New corporate debt calculations suggest downturn may go further

Submitted by martin on 25 November, 2008 - 12:13 Author: Martin Thomas

No-one knows how big the downturn will be in trade and production set going by the financial crisis. But one factor pointing towards a more limited, rather than a bigger, downturn has been the figures for the debt burden of non-financial corporations.

If corporations are very heavily in debt - as they often are after the top of a boom, when they have borrowed heavily to expand - then a financial crisis has a bigger effect. Lower profits hit harder if a large fixed amount in debt repayments has to be taken out of them. A corporation which has repayments of principal falling due, and had reckoned on taking out a new loan to cover at least part of them, may be unable to do that.

But the commonly-cited figures say that on average non-financial corporations have been carrying a relatively low debt burden. The Bank of England's recent Financial Stability Report worried that within that average a significant minority of companies in the UK may have debt burdens too big to manage.

An article by Tony Jackson in the Financial Times of 24 November suggests that the commonly-cited figures for the average debt burden of non-financial corporations may be misleading.

"On the face of it, US leverage [there are various ways of measuring leverage, but Jackson seems to mean debt divided by assets] has not risen. Indeed, for non-financial corporations it has been declining for more than a decade.

"But [an analyst] has argued... that this is seriously distorted by the inflation of asset values. In 1007, he calculates, changes in real estate values along added a daunting $1000 billion plus to non-financial corporate balance sheets...

"[If you measure] corporate debt against corporate output... US leverage last year was at a record - twice the level, for instance, of the early 1980s".

The debt-to-output ratio looks like the best measure of the corporations' ability to cope with their debt, since many assets will not be available to be sold at the price attached to them in 2007 accounts.

Jackson also argues that capital expenditure has been running at "bubble" levels, and is likely to shrink fast.

"[One analyst] puts the US surplus of capital expenditure over depreciation last year at slightly over $400 billion, having been zero as recently as 2003-4...

"The analysts' consensus is that capital expenditure by US non-financial corporations, still nearly 40% above depreciation, will fall back in line by the end of 2010...

"While capital expenditure is a lot smaller than consumer expenditure, it is also more volatile. Put the capital expenditure cycle together with the inventory cycle, and you have a key determinant of boom and bust".

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