after the Fed released disappointing unemployment data and a dour economic outlook. 

The Labor Department has reported that U.S. weekly jobless claims totaled 1.106 million last week. The report comes just a week after the tally dipped below the 1M mark for the first time since March thus raising serious doubts about the sustainability of the economic recovery.

Low Interest Rates

Kroszner says that the Fed is likely to keep interest rates low for much longer in order to make housing and mortgages more affordable.

The Fed has undertaken a series of interest rate cuts, with the last one coming in March when it lowered the benchmark rate to 0%-0.25%, marking only the second time that rates were effectively lowered to zero (the first time was during the 2008 financial crisis). Rates are likely to remain at zero at least until 2022 due to the uncertainty caused by Covid-19, the former Fed governor said. 

He also points out that the central bank will have to perform a delicate balancing act as it tries to raise inflation levels to its sweet spot of 2% without allowing the economy to overheat.

In a healthy economy, prices tend to go up in a process known as inflation. Historically, wages tend to go up at roughly the same pace as the rate of inflation. The U.S. inflation rate has persistently clocked in below the Fed’s 2% target since 2012 thus increasing the probability of falling into deflation whereby prices and wages start declining. Good case in point is Japan whose economy has experienced ultra-low inflation since the late 1990s leading to secular stagnation. 

There are fears that the U.S. could be headed down the same path. 

Lower Forever?

Despite these concerns, Krozner opines that the Fed is more likely to err on the side of caution than risk pushing the envelope too far and end up triggering a recession. In other words, interest rates are more likely to remain at these levels for a long time.

Krozner is not alone in this view.

The Altman Z-Score is a widely used credit-strength test used to predict business failures. It’s creator, Edward I. Altman, has predicted that that the current year will set a record for mega bankruptcies, or filings by companies with $1 billion or more in debt. Altman also expects ‘merely large bankruptcies’ from $100 million upwards to challenge the record set in the last financial crisis.

Maybe this decidedly gloomy outlook is the reason why Warren Buffett, notorious for his aversion to gold investments, recently did a 180 and bought a $564M stake in Barrick Gold (NYSE:GOLD) while ditching his investments in Wall Street banks.

By Alex Kimani for SafeHaven.com

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