The credit bubble claimed another victim today as Smurfit-Stone Container Corp. filed for bankruptcy protection. This is a move that must shock much of the business world. That’s because Smurfit-Stone, one of the world’s largest cardboard box makers, was a company that was making a profit and was not thought to be deep in debt. It had debts amounting to less than a year’s revenue, which ordinarily is considered safe ground for a business corporation. But its debt load was too high for it to get through 2009. What this says to the corporate world is that operating on credit is out of style.
It’s the same thing consumers have been grumbling about since early last year: if you owe more in unstructured debt, such as credit card debt, than you can pay off in two or three months, you’re living on the edge. The banks could decide you can’t continue to borrow the money, at least not at the same interest rate. Then you may owe money with no way to pay it back.
That’s essentially the situation Smurfit-Stone found itself in. In a normal year, it would just go to a bank and take out a new loan to replace the old loan that was expiring. This year, the banks are operating differently, and Smurfit-Stone was forced into bankruptcy.
For two years, we’ve been hearing about banks shoring up their balance sheets. Now, ordinary business corporations will be doing the same thing, cutting back on expenses and seeking new capital to pay off debts, reduce their leverage, and reduce the risk of becoming insolvent. Business corporations are obligated to protect their stockholders, so the most important thing they can do is stay out of bankruptcy, and in times like these, that means not leaning too heavily on the banking system.
In economic theory, when everyone is trying to deleverage at once, it’s not pretty. With every business trying to borrow less and spend less, there is less spending in aggregate, and a decline in total economic activity — we’re talking about a painful, prolonged recession. But it’s hard to see what the alternative is for a world coming out of a credit bubble.