Floyd "the Barber" Norris blasts corporate indebtedness:
nytimes.com
July 7, 2000
FLOYD NORRIS
As Profits Soar, Corporate America Takes
on More Debt
WHEN things go great, the
winners go into debt.
Sometimes they go too far.
With the American economy in its
longest period of expansion ever, the
news for corporate America has been as
good as it can be. Profits have soared
and are at or near record levels by
almost any measure -- in dollars, as a
percentage of revenue or as a portion of
national income. Investors eagerly paid
unprecedented multiples of those profits
when they bought shares.
Yet, with profits pouring in and investors
eager to buy stock, corporate America is
deeper in debt than ever before.
Corporate debt now equals 46 percent of gross domestic product, up
from 38 percent five years ago.
One might expect companies to pay down debt in good times, and they
tend to do so early in an economic recovery, when the bad times are still
fresh. Corporate debt fell in 1991, after the last recession.
But as the economy continues to grow and people become more
confident that good times are here to stay, such conservatism comes to
appear foolish. "It's the perception of certainty that causes so many
prosperous companies, individuals and companies to get in over their
heads," says James Grant, the editor of Grant's Interest Rate Observer.
As a result, the richest of one era can end up in deep trouble when times
change. Mexico raked in the cash when oil prices soared during the
1970's and could not pay its debts in 1982. Japanese corporations
seemed to conquer the world in the 1980's and could not pay their bank
loans a decade later.
In the current corporate borrowing spree, the money borrowed has been
far in excess of what was needed for capital spending, notes Paul
Kasriel, the chief economist of Northern Trust. Much of the money went
to buy back stock -- in large part to offset the shares that were issued to
executives when they cashed in stock options. Corporate America has
bought back more shares than it issued in recent years.
None of this is unprecedented. The two longest periods of expansion
before the current one were during the 1960's and 1980's. In each case,
corporate debt rose rapidly in the final years of the expansion. In the
1980's, Drexel Burnham Lambert, the leader in junk bond underwriting,
came up with a new measure -- the "MAD ratio" -- to reassure investors
that debt levels were not excessive. That stood for market-adjusted debt,
and it showed that many companies were not really very far in debt,
considering the market value of their stock. That was great, until share
prices fell.
Now, evidence is growing that the economy is slowing, and worries are
picking up that corporate profits may not be as robust as expected.
Credit markets are becoming tighter. The junk bond market is reluctant
to finance many companies, and banks are growing more cautious.
If such trends continue, some companies that assumed they could
refinance debt when it came due will find that they cannot. And then we
will see corporate defaults and bankruptcy filings rise to a level much
higher than might be expected even if there is only a modest slowing in
economic growth.
Inevitably, some of the companies that default will be ones that need
never have borrowed money, given how eager investors were to buy
their shares. But the managers feared that issuing too many shares would
depress the stock price, and they knew that their duty was to maximize
shareholder value. So they took on debts that did not look dangerous --
but that proved to be fatal. |
