Economic Stimulus: Dead on Arrival

After September 11, when it became obvious that the country had entered a recession, President Bush proposed his economic stimulus plan and asked Congress to vote on it immediately. But in late December, the Senate adjourned without passing an economic recovery bill. Why did they reject Bush's plan and the Republican alternative passed in the House?

Because the Democrats in the Senate know a few things about the economy that George W. Bush and the Republicans don't. First of all, it will take consumer spending to boost the economy. Businesses have over-spent, are mired in debt, and have too much inventory on their hands. Someone has to buy up that excess inventory to get the economic engine going again.

But it's impossible to buy lots of stuff when you've just lost your job. In 2001, companies announced plans to lay off 2 million workers. In just the first 10 days of this year, every day brought the announcement of more layoffs: Ford 35,000; Burlington Industries 4,000; Merrill Lynch 9,000; FleetBoston 700; US Postal Service 15,000; GM 5,000; Providian 800; Motorola 48,400 (one-third of its total workforce); AT&T 5,000; and on and on.

That's why Senate Democrats are demanding that some of the economic stimulus bill be used for worker retraining programs and to extend unemployment benefits.

The Republicans counter that, by providing tax cuts to corporations and the wealthiest Americans, businesses and rich folks will be inclined to invest more in the economy, expand or open new businesses, and create jobs for the unemployed.

There's only one problem with this scenario: most corporations are in heavily in debt. Any tax break they receive from the government--particularly if it runs up a government budget deficit--will do more harm than good. Here's why:

Government deficits drive up long-term interest rates. When the government has to borrow money, it competes with corporations for a limited pool of investors willing to buy debt instruments. So the price goes up. When long-term interest rates rise, the cost to pay interest on long-term corporate debts also goes up. These increased "debt-servicing" costs eat into corporate cash flows, making it harder for them to pay current expenses (i.e., advertising, rent, and, yes, wages). Any savings from tax credits is minor in comparison and may not even be realized until the companies reach their next fiscal year-end.

How heavily in debt are US corporations? It's hard to tell. For one thing, as the Enron debacle has shown, companies are now adept at disguising exactly how much they are in debt. It's not likely that many other companies have taken Enron's lead and set separate partnerships to remove debt entirely from their balance sheets (while still having to pay the interest to service that debt), but there are other tricks in common practice that the SEC and the Financial Accounting Standards Board are examining closely.

A little practice called "suspense accounting" recently fell under the eye of federal regulators. It refers to a single line item on a corporations balance sheet that represents something known as "goodwill." Goodwill is the amount paid to buy a company that is more than the company's market value. Why pay a premium to buy another company? Mostly to pay off the shareholders so they don't block the merger deal; it's their special cut--their profit on the deal. But Goodwill also represents your gamble that the company you just bought will eventually be worth as much and, hopefully, more than you paid for it.

What happens when that hope doesn't pan out--when the company you bought a year or two or three years ago underperforms and your "goodwill" asset loses its value? In the past you could write off the expense slowly over time, even as long as 40 years, in some cases. Some corporations found a loophole in the law that allowed them to keep the overvalued goodwill on their balance sheets, untouched, for years, in the hope that they could write it off in a really profitable year, when the huge charge would go unnoticed.

Starting this year, however, the Financial Accounting Standards Board has issued a rule that requires corporations to write off overvalued goodwill immediately. The number of companies taking huge charges will skyrocket. Some companies with enormous goodwill on their books include: Qwest Communications $30.8 billion, WorldCom $50.8 billion, AT&T $24.8 billion, Conseco $3.73 billion, Aetna $6.6 billion, NTL Inc. $11.4 billion, and Crown Cork & Seal $3.77 billion. AOL Time Warner just announced a $60 billion write-down related to goodwill, and both JDS Uniphase and Nortel recently announced write downs of goodwill in the tens of billions of dollars. In nearly all cases, the write-down greatly exceeds the corporation's total net worth.

Typically, when companies take such write-downs, their stock prices fall. A huge write-down is a clue that the management team doesn't know what it's doing or has overextended, and so investors shy away. When the stock price fall, the market value of the company falls and, suddenly, a manageable amount of debt looks enormous. The company's credit rating suffers, and we have another Enron on our hands.

In addition, companies are continuing to borrow, instead of pay off their debts. According to the Federal Reserve, companies have run up a record $4.9 trillion worth of debt as of September 30, 2001. This statistic doesn't include financial companies (banks, brokerages, etc.) and farms, which operate on enormous debt loads. This $4.9 trillion figure represents a 6.6% increase over the previous year. In the past two-year period, corporate debt has increased 15%, while corporate assets to back up those debts have only increased 7%. And that's before companies were required to write-down their overvalued goodwill. This year, as companies write down their devalued assets, that spread will increase dramatically.

In fact, corporate debt has risen a whopping 84% since 1994. Some of that money was used to buy factories, equipment, trucks, and telecommunications equipment. But a lot of the money borrowed in the past 12 months has been used by companies to buy back stock to boost their stock prices. Remember this when you read that "at least the stock market is recovering."

Democratic Senators are well aware that tax breaks and a new federal budget deficit will only exacerbate the problem, and they've been getting an earful from their corporate constituents. Bush & Co., however, are so fixated on looting the Treasury that they can't--or won't--see the danger signs. Bush has said that an economic stimulus package will be his top priority this year.

The fight should be spectacular.

--Maria Tomchick. For a list of references for this article, e-mail the author at ets@scn.org.