Friday, September 11, 2009
corporate balance sheet repair
t[T]he Bank of England's fear is that banks are being too averse to risk, that they don't want to lend even to businesses that are fundamentally viable.
And there is evidence that some legitimate requests for credit are being turned down.
But there is something else happening as well: many companies have recognised that their balance sheets are over-stretched, that their debt is too high relative to their devalued assets, and are choosing to repay debt.
Right now it is hard to find a substantial listed or private-equity financed business that actually wants to increase its debt - and many have programmes to reduce their borrowings.
There are, for example, a number of big companies which are technically insolvent: on a realistic valuation of their assets, and including the deficits in pension funds, their liabilities exceed the value of their assets.
They can keep going, because they are generating cash from operations. But although they won't admit it, for fear of panicking shareholders and creditors, they are in what is known as "workout" mode. They are concentrating on shrinking to pay down borrowings.
Paying down debt is rational for each individual business, but it collectively leads to lower investment, lower employment and lower demand in the economy as a whole - and therefore feeds back into worse conditions for business in aggregate and lower economic growth.
This pernicious trend of corporate debt reduction hobbled the Japanese economy for 15 years, according to the compelling analysis of Richard Koo (in his The Holy Grail of Macro Economics).
Corporate debt minimization can't do as much damage here because the debt of British businesses never reached the peaks of Japanese corporate indebtedness - and nor did our asset bubble become quite so egregiously pumped up as theirs.
But if it turns out to be the case that for an extended period, businesses will be choosing to repay debt rather than investing in growth, that will have significant implications for all of us.
It would imply that if households and government also chose simultaneously to cut spending to reduce their excessive debts - and on most analysis, the UK's indebtedness problem is concentrated on the household and public sectors rather than the corporate sector - then the incipient economic recovery could be snuffed out pretty fast.
Which explains why central bankers and finance ministers are only making plans to end their exception stimulus measures, rather than setting a precise date for the withdrawal of the prop.
as peston notes, this is exactly the dynamic of balance sheet recession that has been at work in japan for two decades.