Thursday, 4 December 2008

The sound of inevitability

John Foley of BreakingViews says that this year's key financial phrase has been 'bail out'. He predicts that next year's will be 'refinancing'. He has a point, because there's a lot of debt maturing in the next 18 months (USD 4 trillion he claims, USD 2 trillion in Europe to 2011 S&P claims) and almost all of it will need to be replaced or repaid.

Already, analysts and rating agencies are looking at companies' repayment schedules and identifying maturing debts as key credit risks. If banks choose not to replace maturing credit lines, the companies affected are left with a stark choice: repay, merge or shut down. And for many companies, particularly leveraged firms, the repayment option is simply not possible given the size of the debt involved.

This means that many companies will not survive the next year or so. And already we have seen a wave of firms going bust. While I feel intensely sorry for the staff that have and will lose their jobs, I am not particularly surprised. For one thing, there are a number of firms that have only been keeping going because the economic conditions were so good and credit conditions so relaxed. As soon as anything went wrong, these companies were liable to collapse or hit difficulties.

Tasteless comparison: this is a bit like seasonal death rates. If there is a mild winter then all those people that would have died during a normal cold winter are still going to die, just not yet. The better weather just delayed the inevitable and the next summer and winter see higher death rates than normal.

Woolworths was like this. A frail, confused 99-year-old maintained by the artificial life support of cheap debt (from new entrants to the UK market seeking market share) and profligate shoppers. Without this life support (falling sales, recalcitrant lenders) the patient died.

And so the next few months are likely to see many more companies go under. Unlike John Redwood, I do not see this as a good thing. It is not worth sacrificing people's livelihoods simply to prove an economic theory. However, there is a certain sense of inevitability about bad companies going bust during difficult times. It is something that, unfortunately, we are going to have to get used to in the next few months.

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