The debt bomb - Barron's frets at possibility of depression

Richard Fidler rfidler at
Sat Jan 18 14:41:02 MST 2003

By Jonathan Laing
January 20 2003

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.

Reality Check

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.

Engorged With Debt

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.

Slouching Toward Depression?

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.


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