Bad times for good companies

Banks and brokers have raised around $300 billion so far from sovereign wealth funds in Singapore, Kuwait, Dubai and China, but they still need to raise an additional $800 billion. And the problem now is that every fund that has already put up money is under water. This creates a credibility problem and makes the next round of funding more expensive -- if funding can be found.

Citigroup had to pay 8% in annual interest rates for its first round of new capital but may have to pay 12% or more for the next round, a staggering burden.

And this is where your Coca-Colas, Intels and Mercks come in. Most big companies finance their day-to-day operations with credit, and yet in this deleveraging environment, banks are sucking up all the spare lending capacity in the world.

You could almost say there's a debt famine in the developed world that rivals the calorie famine in the developing world. Companies whose long-term debt is maturing are facing a higher cost of funds if -- they can refinance at all. And many are facing higher borrowing costs regardless of their histories because rating agencies believe defaults are on track to rise dramatically.

This debt rationing, if you will, is smothering businesses and consumers alike, and the pullback in spending capacity is in turn killing earnings at all but a blessed few companies outside the energy sector. It's a vicious cycle that's leaving ruined stock prices in its wake, and it is far from complete.

Leveraged loans of about $150 billion are coming due this year, and a similar amount must be refinanced in 2009. As companies' operating units are starved for funds, it's impossible to determine the real value of their assets from a reading of securities filings. This condition makes our usual task of trying to obtain shares of companies at, say, 1.5 times book value virtually meaningless.

It's times like these that make savvy institutional buyers want to wait until there are massive margins of safety in their purchases, such as when they think they can buy stocks at half of their book values.

No white knights

"All we are describing is how the system sheds excess debt," derivatives expert Das says. "It's not actually a crisis. It's the natural process of destruction of leverage. A company has debt, can't refinance it, has to sell the asset or go bankrupt, and the process goes on until the debt reaches a manageable level. It's a process that central banks can smooth out by lowering rates, but they cannot actually shorten because they cannot force anyone to lend."

Where's the U.S. Federal Reserve in all this? Das points out that the Fed has tried almost a dozen clever lending innovations, costing as much as $400 billion, in the past 10 months to smooth the deleveraging. The Fed also has cut short-term interest rates to 2% and yet has little to show for its efforts. And now it has paused in its rate-cutting campaign due to fears that it is exacerbating the decline of the U.S. dollar and fanning the flames of inflation.

I'm afraid there are no white knights on the horizon, as only time, apparently, can heal these wounds. I hate to sound like a pessimist, but you may wish to wait until the Standard & Poor's 500 Index ($INX) slips under 1,000 to begin buying with confidence again.

Fine print

To learn more about the Bank for International Settlements, click here. Read the annual report here. It's pretty dense, so unless you're ambitious, stick with the introduction and conclusion.

I asked Das how so many U.S. banks could have been so stupid that they made the same losing bets on subprime mortgages at the same time in the middle of this decade. He laughed and noted that bankers may dress well, but they have been lemmings from time immemorial. To make his point, he quoted John Maynard Keynes. In 1931, amid the Great Depression, the famed British economist said: "A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he's ruined, is ruined in a conventional and orthodox way along with his fellows, so that no one can really blame him."

My first column on Das appeared in September; read it here. . . . I also touched base with Das on May 7 for a column headlined "Credit crisis over? Not likely," just before the markets began their latest swoon. . . . I argued that higher gasoline prices would wipe out the benefit of the tax rebates in this column in late May. Recent retail-sales figures suggest that may turn out to be true.

At the time of publication, Jon Markman did not own or control shares of any company mentioned in this column.

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