Jim D.:
>>What worries me is this: The bond market is warning us of
>>turbulence ahead. That would be O.K. if the world's largest
>>economy were being run by experienced, open-minded officials like
>>the ones who got us through the last crisis. But who will actually
>>be in charge? If it turns out to be knee-jerk conservatives who
>>are opposed to any government intervention in markets, you'll be
>>amazed at how badly things can go wrong. *****
>
>wow! the economics elite is scared.
I posted the same Krugman Op-Ed to Lou's list, and I got the
following from Henry:
***** Date: Fri, 24 Nov 2000 20:26:19 -0500
From: "Henry C.K. Liu" <[EMAIL PROTECTED]>
To: [EMAIL PROTECTED]
Subject: Re: Anxious Krugman: "The Bond Market Warning Us of
Turbulence Ahead"(was Re: NY Times: clueless on Argentina)
Krugman is on target that the US ecnomy is heading for a credit
crisis. This is particularly true for the communication sector.
US investors looking for guidance are starting to heed recent
distress signals in the bond market - a storm for the United States
capital markets that may be tougher to recover from than the debacle
in the autumn of 1998. Then, a crisis was precipitated by the demise
of one giant hedge fund, Long-Term Capital Management, while HK had
to make a massive incursion into the equity market. But after the
Federal Reserve Board lowered interest rates, recovery came swiftly
to the US stock market and the US economy was relatively unscathed.
This time around, the turbulence will be set off by many troubled
companies buckling under the weight of excessive debt lent to them at
the height of New Economy euphoria.
As worried investors continue to shun corporate bonds as they turn
away from risk, companies will find it impossible to further raise
the capital that leads to new job creation and continued economic
growth. And since much of the economic growth in this nation over
the past few years came from the big money spent by companies that
had raised cash in the anything-goes bond market, the economy could
slow quite sharply as the money spigots go dry. Greenspan's soft
landing is turning into a hard one, and what is worse, the attempt to
engineer a soft ending has used up the entire runway. As more and
more companies go under, their woes could turn a soft economic
landing into a crash. And the longest American expansion on record
could come abruptly to an ugly end. Even if Greenspan can manage a
soft landing, corporate fixed expenses have built up during this
nine-year period of prosperity and will be hard to roll back, so that
a minor shortfall in revenues will cause a major shortfall in profits.
The bond market's condition has implications for interest rate policy
as well. Before the Fed can cut rates, it must weigh the decline in
credit quality against the need to get the market moving again. The
corporate debt market has grown enormously in recent years, expanding
to accommodate the burgeoning capital needs of hundreds of companies.
Although most investors focus on the stock market, the corporate bond
market dwarfs it in size. So far this year, companies have raised
only $146 billion from new stock issues, compared with $935 billion
in the corporate bond market. The peak of corporate issuance came in
1998 when $1.2 trillion worth of bonds came to market, up from $433
billion raised in 1995.
Just last Tuesday, ICG Communications, a telecommunications and
internet service provider in Englewood, Colo., filed for bankruptcy.
Its stock had traded as high as $39 last March, with $2.2 billion in
long-term bonds on its balance sheet before the bankruptcy. On May
17, GST Telecommunications, a Vancouver voice and data services
provider, declared bankruptcy. Although Time Warner bought its
assets, it paid only 70 percent of the book value of the company's
plant, property and equipment. That left just 50 cents on the dollar
for bondholders.
Bond investors appetite for risk has shrunk markedly. The total
amount of money raised in high-yield bonds this year will probably be
around half the $99.7 billion raised in 1999. In October, only seven
high-yield bond issues came to market, raising a total of $1.63
billion. In October 1999, 17 high-yield bond issues raised $3.3
billion from investors. Such bonds now yield 13.34 percent, up from
the 10.3 percent demanded by investors in September 1998, when
Long-Term Capital Management was sinking and the capital markets
stood still. And high-yield bonds are trading at yields that are
almost 9 percentage points higher than comparable Treasury
securities. Today's high yields and high spreads suggest that
investors realize that many companies issuing high-yield debt
confront much greater risks than they faced two years ago. That is
because in the crisis of 1998, even though one big participant was
teetering, the overall balance sheets of most issuers remained
healthy. Then, the underlying credit fundamentals of high-yield
companies were better than they are now. A recent report on heavy
debt among telecommunications companies argues that the market's
current problems are tied to declining credit quality of underlying
issuers that have continued to add leverage in the face of falling
growth rates.
Last year, 89 companies with debt that was rated defaulted on $24.2
billion in securities; so far this year, 85 companies have defaulted
on almost $24.7 billion of debt. In 1991, when the country was in a
recession, 65 companies defaulted on $19.8 billion of debt. Adding
to the unease over the higher default figures of today, companies are
defaulting on their bonds more quickly than they have historically.
84 of the 152 bonds that defaulted this year were issued in 1997 and
1998. That's 55 percent, which is very significant. For most of the
1990's, high-yield issuers have defaulted in four years on average,
not the two to three years that is becoming common. What these
companies are running into is an unaccommodating market just when
they need to refinance. Between 1991 and 1997, lenders holding
unsecured debt -- those that stand well back in the creditors' line
-- got back on average 40 cents on the dollar invested. But, in the
past three years, unsecured lenders have received 23 percent less on
average, or 31 cents on the dollar, because defaulters are so
overextended. Credit ratings of once high-quality corporations seems
to have collapsed overnight. Investors fear that the woes of such
blue chips may signal a looming recession.
The high-yield bond market, where companies of questionable credit
strength go for money to fund their operations, has grown from $213
billion 10 years ago to $508 billion today -- far beyond the growth
of the economy. Naturally, as the market ballooned, so did the
risks. Besides the dot coms, an economic backbone sector like
telecommunications, most of the money needed for expansion has been
raised in the high-yield bond market. Telecommunications bonds made
up an astonishing 18.6 percent of the market on Sept. 30. The next
industry group, cable television, had just 8.63 percent. The telecom
area is venture capital masquerading as high-yield with only future
earnings to point to. Now, those earnings are in doubt.
Capital spending by telecom companies has never been done before in
an unregulated, free-market environment. This is significant because
regulated industries can bank on guaranteed income from consumers
that can be used to pay interest on the debt amassed to build the
projects. But given the intense price competition in
telecommunications, lucrative cash flows from customers are no sure
thing. That makes many of these bonds precarious indeed.
The precipitous decline of technology stocks in recent months is also
contributing to the high-yield bond market's woes. That is because
investors who were willing to lend to speculative companies took some
comfort in their holdings as long as these companies' stocks -- and
overall market value -- were riding high. Many of these companies
have continued to add debt at a consistent pace, but their market
values have stopped growing or are growing at a slower pace. As a
result, the market leverage of the companies has grown rapidly and so
has their probability of default.
Other indebtedness that is not easily identified is growing at many
corporations. These less visible forms of debt include so-called
vendor financing, increasingly popular at technology companies, and
syndicated lending by banks to new companies. Last month, Lucent
warned investors that it was increasing its expenses to cover bad
debts from its customer financing. The news sent Lucent's stock
reeling, and it dropped 32 percent in a single day.
Syndicated lending by banks is also largely hidden from investors'
views. FDIC found classified credits, loans that are defined as
substandard, doubtful or lost, increased by almost 70 percent this
year over 1999. As the high-yield market has grown in recent years,
the number of brokerage firms and banks willing to trade the
securities has declined. Some of the decline stems from mergers in
the financial services industry, but even the firms that still stand
ready to facilitate their customers' purchases and bond sales have
sharply reduced the amount of money they are willing to offer for
this business. Since 1998, the capital that firms were willing to
commit to make secondary markets in high-yield bonds has been slashed
by at least 50 percent.
Unlike 1990 when financial institutions held most of under water
securities; today, the risks in the market are more widely spread
among financial institutions, insurance companies, sophisticated
investors like those who put money in hedge funds and individual
buyers of high-yielding mutual funds.
Even if Mr. Greenspan cuts interest rates in coming months, it may
not help this situation. The cost of debt capital for high-yield
telecom companies is 15.6 percent; if the Fed eases by 200 basis
points, it wouldn't substantially lower their costs. Furthermore,
since the huge growth in capital spending that has fueled economic
growth in the United States was largely funded by high- yield bonds,
when the market freezes, it cuts off access to capital. When a big
growth engine stalls, the economy could get hit hard.
In the past four years, debt at a group of seven high-grade
telecommunications companies, including AT&T, Verizon and SBC,
exploded from $93 billion, to $210 billion, an annualized rate of
almost 23 percent. At lesser-quality telecom and media services
companies, like Global Crossing, Nextel Communications and PSI Net,
high-yield corporate debt and convertible bond issuance ballooned to
$275 billion, a compounded annual rate of 60 percent, in the period.
To put this binge into perspective, the entire value of high-yield
debt issued between 1983 and 1990, the heyday of junk-bonds, was $160
billion.
These companies' capital structures now are simply too indebted for
their cash flows to cover interest payments. The investment thesis
for many of these firms was that, as they were nimbler and faster
than the incumbents, they would quickly raise capital, build out
networks with the latest technologies and then sell the completed
networks to the large investment-grade telecom companies which needed
the new assets. Now, however, even the big companies are strapped
for cash and are not in a buying mood. This puts immense pressure on
the speculative companies whose debt levels exceed the value of the
plant and equipment they have sunk in their networks. For example,
PSI Net has $4.6 billion in debt and preferred stock, more than
double its $2 billion in net plant and equipment. Its interest
expense and preferred stock dividends for the past 12 months totaled
$400 million, compared to revenues of $1.04 billion. The company's
net operating cash flow was a negative $241 million in the past 12
months. PSI Net's stock reflects these difficult economics; it has
crashed from $60.94 a share last March to $1.63. The company's bonds
are fetching less than 40 cents on the dollar. But other speculative
companies' stocks are still trading at fairly fancy premiums, even
though their debts exceed the value of their hard assets. This
suggests that those companies are bound to feel further pain.
As to Bush Economic Team:
Lawrence Lindsey, a former volunteer for George McGovern, the 1972
Democratic presidential nominee, now holds a position within the
George W. Bush campaign that is likely to make him Assistant to the
President for Economic Policy. Lindsey, having turned conservative,
now argues the supply-side line that the current government and
philosophical structure of the leading nations of the world has been
designed to battle past challenges, most notably the Cold War. He
asserts that nations can effectively confront new economic and
financial crises only by unleashing the power of democratic
capitalism to establish innovative global economic arrangements, i.e.
be a submissive colony of the US global system. He proposes what many
in the Third World have identified as neo-imperialism and
neo-colonialism as a natural law disguised in the form of
neo-liberalism, just as the British economists since Amith did with
classical economics theory during the British Empire. Lindsey was a
member of the board of governors of the Federal Reserve System from
1991 to 1997, a policy advisor to President Bush, and a member of
President Reagan's Council of Economic Advisers. Lindsey's new book,
Economic Puppetmasters: Lessons from the Halls of Power, focuses on
the constraints that neo-liberal economics places on modern
decision-makers. Lindsey claims that decision-makers may never be
the masters of the systems over which they hold sway, no matter how
much they delude themselves and the public into believing that they
are. More typically, they are the system's servants, constrained by
the prejudices of existing theory, by the information flow that has
developed in the bureaucracies they oversee, and by the constraints
that other decision-making forces impose on them. Thus one of its
principal lessons is how a knowledge of these constraints--an
understanding of the neo-liberal economics of the modern world--is an
extremely important tool of government today. Even powerful leaders
are very tightly constrained by institutions and history, that
strings are being pulled elsewhere by the "unseen hands" of the
market system, and that the high politicians spend most of their time
frantically trying to pretend that they are leading the parade. In
other words, nations and their governments might as well surrender to
US financial hegemony, which is the product of natural laws of
neo-liberal economics.
John Taylor might soon be appointed to the Fed Board of Governors.
His is the author of The Taylor Rule: if inflation is one percentage
point above the Fed's gaol, rates should rise by 1.5 percentage
points. And if an economy's total output id one percentage point
below its full capacity, rates should fall by half a percentage
point. Governor Laurence H. Meyer is a supporter of the Taylor Rule
It is a not-widely-known fact that there are currently two vacancies
on the Board. Senator Phil Gramm blocked approval of two appointees
by Clinton in order to allow appointments by his fellow Texan, young
Bush. Taylor has been an adviser to Bush. Robert Novak claims in
today's Washington Post that Greenspan is secretly for Gore and that
Bush will undermine him in revenge for his perceived tanking of Bush
sr. in 1992 with tight monetary policy. Also, Larry Lindsey is a
supply-sider. Might be some interesting things coming up soon....
Henry C.K. Liu *****
Yoshie
