Joel Stern thinks it's time we all stopped worrying and learned to love corporate debt.
In the current climate of American thought, such a suggestion is roughly akin to proposing that we form a military alliance with Siberia. After all, just about everybody agrees that business debt has gotten ridiculously out of hand; that the country has become dangerously overleveraged, and that the scariest symbol of the 1990s is Donald Trump, grasping for new funds to pay off old loans he never should have incurred in the first place.Not so, says Stern, an iconoclastic New York economist who heads the firm of Stern, Stewart & Co. and whose contrary thinking has often been well ahead of the crowd.
As Stern sees it, the growth of business debt in recent years has been neither excessive nor surprising - and has been, in fact, a major contributor to the remarkably sustained strength of the American economy.
Since just about all of that is in opposition to today's conventional thinking about the evils of debt, it deserves, at minimum, a bit of elucidation.
First, how can the man seriously argue that American companies have not been on a dangerous borrowing binge? It has been widely reported, for example, that U.S. corporate debt, relative to stockholders' investment, has soared from barely more than 50 percent in 1982 to over 90 percent today.
"This looks serious indeed," says Stern, "but virtually all serious researchers on the financial markets claim this method of measurement is simply wrong. It focuses on book value (an accounting estimate of the company's assets minus its liabilities) rather than the far more relevant market value. The relative doubling of debt is much more than offset by the quadrupling of share values during the same period, and thus the debt-to-equity ratio has diminished very considerably."
In other words, he says, stockholders' equity looks tinier than it really is when you figure it in terms of prices that may have been paid for assets years or even decades earlier.
Stern concedes, however, that corporate borrowing has indeed accelerated in recent years. And why not, he asks? The very members of Congress who are now complaining about it are the ones who produced it.
The 1986 tax overhaul was a classic example. For the first time ever, the corporate tax rate was placed substantially above the maximum personal income tax rate. What's more, individual tax deductions for borrowing were reduced or eliminated, while the corporate writeoffs were left untouched. Both these developments made corporate borrowing increasingly attractive. As Stern put it to me, "Provide subsidies for economic agents to behave in a particular way, and we can expect them to exploit them."
Finally, in perhaps his most unorthodox argument, Stern contends that the increased corporate borrowing has been a strong net plus for the American economy.
Why? Because it disciplines management to become more efficient.
He cites, for example, the conclusion of Professor Michael Jensen of the Harvard Business School that "the use of debt is beneficial because it encourages management to minimize waste in repaying its debt and to retain only those assets that can be managed best by existing management, selling off operations that offer unacceptable returns."
And he points to studies over the past three years by three University of Chicago professors, Steven Kaplan, Katherine Schipper and Abbie Smith, reporting that companies that took on higher debt ratios - so far from falling behind in the competitive struggle - on average reported "a substantial improvement in the operating performance and value of the firm."
Do I personally buy Stern's argument? Only up to a point. Clearly, for companies as well as individuals, debt can become excessive - and the real test will come when the nation next encounters recession, which we have managed to avoid on a countrywide scale since 1982. But it is equally true that Congress itself has been America's No. 1 debt generator, both by horrible example and by legislative change. Debt is merely a tool, as anyone who has ever bought a home should know; those who misuse the tool should in the end blame themselves, and not the hardware store.