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How Much Debt Does the S&P 500 Have?
About 25 years ago I worked for a few months with a team of deep
thinkers who were trying to convert Capital Leases into Operating Leases
for tax and accounting purposes. The objective was to get the most
optimal treatment; (1) tax deductible amortization of the asset and (2)
keep it off the balance sheet so as to hide the true debt level and
therefore improve balance sheet ratios. There were strict rules that
were supposed to avoid this. But is was a goldmine idea if it could be
done. This was early derivative days. Make something look different than
what it actually was. I thought it was a dumb idea, so I quit and went
to sell junk bonds at Drexel. Turns out the folks involved figured it
out and made a bundle selling it. I am still glad I was not involved.
Now, a quarter century later, the regulators are catching up to this. It
is possible that changes will be made. If they do, it will have very
significant implications. The Economist has an article that sums things up pretty well. Here is the link, some sections of the report:
This new rule, proposed on August 17th by the two regulators (IASB and FASB), has shocked companies everywhere.
The
change will make a lot of firms look wobblier: a survey by
PricewaterhouseCoopers, an accounting firm, found that it would add
about 58% to the average company’s interest-bearing debt.
Many
companies are close to their maximum debt limits, and the new rules
could push them over the edge. Small wonder they are howling.
Other
companies will see their apparent return on capital plunge. Many firms
will see their debt-to-equity ratio rise and their ability to borrow
fall.
You can look at each company's BS and estimate what the impact of the
new rules will be. The article suggests that airlines and retailers will
be hard hit. The list of companies with Operating Leases is endless. I
would imagine that most of the S&P 500 will be impacted one way or
the other. I did look for macro information on total outstanding
operating leases and did not find a source. I think we are talking a
trillion or so. Does anyone have a source for the big picture?
Watch for a big fight over this issue. Look for GE to be the biggest
opponent to any changes. I think they have the most to lose in this.
It makes me laugh/cry to see that it took them 25 years to come to the conclusion that lease accounting was being abused.
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+100
No reason, unless that is the reason.
FUBAR.
I'm amazed at how I can talk to anyone about corruption inside of some institution that they have personal knowledge about, yet they never extrapolate this corruption out to other institutions. Since they have no personal knowledge of them, they simply trust their faith, because they cannot stand to know the alternative, that we are all fucked.
So true. As a working research scientist I can tell you that people believe scientists wouldn't alter results to advance their careers and receive more funding and recognition. But this is very naive as this happens all the time. Corruption and misuse of funds is rampant especially at large national laboratories where power is concentrated.
The vast majority of people have been brainwashed when young and impressionable to believe that should spend their lives striving to be accepted within the power circle... or at least a well compensated slave (although they do not envision it that way at the time).
Without getting into the extremely esoteric, there is nothing finite about the system that we are living within. Rules are only rules for those that believe them to be rules and do not have the power to ignore them. Is this right? IMO, it is neither right or wrong, but only a means to an end. While the people on this board might be discussing the injustice of something, somewhere in the world there are people discussing larger problems about how to manage the entire herd of humans, somewhere else in the world there are people dying from thirst or starvation and in another part of the world people don't give a damn about materialism and are trying to figure it all out to connect their 3 halves.
Sure, I believe in honesty, personal freedom and treating others with respect. I believe in questioning, understanding doing something about it and growing. Do I really need a financial prison (err system) to help me do that? Probably not. Have I got so much invested in my first 50+ years within the system that it is damn hard to find my way out. You betcha. These prison bars are made of velvet and excrete vodka on the rocks (with an olive) and a nice juicy steak cooked to perfection.
CD, in this case, the regulators are actually following the rules to the letter. Most lease accounting in the US is based on FASB 13 which, I believe dates back to the late 1950's or early 1960's. Everyone is going by the book in this case and although there have been some attempts at changing the rules, they have been half-hearted, partially because everyone has felt that the rules of the game have been working so well for everyone involved.
I agree. Let me quote myself from above.
I agree, in this case everyone's going by the book because the book is written to allow the thieving. Oh sure, there really are rules and regs to keep things from completely getting out of hand. After all, there must be rules. BUT the rules are written to favor the few at the expense of the many. And without being insulting in the least to you my friend, most people can't see this fact because they are immersed in the game.
They know the rules so well and have been around it for so long that it all just makes sense. But pull average Joe in off the street or ask a passing space alien what he (she? it?) thinks about the "system" and they will respond in short order with a common consensus.
Rigged. And the regulators are part of the rigged game.
And just think about it: Not only do they regulate poorly, but the get to be paid twice the salary of the Average joe for doing so!
Our S.E.C. Or as I call them, the US Department of Winkin', Blinkin', and Nod.
I believe you forgot "Wankin'" in there!
I di not take it as an insult my dear friend and especially from such a lofty commentator as yourself. (BTW, happy anniversary!). My point was that the rules were written at a point in time when corporate leverage was not the issue that it is today. Remember that in say, 1959, securitization didn't exist. So taking a lease off the balance sheet didn't seem like such a big problem. I might also point out that under international accounting rules, where the auditor's judgment counts a great deal more than it does here in the US, taking a lease obligation off the balance sheet is much more difficult. Here in the US, under the old FASB 13, it was much easier to "game" the system. Thereby further proving your point.
Cheers.
And well as yours. The more I pull back to bring the big picture into focus, the more my stomach turns. I fully understand why so many seek drink, drug or other diversions to kill the pain of the ugly truth. Unfortunately it will only change when people begin to talk about the painful truths they so desperately try to avoid. Part of our conditioning is to avoid talking about our conditioning.
Have a good weekend.
As a culture we tend to distance ourselves from people who speak the truth because we would rather live with a known lie than to invite an uncomfortable conflict and a resolution that might hurt the liar. Odd, no?
I recall a weeklong exec financial education trip to Wharton back in the mid-90s. One of the case studies was of Marriott corporation which at the time had superior earnings based on their degree of leverage. The lesson for us was not that we could have a more profitable company with greater leverage, but that there is greater and unreasonable risk associated with leverage.
I guess the financial engineers figure that one out. Create companies that were too big and too connected to the power structure to be allowed to fail and have the saps, errr I mean people, absorb the risk. Problem solved! Superior earnings and no risk.
Precisely. And also why I selected Cognitive Dissonance as my ID. Because the funny thing about denial is that while we may be (sub)consciously pushing away the pain and dissonance, in the background, our subconscious mind is absorbing everything.
So when the time comes for the student to wake, the teacher will already be present in the form of subconscious knowledge and understanding coming to the surface to be transferred into the conscious awareness. And this often happens (relatively) quicker if there are subliminal reminders of our dissonance present.
Hence my ID.
Odd, no? :>)
The mental conflict that occurs when beliefs or assumptions are contradicted by new information. The unease or tension that the conflict arouses in a person is relieved by one of several defensive maneuvers: the person rejects, explains away, or avoids the new information, persuades himself that no conflict really exists, reconciles the differences, or resorts to any other defensive means of preserving stability or order in his conception of the world and of himself. The concept, first introduced in the 1950s, has become a major point of discussion and research.
Man, I should have selected my ID with a bit more thought.
I would say, "In a minority, yes" .... Odd? Not to me. I think there will come a time when people will need people who have not been dead or asleep to help them with the new reality.
And you as well.
Just wanted to additionally point out that this would pop the CRE bubble for sure. Probably the biggest reason for the inflated CRE property values is in this capital vs. operating distinction. It's really hard for me to get a feel for just how big the pop is going to be, but 50-60% would not suprise me in the least, and 30% would be optimistic.
Thanks rorotrader, I needed that reflective video to make my weekend . The only suggestion for improvement would be to have the last scene of the video showing the Fed Reserve in deliberation during their last meeting.
Why, thank you for the kind words, GE......
On a reflective note please find a link to theme music to close the week.......hope the cut/paste works.....Gnarls Barkley, Crazy.......music and lyrics........the content seems to fit the Zero Hedge context........
"I remember when, I remember when...... I lost my mind,......... and I think you're crazy."
http://www.youtube.com/watch?v=aJ44psLHvIc
RoRo
If you can remember when you lost your mind, then you didn't lose it...
I know, I know, enough already.
Soon we will have new accounting rules to bring off- balance sheet BS onto the Balance sheet.
And the clearly opaque will become opaquely clear.
I hear a violin and laughter on the hill... burning effigy....
Why, thank you Kayman
I remember when,
I remember when I lost my mind
There was something so pleasant about that place..........beautiful poetry, lyrics and music juxtaposed against the dark and the lies.
The lies, the lies, so many lies to kill.
And, this one is dedicated to ZH.......and the lovely RobotTrader.......My world is empty without you........
http://www.youtube.com/watch?v=7SuSsvJUqKI
It is part of the entire global credit bubble, in part created by a new breed of financial engineers in an era of infatuation with fast talking MBAs [mine was from 1961] and politicized regulators resulting in Enrons, securitization, swaps, derivatives etc. Bottom line is every sector of ecomomy is in debt because we have leveraged our future. Private debt now over 33 billion, pension funds 20-30% underfunded and taking on more risk, public debt increasing and unsustainable were it not for China and our fragile status as a reserve currency, and now more cracks in business leasing practices. It cannot end without pain.
1-800-CALL-BENB
or call Chuck Prince for advice on how to ignore these obligations
Currently, the really active banks in this business are BofA, , JPM, PNC and Wells. Citi used to have a gigantic portfolio but has been selectively selling deals as their tax position has kept them from investing in new deals.
It's amazing how much power there is in wielding this "FASB tool".
Implement mark-to-market, market crashes,
Implement mark-to-myth, market rallies,
Implement these new leasing rules... you get the picture.
Wasn't it a FASB level 3 rule implementation that helped take out Bear Stearns?
(both my memory and my google-fu are weak)
Why it was Rule 157.
I think 157, which was an expansion of FIN 46, required under certain circumstances the consolidation of special purpose entities. While it continued to exempt the securitization vehicles, a lot of other stuff got caught and brought on balance sheet and all of the sudden lots of leverage that was off the balance sheet and off the radar screen magically appeared.
BTW, this is a joint proposal from both the FASB and the IASB and is part of the "harmonization" of US and international accounting standards so the politics of this will be interesting going forward.
I read this in the FT too. When is this supposed to become effctive if it ever does ? Or are the powers-that-be just discussing it yet ?
The comment period end on December 10, 2010 and the rules would be applied retroactively once adopted so it is anticipated that if adopted in their current form, 2010 financials or 2011 financials, at the latest, will reflect the new rules.
Mitch......the comment deadline is correct. However, my very vague recollection was a proposed mandatory implementation target date effective in '12 or '13 financials....can't fully recall. I just remember doubting the gimmicks could continue that long.
Excellent piece, Bruce, and other commentors.
Excellent piece, Bruce, and other commentors.
+1
+2
Christ almighty... But there's no way Wall Street or PonziGeithner are gonna let the proposed rule pass. Remember these trolls are sprung out of the Greenspan-rising-equities-is-the-most-important-thing cult...
you got it.
People say GAAP is pliable.
Bruce, as someone who spent a great part of his career in the leasing business, I can tell you that about $1.3 trillion in leases is the going industry estimate for the amount of off-balance sheet obligations on listed companies. In my judgment, that number is low by a factor of 2.
I agree Mitchman, having spent 25 years catching the pitches of lease/salesmen. The $2.6 trillion number is reasonable, although high-end estimates I have heard for health-care alone run in the $1.5 trillion range.
Of course, being an accountant by training and balance sheet-centric by nature, I usually wanted the lease capitalized.
I come from the school that says you should match the revenues produced by the asset with the cash out needs to finance.
Call me old fashioned but that approach has made our org bullet-resistent for the last 3 or so years. Notice I did NOT say bullet proof 'cause the one that gets you, you never hear.
Thanks for the note, Turk. I was always on the side pitching the glories of the earnings accretive nature of the off balance sheet treatment.
The source on that is a 2005 SEC study. It estimated, by extrapolating from a sample, that "active U.S. issuers" had $1.25 trillion of off-balance-sheet obligations stemming from operating leases.
http://www.sec.gov/news/studies/soxoffbalancerpt.pdf
You have to love the blogs. I pose a question and less than an hour later comes the answer with a source to prove it. Thanks Tom.
Note that the source is the SEC. I would double that number to $2T.
I found this graph. If you believe it then corporate debt = 50% of GDP or about $7t. Add in another 2T for this and you have a 30% increase. That is a very big change. A bit scarry.
Nice graph. So much for the "corporate balance sheets have never been in better shape" hyperbole. Leverage is as high as ever. The only real improvement is the average maturity of the debt portfolio has been extended. Massive cash on the balance sheet is NOT a positive signal.
Thank you for that. The key to the new rules from a GE Capital perspective is that a great many of the transactions on which they act as lessors (not as lessees like the airlines) are "leveraged leases" where they only contributed about 20% of the cost of the asset and financed the rest of the asset cost with non-recourse debt. (The same is true for all of the bank-affiliated leasing companies). The new rules would force them to put this non-recourse debt on their balance sheets with a matching asset that reflects the fact that they have granted a lessee the right to "Use An Asset." You can see that there will be some gigantic balance sheet inflation throughout the S&P 500 and beyond if these proposals are adopted in their current form.
Thanks for this. 2.6 Trillion. Well that should sink the s&p by 20%. What a joke. The fact is this is already the case. It is just not being reported the right way.
Bruce, sorry if I am hogging the site. The implications for the revenue and ROE side are even more interesting for the likes of GECC.
Actually I would like more info. Can you estimate a proforma BS for GECC?
Does it double? Triple? Quadruple?
I'm sorry. Their accounting is so opaque that it is literally impossible to estimate. Nine digits is a certainty and the only issue is the size of the first digit. I would be shocked if that first digit is less than 2.
Actually Bruce, let me recant. GECC is one of the largest lessors of rail cars in the world and GECAS one of the largest lessors of commercial aircraft in the world. So if the first number is a 3 or even a 4 I would not be shocked. For a good insight on GE's accounting practices, particularly as it realtes to their accounting for acquisitions in order to maintain their growth and margins, see the work of Charles Ortel who used to be a frequent guest (!) on CNBC. GE's AAaa rating is about as solid as the US's.
CNBC talking up GE's AAaa rating is the same fucking thing as GE itself talking up its AAaa rating. GE controls CNBC. Fuck, if GE wants it can make CNBC girls show more cleavage and talk up their AAaa rating every morning.
GE and U.S. debt is about as solid as a 70 year old woman's teats.