By Robert F. Mancuso, Managing Partner, The Dellacorte Group -- Just a few short months ago, it seemed that the worst of the financial crisis was behind us. Public discourse had progressed beyond fears of a broken financial system to questions of whether the US regulatory response would over-reach, creating a new problem in the process of fixing the original problem.
Recent events, however, lay bare the possibility that an escape from financial collapse has been displaced by a new set of serial crises lurking beneath the surface of the seeming recovery. These newly identified financial and economic challenges have the potential to do as much harm to our country and to business owners as the subprime mortgage crisis.
So, what are these new risks? What is the nature of Financial Crisis II?
Instead of a subprime mortgage crisis stemming from the inability of individuals and businesses to repay loans obtained when credit was excessively easy, we are facing extreme debt of multiple types. It is widely believed that there is approximately $1 trillion of U.S. corporate debt that will need to be refinanced in the next four years. It piled up during the 2004-2007 period to finance LBOs, MBOs, acquisitions and stock buybacks – a time when tens of billions of dollars were borrowed. This level of debt begs a number of questions:
Who will buy $1 trillion in corporate debt and what impact will it have on interest rates? According to some sources, as many as 40 states will be unable to balance their budgets this year. California and New York have already failed to submit balanced budgets and municipal government entities are poised to default.
Cleaning up corporate debt will leave us with billions of dollars in new municipal debt that will need to be refinanced in the next two years.
Who will buy the billions of dollars of municipal debt and what will be the impact on interest rates? It is believed that at least four members of the E.U. will default on their debt in the next two years. In addition to Greece’s $40 billion rescue package, Portugal, and Spain have already made the front pages of newspapers – and I have little doubt there is more to come.
Who will buy the new U.S. government debt and what will be the impact on interest rates? With bailouts and issues of their own, many foreign countries are in no position to buy up government debt from the U.S. The few governments that have the resources to do so recognize their “upper hand” status, giving them more bargaining power when it comes to interest rates.
Who will buy all the new sovereign debt that needs to be sold to cover the EU bailout, and what impact will this have on interest rates globally? The Treasury offers little insight, with some estimates suggesting up to a third of U.S. tax revenues going to pay down U.S. debt, which is only growing.
Financial Crisis II is a dangerous game of debt dominoes. With corporate, municipal and sovereign debt firmly rooted in mid air, the free-fall of any one augurs a catastrophic cascade. Runaway oil spills aside, Wall Street, Main Street and Pennsylvania Avenue have been breathing easier of late as capital markets and corporate lending show nascent signs of recovery. What they aren’t doing is preparing for the next financial storm. We may have weathered the Great Credit Crunch. But the next crisis may be nearer than we think.
Robert F. Mancuso is founder and managing partner of The Dellacorte Group, a New York-based, middle-market focused merchant bank active in corporate advisory services and private equity. He has worked in the private equity and capital markets arenas for nearly 35 years.