Debt Crisis


U.S. Firms, Consumers Strain Under Debt Despite a Boom

American companies and individual consumers alike are struggling to meet their debt payments, even as the economy's expansion enters record territory.

The difficulties, the worst since the U.S. economy emerged from recession in the early 1990s, suggest to some analysts that below the economy's rosy surface are growing difficulties. If companies and individuals can't keep up with their debt now, amid a robust economy, there could be wider-spread difficulties in any downturn, those analysts say.

Some optimists insist that it is the economy's exuberance itself that has lured companies and individuals to take on too much debt and that the increased problems won't cripple the economy. But everyone in the bond market concedes that the increases in bond defaults and personal bankruptcies are significant.

As many as 5.3% of U.S. companies with outstanding junk bonds defaulted on interest payments in the past 12 months, up from 4.1% in calendar year 1998 and 2.1% in 1997, and the fastest pace since 1992, according to Moody's Investors Service.

"The trend quite frankly merits attention, and some would consider it alarming," says John Lonski, Moody's senior economist, who says defaults could reach 6% this year.

The man on the street is having the same problem as corporate America. About 1.35% of all U.S. households declared bankruptcy in the 12 months ending June 30, off a tad from the previous 12 months' 1.38% figure, but up sharply from 0.8% in 1995, according to the Administrative Office of the U.S. Courts.

The continuing difficulties for individuals, in particular - coming as they do despite a puny nemployment rate and record stock-market gains - have economists scratching their heads.

"Given the job market's improvement and the fact that growth and income are above inflation, it stands to reason that personal bankruptcies would be coming down, and it's surprising they're at a such a high level," Stuart Hoffman, chief economist at PNC Bank in Pittsburgh, says.

Overall, 2.1% of companies with any kind of bonds defaulted in the past 12 months, up from 1.3% in calendar year 1998 and 0.7% in 1997.

High-profile companies defaulting on their debt recently include Iridium LLC, Planet Hollywood International Inc. and Harnischfeger Industries Inc., leveling heavy losses on both stock and bond investors.

The soaring number of corporate defaults continues a trend that started in 1998, says Leo Brand, a Standard & Poor's analyst who says a record $27 billion of debt has been defaulted upon this year, up from $11 billion in all of 1998.

The debt troubles suggest to some that if the economy hits a speed bump, or the stock market slumps, both companies and consumers could quickly rein in spending, hurting the economy in the process.

Such a scenario "could bring upon a credit crunch that would imperil the eight-year-long expansion," Mr. Lonski says.

Indeed, since 1980, "every increase in the default rate has been associated in some way with a decline in the GDP growth rate," notes Claude Amadeo of Bridgewater Associates, a Westport, Conn., money-management firm. The recent rise in defaults amid strong growth "sends up a flag that corporate-debt burdens may be more troublesome than the broad numbers indicate."

And the fact that household debt as a percentage of gross domestic product is at its highest level ever suggests that "if the economy declines, and stock and home values fall, households, who have a negative savings rate, will have trouble servicing their debt," Dan Bernstein, Bridgewater's director of research, says.

"It makes you wonder what happens if the economy turns down significantly."

Despite the troubling figures on defaults and bankruptcies, some analysts say there is no reason for excessive hand wringing. For one thing, American companies on the whole are demonstrating impressive profit growth. It is just lower-tier companies that are suddenly struggling.

"It's not that there is a dark side of financial stress building," Robert DiClemente, Salomon Smith Barney's chief economist, says. "Rather, the profit picture is improving, but those companies that are weak and vulnerable to default" are having difficulties.

Much of the trouble stems from the fact that too many companies with faulty business models, and little track record of turning out profits, have been able to sell bonds amid the robust junk-bond market of recent years. Now those debts are coming due, but many companies - especially those with the lowest credit ratings - don't yet have enough in the way of profits.

"This isn't the deterioration of credit worth that we saw in 1989 and 1990," Mr. Lonski says.

In fact, while the level of corporate debt to gross domestic product has risen to about the levels of the late 1980s, "the rise in debt levels over the last few years is still small in relation to the very large increase between 1982 and 1989," Mr. Amadeo of Bridgewater says. At the same time, debt as a percentage of liquid assets among U.S. companies is much lower than in the early 1990s, suggesting that most companies are unlikely to have trouble meeting their debt payments.

In fact, credit strength of all but the weakest U.S. corporations showed signs of improving in the second quarter, according to Moody's. Still, Moody's cautions in a recent report that "the rising number of bond issuers with lower speculative-grade ratings points to a likelihood of increasing numbers of bond defaults over the next year."

"The real issue is if there's an external shock to the economy, then you could have trouble, because you have relatively high debt levels and high default levels, given the strength of the economy," Mr. Bernstein says.

Why have many consumers loaded up on debt in recent years? Many have bet that the economic expansion would continue. Now, many cannot make their payments - a difficulty for these individuals, of course, but not necessarily for an economy generating wealth for most consumers.

"It's become less onerous to declare bankruptcy, and some people have taken on too much debt, leading to financial difficulty," Mr. Hoffman says.

Some analysts say the stigma surrounding a bankruptcy filing has lessened in recent years, increasing the numbers filing for bankruptcy. In fact, there is an effort under way by Congress to make it harder for individuals to file for bankruptcy protection.

The high level of bankruptcy filings "reflects a new behavior of declaring bankruptcy rather than being delinquent [on debt payments]," Mr. DiClemente says. "Net household worth is unbelievably strong and granted, it is skewed by those at the top, but I don't really see a weak underbelly in households."

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