Debt, the Phantom Menace, so Far Remains Just That

Economic booms and stock bull markets typically die of excesses: too much of their own good things.

Too much inflation fueled by too much money, too much debt that can’t be repaid, too many overpriced stocks whose companies can’t deliver--these are the excesses that usually mark the end of the party.

And therein lies the challenge for anyone today who’s intent on looking for trouble rather than simply enjoying this economy and market: With few exceptions, it’s hard to find the classic excesses that denote a cyclical top.

Last week, for example, the government reported virtually no net inflation at the wholesale or retail price levels in June. What’s more, Friday’s report on U.S. factory capacity utilization showed the overall rate at 80.3% in June, hovering at its lowest level since 1992.

In other words, there’s plenty of capacity around to make more goods, if demand remains strong. That, too, is anti-inflationary--and a far different story from 1994, when the rate neared the historical danger zone of 84%, spurring the Federal Reserve to tighten credit.

Of course, there is another inflation issue today, which is the continuing inflation of stock prices. Major U.S. share indexes all hit new highs last week. The Nasdaq composite is on fire again, surging 2.6% last week to a record 2,864.48 by Friday. In less than seven months the index has zoomed 30.6%--the kind of return professional money managers used to be content to earn over two to three years.

Microsoft is now worth half a trillion dollars, the stock market says. There is perhaps good reason to be afraid if Bill Gates’ empire really is worth that sum, and maybe more reason to be afraid (for the market overall) if the company’s true value is far less.

In any case, as lofty as share valuations may be, the market can’t help itself. It is merely responding to what remains a very bullish backdrop of healthy domestic economic growth, strong corporate earnings and rising expectations for a sustained recovery in populous East Asia.

It’s worth noting that one year ago, two of those three positives were missing--earnings growth at many U.S. firms had stalled, and Asia was still getting worse. So when Russia devalued its currency in August, it sucker-punched an already woozy Wall Street.

If fearful investors can’t find enough to worry about in the latest economic or corporate profit data, however, some are looking to another traditional source of trouble: rising debt levels.

U.S. consumer installment credit outstanding jumped $12.1 billion in May to $1.34 trillion, continuing an acceleration of the pace of borrowing that began in mid-1998. And on the corporate side, Ford Motor just floated the biggest company bond offering ever, totaling $8.6 billion.

Is debt the lurking menace that will ultimately crash the U.S. economy’s long-running party?

There are some reasons to be worried--some, but probably not enough quite yet.

In the corporate sector, for example, many companies have boosted their debt loads in the 1990s. But because interest rates have declined so sharply--while corporate profits have exploded--the interest payments on that debt are modest compared with companies’ aggregate earnings.

In 1989, just before the economy sank into recession in 1990, U.S. nonfinancial companies’ total pretax profit was just 162% of the net interest payments they shelled out that year, according to Moody’s Investors Service.

By contrast, in the 12 months ended March 31, companies’ pretax profit was a huge 506% of net interest payments made. Most companies are simply generating far more cash, relative to debt costs, than in 1989, when debt levels from the 1980s’ economic expansion reached their zenith.

While the corporate sector’s debt picture overall looks healthy, however, there is one warning light flashing: Defaults by high-yield junk bond issuers are up.

In the 12 months ended June 30, a total of 4.6% of all junk issues were in default, Moody’s says. That was up from 3.4% in calendar 1998 and the highest since the 4.8% of 1992.

What the trend shows is that even in a great economy, more companies at the lower end of the quality spectrum are having trouble making payments on their debt.

“The deterioration in credit-worthiness has been most pronounced among smaller companies,” says Moody’s economist John Lonski in New York.

That also may be reflected in an uptick in delinquency rates on business bank loans. That rate was 1.91% of all commercial and industrial loans made by banks at the end of the first quarter, the highest since the second quarter of 1996, Moody’s says. The bottom was 1.56% in the fourth quarter of 1997.

Still, the current default rate is a far cry from the 6.11% in the first quarter of 1991. Moreover, U.S. banks are so much better capitalized than in 1991 they can easily cope with modest loan losses.

The Federal Reserve, in a new report on the health of the banking industry, says nearly 95% of total bank assets at the end of last year were held by banks the Fed considers “well-capitalized.”

That figure was less than 40% in 1991, the hangover days for banks after the 1980s lending binge.

If serious debt excesses aren’t yet apparent in the corporate or commercial banking sectors, what about the consumer sector?

The popular wisdom is that American consumers are spending like mad with borrowed money. There is some truth to that.

The continued high pace of car and light-truck sales, for example, has mostly been financed by loans, as you would expect.

But is the average family overstretched by debt payments?

There are few signs of that in the overall payment delinquency rates on credit card debt and mortgage debt. Credit card delinquency rates have held steady since 1996, Moody’s says. And the mortgage delinquency rate actually declined in the first quarter to the lowest level in four years, the Mortgage Bankers Assn. says: 4.1% of loans were delinquent as of March 31.

Naturally, people feel a lot richer and able to carry more debt, especially if they’ve owned stocks. Nonetheless, consumers’ monthly debt payments now take 15.3% of their disposable income, on average. That’s a full percentage point higher than the 1989 figure, says Susan Sterne, principal at Economic Analysis Associates in Greenwich, Conn. And many people pay much more than 15.3%, of course.

That debt load is affordable as long as consumers’ incomes and asset levels keep rising and interest rates stay relatively low, economists say. The big test will come when stock prices decline for an extended period, or when soaring home values (on which the ‘90s surge in home equity loans is based) stop rising or pull back.

A lot of people have died holding their breath for those events to occur in the 1990s.


Tom Petruno can be reached by e-mail at