NEW YORK – To respond to economic shockwaves from COVID-19, the Federal Reserve launched extraordinary measures to help companies correct their balance sheets, with actions that dwarfed the Fed’s efforts during the Great Recession. In bad times, the Fed can take bold steps to provide liquidity that can be used to maintain payroll, keep businesses running, and stimulate the real economy. But research from Columbia Business School shows that in the opening months of the pandemic, the Fed’s interventions led to a surge in companies issuing bonds with the funds largely used to hoard cash or repay bank loans.
The US corporate bond market has experienced a “V-shaped” recovery since, rebounding as fast as it fell, but the same cannot be expected for real economic activity, including employment. In new research, Columbia Business School Professor of Business Olivier Darmouni and Finance PhD candidate Kerry Siani find that the bond issuance propped up by the Fed actually crowded out bank loans despite the financial sector remaining healthy throughout the early months of the crisis, even for many “high-yield” riskier companies.
“Instead of supporting Main Street, the Federal Reserve’s intervention has actually led to companies putting money back into the pockets of banks through loan repayments,” said Professor Darmouni. “As a result, the Fed’s impact in driving an economic recovery, improving employment, wages, and production has been muted.”
This is the first study to collect data for all companies that issued bonds thru June 2020 that report their ﬁnancial statements in U.S. dollars. Professor Darmouni reviewed over 300 companies for which Capital IQ reports data for the ﬁrst quarter of bond issuances and 90 percent of those companies’ second quarter data. Next the study examined changes in the companies’ debt compositions during the second quarter of 2020, marking the latter part of the first wave of the pandemic and revealing that a large share of bond issuers that borrowed in the first quarter used the second quarter to repay bank loans through new bonds. These actions by companies crowded out bank loans in two ways:
- The companies issued bonds even while their existing credit lines were untouched: Chevron had $5 billion of its credit line available at the beginning of 2020, yet it still issued $650 million in bonds the following quarter.
- The companies that did draw down on bank loans then issued bonds in order to repay the bank rather than invest in their operations: Kraft Heinz downgraded from IG to junk in February 2020 and drew $4 billion from its credit line between February and March. By May, the company issued $3.5 billion in bonds and used these funds to repay its entire credit line drawdown.
“We know the government, the Fed in particular, has very good tools at its disposal to revive markets to achieve a ‘V-shape’ recovery,” said Professor Darmouni. “But the real economy outside of the financial markets will not go back to normal until the source of the problem is addressed. In a once in a generational pandemic, the traditional ways won’t work and the path of our recovery should match the path of our ability to handle the health crisis.”
The study, Crowding Out Bank Loans: Liquidity-Driven Bond Issuance, is available online here.
To learn more about the cutting-edge research being conducted at Columbia Business School, please visit www.gsb.columbia.edu.
About the researchers
Professor Olivier Darmouni is a financial economist whose research interests span corporate finance, banking and industrial organization. He applies a variety of empirical methods...Read more.