Tuesday, August 02, 2005

On Corporate Debt

A currency trader corresponant wrote:
I am not sure where you get your figures on corporate indebtedness but everything I have read points to the relative health of corporate balance sheets.

So, I realized I needed to look deeper in to corporate debt. The figures I uncovered are revealing. As for where I get my numbers, I just look them up on my brokerage site — harrisdirect. The number that caught my eye is the figure for the S&P 500: 1.08. 108% of equity! Also, the S&P has a P/E of 20 [these are the most recent figures. Debt is actually trending down, from 110% in March. But the P/E is trending up, from 17 in March]. Normal corporate debt should be around 1/3 of equity. And in an era of rising interest rates, companies should pay down debt.

Much of the S&P 500's debt is related to housing and real estate: fannie mae and freddie mac are high on the list of topheavy S&P components. Fannie is at 23 times equity, Freddie is 16. Wow. Goodyear is a proposterous 105 (I double checked this, it is real). Of course we can ask who needs Goodyear, when we can buy better tires from Asia? Goodyear is just another rust belt relic. Goodbye, blimp. All of the american auto sector is heavily indebt, for that matter. But Fannie and freddie, if they turn turtle, we are in very big trouble. Of course the government would want to bail them out. But with what money? Fannie Mae’s debt adds up to almost a trillion bucks. Can even the USA float bonds that size? America's entire national debt is 8 trillion.

Looking up the numbers of the dow components, many of the large caps on the dow have normal to negligible debt. Disney, Home depot, Wal mart, Merck, and DuPont are all OK. Exxon, swimming in oil-revenue cash, has almost no debt at all. Others are outrageously overloaded: Citigroup is 1.9, GE, 1.89. Of course one could argue that fannie and freddie naturally have high debt, their business is to buy mortgage debt. And because homeowners are the last to default, it is relativly safe. But two things have changed:
a) people are buying homes on short-term speculation.
b) if homeowners' variable rate mortgages go up to a level that they cannot pay, and they don't have enough equity in the house to sell, then they will default.
Another problem with the banks' and mortgage companies' debt is they they have swollen to a huge proportion of the market. The manufacturing sector has practically no equity any more. There is no sector of the market that can hold up if the home-debt bubble collapses, because real estate is almost the whole market.

1 comment:

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