Telco debt now exceeds S&L, junk bond levels
By: Jacqueline Thorpe
The U.S. economy's exposure to telecom debt is almost as large as its exposure to the 1980s savings and loan crisis and the 1990s junk bond failure combined, new research shows.
The massive debt load, along with the fact that business spending is likely to remain moribund for some time, will likely keep the the U.S. Federal Reserve from raising interest rates this year, Jeff Rubin, chief economist at CIBC World Markets, said in a report yesterday.
"I'm saying there will be no meaningful recovery in business spending this year and therefore I don't think the Fed will go," Mr. Rubin said.
Analysts have been pushing back their forecasts for when the Fed would likely begin raising interest rates from their current 40-year low of 1.75%. Many experts now believe it could begin the process at its meetings in August or September.
Mr. Rubin thinks that would be premature, largely because massive telecom debt levels leave the U.S. economy vulnerable.
Outstanding telecom debt stands at about US$525-billion, or almost 5% of U.S. gross domestic product.
That is well beyond the economy's exposure to junk bond debt in 1989, when there was some US$189-billion debt outstanding amounting to 3.5% of GDP. And in the late 1980s, it cost taxpayers some US$175-billion, or 3% of GDP, to bail out the savings and loan industry.
Mounting insolvencies in the U.S. thrift sector together with a blowup in the junk bond market spurred the Fed to ease rates well before the onset of the 1990 recession, and kept it from tightening almost three years after the recession ended, Mr. Rubin said in his report.
He thinks the Fed will be patient this time as well.
"Interest rates may be low but financings will not come easy in the post-bubble economy," he said. "With the Nasdaq retreating back to pre-1998 valuations, and close to US$90-billion in telecom debt in default or at imminent risk of it, neither the public equity or bond market will be too eager to finance the expected investment rebound that the recovery ultimately must have."
If the massive overhang of debt continues to make borrowing difficult, weak demand in the IT sector will also restrain business spending.
Capital spending in the telecom sector has already plunged by 25% since the bubble burst in the fourth quarter of 2000.
"With giants like WorldCom Inc. slashing billions out of capital spending don't be surprised if real telecom investment drops another 30-40% over the next five quarters," Mr. Rubin said.
The trouble is that there is nowhere near enough demand to fill the explosion in capacity wrought by the fibre-optics revolution, said the CIBC report, to which economists Peter Buchanan and Avery Shenfeld also contributed.
Fibre-optic cable can carry hundreds of thousands of times more bandwidth than either microwaves or satellite transmission. Every nine months, optical transmission costs are halved, twice the pace of improvement for computer processing power.
Even at peak demand, capacity is nearly twice as large as system traffic, while at average demand, capacity is almost 20 times as larger.
"What photonic technology is designed to carry is a massive load of digital information of the order of magnitude that is needed to generate virtual reality holograms," it added, only half jokingly. "Bootleg music downloads and the occasional videoconference are not going to pay the freight."
In the absence of some breakthrough application that will exponentially raise fibre-optic usage, it will take years -- not quarters -- to economically utilize the capital stock already in place.
CIBC World Markets said while the outlook for spending on computers and software is nowhere nearly as bleak as it is for the telecom sector, real demand growth here is unlikely to match the near-30% annual rates of the late 1990s soon. Missing are the hundreds of newly minted dotcoms and Y2K preparations to drive spending.
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