Companies Are Feeling Effects of ‘Debt Binge’ in ‘80s, Economists Say

Hardly a day passes, it seems, that the newspapers don’t have stories about companies staggering or collapsing under the weight of debt. Firms like Campeau Corp. and Drexel Burnham Lambert Inc. have become synonymous with credit and debt problems.

But there are other, smaller companies that have found themselves in similar straits, like Interco Inc., Seaman Furniture Co. and Revco D.S. Inc.

More firms are likely to encounter trouble, economists say. As that happens, the economy could suffer from the fallout of the 1980s debt binge.

“As (debt) has increased, it has become somewhat more of a problem and tends to further aggravate the slowdown in economic activity at the corporate and national level,” said Jerry J. Jasinowski, chief economist for the National Assn. of Manufacturers.

At an extreme, corporate debt problems could snowball into a financial crisis for the entire country, Jasinowski said, adding that while such a scenario is unlikely, “you can’t rule it out altogether.”

One danger of debt overload is that, with the interdependence of U.S. industries, one company’s problems can threaten the stability of others.

Before Campeau’s Federated Department Stores and Allied Stores units filed for bankruptcy court protection, for example, the retailer’s vendors worried that they could lose millions of dollars in business or not be paid for merchandise already shipped.

Jasinowski spoke of another danger: Companies could be so stymied by debt that they lose their competitive edge, especially against foreigners. When a firm spends more money on debt payments, it has less money to grow or improve.

Jerome E. Hass, professor of managerial economics and finance at Cornell University’s Johnson Graduate School of Management, said Interco was an example of an indebted manufacturer that could lose business to rivals. Interco is strapped for cash because it hasn’t been able to sell assets to finance a $2.8-billion recapitalization.

The company’s Converse unit, which makes sneakers in competition with well-known brands like Nike and Reebok, has to keep up its research and advertising spending to contend with its rivals. If Interco’s finances don’t improve, funds for those key areas could be cut back, Hass said.

Jasinowski acknowledged that loss of productivity and investment because of debt is not widespread now. But he said it contributes to the current economic slowdown, and the country could begin to feel the impact in a few years.

Certainly it could be felt if more companies run into trouble, and many economists expect it’s only a matter of time.

“If the economy turns down, then there’s going to be numerous cases of financial distress,” said Gregg A. Jarrell, a finance professor at the University of Rochester’s William E. Simon School of Business. He said some companies will have problems even if the economy’s growth remains unchanged.

Companies went into debt because money was easy to buy in the 1980s.

When junk bonds became the way to finance acquisitions or restructurings, many companies willingly committed themselves to millions of dollars in high interest payments. At its height, the junk bond market was worth more than $200 billion, and many of the bonds carried interest rates of 16% or higher.

When the market collapsed--contributing to the demise of its creator, Drexel Burnham Lambert--financing became scarce.

Few companies thought they would be unable to pay high interest bills. But many also didn’t expect the economy to slow, which it has, and they didn’t expect interest rates to rise or profits to fall.

Furthermore, said Jarrell, “it’s inevitable as time passes that some of the businesses that these firms are in will turn down before they get their leverage down . . . and that some of the projections to support the debt will be overly optimistic.”

Part of the problem, he said, is that some industries are cyclical, and when they go through low points, highly indebted companies get hurt first.

The slumping retail business has provided some of the most painful examples of the hazards of excessive debt. Besides Campeau, retailers such as Seaman and Revco, both of which changed owners in deals financed by junk bonds, found that they couldn’t meet debt payments because of insufficient sales.

Nonetheless, debt-burdened companies are not collapsing around us, as some descriptions suggest.

The number of business failures in the United States fell 5.7% from the beginning of this year through mid-February, compared with the same period of 1989, figures compiled by Dun & Bradstreet Corp. show.

For all of last year, business failures, which include bankruptcies, dropped 12.9% from 1988.

The problems of some larger businesses may have dominated headlines, but “many of the small businesses did not incur lots of debt and are not weakened by leveraged buyouts they may have done,” said Lawrence Chimerine, an economist with Wefa Group, an economic forecasting service in Bala Cynwyd, Pa.

A company that can’t pay bills or obtain more credit must take drastic steps to avoid default.

Some look for new investors to provide a quick cash infusion. The British company Waterford Wedgwood PLC did this recently to alleviate some of its debt burden.

Some sell assets. But, as Interco has found, finding a buyer for an entire division isn’t as easy as it once was.

Moreover, prices for subsidiaries--like prices for entire companies--have fallen. That means the proceeds from a sale may not go as far to reduce debt as a company had hoped.

A firm in trouble can also try to renegotiate terms with lenders, as Interco did recently.

If all else fails, companies can begin reducing costs. That means layoffs.

“An interest payment cannot be laid off in the same way an employee can be,” said John Lonski, senior economist with Moody’s Investors Service Inc.

If the economy slows further, he said, “we should see companies respond all the more quickly in the way of laying off employees.”