Individual and corporate credit users of late have been treating rising interest rates with a calm that hardly befits the situation.
The perception, widely held, is that the economy now is better able to handle its debt because many more loans than before carry adjustable interest rates. Flexibility is built in - or so it is said.A strong argument can be made, however, that the economy instead is much more credit-sensitive than before. The viewpoint involves, among other things, the type of credit, the amount and length of it, and the tax consequences.
The calm view of the credit future involves a view of adjustable rate loans, which are far more common on big consumer items than in years gone by. Many see these loans as a positive factor in the credit outlook.
That is, instead of being denied loans, as frequently occurred in the days of fixed-interest rates, borrowers will be granted credit. This, it is argued, lessens the dangers of a credit crunch that would bring the economy down.
A more concerned view of the situation, however, sees adjustable loans as a threat to stability. With interest rates rising, people may find themselves unable to remain current on loan payments. Same effect: The economy suffers.
But there are even more vital elements involved.
Except for home mortgage loans, interest on adjustable-rate consumer loans will be taxed more heavily next year. Currently, 40 percent of interest escapes federal income taxes. Next year, the deductible percentage drops to 20.
Rising interest rates and falling deductibility, therefore, can produce a one-two punch that could put some folks down for the count.
Moreover, many of these consumer loans are for periods considerably longer than just a decade ago, and that too can create problems. Car loans are made for as long as five years now, which often may be longer than the life of the car.
Stress already is becoming serious in some automobile markets, with the repossession rate rising markedly this year. But repossession doesn't always resolve the problem. Some five-year-old cars simply aren't worth taking back.
The corporate market has its own problems. Business demand for short-term credit has been fueled by the surge of leveraged buyout activity. Some of these loans probably are poor to begin with, but an increase in interest rates, and perhaps an economic downturn as well, might quickly turn them into bad loans.
It might not take much of a downturn to show how unsound some of these LBO loans are, because many were made on the basis of cash flow analyses that were optimistic even for a booming economy.
LBOs also are soaking up liquidity, threatening to limit funds available for more productive activities. Illiquidity could develop in 1989 because gross national product has been growing much faster than total bank reserves.
Congress could radically change the game too, although the chance of it being able to do so within the next year is questionable. Still, it is possible that a Congress trying to reduce budget deficits might seek revenue by taxing some of the LBO debt. Right now, interest companies pay on LBO debt isn't taxed.
Perhaps the nicest thing that can be said about the credit situation is that interest rates might not rise, as so many forecasters expect and as Fed policy would seem to indicate.
Among others, for example, Merrill Lynch & Co. expects that a slowing of economic growth in 1989 will allow interest rates to fall sharply. But even if they do, there's an awful lot of debt out there to be serviced.