Sunday, July 12, 2009

We Talkin About Credit, Debt, & Leverage Man!

Lets get this out of the way first.

One of my all-time favorites.

I am just waiting for Geithner and Bernanke in their Air Jordan's one day testifying in front of Congress.

"We talkin bout credit man"
"We talkin bout leverage man"
"We talkin bout debt man"

US Companies as well as consumers are sinking deeper into debt as the economy continues to drag. Unbridled borrowing by both classes during the boom cheap credit years has swelled debt levels to the highest levels on record.

Many US Companies because of their debt burden are at risk of going bust as economic malaise lingers. Even "IF" the longest recession in decades is now petering out, growth will be so feeble that companies can not rake in enough earnings to offset their debt mountain, leaving many dangerously exposed. In the first quarter, the debt of U.S. industrial companies in aggregate exceeded 100 percent of their annual income for the first time ever.

This ratio has never been higher. As the downturn lingers, earnings drop off a lot more quickly than you can deal with debt.

The total debt of U.S. non-financial companies was $7.2 trillion at the end of the first quarter, up from $4.3 trillion in 1999, according to Federal Reserve data.
And over the last four decades,the amount of debt outstanding has exploded and corporate profits have grown but not to the same degree. This is very consistent with consumer debt levels and nominal wages and hours worked.

More leverage, at least up until this last crisis, became more acceptable. Now, as the economy struggles the widening gap of debt levels over earnings becomes especially perilous for companies and disastrous for consumers, and for the economy itself. This is one of the lagging processes coming out of this cycle. It is still a high debt burden for companies and households even after this recession is long over.

De leveraging by both consumers, banks, and non-financial companies will go on far after the recession ends. The days of easy credit are over. Our entire way of life in the states is based off of credit, and credit is gone. Washington DC is in a desperate death match to bring back the status quo to America, as they have no option B, because consumers have no plan B to live without credit. Its just not happening.

The economic downturn has caused U.S. profits at companies to plunge, forcing up their leverage, or ratio of debt to income. So to as unemployment surged, household budgets are way in the red.

The rally we have seen can be seen as a "multiple (PE) expansion rally", but looking closely analysts expect a decrease of about 36 percent in SP 500 corporate earnings in the second quarter from a year earlier and no improvement from the first quarter.

Many U.S. high yield bond issuers that were levered 6 or 7 times before the recession began are now levered between 8 and 10 times as profit margins shrink, these dynamic just cant go on until the tap runs out.

We have already seen General Growth Properties, a mall operator file for bankruptcy protection earlier thus year. GGC actually at the time of their filing was cash flow positive, they filed for bankruptcy because they couldn't and refinance their huge mountain of debt.

Many companies have anxiety about shouldering too much debt in a forbidding economic landscape is itself acting as a restraint on economic growth, because many firms will hesitate to invest in expansion. Reluctance to borrow will be a big restraint on recovery, as the recovery depends upon flow of credit, because the system is designed that way.

After gorging on cheap credit in the early 2000s, companies new found emphasis on austerity and living within their means may constrain economic growth for the next 10-15 years. It took exceptionally easy credit conditions to spur this debt ratio higher. Now, with lenders, borrowers, and regulators all burned by the financial crisis, it will take a decade's worth maybe more time and possibly many business cycles for companies to feel that they can expand debt again on a wide scale.

The only options, They can slowly work it off, they can refinance at lower rates or they can just default.

As government bailout of the economy and financial markets have seemingly for the time being averted another "Great Depression", many have trimmed their forecasts for the U.S. corporate bond default rate, now seen peaking at about 13 percent in the fourth quarter. That's below 1930s levels of about 15 or 16 percent, but still high.

Whats more worrisome is that so far this year High Yield Corporate Bond issuance has surged, wetting the appetite of fixed income bond funds which have seen huge fund inflows from investors who liquidated stock equity funds. More crap CMBS/CRE deals are being underwritten and packages to investors who weren't burned the first 15 times around.

Money needs to go somewhere, where it goes just funds the next bubble.

Like I said, they have created a system where credit needs to flow. If the credit stops, the system stops, like it did after Lehman failed. Any recovery and plan by the powers that be is based off this simple metric. That is why they want business as usual, because no credit means no business which means no Goldman Sachs which means Skynet takes over.


  1. Leverage begets more leverage. On the surface its nice to say de leveraging, but this is extremely painful in the short/mid run. Companies will be forced to sell off divisions to pay off bad loans Consumers will file for bankruptcy. Its time to take our medicine like the Japanese did in the 90's

  2. Japan is still taking their medicine. Deflation has killed the will of the Japanese people. Thanks for reading.