How bad will things get?
*The Economist, March 27, 2008
“The recent rise in corporate bankruptcies in America may well be a sign of much worse to come
CAPITALISM without bankruptcy, it is said, is like Christianity without hell. With recession looming, the air in America’s bankruptcy courts is thick with brimstone and the coals are being heated in readiness for the many sad souls whose sin was to borrow too much. After several heavenly years, in which bankruptcies fell to record lows, going bust is back. How bad will things get?
If the debt markets are to be believed, companies could be in at least as much trouble as they were in the previous two downturns, in the early 1990s and at the start of this decade, after the dotcom bubble burst. A leading indicator is the spread between yields on speculative ‘junk’ bonds and American Treasury bonds. A year ago, the spread was only about 280 basis points; the long-term average is around 500 points. This month the spread exceeded 800 points for the first time since March 2003, reaching 862 on March 17th.
The bankruptcy rate (in the previous 12 months) for high-yielding bonds has so far edged only modestly higher, to 1.28% from a record low of 0.87% in November. But most forecasters expect it to rise sharply over the coming months. For instance, Moody’s, a ratings agency, predicts that the default rate will rise to 5.4% by the end of this year, mostly due to problems in America. (Moody’s also expects a rise in European bankruptcies this year, but only to 3.4%, thanks to lower levels of borrowing and less exposure to economic weakness.)
That is a relatively optimistic prediction, for it would merely return the bankruptcy rate close to its long-term average after an abnormally trouble-free period, and it assumes only a mild recession in America. But if there is a severe recession, the default rate ‘could go to double figures,’ admits Kenneth Emery, head of corporate-default research at Moody’s.
Other forecasters are much gloomier.”
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