The Debt Time Bomb

The U.S. economy is still struggling. And the credit markets are still failing to function – mostly because the roots of the American financial system remain diseased. Thanks to the crisis-deferral tactics of former Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke, the American banking system is now grafted onto the diseased roots of dishonest asset pricing, deceptive accounting, capricious government intervention and malign regulatory overhauls.

“As a nation, we blew it. We had the chance to implement constructive changes and we blew it. When we finally had the chance to purge of the rot from the financial system, we chose the exact opposite path: we bailed out the rot, and forced the healthy to subsidize the process.”

A handful of privileged folks are benefiting. The rest of us are paying.

Historically corporate defaults spike as downturns ease, and then fall back to more normal levels. But the recovery may be delayed this time around. Companies aren't cleaning up their balance sheets that much, and current debt levels are unsustainable. The debt overhang could hamper the economy for years to come.

The problem, of course, is “that corporate borrowers binged on credit during the boom years. Now U.S. companies carry some $1.4 trillion in high-yield bonds and loans, a burden that's nearly triple the amount in 2001,” according to Standard & Poor's research group. “More than half of the debt comes due in the next five years.”

Amid slipping sales, the companies are slashing payrolls, jobs and dividends.

It's proving more difficult to unwind debt today than in previous downturns. Distressed companies can't easily sell assets to pay off debt amid present harsh deal-making environment. And many owe more than their underlying assets are worth—not unlike homeowners who owe more on their mortgages than their homes would fetch on the market. Meanwhile, big banks and other financial institutions, still battered and bruised from the financial crisis, don't have the strength or the will to refinance all that debt.

The economy may be better off if companies filed for bankruptcy at the outset. Sure, Chapter 11 isn't a cure-all. Many companies that get out of bankruptcy return to court in what experts sarcastically refer to as Chapter 22.

Losing part or all, high-end homes everywhere are taking a beating as a result. As home prices slide, many high-end homeowners – like so many of their subprime counterparts – find themselves hopelessly upside down in their mortgages. Once the value of a home falls well below the size of the mortgage against it, the homeowner loses the incentive to continue making payments. The calculation is approximately the same, no matter whether the mortgage is $100,000 or $1,000,000.

The truly rich would not go into foreclosure, no matter how disadvantageous that mortgage math might become. The truly rich possess other assets that could be liquidated to satisfy their mortgages.

But many of the theoretically rich individuals of the late great housing bubble were never really very rich at all. They were simply “credit-worthy.” They earned enough money to qualify for a monster mortgage. As long as nothing changed, paying the mortgage was doable. But now the situation has changed, paying the mortgage is absolutely non-doable.

It’s now a snowball that rolls off the mountain getting bigger at every turn. Lots of big-ticket employees lost their jobs; home prices tanked and credit disappeared. When added all this up, there is an enormous mountain of pain and suffering, even in “rich” households. Big-ticket mortgages are the new sub-prime. “For three straight months, option adjustable-rate mortgages have generated proportionally more delinquencies and foreclosures than subprime mortgages.”

In other words, the housing-bust-cum-credit-crisis might not be over just yet. Meanwhile, the commercial-real-estate-bust-cum-credit- crisis is just getting started.

But now that credit has disappeared from the economy, thousands of businesses are discovering that they cannot survive the new ‘normal culture’ that relies on solid paychecks and savings, and NOT on credit. And so, one by one, business doors are closing and the empty commercial spaces are piling up, pushing prices further down in the process.
There will not be any genuine bottom in the market until there is a bottom in the prices of commercial real estate mortgages, and that is still a long while off.

Millions more consumers will freeze up as their finances go over the cliff. More bank losses will drag down even more so-called "blue chip" retirement portfolios and the impact of the consumer bust as written about before will "multiply" yet again. Millions more could lose everything.

There are still numbers more time bombs around: Social Security, Medicare, Pensions, Credit Card to name a few.