RE: Dead Metaphors Society

["Michael Keaney" <Michael.Keaney@xxxxxx>]

Tom Walker doubts:

"soft landing for the economy"

=====

One of the more interesting activities of an otherwise unremarkable
weekend was catching up with the newspapers left unread owing to the
extraordinary events of last week. This article seems very pertinent in
light of the above, and, as with a lot else in recent times, seems to
throw yet another traditional assumption of orthodox finance out of the
window, thanks to the myopic obsession with "shareholder value":


Of bonds and disquiet:

The corporate bond market today is a
much riskier place than it was 20 years ago

Financial Times, Sep 11, 2001
By PETER MARTIN

In equity markets, the most dangerous words are: "This time it's
different." In bond markets, though, the most dangerous words may yet
prove to be: "This time it's the same."

The bond market is a sober place. Its denizens will tell you that they
are never carried away by the euphoria that infects their equity market
cousins. The rating agencies provide reams of statistics on which bond
buyers and analysts can draw to back up their view that just as good
times inevitably turn bad, bad times can be relied upon to usher in
renewed prosperity.

But two things have happened in the past 20 years that make the
corporate bond market a riskier
place.

First, the days when companies used to take pride in an iron-clad
balance sheet have gone. The
pressures to maximise shareholder returns have made it simply
uncompetitive to have a triple-A rating any more. Shareholders expect
finance directors to work the balance sheet harder.

A few snapshots illustrate the trend: in the 1980s, of companies
acquiring Standard & Poor's bond ratings for the first time, an average
of 10 per cent a year had triple-A ratings. In the 1990s, that figure
was slightly more than 3 per cent. Downgrades have exceeded upgrades for
19 of the past 20 years. US corporate debt has risen from slightly more
than half the annual corporate contribution to gross domestic product to
more than 85 per cent of it. And S&P's median rating for US companies
has dropped a notch in two decades, from single-A to triple-B.

Running a company on a higher debt/equity ratio delivers better returns
to shareholders, in the short term at least. And it may well make sense
in an era of economic stability, when the overall riskiness of the
company's operations is lessened by steady growth.

Still, if the era of stability is interrupted - as it seems to be this
year - higher levels of debt make companies much more fragile. In the
first half of this year, rated bond issuers defaulted on Dollars 51bn
(Pounds 35bn) of debt, according to S&P. And this was a period when the
full impact of the slowdown had not yet had time to work its way through
into companies' debt service.

Default does not necessarily mean that the company is going under: it is
perfectly possible for a business to restructure its debt or to conduct
a fire sale of assets. But it is a good indicator that the company has
taken on an unsustainable load of debt.

Or started with it. Because the second trend is one that began with the
junk-bond revolution of the 1980s: a much greater tendency for new
companies deliberately to establish themselves with weak balance sheets.
In 1998, the peak year of this cycle for the issue of speculative-grade
debt, 24 per cent of new issues were rated at double-B, a category that
has demonstrated a 16 per cent chance of default over 15 years. And 37
per cent were rated single-B, with a 15-year probability of default of
30 per cent.

Those default numbers probably overstate the strength of the new
arrivals, because the historical figures include "fallen angels",
companies once strongly capitalised that have fallen on hard times. Such
businesses often have hidden strengths that can be revealed by a change
of management. Newly launched, thinly capitalised companies are
inherently more vulnerable.

In other words, this time it is different - and worse. Do bond investors
realise that they have been assuming risks on this scale? Up to a point:
speculative bonds have fallen sharply as a proportion of the total
issuance this year and issuers have had to pay much higher prices. But
investment-grade bond issuance has exploded, as finance directors have
taken advantage of the bull market in bonds triggered by US interest
rate cuts.

Bond risks are only some of the recent changes in the financial system
of the developed economies. Managers are lavishly incentivised to push
up the return on equity. Bond investors are assuming equity-like risks.
Venture capital and private equity firms are pushing for much more rapid
payback. Lending decisions are increasingly divorced from the long-term
assumption of credit risk.

For 10 years, the markets' attention was focused on the way that these
changes helped push equity prices steadily upwards. But now that
equities' irresistible rise is over, investors are starting to wake up
to the structural changes that accompanied the bull market in stocks:
increasing fragility and twitchiness elsewhere in the financial system.

These changes will probably not be disastrous: the soothing long-run
probabilities of bond-market statistics will in time achieve their
predictable damping effect. But before that, we are likely to experience
more painful and unexpected consequences than we yet realise.

Standard & Poor's: Corporate Defaults, January 21 2001; and Global
Credit Market Trends, Q2
2001. www.standardandpoors.com

Full article at:
http://globalarchive.ft.com/globalarchive/articles.html?print=true&id=01
0911001422

Michael K.