Monday, December 05, 2005

Bankruptcies up in 2006? Stacking the deck 

I'm not buying this.
But one often-overlooked source suggests dark times ahead for the U.S. economy. The source is Euler Hermes, a France-based company that ... is the Michelin Guide of business failure. Its researchers constantly scan the globe for the latest in bankruptcy and liquidation to compile the Global Failures Index. And lately Euler Hermes doesn't like what it's seeing in the United States. The firm predicts that in 2006, U.S. business failures will rise for the first time in the 21st century.

...Contrary to what one might expect, and despite scores of high-profile bankruptcies, the number of business failures�businesses filing for either Chapter 7 or Chapter 11�has fallen in each of the last four years. U.S. business failures fell from 39,885 in 2001 to 34,167 in 2004, according to Euler Hermes. And through the first half of 2005, when 16,799 businesses failed, corporate fiascoes were running at their lowest annual rate for 25 years.

...[Euler Hermes chief economist Dan] North believes that both trends are working against American businesses large and small. First, interest rates have been rising. The Federal Reserve has increased the federal funds rate from 1 percent in 2004 to 4 percent today and shows no sign of stopping. Long-term rates on instruments like mortgages and government bonds have been rising, albeit at a slower rate. Just as lower interest rates can extend the life of a struggling business�refinancing helps companies, not just strapped homeowners�a climate of rising rates can cut them short. ...

Second, North believes the pace of GDP growth will slow, which will lead to business failures. When the economy has been growing at a steady clip, businesses tend to invest and build up their infrastructures to accommodate continued robust growth. When growth fails to materialize as expected, they can easily get caught short, with too much capacity, too many employees, and too much debt.
This is rubbish on many levels. First, as the Euler Hermes report itself makes clear, there is a third factor which Daniel Gross completely ignores -- the change in bankruptcy laws which has led a number of firms to move ahead filings before more stringent rules take effect. We already discussed these with the airline industry filings, but there will no doubt be others. So we may in fact see numbers go up without saying anything about the state of the underlying economy.

Second, there is no sign that higher interest rates are causing any problems with firms, as NABE reports capital spending remains strong and is expected to continue to do so. Any remaining rise in long-term interest rates is likely to be between 50 and 75 basis points, not causing any further pressure on firms, and GDP growth has been 10 quarters in a row in a sweet spot between 3-4.5% growth, unlikely to reignite demand-pull inflation. Hurricane Katrina might cause some problems -- and yes, you could get some more business failures in the Gulf area.

Of course, if you've got your mind made up that a recession is just around the corner, you can predict a rise in business failures, but you can't then reverse causality in another column. We can follow your trail, sir.