Global Toxic Loans

Beneath the surface of the global financial system lurks a multitrillion-dollar problem that could sap the strength of large economies for years to come.

The problem is the giant, stagnant pool of loans that companies and people around the world are struggling to pay back. 

Bad debts have been a drag on economic activity ever since the financial crisis of 2008, but in recent months, the threat posed by an overhang of bad loans appears to be rising. 

China is the biggest source of worry. Some analysts estimate that China’s troubled credit could exceed $5 trillion, a staggering number that is equivalent to half the size of the country’s annual economic output.

Official figures show that Chinese banks pulled back on their lending in December. 

If such trends persist, China’s economy, the second-largest in the world behind the United States’, may then slow even more than it has, further harming the many countries that have for years relied on China for their growth.

But it’s not just China. 

Wherever governments and central banks unleashed aggressive stimulus policies in recent years, a toxic debt hangover has followed. 

In the United States, it took many months for mortgage defaults to fall after the most recent housing bust — and energy companies are struggling to pay off the cheap money that they borrowed to pile into the shale boom.

In Europe, analysts say bad loans total more than $1 trillion. 

Many large European banks are still burdened with defaulted loans, complicating policy makers’ efforts to revive the Continent’s economy. Italy, for instance, announced a plan last week to clean out bad loans from its plodding banking industry.

Elsewhere, bad loans are on the rise at Brazil’s biggest banks, as the country grapples with the effects of an enormous credit binge.

“If you have a boom and then a bust, you create economic losses,” said Alberto Gallo, head of global macro credit research at the Royal Bank of Scotland in London. “You can hope the losses one day turn into profits, but if they don’t, they are a drag on the economy.”

In good times, companies and people take on new loans, often at low interest rates, to buy goods and services. 

When economies slow, these debts become difficult to pay for many borrowers. 

And the bigger the boom, the more soured debt that is left behind for bankers and policy makers to deal with.

In theory, it makes sense for banks to swiftly recognize the losses embedded in bad loans — and then make up for those losses by raising fresh capital. 

The cleaned-up banks are more likely to start lending again — and thus play their part in fueling the recovery.

But in reality, this approach can be difficult to carry out. Recognizing losses on bad loans can mean pushing corporate borrowers into bankruptcy and households into foreclosure. 

Such disruption can send a chill through the economy, require unpopular taxpayer bailouts and have painful social consequences. 

And in some cases, the banks might find it extremely difficult to raise fresh capital in the markets.