Bernanke Opens Door to Buying More Securities If Economy Falters Further.ArticleVideoInteractive GraphicsComments (127)more in Economy ».EmailPrintSave This ↓ More.
By JON HILSENRATH And SUDEEP REDDY
Federal Reserve Chairman Ben Bernanke walked with Fed Gov. Donald Kohn on Fridayoutside the Jackson Lake Lodge before the opening session of the Kansas City Fed's annual symposium near Jackson Hole, Wyo.
.JACKSON HOLE, Wyo.—Federal Reserve Chairman Ben Bernanke opened the door to bolder steps by the central bank if the economy continues to falter, amid fresh signs that growth has fizzled in the past few months.
Sudeep Reddy and Neal Lipschutz break down comments today by Federal Reserve Chairman Ben Bernanke on the U.S. economy and look at what's left in the Fed's arsenal. Plus, Microsoft Co-Founder Paul Allen Sues Google and others over patents.
Speaking Friday to world monetary policymakers gathered in Wyoming, he said "policy options are available to provide additional stimulus" to the U.S. economy, should it be necessary.
The latest sign of trouble for the economy came Friday as the Commerce Department revised down its estimate for second-quarter growth in gross domestic product. The economy grew only 1.6% in the period, not the 2.4% annual rate previously estimated.
Stumbling GDP growth adds to the gloom already created by plunging home sales and other signs that consumers are shying away from spending. Technology bellwether Intel Corp. warned Friday its third-quarter revenue could fall short of estimates because of weak demand for personal computers.
Japan Warns on Intervention After Yen Rise. Access thousands of business sources not available on the free web. Learn More.All of this drives home a grim political reality for the Obama administration and for Democrats facing elections this fall: What many had hoped would be a "summer of recovery" is ending on a dismal note.
"The pace of recovery in output and employment has slowed somewhat in recent months," Mr. Bernanke said in his speech in Wyoming, an annual event hosted by the Kansas City Fed. He made the case that growth will pick up in 2011, spurred in part by consumers who have shored up their damaged finances. However, he also made clear the Fed would respond if that forecast is wrong and growth continues to falter, and expressed confidence that its efforts would work.
Mr. Bernanke sketched out four options the Fed could deploy to boost the economy. At the top of the list is the resumption of a program of long-term securities purchases by the Fed, which could help to drive already-low long-term interest rates down even more. The Fed can't use its traditional lever of pushing short-term interest rates down because it has already pushed them to near zero.
.Another option would be to lower the interest rate banks get for reserves they keep with the Fed, even though it's already quite low, Mr. Bernanke said. He also said the Fed could promise to keep short-term interest rates low for a longer period than markets currently expect. A final option, which Mr. Bernanke ruled out but which some private sector economists recommend, would be to raise the Fed's inflation target to more than 2%, from its current informal target of 1.5% to 2%, Mr. Bernanke said.
Investors were buoyed by the news. The Dow Jones Industrial Average surged 164.84 points, or 1.65%, to close at 10150.65.
Economists still put low odds on the economy falling back into recession, but they acknowledge that the likelihood has been rising. Double-dip recessions are rare in history, sometimes the result of policy mistakes—such as pulling back stimulus too quickly or aggressively, as happened in the U.S. in the 1930s and in Japan in the 1980s. The most recent case of an economic relapse in the U.S. was the 1981-82 recession, which followed the 1980 downturn.
Goldman Sachs has one of the most pessimistic outlooks for growth among Wall Street banks, but even it sees the economy growing 1.5% in the second half of this year and early 2011. Goldman economists put the likelihood of a double-dip recession at 25% to 30%, a substantial risk but still unlikely.
One of the biggest potential challenges is stagnation in hiring, or a return to declining payrolls—which would choke off momentum for the private sector to grow. "If the labor market starts to shrink again, it has effects on both workers' confidence and on their incomes and that tends to reinforce the downside," said Goldman Sachs economist Ed McKelvey.
Friday's GDP report showed a surge in imports, which grew at the fastest rate in 26 years, during the second quarter. Growth in imports far exceeded U.S. exports and wiped out more than three percentage points of U.S. growth in the quarter.
Mr. Bernanke said the deterioration in trade in the second quarter might have been due to "temporary factors" and said exports could be a source of growth in the months to come.
..Many companies are socking away cash, rather than investing in new projects, in part to guard against risks they see emerging. Friday's GDP report showed for the first time that a key measure of after-tax corporate profits in the second quarter remained strong, rising 25% from a year earlier. But that represented only a 2.9% increase from the previous quarter, far slower than the gain in the first quarter.
"This is what business has been trying to tell policymakers all along—that confidence isn't high, uncertainty is great and there's a reluctance to take on risk," said Ronald DeFeo, chief executive of Terex Corp., a Westport, Conn.-based heavy equipment maker.
Mr. DeFeo, just back from Brazil, hasn't shifted back into cutback mode. "All we're doing," he says, "is trying to go those markets in the world where business and opportunity are better matched than in the U.S."
Richard Mershad, chief executive of Micro Electronics Inc., a computer retailer, said U.S. consumers remain extremely cautious in their spending.
The Hilliard, Ohio, company has avoided adding workers for the past three years, instead trying to raise productivity by automating more of its distribution to drive costs down. Mr. Mershad said he's "a little bit concerned about another dip" in the economy and plans to keep the company focused on cutting overhead expenses. "We have to do more with less," he said.
A similar sense of caution is entrenched in corporate board rooms across the U.S. and poses a major challenge for policymakers like Mr. Bernanke.
Mr. Bernanke's speech signaled that the Fed's position has shifted notably in the past few months. Early this year, officials spent much of their time planning an exit from easy money crisis policies, and unwound several of their emergency lending programs. Now, if the Fed takes any action, an easing of policy looks more likely than any tightening.
Fed officials disagree on whether more action is needed and whether the steps the Fed chairman outlined would be effective. The consensus-driven Fed chief is weighing the arguments among the dozen regional Fed bank chiefs and the four other Fed board members who have a say in Fed policy as he assesses whether to do more.
"None of the (Fed's options) would move the needle significantly on either the economy or the risk of deflation," Harvard professor Martin Feldstein said after the Fed chairman's speech. Interest rates are already very low, he noted, but that has not generated much consumer or investment demand. "He's in a bad spot."
Inflation trends weigh heavily on Mr. Bernanke's mind. The threat of a Japan-like period of falling consumer prices looms. Though Fed officials don't believe deflation is likely to happen, Mr. Bernanke made clear his tolerance was running low for further declines in inflation, which is already low, at 1%, and below the Fed's informal objective of 1.5% to 2%.
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For America's weakest companies, today's credit markets are a miracle drug allowing them to cheat death.
Many firms with speculative-grade credit ratings are tapping a record high-yield bond market to repay existing debts. They also are refinancing their loans, pushing out maturities and nabbing lower interest rates. This "kick the can" approach has paid off for companies that investors left for dead just 18 months ago, including Rite Aid Corp., MGM Resorts International and auto supplier Tenneco Inc.
These companies' fundamentals still give cause for concern. MGM, for instance, recently posted a wider second-quarter loss of $883.5 million, compared with a $212.6 million loss a year earlier. Slowing MGM's progress: an inability to coax profits out of a new Las Vegas development.
Still, riskier debt is among the only ways to find higher yields as the Federal Reserve keeps interest rates near zero and yields on government bonds stay low.
Weaker companies are enjoying the spoils. "Junk-bond" deals this summer have yielded around 8.6%, according to Barclays Capital. That is lower than a year ago, when these yields were around 10%, and a far cry from the more than 20% that investors demanded during the financial panic in late 2008.
Only 5.5% of companies around the world with junk credit ratings have defaulted in the past year, according to Moody's Investors Service. As of November, 13.5% of these companies had defaulted during the previous 12 months.
But even as investors throw cash at these firms, a number of them could have trouble generating enough cash flow to service the debt in coming years, say analysts and restructuring advisers.
"For the 'maturity wall' to not be a problem and things to get better, you need real economic improvement, and that's not happening," said Kingman Penniman, head of credit research firm KDP Investment Advisors.
Some $800 billion in debt on risky companies' books matures over the next four years, according to Moody's. Lenders' decreased risk appetite, a double-dip recession or a prolonged period of mediocre economic growth all pose threats to the market's ability to absorb companies' refinancing needs, Moody's says.
"The interest rates don't seem to be following some of the fundamental risk profiles of the companies," said Kevin Cassidy, a Moody's senior credit officer.
About two-thirds of the new funds have been used to repay existing debt, rather than for deals or other capital expenditures. Companies rated B- or lower have issued $31.2 billion in debt so far this year, according to Diana Vazza, head of Standard & Poor's Global Fixed Income Research.
"When the dam breaks, it will be unbelievable," said Barry Ridings, the vice chairman of U.S. investment banking at Lazard Freres & Co. who advises companies restructuring their debts. Low-margin, consumer-dependent companies are "all going to be in trouble at some point if they have too much debt."
Many companies are getting new life both from junk-bond investors and banks. MGM, the big Las Vegas casino operator, nearly collapsed in 2009 amid more than $14 billion in debt and huge downturns in consumer spending and real-estate values. But MGM muddled through. In March, it extended maturities on more than $4 billion of a credit line to 2014 from 2011. It also sold $845 million in senior secured notes to repay some of that bank debt.
Moody's upgraded MGM's credit rating in March, but the casino operator remains in risky territory. It still has over $13 billion in long-term debt. "We believe that we have sufficient liquidity to address our upcoming debt maturities," said MGM's finance chief, Dan D'Arrigo.
The company's stock trades under $1 and maintains a weak credit rating that suggests it is at high risk for defaulting. The company didn't respond to requests for comment.
Risks aside, Investors are only too happy to do these deals, as they search for higher returns amid low yields on safer paper.
"All these companies don't have the cash flow to pay off all their debt, but they were never expected to," said Russ Morrison, a bank-loan fund manager at mutual fund Babson Capital. "They were expected to gradually pay it down and delever. Those things are just standard in this market."
Blockbuster Inc. shows how overconfident investors could be left holding the bag. Last fall, the movie-rental chain tapped the booming high-yield market to raise $675 million in new senior bonds. Investors enticed by the debt's 11.75% yield helped Blockbuster raise about twice the funds originally sought. The company used the money to eliminate its bank debt.
But Blockbuster continues to lose money amid intense competition from movie-kiosks operated by Coinstar Inc.'s Redbox and Netflix Inc., which mails DVDs and streams movies online. Today, its senior bonds have lost more than half of their value, and the company is warning it may have to file for Chapter 11 bankruptcy protection, or in the worst case, liquidate. Blockbuster declined to comment.
Other firms have defied the odds. In 2006, private-equity firms saddled hospital operator HCA Inc. with huge debt in a $31 billion leveraged buyout. In March, HCA pushed out the maturity on $2 billion of its bank debt to 2017 from 2013 and sold $1.4 billion in bonds to eliminate other bank obligations. Today, HCA is mulling a public offering of its shares.
Many companies, including Harrah's Entertainment Inc. and Unisys Corp., have avoided bankruptcy with distressed-debt exchanges. In these deals, companies often ask investors to retire current debt for new debt that matures later with sweetened terms, equity, or a combination of both. These deals can also feature debt buybacks.
Energy Future Holdings Corp., the former TXU acquired in a record $45 billion 2007 buyout by private-equity firms KKR and TPG Inc., recently said it would exchange $3.6 billion in notes for $2.18 billion of new notes and $500 million in cash. Despite that and other recent deals to chip away at debt, Fitch Ratings downgraded Energy Future two notches, noting it has $22 billion in debt due in 2014. Energy Future declined to comment.
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