Counterpoint 2:
Higher Short-Term Costs May Slow Economic Recovery
from Bloomberg
By Liz Goldenberg
New York, Feb. 27 (Bloomberg) -- The U.S. economic recovery may be slowed as an increasing number of companies are forced out of the short-term capital markets and have to resort to more expensive methods of financing.
The outstanding amount of commercial paper, debt maturing in nine months or less and typically the cheapest way for corporations to finance day-to-day operations, is at its lowest level since December of 1999. In the last five weeks, the amount fell by $36.1 billion to $1.406 trillion.
Companies including Qwest Communications International Inc. and Tyco International Ltd. have been forced into borrowing at higher interest rates, taking bank loans, for instance, after reductions in their credit ratings shut them out of the commercial paper market. Higher borrowing costs may limit firms' ability to make investments in inventory and new plants that would boost the economy, analysts said. Investor concern about accounting fraud since the collapse of Enron Corp. has exacerbated the problem.
``There's a crisis of confidence with this whole accounting thing,'' said Bob Lunder, head of government-bond trading for Bear Stearns & Co.
The cost for a company with an investment-grade ``BBB'' long- term unsecured rating from Standard & Poor's to arrange and use a one-year bank line averages about 88.2 basis points above benchmark lending rates. A firm with access to the commercial paper market can borrow for a month for about 34 basis points above the same benchmark levels. A basis point equals 0.01 percentage point.
Business Investment Declining
Business investment in equipment and software has fallen for five straight quarters and Federal Reserve officials say such spending will have to increase for the economy to rebound from the recession that began last March.
While ``the contraction in business capital spending appears to be waning,'' spending on ``communications equipment continues to decline, and there are few signs of a broad-based upturn in capital outlays,'' said Fed Chairman Alan Greenspan in his testimony to Congress.
Investment in equipment -- credited with a surge in worker productivity during the last six years -- declined at a 5.2 percent annual rate in the final three months of last year. That followed an 8.8 percent pace of decline in the third quarter.
Sprint Corp., which has seen commercial paper costs rise even though its rating remains unchanged, this month cut its 2002 long- distance capital spending budget by $100 million to $3.4 billion, down from $5.3 billion last year.
While the amount of outstanding commercial paper is expected to fall during a recession, analysts say the recent decline has been unusual as it comes amid signs the economy is recovering.
Last year, commercial paper dropped 11 percent to $1.439 trillion from $1.615 trillion, the largest year-over-year decline since 1971, according to Fed statistics. In 1991, during the last recession, outstanding commercial paper fell 5.3 percent.
Reasons for Decline
Part of the 2001 decrease came because borrowers took advantage of low longer-term interest rates to reduce their reliance on short-term borrowing, said Lou Crandall, chief economist at Wrightson Associates Inc., a research firm.
Investor concerns about credit quality also played a role. Moody's Investors Service last year cut commercial paper credit ratings a record 93 times -- and raised them just 22 times. Already this year, Moody's has cut commercial paper ratings on 12 companies, including Gap Inc. and Ford Motor Credit Co., while upgrading none, said Kamalesh Rao, an economist with the ratings company.
Many borrowers unable to sell commercial paper limit the rise in their borrowing costs by putting accounts receivable into a special purpose company that sells debt backed by them. The rates they pay are higher than on commercial paper, though lower than on bank loans.
Asset-Backed CP
Tyco set up a $1.2 billion facility to sell receivables owned by its CIT Group finance unit as a way of securing cash after it was shut out of the commercial paper market. The receivables will back commercial paper with receivables, giving it access to lower- cost financing than bank credit lines.
Investors held $727.2 billion of asset-backed commercial paper, short-term debt collateralized by receivables and loans, for the week ended Feb. 20, down from the record $754.1 billion on Jan. 9. In 2001, asset-backed commercial paper rose $103.5 billion, or 16 percent, to $745.3 billion.
Higher short-term borrowing costs for companies may help the Federal Reserve do its job. The Fed raises short-term rates when it senses an economic recovery might touch off inflation.
Fed Effect
``If more and more firms have trouble rolling over commercial paper, it will probably cause the Fed to tighten slower than otherwise,'' said Joe Tully, a managing director for Prudential Investment Management in Newark, New Jersey, who oversees more than $60 billion in assets.
There may be a danger in overstating the effects that lower credit ratings and investor concern about false profits have on the market, said Crandall, the Wrightson economist.
``We're not going to know from the numbers how much of this is being driven by healthy defensive reactions by corporations, or how much is actually being driven by a drying up of the capital markets,'' he said.
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