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Chadwick: Out Of The Ashes

It is evident that banks and finance companies are doing everything in their power to rebuild their balance sheets.

In an effort to lower their own borrowing costs, they are looking to the Federal Government for guarantees. They are actively engaged in the business of shrinking their own balance sheets, i.e. reducing their loan portfolios. And in the process of trying desperately to survive and eventually some day to thrive once again, they are abrogating the very rationale for their existence.

They might as well simply hang out a shingle that says: Not Open Today (or Tomorrow or who knows for how long).

But the entire economy is not dead and while the recession is severe and will likely last longer than most we have experienced, there are hundreds and thousands of real live companies in the US where business may be down but it is still very much alive. Those companies are not trying to shrink their balance sheets because they have perfectly fine balance sheets. They are not going to the Government for help because they don’t need to.

All they need is a neighborhood bank or a finance company to make them a loan and continue to do business with them now as they once did in both good economic times and bad. But the shingle says: Not Open Today (or Tomorrow …….).

This situation has been going on for nearly six months now, and it is in itself exacerbating the economic crisis, deepening the recession and causing once healthy companies to fail. Credit used well is good and needed for economic growth. Credit denied to good companies is seriously bad for the economy. At times it seems that there is no exit on this dead end street of capital denial.

But capitalism has a way of finding solutions and a new class of lenders is emerging, namely the pension plans and insurance companies who need to own in their portfolios the long term debt of healthy companies, even companies that are not AAA rated, yes even junk bonds. The Cablevision junk bond offering two weeks ago is a case in point. Yielding 11.3% for five years, it was oversubscribed and swallowed up fast by serious investors, not traders or flippers. Several investment grade utility bond offerings have similarly been swallowed up by long term buyers. These securities are not being traded because the buyers want to hold on to them till maturity. That is good.

Such response is much like the tiny green shoots that emerge from the forest floor after a ravaging fire. They are stronger than the fire that destroyed the giant trees. And they start the new cycle of growth that eventually rebuilds the forest. As more corporations needing capital discover that non-bank lenders exist, the pace of deals will accelerate and the banks will be less needed and more marginalized.

It will be a long process but the first signs have definitely shown up. That is good news for the U.S. economy in an environment of endlessly depressing news.

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Patricia W. Chadwick has had more than 35 years of investment experience. She is the founder and president of Ravengate Partners LLC, a consulting firm that provides advice on financial markets and global economics.