Overdue credit
The Lex Column, 04/27/09
One fact even the darkest prophets of doom must concede is that the economy will pick up eventually. When it does, however, do not expect credit growth to join the party straight away. Analysing US recoveries following financial crises going back to 1970, the International Monetary Fund shows that, on average, credit growth does not become positive for almost two years after output turns.That suggests two things: first, that a lack of credit may temper the early stages of a recovery. Second, companies with a heavy reliance on debt funding may suffer for longer than they think.
To test this, the IMF looked at production data across manufacturing sectors. It found that a typical company that uses high levels of outside financing grows 1.5 percentage points more slowly than one that funds itself via retained earnings following a crisis. Worst affected are industries whose products are less internationally traded – almost another 2 percentage points is lopped off growth for companies dealing less with imports or exports. Having highly shipped products, on the other hand, cancels out the drag from an over-reliance on debt funding.
Counter-intuitively, companies reliant on debt are not helped by having a higher proportion of tangible assets on which to secure financing. However, having relatively fewer tangible assets, as one would expect, exacerbates the drag. The conclusion for investors hoping to play a recovery is obvious: buy companies making tradable goods, but check out their funding mix first.
This analysis shows governments are dead right to be prioritising the health of the banking system. As more industries begin squealing for increasingly limited resources, policymakers must keep their focus on repairing bank balance sheets and credit markets. It will be tough love. But everyone will benefit more rapidly when the good times return.
