Financial Storm Recedes, Corporate Bankruptcy Rises

Let me reiterate that financial crisis is over and in this new year, we will see less turbulence in financial services than in 2008. The dangerous process of deleveraging becomes less dangerous as leverage itself is reduced and the capital injections from the Troubled Asset Relief Program (TARP) into the major US banks have hastened their recovery.

This year, however, we will see the transition of problems from financial to real economy with corporate bankruptcies to be a key concern for investment community. The resilient US consumer started to give up in the 3Q08 and with the personal consumption n making up over two-thirds of aggregate demand, this will be the centre of the dynamics that will play out in the real economy. The negative wealth effects from housing and equity market losses, the disappearance of home equity withdrawal from the second half of 2008, mounting job losses, tighter credit conditions and high debt servicing ratios will drive share of bankruptcies in retailing industry. The recession will inevitably push more retail chains over the edge with the highest casualty rate being among high-end and specialty retailers.

The real economy outlook to a large extent will depend on outlook on equity market. According to Tobin’Q, S&P 500 is still too expensive relative to the cost of replacing assets. After RTC was established in 1989, it took 1 year for the stock market to bottom, 2 years for the economy to bottom and 3 years for the housing market to bottom.

As defaults rise, the new rules governing Chapter 11 of America's bankruptcy code will face their first test. Long admired as the world's best system for allowing corporate liabilities to be restructured while giving firms a decent chance of staying in business, the rules were tightened in 2005 to deter firms from staying in Chapter 11 too long and to stop the managers of bankrupt firms from paying themselves too much. More companies that file for bankruptcy protection are shutting down, lawyers say, because they cannot obtain enough financing to operate while they reorganize. Part of the problem is that in recent years, large lenders to corporations have been hedge funds, private equity investors or other institutions.

The number of construction companies that failed in November 2008 rose more than 40% from a year earlier, increasing by a double-digit figure for the eleventh straight month for the first time in 15 years. The number of corporate bankruptcies rose last year to 28,322, but that is the second-lowest number of filings since 1980, according to the American Bankruptcy Institute.