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Anatomy of a credit crunch induced bankruptcy - Eric Janszen

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  • Anatomy of a credit crunch induced bankruptcy - Eric Janszen

    Anatomy of a credit crunch induced bankruptcy in debt deflation

    You know things are bad when wholesale liquidators -- companies that sell goods for companies that are going out of business -- are themselves going out of business

    When we first started to outline the dimensions of this economic depression back in 2006, we did not foresee the extraordinary rate of economic decline we are experiencing today. Processes we expected to take months to transpire are happening in a matter of weeks. Nor did we imagine the range of businesses that are now getting caught up in this disaster. Usually a retail sales collapse starts at the luxury end of the market and slowly works its way down. Not this time. A document sent to us (hat tip to Sapiens) is indicative, a recent bankruptcy court filing by a wholesale liquidator. That's right, a company that sells goods for companies that are going out of business is filing for bankruptcy protection.

    Below are excepts of the filing by the company, identified here only as Debtor, with comments.



    The Debtor has many subsidiaries.



    The Debtor is not a neophyte that has not gone through a downturn before. Debtor was founded 25 years ago at the start of the post 1980s recessions, and survived the early 1990s and 2001 recessions.



    Debtor does business with established vendors. Going over the whole document, it appears that Debtor is and has always been a well run company. If there is a weakness in Debtor's business strategy in the current environment, beside the taking on of excessive debt, it is that the Debtor did not focus on the well healed but rather those who can only afford goods at below standard retail prices, even when times are good. That said, you'd think a few hundred thousand laid off FIRE Economy workers might improve the company's prospects as they join the ranks of Debtor's "lower and lower/middle income" target customer base. Apparently there are not as many newly minted poor joining from the upper rungs of the income ladder as there are customers falling the bottom rungs into abject poverty.



    Debtor has some very big stores. If they do not emerge from bankruptcy, the goods supply will no doubt be missed.



    Debtor employs a lot of people, nearly 2,000 total. If they do not emerge from bankruptcy those jobs are gone.



    Alas, the Debtor could not resist the siren song of the private equity boom, and early in the game; they took PE money in 1998.



    Debtor enjoyed sustained profitability until the post credit bubble economy pulled the rug out from under Debtor's customers. Whipsawed by energy inflation then falling incomes due to rising unemployment, the discount clearance wholesaler's goods became unaffordable to its customers.



    Unfortunately for the Debtor, the 60% the PE boys own is a majority stake, so even though the company has been profitable for its entire 25 year life, when the economy turned down the boys still wanted to get their piece of the cash flow first.



    The Debtor has many creditors, and just as the economy took away its customers its creditors tightened up on it lending terms, forcing a reduction of inventory in demand, reducing the supply of goods wanted by the remaining customers, further lowering sales below capacity, and feeding a vicious circle.

    Debt Deflation versus Goods Price Deflation

    This is where the business rubber meets the debt deflation road, and why it's important to distinguish between debt deflation and all-goods price deflation, because what happens next is that as supply falls, goods prices will rise (see F.I.R.E. sales and Fire sales).

    But don't take our word for it, again. Consider this report today by Richard M. Ebeling at the American Institute for Economic Research (AIER).
    False Fears of Deflation in Dangerous Inflationary Waters

    The Consumer Price Index (CPI) data for December has made many commentators raise the fear of a coming deflation. There is only one problem with these concerns: There are no deflationary forces at work. If anything, a huge inflationary process has been undertaken by the Federal Reserve over the last several months.

    The Department of Labor reported January 16 that the CPI for all urban consumers (seasonally adjusted) decreased by 0.7 percent for December and was a mere 0.1 percent higher than a year earlier. Prices have not declined significantly, and the trend certainly has not been deflationary.

    Since the time of Adam Smith, economists generally have defined inflation or deflation as a rise or fall in the money supply (broadly defined). Whether or not such a monetary change brings about a rise or fall in the general level of prices will depend on people’s demand to hold money relative to the increase in the supply of money.

    At a time of economic crisis and uncertainty such as the present, individuals may choose to hold money balances larger than usual as they try to hedge against a more unpredictable future and restore their financial balance.

    But normally the crisis atmosphere passes after a period of adjustment during which the write-downs are made and markets rebalance, with the likely future being less cloudy. At that point demands to hold a larger than usual amount of money tends to diminish.

    The Federal Reserve is fearful that the collapse in housing and assets prices coupled with individuals and financial institutions shoring up their cash positions will put significant downward pressure on prices in general. So over the last several months, the Fed has undertaken a massive increase in the supply of money and credit.

    As shown in the chart below, the Monetary Base (dollar cash held by the public and bank reserves held at the Fed) increased from $871 billion in September 2008 to nearly $1.7 trillion in December 2008. This amounts to a 95 percent increase in only four months. M-1 (Cash and demand deposits) increased by 40.2 percent and M-2 (M-1 plus and variety of forms of demand and savings deposits) grew by 17.4 percent at annualized rates of increase over this period.


    By any definition, there has been no monetary deflation that would have decreased the amount of money and credit in the economy. The current monetary expansion comes before any reestablishment of a non-crisis demand for money by consumers, producers, and financial institutions. And its magnitude warns of a serious danger of significantly rising prices in the future if the Federal Reserve fails to reverse the expansion.
    The threat facing the economy as a whole in 2009 will be the consequences from this vast inflationary increase in the monetary aggregates.
    In case you are not familiar with the AEIR, they have been at this economic analysis and forecasting game a lot longer than we have. We recommend this AEIR article from Nov. 1934 (PDF). You will find it eerily familiar (hat tip to Paul and Wes for passing it on).

    Today the gold market once again frustrated the impatient deflationistas who have been calling for gold to fall to under $450 since at least mid 2008. Settling just below $900, market participants confirmed what the AEIR and others who understand how the economy and monetary system operate already know, that on the other side of all of this money pumping by the Fed is a tide of inflation that will be expressed as rising goods prices, no matter that prices of assets inflated by CDOs and another financial magic -- such as houses and retail commercial real estate -- are down for the count.

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    Last edited by FRED; 01-26-09, 04:25 PM.

  • #2
    Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

    How vast of an inflationary force are we talking here? And when do you guys think it is set to ignite? Do you think inflation will be really bad in 2009 or will it slowly creep its way up over the year and into 2010?

    Thanks for the good post, by the way.
    Last edited by BadJuju; 01-23-09, 06:46 PM.

    Comment


    • #3
      Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

      I thought that Gold would go down as i had gotten in big time. Go figure.

      rick

      Comment


      • #4
        Re: industrial ebay?

        maybe in this one market segment the bankruptcies have more to do with ebay & ebay's industrial counterparts than with the credit crunch?

        Comment


        • #5
          Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

          This commentary really makes me wonder...

          What percentage of major companies out there don't have private equity or hedge fund sepsis?

          Any?

          Hoo

          Comment


          • #6
            Re: industrial ebay?

            Originally posted by Spartacus View Post
            maybe in this one market segment the bankruptcies have more to do with ebay & ebay's industrial counterparts than with the credit crunch?
            We thought about that. eBay has been going down along with all of the other retailers.



            eBay tried to turn itself into competition for retail stores versus staying in its niche as an auction site.

            Guaranteed most of Debtor's customers do not buy from eBay stores or auction on eBay.
            Ed.

            Comment


            • #7
              Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

              Thank you EJ, I understood that no problem.

              Rick i bought Gold @ these prices, but the was $2.08 at the time..............Oh how things have changed ;)
              Mike

              Comment


              • #8
                Re: industrial ebay?

                Very thorough ... your response reminded me of some numbers I saw about a week ago that US post, UPS and Fedex traffic is declining.


                Originally posted by FRED View Post
                We thought about that. eBay has been going down along with all of the other retailers.


                eBay tried to turn itself into competition for retail stores versus staying in its niche as an auction site.

                Guaranteed most of Debtor's customers do not buy from eBay stores or auction on eBay.

                Comment


                • #9
                  Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

                  After Itulip posted the Waterford crystal bankruptcy, it seems like the companies that are most likely to crash and burn are those heavily in debt.

                  I think if anyone is thinking in investing in a company during this recession/depression, the first criteria would be for the company to be debt free and, even better, if its competitors were to have excessive debt. It's more likely to be the one left standing perhaps.


                  Just a thought.

                  Comment


                  • #10
                    Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

                    I know who the "wholesaler" is: does not change my life or EJ's article however...
                    Last edited by LargoWinch; 01-23-09, 09:17 PM.

                    Comment


                    • #11
                      Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

                      Originally posted by EJ View Post
                      ...Today the gold market once again frustrated the impatient deflationistas who have been calling for gold to fall to under $450 since at least mid 2008. Settling just below $900, market participants confirmed what the AEIR and others who understand how the economy and monetary system operate already know, that on the other side of all of this money pumping by the Fed is a tide of inflation that will be expressed as rising goods prices, no matter that prices of assets inflated by CDOs and another financial magic -- such as houses and retail commercial real estate -- are down for the count...
                      Where the currencies have already been inflated [debased] compared to the reserve currency, the inflation is already underway. Canada's latest stats out today:
                      Food prices eat in to household incomes

                      Alia McMullen, Financial Post
                      Published: Friday, January 23, 2009
                      Car-driving Canadians continued to receive a welcome reprieve from lower gasoline prices in December. But for those that like to eat, which is likely most, food prices have persistently escalated and are predicted to remain costlier in the coming months...

                      ...The cost of food rose 7.3% in 2008, inching up 0.3% in December for a fourteenth straight month of increase, Statistics Canada figures showed Friday. Marking the sharpest increase was the cost of fresh vegetables, which were 26.9% higher than in December last year. Other notable increases included a 18.9% rise in fruit prices, a 12.4% increase in bakery product prices, a 6% rise in the cost of dairy products and a 5.5% increase in meat prices...
                      [Starving Steve must live in a different Canada from the one I live in ]
                      Now the obligatory deflation scare paragraph:
                      ...While it might not be reflected in the grocery receipts and mortgage costs, the overall cost of living is falling. Consumer prices fell a seasonally adjusted 0.4% in December to take the annual rate of price change down to 1.2% -- the lowest reading since Jan. 2007. The inflation rate has fallen sharply from its recent peak of 3.5% in August, causing some economists to speculate that Canada is crawling dangerously close to deflation, an economically damaging spiral of price decreases that comes hand in hand with production cuts and job losses...
                      Followed by this little deal closer:
                      ...Core inflation, which is the preferred measure of the central bank, was unchanged at an annual pace of 2.4% in December. The Bank of Canada predicted this rate to bottom at 1.1% in the fourth quarter, below its 2% target, but safely above deflationary territory.
                      So if it wasn't for falling energy prices there would be no "deflation" in Canada...

                      Comment


                      • #12
                        Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

                        Originally posted by GRG55 View Post
                        Where the currencies have already been inflated [debased] compared to the reserve currency, the inflation is already underway. Canada's latest stats out today:
                        Canada should be seeing general inflation over the last year or so based on the decline of the Canadian dollar. It's down in relative value over 25% since the peak in late 2007. While it's not a 1:1 correlation, a falling currency will tend to raise commodity prices. Gold tends to have a much more direct correlation than lettuce, but lettuce growers do need to make money.

                        CanadianDollar.jpg

                        As I was writing this I started to wonder if the "deflation" we're sensing in the US isn't partly related to the rise in the relative value of the US$. The US$ is up about 20% over the last 6 months. It may simply be coincident circumstance and a too large inventory overhang but suppliers in our industry are discounting with abandon. Is this a short term issue? As I read it, EJ's post posits a whipsaw price deflation leading to product shortages and commodity price inflation. I don't see how we have inflation in 2009 but I'd like to understand the inflation argument more clearly.

                        Comment


                        • #13
                          Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

                          The most worrying aspect is the action of the PE boys (as EJ likes to call them). We have to assume that they in turn have their own creditors who in turn have turned the screw.

                          The most useful lesson for the long term is to relate the overall philosophy of the PE boys. What were they doing? If the answer is they were setting out to improve the balance sheets of the companies they were buying into, why did they use borrowings instead of equity capital? Yes, you are all correct; this is my pet hobby horse, but this example makes for an excellent illustration of what I am working to get across.

                          In fact, the PE boys were not in the business of creating a long term stable business environment for the companies they bought into. No! They were simply in the business of selling debt for as much money as they could make in the short term.

                          Why could they do that?

                          The short answer is that there was nowhere for a long term stable business, trading well within their normal parameters, to find equity capital. The only thing on offer was debt.

                          Borrowings are not capital.

                          This is a classic "house made from playing cards". Pull one from the building and the whole thing collapses. So in fact, what we have is the end result of our central banking and regulatory institutions turned their backs on the idea of the leading financial institutions taking a paternalistic attitude to their responsibilities towards the economy and collectively setting FIRE (please excuse the pun) to the foundations of any form of good old fashioned capital based, stable, economy.

                          Someone threw down the proverbial handful of silver and from that moment onwards, they have scrabbled around on the ground looking, increasingly desperately, for more of the same.

                          They created a world of Debt Junkies in the form of PE Boys in a Feudal Mercantile economy.

                          Comment


                          • #14
                            Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

                            Originally posted by santafe2 View Post
                            As I was writing this I started to wonder if the "deflation" we're sensing in the US isn't partly related to the rise in the relative value of the US$.
                            See Confusion reigns: A crisis-driven global rush to dollar liquidity is not deflation
                            Ed.

                            Comment


                            • #15
                              Re: Anatomy of a credit crunch induced bankruptcy - Eric Janszen

                              Originally posted by EJ View Post

                              But don't take our word for it, again. Consider this report today by Richard M. Ebeling at the American Institute for Economic Research (AIER).
                              False Fears of Deflation in Dangerous Inflationary Waters

                              The Consumer Price Index (CPI) data for December has made many commentators raise the fear of a coming deflation. There is only one problem with these concerns: There are no deflationary forces at work. If anything, a huge inflationary process has been undertaken by the Federal Reserve over the last several months.

                              I am skeptical there are "no deflationary forces." What about the de-leveraging taking place for foreign entities paying back their loans to US banks that they took out during the credit bubble of recent? They buy dollars to pay back loans, causing the dollar to rise and making imports cheaper from an exchange perspective. That seems like a deflationary force.

                              I can't think of many more examples, if any, but I'm not sure that "no deflationary forces" is a true statement. (There may be one or two roads that don't lead to inflation.) But I guess this article wasn't posted because EJ agreed, but because the article agrees with ITulip's perspective of inflation rather than deflation.

                              I'm not convinced that this currently climate won't last longer than many expect. High inflation may take more than a few months, though it is a near guarantee.

                              Comment

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