Balance Sheets Are Barriers Against Contagion

I played dominoes often when I was a kid. The preferred variant in our home was muggins, or straight dominoes, in which players attempt to position their tiles so that the exposed ends total a multiple of five. My father taught me the game, believing it would help me to do math in my head.

My less nerdy friends played with dominoes, too. They’d set them up in long columns, and then set off a chain reaction by pushing over the first tile. Back then, a sophisticated layout included 100 pieces and would occasionally attempt a slight turn; today, domino architects are creating systems of more than 50,000 tiles, which take days to assemble and almost ten minutes to topple.

Dominoes have been front of mind lately for economists, as we try to anticipate the fallout from a potential recession and recent market corrections. Financial systems have become much more intricate over the last generation, and a topple in one sector has periodically jeopardized the entire network. The Asian Financial Crisis of 1997-98 spread to Russia and then New York; the U.S. mortgage crisis spread from Main Street U.S.A. to…almost everywhere.

This time around, balance sheets across the economy are serving as barriers against contagion. Lessons learned from the 2008-09 crisis have led firms, financial institutions, and regulators to safeguard themselves, reducing the risk that stress will spread.

Chart: U.S. Corporate Bond Issuance and U.S: Interest coverage ratios

Corporate balance sheets are arguably in better shape than they have been in many years. Backstops provided by governments and central banks facilitated immense fundraising in 2020 and 2021, even among low-rated obligors. Borrowing was extended for longer terms, at very low interest rates. Cash levels at S&P 500 firms stood at $1.5 trillion at the end of 2019, and peaked at $2 trillion at the end of last year.