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Don’t forget the Wall of Debt!

A lot has happened since November 2008 when the Global Financial Crisis took hold and three of our largest banks had to be bailed out by the government. It was then that Britain first implemented the emergency remedy of quantitative easing to combat the crisis; a strategy then followed by the US and others. 

The government has slowly been selling its shareholdings in RBS and Lloyds Banking Group over a number of years, and the Bank of England has been doing the same thing with the gilts that it bought when quantitative easing was put in place. There is over £400bn worth of gilts which are waiting to be slowly sold back into the economy in order to restore the economy to its pre-crash position. This is set to be a long journey and may well last another nine years or more.

QE was brought in because the traditional tool of lowering interest rates was not available - rates were nearly at zero already. Low-interest rates and the increase in money in the system created by QE means that a fundamentally bad business can borrow money cheaply, and can continue without falling over (for a while at least). The current economic environment allows businesses to break one of the core rules of entrepreneurship – Fail Fast. Many of the ‘zombie’ companies that still stagger on would be better to fail. The people in those businesses would be free to go out and do the things that they really want to do with corresponding levels of enthusiasm and productivity. Debt which is never going to be repaid can be written off; investments which will never yield a return can be written down; the balance sheets of banks and pension funds can be brought closer to reality. It will sting a bit, but the plaster needs to be removed at some point.

Like the shares in the banks still owned by government, like the gilts bought by the Bank of England, the wall of corporate debt that was borrowed before the financial crisis is still largely in place. Companies need either to fail or to grow. There are too many companies that lack the financial pressure to fail but are unable to grow in today’s Britain. It was vital to create a stable environment in the wake of the crisis but that manufactured calmness cannot continue forever. The time must come when the debts are repaid.

Interest rates have just gone up for the first time in almost a decade, but the increase seems not to have been passed on across the board. In isolation, you might look at the economy and the last budget and hope for a brighter future. Even without a magic money tree, we have slowly been recovering. If that was the end of the story, then the prognosis might be cheering. But there is the rather large and thorny problem of Brexit, which threatens to undo all the careful financial surgery that has kept Britain alive over the last 9 years.

The future is far from certain and all business must face the fact that changes in the political climate occur quickly and unexpectedly, and often detrimentally to financial health. Finance likes stability. Continued political uncertainty may mean that some businesses can no longer sustain their levels of debt – especially if there is another interest rate rise.

The wall of debt still stands, and the longer it takes to dismantle it brick-by-brick, the greater the chance that it topples.

If you would like to understand the options for reducing your business’s debt burden please contact:

Michael Arnott, Partner

0203 096 0112

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