Bad Debts Mounting

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Bad Debts Mounting
By Dan Green
12/07/00 12:00 PM ET

Mega-lender Bank of America surprised the markets yesterday by announcing that earnings would fall far short of expectations, in part due to problems with bad debts. Bank of America, like nearly every other lender, extended credit too easily as the economy boomed, and it is now preparing to pay the price.

Years of accelerating profit growth and strong equity markets allowed many firms with somewhat questionable financial prospects to get loans. This year, as a result, credit agencies like Moody's are downgrading corporate debt at the fastest pace in a decade.

The junk bond market has collapsed in recent months, as lenders have belatedly become more cautious while numerous borrowers are defaulting on their debts. November was the second-worst month this year for junk bond defaults. Trading has nearly halted in many poorly rated firms' debt, as investors seek safer returns in higher-rated corporate bonds or Treasurys.

Commercial and industrial loans are also performing poorly. While bank loan quality has not yet suffered too badly, many commercial and industrial loans, especially large loans made by several cooperating banks, are not being paid off on time.

There are clear similarities between events in the high-yield debt markets and the IPO market. In both cases, companies were able to acquire capital too quickly in the same way that investors and lenders became reckless in the pursuit of extraordinary returns.

Unfortunately these same relationships work just as well in reverse. Just as the IPO market is now effectively closed, so too are the credit markets tightening very quickly, and perhaps excessively, in reaction to mounting piles of bad debt. The closure of the IPO market is unfortunate for investment bankers and high-tech entrepreneurs, but has yet to measurably impact the economy or the pace of innovation. Credit markets are another story, however. Bank loans in particular are essential to economic growth. This is why Fed Chairman Alan Greenspan's speech Tuesday repeatedly urged bankers to continue to extend credit even as bad debts mount.

The slowdown in debt and equity market deals, coupled with the deterioration of credit quality on outstanding loans, are hammering Bank of America and are likely to hit the firm's competitors. The natural response is to batten down the hatches, contain costs, and curtail lending.

Lenders surely needed to be chastened for making too many bad loans, just as stock investors were pummeled for throwing money at money-losing companies as the Nasdaq rose to 5,000. The stock market's decline is bad news for large swaths of the economy, but pales behind the destructive potential of too sharp a slowdown in bank lending.

When banks become too cautious, firms are less able to hire new employees or make productive investments. Credit squeezes, often inspired by the Fed, worked hand in glove with rising oil prices to spark the last three major recessions. You can bet that Alan Greenspan is not eager to let the economy slip into recession, especially as oil prices seem to be under control and the economy's worst excesses are already fading. That is why the Fed will lower interest rates sooner rather than later.



-- (M@rket.trends), December 09, 2000

Answers

At some time in the near future, America's debt will CRUSH all hopes of recovery. The other nations will perceive this peril and sell US dollars. Then the horrendous slide will begin.

Nothing will be able to stop it, not even the Greenspan Put.

The coming Depression will cause much sorrow.

Get prepared while you can. There are still many good food buys to procure. Store them in a cool, dry place and don't tell your enemies.

Eventually, even your best neighbors will turn against you when they are starving.

You might laugh now, but your smirk will be wiped away when the hard times come...

-- dinosaur (dinosaur@williams-net.com), December 09, 2000.


It's time to get out Howard Ruff and & Gary North's books on surviving the hard times. We not only have a bad debt problem, but an energy crisis combined. In 1974-75, this same secnario reared it's ugly head and sent us into a recession like no one has seen since the Great Depression. But don't listen to me, keep charging those credit cards...I advise getting cash advances on any 0 to low interest rate on credit cards you have or....if you can find any good offers out there. I was receiving on an average per week, 5 offers from credit cards companies. I haven't received any for 2 months now.....what does that tell you?

-- Mrs. Cleaver (Mrs. Cleaver@LITBBBB.vcom), December 09, 2000.

I haven't received any for 2 months now.....what does that tell you?

Please clue me in. I have exactly ONE credit card...Discover...which is NOT honored everywhere, and I've paid the bill completely every month since I've had it [except when I've misplaced the bill.] I still get the daily mailings, and the daily phone calls. Pray tell...what DOES this tell me?

-- Anita (Ania_S3@hotmail.com), December 09, 2000.


Q. Pray tell...what DOES this tell me?

A. That it doesn't pay to Discover?

-- (raven@never.more), December 10, 2000.


For those interested in food supplies. Ark Institute is giving away their 1999 stock of 50 varieties of nonhybrid vegetable garden seeds worth $150.00 for $25.00 S/H. They're at arkinstitute.com.

-- Johnn Littmann (littmannj@aol.com), December 10, 2000.


This is why this forum is so entertaining. The first whiff of an economic downturn and people are preparing for the Great Depression. Last year, I suggested there would be a recession and the best preparation was not building a bunker, but paying down debt. It's more expensive to grow your own food than buy it at the local market. Sure, I like home grown vegetables, but I don't kid myself about the efficiency of the process.

-- Ken Decker (kcdecker@att.net), December 10, 2000.

Sorry Anita, I left out a couple of clues. I meant to say that I haven't received offers from credit card companies urging me to send away for their cards for 2 months. I was getting offers in the mail with 0 interest rates if I transferred balances from other credit card debt to theirs. I have Discover Card and a Visa with our credit union. Whatever I charge, I pay off as soon as I get the bill.

I also agree with Ken Decker and the garden scenario. It takes water, fertilizer, and lots of TLC to grow a garden. It's more expensive than buying from the grocery store. However, a head of Romaine lettuce here in California is averaging $1.99 a head, and at one store I saw it for $2.49. Weather is the blame for high produce costs. Also, farmers are having a hard time finding farm workers, they seem to be finding better paying jobs in restaurants and other industries.

-- Mrs. Cleaver (Mrs. Cleaver@LITBBB.vcom), December 10, 2000.


>> The first whiff of an economic downturn and people are preparing for the Great Depression. <<

Maybe people are applying the simple idea that the longer the boom, the steeper the cliff at the end of the boom. Historically, there is some justification for this attitude. Long periods of prosperity tend to build up excesses. The longer the proserity, the greater the excess. We seem to be hovering near the end of the longest period of unbroken economic expansion in US history. It remains to be seen what excesses need to be wrung out of the system.

It is very hard to tell right now just what is excess and what is not. Banks have been very aggressive about extending credit. They have profited from that policy during this past decade. That makes them "good" loans by every objective measure. But during a recession the measuring stick changes, sometimes radically.

Under the current regime at the Fed, I suspect we are more likely to see a downturn that delivers a long period of stagflation, rather than a sharp plunge over the cliff followed by a steady climb. Greenspan is already hinting at an easing. I suspect it won't come in December, though.

>> Last year, I suggested there would be a recession and the best preparation was not building a bunker, but paying down debt. <<

Still excellent advice. Ben Franklin would be proud of you. The same applies to your advice to diversify investments among both aggressive and conservative choices. How are you allocated, Ken?

-- Brian McLaughlin (brianm@ims.com), December 11, 2000.


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