Smart piece from Milken that comes closest to my preferred framing of the mistakes on the domestic side (putting aside the structural imbalance of trade globally)

OPINION: "Why Capital Structure Matters," by Michael Milken, Wall Street Journal, 21 April 2009.

Lotsa quoting here, because it's worth it and I can't write it any better, although I will comment within using brackets.

Thirty-five years ago business publications were writing that major money-center banks would fail, and quoted investors who said, "I'll never own a stock again!" Meanwhile, some state and local governments as well as utilities seemed on the brink of collapse. Corporate debt often sold for pennies on the dollar while profitable growing companies were starved for capital.

If that all sounds familiar today, it's worth remembering that 1974 [when I came of age, mind you, so it really sticks with me] was also a turning point. With financial institutions weakened by the recession, public and private markets began displacing banks as the source of most corporate financing. Bonds rallied strongly in 1975-76, providing underpinning for the stock market, which rose 75%. Some high-yield funds achieved unleveraged, two-year rates of return approaching 100%.

The accessibility of capital markets has grown continuously since 1974. Businesses are not as dependent on banks, which now own less than a third of the loans they originate. In the first quarter of 2009, many corporations took advantage of low absolute levels of interest rates to raise $840 billion in the global bond market. That's 100% more than in the first quarter of 2008, and is a typical increase at this stage of a market cycle. Just as in the 1974 recession, investment-grade companies have started to reliquify. Once that happens, the market begins to open for lower-rated bonds. Thus BB- and B-rated corporation are now raising capital through new issues of equity, debt and convertibles.

This cyclical process today appears to be where it was in early 1975, when balance sheets began to improve and corporations with strong capital structures started acquiring others . . .

Over the past four decades, many companies have struggled with the wrong capital structures. During cycles of credit expansion, companies have often failed to build enough liquidity to survive the inevitable contractions. Especially vulnerable are enterprises with unpredictable revenue streams that end up with too much debt during business slowdowns. It happened 40 years ago, it happened 20 years ago, and it's happening again . . .

The current recession started in real estate, just as in 1974. Back then, many real-estate investment trusts lost as much as 90% of their value in less than a year because they were too highly leveraged and too dependent on commercial paper at a time when interest rates were doubling. This time around it was a combination of excessive leverage in real-estate-related financial instruments, a serious lowering of underwriting standards, and ratings that bore little relationship to reality [all deeply encouraged by the global structural trade imbalance that kept our money so amazingly cheap in cost of usage]. The experience of both periods highlights two fallacies that seem to recur in 20-year cycles: that any loan to real estate is a good loan, and that property values always rise. Fact: Over the past 120 years, home prices have declined about 40% of the time.

History isn't a sine wave of endlessly repeated patterns. It's more like a helix that brings similar events around in a different orbit. But what we see today does echo the 1970s, as companies use the capital markets to push out debt maturities and pay off loans. That gives them breathing room and provides hope that history will repeat itself in a strong economic recovery . . .

Got it?

Comments

[joe Michels]

So if this is just another cycle, and I too came of age during the Jimmy Carter years, why are we so willing to turn over control to the government? Why not just hunker down and wait out this deep recession?

My grandparents raised a family during the Great Depression, my parents raised me during the 70's resession(s), I'm doing the same thing now. We all survived and all became more wealthy over the years because of our free economy.

Why are we willing to risk the loss of a free economy to "reduce" some pain and hand control over to the government? In truth there will be no reduction of pain, just the eventual loss of free economic principals and freedom.

[Matthew Garcia]

Though economic "cycles" have been well-identified for many years (decades?) because of the work of economists who respect that history and once in a while can step far enough away to see the patterns, one of the most enlightening books of my young education in history has been Arthur Schlesinger's Cycles of American History, which has mostly political but also economic and military overviews built into the analysis. However, that work has not been substantively updated since its original publication in the mid-1980s (the 1999 paperback seems a mere reprint under a different publisher, but please correct me if I'm wrong there) and would become even more valuable to those learning their history today with a good addendum by faithful fellow thinkers. Milken seems to cover the financial cycles of the past 30+ years with a similar view to the idea that history does not necessarily repeat itself exactly, but it does bear a striking resemblance to memory sometimes.

[Larry Dunbar]

"Milken seems to cover the financial cycles of the past 30+ years with a similar view to the idea that history does not necessarily repeat itself exactly, but it does bear a striking resemblance to memory sometimes."

In the 70's, I don't remember losing a car manufacturer--or two--or three, so that is yet to be seen. I think that will be the best marker for what's going on.

[Yomi Johnson]

This is a great write - up by M. Milken - now that a major car manufacturer is gone! I think we can all heave a sign of relief - things should get better pretty soon - I hope, if the helix theory should be believed. Very well written article.