Instead of Deleveraging, Companies are INCREASING Leverage, Putting the Economy at Heightened Risk

As I have repeatedly tried to point out, the problem is too much leverage, and what is needed to fix the economy is for the financial players to deleverage.

But instead of encouraging orderly deleveraging, the government has done everything it can to prop up and even increase leverage.

The Wall Street Journal has confirmed the problem in a new article:

Deleveraging? What deleveraging? Since the start of the credit crunch, corporate leverage has risen at a faster rate than it did at the peak of the boom, even as firms work hard to reduce borrowings. Companies that once embraced leverage in the name of shareholder value now find their debt piles balanced precariously on shrinking earnings. Absent a swift recovery, leverage is likely to rise even higher…

The picture is more worrying for companies where deleveraging should be the top priority: those bought by private-equity firms. For example, look at chip maker Freescale Semiconductor. When taken private in December 2006, it had leverage of just over 5 times, but relentless earnings pressure has pushed that figure ever higher. Analysts now forecast leverage will peak at more than 10 times earnings before interest, tax, depreciation and amortization, despite an exchange offer that cut debt by $1.9 billion.

Meanwhile, among the most aggressive European LBOs, leverage is standing still or rising, according to Fitch Ratings…

None of this bodes well for credit ratings. Even if total debt outstanding is stabilizing or falling in some cases, the ratings agencies focus on metrics such as asset-backing and interest cover. In the first quarter, Standard & Poor’s downgraded 523 companies and upgraded just 38, giving a record downgrade ratio of 93%. That will make it harder for companies to refinance at attractive rates, leaving many running hard just to stand still.

Way to go Geithner, Bernanke and Summers. Instead of insisting that a couple of levels be taken off the top of the house of cards, you’ve encouraged the gamblers to add new, ever-flimsier layers.

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  • http://www.blogger.com/profile/12445876932247713605 Rusty Mason

    It’s becoming more difficult to accept that the banksters and government officials are making the economic situation worse merely out of stupidity. No one could be that stupid.

  • http://Timnoreply@blogger.com Tim

    Freescale was an LBO from 2006 and its leverage is measured on a cash flow basis, debt/ebitda. Therefore, leverage has gone up because ebitda has fallen, not because of “government officials” Also, the government is trying to make sure that credit is available, not encouraging increased leverage. Credit is the fuel for economic expansion. Without it, the economy melts down. Securitization markets are essentially shut and the “shadow banks” like SIVs, conduits and CDOs provided a tremendous amount of credit to the economy. We need to replace a portion of the credit they created to allow consumers and companies to get the credit they need. Only Government has the capacity to fill that role since traditional banks are grappling with their own problems.

  • http://Anonymousnoreply@blogger.com Anonymous

    Tim,Credit is not the fuel for economic expansion, capital is. Capital cannot come from credit created out of thin air, it must come from savings. Your solution of more consumption is what created this mess to begin with. Instead, people need to cut spending, close the credit spigot and save.Propping up our phony economy with more credit, only prolongs and worsens the bubble we’ve created. This leads to more severe problems down the road and even more money taken away from actual productive entities. Once overleveraged companies are allowed to fail this will make way for productive, well-managed companies to pick up production. That’s the only way to really expand an economy.

  • http://Anonymousnoreply@blogger.com Anonymous

    Tim,In addition to the great corrective comments above, the "problems the banks are grappling" with, among other things, are that they DO NOT TRUST EACH OTHER. They know that they are insolvent, and worry that other banks, unwilling to reveal their off-book holdings, may be just as insolvent. JPMorgan, for example, has 70 Trillion in derivatives, the true value of which it is concealing, with the aid of the FED/Treasury. There is at least one trillion in losses hidden in that 70 Trillion.

 

 

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