The Debt Bomb
DJ. BARRON'S: The Debt Bomb: Only Housing Is Keeping The Fuse On America's
Borrowing Habit From Burning Down
By Jonathan R. Laing
Bubbles have long been part of the financial firmament. The tulipmania in
17th-century Holland and the notorious South Sea Company stock bubble a century
later in England are lowlights of economic lore.
History is replete with numerous other examples of financial manias followed
almost ineluctably by huge price busts, down to our own era. Japan is still
paying the price of deflation and economic narcolepsy a decade after bubbles in
its stock and real-estate markets popped. Debt collapses in Asia and South
America punctuated much of the 'Nineties. The bursting of the U.S. tech-stock
bubble in early 2000 led to the vanishing of more than $5 trillion in wealth,
at least on paper. Now, many worry that a U.S. housing bubble, lofted by
four-decade lows in mortgage rates, could explode, eviscerating consumer
spending and economic growth.
Curiously, however, one reads almost nothing about what may be the biggest
bubble of them all -- the huge ballooning of total debt in the U.S. That
measure, an aggregate of the borrowings of all households, businesses and
governments (federal, state and local), zoomed up from about $4 trillion at the
beginning of 1980 to $31 trillion as of 2002's third quarter, according to the
latest available Federal Reserve flow-of-funds data.
While some observers see no cause for alarm in these figures, others fear
that this debt surge could be edging the U.S. economy toward the abyss of a
bust -- and then into a depression.
The 'Nineties economic boom boosted wage, profit and productivity growth,
enhancing the ability of consumers and businesses to service debt. Yet,
after-the-fact revelations about the accounting shenanigans of that period lead
to an important question: How much of the profit boom and productivity miracle
was real?
It may have been as much an artificial product of debt leverage as of true
internal growth. Credit-market debt now equals 295% of gross domestic product,
compared with 160% in 1980 and less than 150% during much of the 1960s. More
ominously, debt as a percentage of GDP exceeds the previous record reading of
264% from early in the Great Depression -- when the aftermath of the Roaring
'Twenties borrowing binge collided with a sharp economic contraction. And
today's debt load is clearly starting to pinch consumers and businesses:
Credit-card charge-offs of bad loans exceed 7% of total debt outstanding,
compared with the previous peak around 5%, reached in the mid-1990s, according
to Standard & Poor's.
U.S. personal bankruptcy filings in last year's third quarter jumped some 12%
from the level a year earlier. And when 2002's total is in, it will almost
certainly eclipse 2001's record 1.43 million.
Meanwhile, mortgage delinquencies are soaring, particularly among less
creditworthy borrowers. In the "sub-prime" market, delinquencies have jumped to
8.07% from just 4.50% in 1999, according to Loan Performance, a San Francisco
tracking firm. This market, which caters to people with checkered credit
histories, accounts for about 10% of the $5.8 trillion of U.S. mortgage debt
currently outstanding. Delinquencies on Federal Housing Administration loans,
which make up about 15% of the dollar amount of U.S. mortgage debt, are at a
30-year high of 11.8%. The typical FHA borrower is a first-time home buyer with
limited funds.
Despite the big home-price jump seen in many regions, soaring mortgage debt
and drooping stock prices have severely crimped the net worth of U.S.
households. According to the latest Fed numbers, net worth at the end of the
third quarter had fallen to just 4.9 times disposable income, about 22% below
the 6.3 at the end of 1999.
The corporate debt market has seen huge defaults, too, by such formerly
investment-grade behemoths as WorldCom and Global Crossing. Defaults in the
junk-bond market -- which accounts for more than 15% of the $5 trillion
non-financial corporate-debt market -- have abated somewhat from early fall,
when the 12-month default rate spiked to over 18%. Yet even with the high
mortality rate of the weak and the lame to date, the corporate-debt contagion
hasn't run its course, warns Moody's chief economist, John Lonski. He contends
that the credit cycle can't be deemed to have turned when 88% of his company's
latest credit actions were downgrades -- worse than the previous record, 86%,
set in 1990 during the Drexel Burnham junk-bond panic.
Ray Dalio, president and chief investment officer of Bridgewater Associates
in Greenwich, Conn. -- an outfit that manages around $35 billion in currency
and hedge-fund assets -- believes there's a 30% to 40% probability of a U.S.
depression over the next two-to-five years.
Dalio notes that, during a recession, interest rates can be lowered to
stimulate the economy by making it cheaper for businesses to invest and
consumers to buy big-ticket items. Lower interest rates also boost asset
prices, by raising the capitalized value of future income streams.
Depressions have a different dynamic. They tend to come after years of debt
buildup, when monetary easing no longer works because interest rates are
already near zero. Thus, no further debt-service relief is available for
overburdened businesses, consumers or governmental units -- especially if
deflation causes their incomes to fall. Even if rates hit an irreducible zero,
the real burden of debt rises during deflation. Borrowers still have to repay
their debts in current dollars while their revenues and collateral fall in
value.
In a frenzy to raise cash, debt holders sell assets and cut spending. As a
result, the value of the collateral underlying existing debt suffers.
Deflationary forces are only exacerbated by businesses cutting prices to
stimulate demand in a vain attempt burnish cash flows. In addition, as
unemployment rises, consumer demand falls.
The process is not reversible by normal fiscal or monetary stimulation, as
seen in the U.S. during the Great Depression and in Japan since the end of
1989, Dalio avers. The Bridgewater executive is quick to say, however, that the
U.S. could avoid depression and simply muddle through the next few years.
Still, a number of questions worry him: Why has the bear market been so
impervious to two consecutive years of pedal-to-the-metal monetary easing?
Normally, stocks would be on fire after such a span. And what will a Fed out of
monetary bullets do if unexpected problems in Iraq or another major terror
attack on U.S. soil upset the economy further?
Oft-bearish Morgan Stanley economist Stephen Roach also views the U.S. debt
load as a serious problem. "There's no question that we have a debt bomb, but
More To Follow In Story Number 64966
2003-01-18 04:00:51 UTC |
