Delevering Our Balance Sheets
This is going to be a big theme in the coming years. My partner Albert wrote three posts last week looking at the explosion in household debt, corporate debt, and financial sector debt in the past 40 years. He’s got a bunch of charts in his posts but they all look something like this:
We have witnessed a massive borrowing binge in this country over the past 20 years and it’s been particularly nuts in the past 10 years. Rates have been low, lending standards even lower, and everyone has been borrowing. Its true that much of the household debt is collateralized against homes and will be either paid off over a 30 year amortization schedule or foreclosed on, liquidated and written off. I think the household debt chart has nowhere to go but down over the next five years.
Corporate debt and financial sector debt are in some ways bigger problems. We are going to see a wave of bankruptcies in the corporate sector as this recession hits over levered corporations hard. And we’ve already seen the financial sector implode as a result of over levered balance sheets.
Albert didn’t really share with us his conclusions from his work. But I think it’s pretty obvious. Much of the cash flowing through households, corporations, and banks and brokerages will go to delevering activities in the coming years. There’s really no place to go but down on these charts.
This will stifle the economy, impair spending, and make it very difficult to get the economy growing again.
The markets are already reacting to this. Stocks have come way down and many think they will come down even further as Q4 2008 and 2009 earnings start coming in. Another factor to think about is that investors are moving from the equity markets to the debt markets. Debt has seniority to equity and when debt is trading at prices that can generate equity like returns, public market investors will do the sensible thing. Both of these factors don’t bode well for the equity markets for the next several years.
So is there a ray of light anywhere in this analysis? I think so. Venture capital does not rely on leverage. Startup balance sheets (for the most part) have little or no debt. The Internet takes costs out of the system and allows consumers and corporations to get more for less. We are working in one of the few bright spots of a badly broken economy.
But we should all be prepared for a long slog out of this mess during which capital will be less available and at lower valuations, exit opportunities will be few and far between, and revenue will be hard to come by. It will not be for the faint of heart.