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For on d e l i v e r y r< i. S . T . lESEAR TO il* federai of St. LOUiS 1986 Address by Manuel Vice Board of Governors of H. Johnson Chairman th e Federal before Conference How Citizens on Much for a How Sound Economic Much Economy Washington, November Syi the Financing Debt, Reserve 19, D.C. 1986 Growth: Equity? Foundation T h e G r o w t h of C o r p o r a t e D e b t : I m p l i c a t i o n s and P ol i cy R e s p o n s e It is today* The important am sure Prize a pleasure topic one you of and with and public While I certainly growth of of private The Federal the public rapid Reserve potential debt to for of of some increase the number the were the focus future t hi s held attention is debt, of business corporate to and Nobel honor. both the associated the a component its growth. interest a debt leverage I morning. on spending failures. an regarding great First, is a special Problems concerns group i s — as latest pertain discussed debt corporate is growth corporate reasons. our program my this implications join economy. increased of To address participants the corporate inhibit Secondly, economic its namely several and and of I will debt, equipment. in debt growth share rise here conference B u c h a n a n — on debt, sector its of sectors sector be impressive. about private to and list a g r e e — very Apprehensions me debt the winner--James public for buildup on plant may Thirdly, lead the to the h as and to an - greater may be likelihood assuming t hi s may and, therefore, pated more of reluctant The been because of it growth economy debt bias to as of debt not to when As less stable particular importance to the argue because increased that the Federal necessary, of Reserve thereby will be introducing an policy. debt in because slowed corporate system Since unantici has a portfolios. to an value-added institutions vulnerable f or about loan financial more sector, only growth remains of of some corporate a whole. relative is that financial economy monetary persisted still rates it their the t he tighten noteworthy corporate 1984, making - suggests in making Finally, to h as risks corporate growth it to shocks, the inflationary has to Reserve. leverage defaults greater contribute economic Federal of 2 th e it current has extended the rapid, but also period. While th e pace considerably product has the since points corporate consequence, expansion been 5 percentage in economic faster sector level risen to of a or early than in the corporate succession of - new post-World those typical This portion to normal the by and has stemmed and some purpose since of some not heavily affected century. expansion has been rapid growth for from the in stock the investment goods, or to but to restructuring increased debt-equity firms. of share three debt and ratios. Some of or distinction designed to because retired significant for buyouts, the is explicit insignificant off target firms, more of restructuring fend the not desperation leveraged nonfinancial have the repurchases The primarily all the mergers were purchases past rather leverage. For below attributable corporate a well is repurchases unusual remains debt of through leveraged. ratio that stable occurred the in financing occurred mergers new firms, previously debt-financed Both th e share some equity in increasing and of though failing has - peaks, borrowing borrowing healthy II earlier debt of War 3 than mergers firms were these largely $300 billion years. decreased With equity asset have values dramatically adjusted to reflect -4- replacement costs, corporations up from 37 has growth of stock new While firms the that increasing of leverage There A principal through to firm level, ar e . Also, efficiency with in to at a the debt-equity post-World end retained of War 1 9 83, earnings and ratio II This a of record has nonfinancial of 50 happened relatively percent, despite robust pace offerings« there clearly have combined aggregate risen percent strong the their proportion of debt. be hard is the investors whereas leverage by differing many of a number one involved value must are risks restructured, market the are of as (up and passed to been outstanding individual able to securities Consequently, why advantage. interest those have t he th e increase by attraction ignore. reasons tax providing needs to firms f or on tastes, Returns debt through a point) a wider investors can choice of thereby are as like from not capital taxed dividends improve leverage. at passed the on shares capital market securities facilitating to investors t he channeling - of risk toward the investors 5 - best able and most willing to accept it. Recently, enhances control the choices are proscribed revenues pay in that Why excess sheets where but stances« heavy loads of has of environment been of so represent one a more among could to costs lend open-minded are view Managers if if committed leverage is augmented a few sharply a reduces to is so more« adaptation and it leverage decisions restructuring in that funds« recently have include production because especially firms an idea expenditure widespread The th e allocating developments petroelum taking debt, leverage« may on materials reluctant concentrated examples, in be in capital and would more investors managers labor leveraging opportunities by of advantages As to a number been focused misguided leveraging has the on has management from lenders apparent, enduring of available interest high attention new of not the of as more balance industries to new circum changing regulatory mergers in investment -6- broadcasting• their preference leverage may be may the have past have be partly Three debt In for factors done five bonds and by lower rates the petroleum leverage, largely offset so a over that time by interest substantially, about two-thirds combined business cash flow needed huge growth in At same t he expansion to the with service amount case, while of by investors in short-term have largely years, decreased during the t he have raised broadcasting byproduct greater may of case, mergers earnings tha t retention« probably increased preferences reducing the entailed. rates paid falling on by by have debt in recent on on half paper or corporate actually in firms almost short-term recovery debt risks which reduced years, new on Over debt long-term loans. cash th e is The flow share despite interest for of t he being paid • 2-1/2 th e times the restructuring time, lo w s more of stock four expensive prices years for have soared and are now ago, on average. This firms, as it t he raises 2 to makes cost of -7- the shares more attractive between has purchased. balance grown, th e illusory. ratio four of than Over to in the past access lessened the stringency. loan to credit, f or techniques few and of being have access many such to firms as many unable of earning the values, stable and late of assets ratios the over and discrepancy power debt-equity market middle firms markets. helped regardless sheet that safer is aggregate t he past 1970s, though 1960s. years, credit true roughly the borrowing extent the their been make the and during Deregulation respects, possible of risk commitments loan other to To at has 1950s also balance measured than the improved in equity lower may values increase debt it investors. sheet Indeed, years — higher to But In to some borrow financial ensure of new interest rate the and benefited respects, at access in borrowing of also markets t he changes because have times and of credit markets increased currency this of the ha s credit growth healthy use of firms conditions. have from In become and swaps, acceptance third - party guarantees, and among others. short, In only technological risk evaluation, ready access difficulty in Taken in cope t he with than some in in for debt information financial when low-rated may they reflect processing innovations may that have bonds, and not therefore ensure had firms more these they that credit suggest that a desire many market to developments some take corporations increase on more are now may be are in risk, debt but better do es rather able to debt. it was individual shocks, whether economy as could increase markets reflect Nevertheless, now market past. th a t fact some also credit the necessarily reflects but - new-issue advances together, encouraging n ot to th e 8 while some produce years firms may specific a whole. adverse higher A ago, be to sharp leverage the more corporate vulnerable particular rise in consequences. somewhat sector to The or rates latter especially unanticipated industries interest and safer to for t he macro example, contingency is -9- especially long-term in the years are worrisome debt aggregate of rapid already leveraged facing debt th e for The problems steel of over industries, high leverage the suffered past of in t he cause contributed to three leverage Although fundamental to y e a r s — though effects industries. the short-term recent complicating recent and in worsened not of individual for of then risks hold t he to same debt firms, financial the shareholders expected the not were capitalized some in ratios maintained has growth. high energy, highly of the problems failure firms. potential firm ratio t he sheets Substitution for of have estate, balance these some this real view firms visible agriculture, of that in solely equity keep t he total variability does with new not total exchanges the may with the changed. f i r m ’s returns. cash raise increase If, f or newly shareholders, along little on it necessarily equity debt while instability. existing are claims of equity, market of investors fo r created and those same flow the example, remaining The risks and a debt same equity, investors the same - If these investors well-diversified debtholders their many purchased can then sell investors, presumably investments. the But capitalized concentrated doses; problems more in the n , may not be leveraged, but rather t he soundness So firms f ar, that immediate estate steps have light have for of have both have not the many small. Such substantial loss extent the arise. taken risks banks many most that in A by critical the created firms by the one debt institutions of and taken. improved and serious of is in danger that from become deterioration agriculture, thrift some recently, have Of with the greater energy and real institutions. Examination thrifts problems dramatically. circumstances, been been been impact banks these already remain lenders. is on to w e l l - c a p i t a l i z e d , financial can the a the risks restructured concern supervisors ments there lending In of the debt risks to thinly - t he absorb by debt, 10 additional staffs capital been of supervisory bank adequacy strengthened, require and we - have proposed a urge banks exercise in regard It sharply has to to is debt stock loads. growth If bad; efficiency, But aggregate, debt some growth positive critically it is may run the in may risk of and ways it. work sector of t he increased to and may funds economic debt improve help restricting the growth in of are higher debt market and enhance corporate of competition. desirable not employed. allocation stimulate many are capital used firms conditions, justify effects promote to risen leverage industry rates borrowed Even have nonfinancial negative that continue especially firms changed stimulate impair corporate debt interest how actually spinoffs the on used than some or We standards, of companies, the and rules the Indeed, takeovers Broad ratios lower rather in leverage for debt requirement. lending and stability capital prudent prices, depend increased capital firms. in sharply. - leveraged that that, necessarily higher highly true and risen risk-based 11 loans to - stop of a few dictating We highly noted that and be economic have the There in the banking, discussing relevant stem often case. to recent Federal policy the to Many debt problems from the inflation th e decisions. problems of it should well foster some of this more any risk number taking of likelihood the Many Reserve; t he loan And from years. business exist. the of then, of these of to be would public increased leverage policies monetary financial I will a more increased than possible greater namely, regulation responses, Federal encourages arising the do are to in individual Potential subsidize responses and easy. may or policy of laws ourselves making sector facilitate observed central tax - place or rest corporate vulnerability functions cannot ratios however, current private We leverage leveraged otherwise and ones. cannot, leverage In bad 12 focus that we relate to policy, to institutions. on those Reserve. that of we the assumption have 1970s. of experienced in Inflationary additional recent years psychology high-yield debt -13- since borrowers anticipate money that be cessation leads of to will of inflation severe rising that sectors very industries in which Agriculture, serve minimizing leveraged as stability. A real debt for borrowers which debt. promotion from of some examples problems price It and objective of continue be future. that attempts in to the employ associated do the monetary The inflation this of the sometimes the continuation suggests 1970s are the today. commodity-based by an increasingly creating of speculative And Reserve to price those stability today. remedy contribution promoting buildup Federal a important with price policy as an avoids rapid maintenance fundamental to make environment promote with phenomenon. can can and history in and debt unanticipated problems estate this policy sector. often of Recent worst real The expected inflation t he such burdens who industries. some potential incentives The increases and stable repay terms. monetary corporate will real benefited energy, they in their having Accordingly, to less problems prices industries worth that it is a will recognizes debt problems -14- will likely only create the type of problems it was intended to solve. In addition system's adopt liquidity additional system. for the can supervision bank create system for of system, risk discount is that to Federal to the the certain In carrying subsidized borrowing. a internalize to risk sound through of t his related banks the function, taking, While there For institutions this risk system. and Because new out healthy, a safe financial financial area. can responsibilities excessive regulatory t he Reserve healthy h as of very ensuring Federal Reserve financial promote and a stable, discourage remains institute helps promote stable unwittingly window seeking standard in to stability crisis, companies. certainly attempting of regulation a more improvement process are and price to the incentives current we times holding promoting and in policies thereby room pursuing Specifically, including it to is the always example, the financial deposit insurance potential capital cost in of problem, reserve risky -15- activities. discipline a re to with should be encouraged wherever the far broader than take this role any in the used growth in federal growth borrowing less should can the be be As we debt. is bad. all with But to restrained so ameliorating the If trade that such relating focus action deficit as market to debt growth I have been asked well, reduction or play an important response to the extent federal more that feasible. corporate the purposes, is must policy productive financed. it too borrowing As objective sector know macroeconomic of the concerns corporate government overall for activity macroeconomic afternoon. rapid government help consistent course, of is is Of control of This borrowing, that public government productive is taken, well. problem all debt spending private it not sector should
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