A Time Bomb For Borrowers?

Private debt and its risks are rising

Are U.S. corporations and consumers taking on too much debt? The degree of leverage in an economy is perhaps the key measure of its exposure to financial problems.

By some yardsticks, there has been a dramatic acceleration in the amount of private borrowing. While the federal government has started paying down its debt, debt held by nonfinancial corporations rose at an annual rate of 10.7% in the first quarter. That's on top of a 10% rise in 1998, the highest figures in a decade. Moreover, the amount of short-term commercial paper issued by domestic nonfinancial corporations is up by a staggering 20% over a year earlier.

So far, bigger debt has not translated into larger interest payments. But with rates on the rise, companies--especially those that depend heavily on short-run loans--will see profits start to erode.

Even more worrisome is the buildup of household debt. To be sure, the rate of increase in consumer credit such as credit-card debt and auto loans slowed in the second quarter, to a 4.5% rate, down from 9.7% in the first quarter. But the amount of margin debt--borrowing against stocks--has exploded in recent months and is not included in the consumer-credit data. In the second quarter alone, the amount of margin debt at New York Stock Exchange member firms rose by some $20 billion, vs. a $15 billion hike in consumer credit. Indeed, margin debt has doubled since 1996, pushing the ratio of margin debt to consumer borrowing to its highest level in years.

Part of that increase, of course, reflects the enormous rise of the stock market. Investors can borrow up to 50% of the value of their stocks, so as prices rise, they can borrow more. But if stock prices fall sharply, they will be forced to pay back some of the loans or sell the stocks--and the hit to the economy in either case could be quite large.