Henes: You Can’t Stop a Flood by Adding Water: It’s Time to Reduce, Not Add, Debt for Long-Term Economic Strength

Leading up to the Great Recession, our economic growth was fueled by debt.

Home ownership increased through lax underwriting standards and an irrational belief that housing prices would always go up.

Consumers used credit cards to make purchases beyond their means. And, as the old bank model of originating and holding loans evolved into originating and selling loans, corporations were able to borrow at will, dangerously increasing leverage ratios. When the economy collapsed, we realized that the percentage of total debt in this country as compared to GDP was more than 350%.

Staring at an over-levered nation, we focused on reducing our debt to build a strong foundation for long-term growth, right?

Lester Lefkowitz | Stone | Getty Images

Wrong.

Feeling the need to drive growth in the short term, we ignored the debt problem and increased debt.

Imagine that you are sitting in your house, watching flood waters rise, fearing that your house could be washed away and the government walks in and says, “here’s our plan to save your house - we are going to add more water to the flood.”

After realizing this was not a joke, you would run, not walk, to find higher ground and kiss your house goodbye.

In February of 2009, I explained the following:

We are dangerously over-levered.

This should raise serious issues regarding where our country is headed as our government effectuates bailouts, stimulus packages and the like. It is understandable for the government to want to stop the pain we are experiencing. But, the government may be focused on the wrong things.

The right thing to do - the prudent thing to do - is for our government, citizens and corporations to restructure their balance sheets and reduce their debt. We will not be able to grow again until this is done. Yet, what we hear from the government is that we need to find a way to unlock the credit markets so people and companies can begin borrowing and begin growing.

Focusing on growth at this moment in time may not only be wrong, but it may be dangerous...

Our focus should be on positioning our country and its corporations and citizens to be strong and, eventually, to grow. To do this, we need to de-lever our nation’s balance sheet. The government, our fellow citizens and our corporations need to get rid of their debt. We need to let this happen. Once the debt is gone, we will be strong and primed to grow again.

As troubling economic data comes pouring in and our “economic growth fueled by more debt” experiment seems to have failed, we need to come up with a plan to restructure our nation’s balance sheet and operations. We need to reduce our nation’s debt and to position ourselves for long-term growth and strength. This will not be easy because restructurings never are. But, if we do not fix our debt problem now, it will only get worse later.

Jon Henes is a partner in the Restructuring Group of the law firm of Kirkland & Ellis. Jon's practice involves representing debtors (including portfolio, privately-held and public companies), creditors' committees and distressed investors (including hedge funds, private equity funds and companies) in acquisitions, restructurings and bankruptcy cases.