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The following article appeared in Left Business Observer #56, December 1992. It was written by Doug Henwood, editor and publisher. It retains its copyright and may not be reprinted or redistributed in any form - print, electronic, facsimile, anything - without the permission of LBO.



Financial crisis averted?

Going into the recent recession, the U.S. financial structure was the most strained it had been in sixty years. Measures of indebtedness were at record levels, and the interest bite was by far the sharpest ever. As the recession began, it looked like all hell could have broken loose.

It hasn't -- so far. Of course, respected opinion has come to accept an enormous amount of financial and social distress as normal; if a thousand bank failures, record levels of personal and corporate bankruptcy, and the return of tuberculosis to New York City don't count as some sort of crisis, what does? But the crisis has largely been managed or contained. An economic system that delivers 20 years of declining real wages should be in the midst of a serious legitimation crisis, but it isn't, at least not now. Should Clinton fail then it could be, but that's for 1993 or 1994.

The ideological non-crisis is a topic in itself; let's concentrate for now on why the financial crisis never got as bad as it could have. Before speculating on what never happened, however, it's fair to review why expectations were high for financial melodrama. For simplicity's sake, we'll focus mainly on nonfinancial corporations (NFCs), holders of most of the productive wealth of the United States. When the recession began in 1990, debts of NFCs were almost 15 times pretax profits, compared with under 11 times in 1929. Interest payments ate up 39% of pretax profits, compared with 14% in 1929.

(Interest here is measured against EBIT -- or earnings [profits] before interest and taxes; a firm with $100 in pretax profits, and $50 in interest payments, has an interest burden of 33% of EBIT.)

Mid- and late-1980s research by Ben Bernanke, John Campbell, and Toni Whited (BCW) discovered that corporate debt was concentrated among a small number of firms, but the debt-heavy were in a hideous bind. The median firm -- at the 50th percentile -- in the BCW sample of about 1,200 publicly traded firms (which excludes small business) devoted 20% of its cash flow to interest payments in 1980, up from 13% in 1969, not much below the 1988 level of 22%. At the 90th percentile, however, firms devoted 186% of their cash flow to interest, up from 34% in 1969, and 56% in 1980. Firms at the 95th percentile lost money, so the calculation is meaningless -- a situation that had persisted since 1982; in 1969, these firms paid 44% of cash flow in interest. Though BCW don't say, it's safe to assume that firms at the 70th and 80th percentile were barely earning their interest payments, if that.

In a study published in 1988, using financial data like profits, stock prices, and interest rates running through 1986, Bernanke and Campbell simulated recessions