Fragile US Economy Faces Recession Test

Some top economists warn that the nation's high debt levels are likely to deepen expected slump, but others have brighter outlook

HIGH levels of corporate, consumer, and government debt have made the United States economy more fragile. That thesis, offered by some economists for several years, could be facing its big test - a recession.

``The next downturn - whatever its immediate cause - will likely be more severe than it would have been if the purchasing power of households was less dependent on debt,'' states Robert Pollin, an economist at the University of California, Riverside.

Mr. Pollin reaches this conclusion in a study on consumer debt for the Economic Policy Institute in Washington. The study warns that the ratio of total debt of American households relative to disposable income after taxes, now at a postwar high of 93.9 percent, could dash hopes that any coming recession will be shallow and brief.

Government figures released this week show the economy still growing slightly in the third quarter. But most economists expect output to decline in the current quarter or early next year.

Pollin is joined in his assessment of the extra risk resulting from high debt levels by other economists, including Benjamin Friedman of Harvard University; James O'Leary, a consultant to United States Trust Company of New York; Henry Kaufman, a Wall Street economic seer; and two Princeton University economists, Ben Bernanke and John Campbell.

``The economy is more vulnerable now than it was in the 1960s and the 1970s,'' says Mr. Campbell. He and Mr. Bernanke have done a study showing that 20 percent of a sample of large US corporations would have liquidity problems should a deep recession, like that of 1973-74, occur today.

Interest expenses, Bernanke notes, have become a much larger fraction of corporate cash flow. Many companies will be squeezed ``much more quickly'' when a slump depresses earnings. Their cost cutting measures could worsen a recession.

``Many companies in the nonfinancial sector have borrowed in a way that requires continued growth in earnings to service their debt,'' says Professor Friedman. A deep recession could produce a level of bond defaults and bankruptcies ``not seen in the post World War II period.'' But he expects the Federal Reserve System to ease credit aggressively should such a serious downturn show signs of materializing. That would avert a ``financial crisis.'' Not every economist shares this gloom over debts. ``The story doesn't ring as plausible to me as a few years back,'' says Jerry Jordan, chief economist at First Interstate Corporation in Los Angeles. He says consumers have already started a process of shrinking their debts to a more manageable level. Further, interest rates have fallen, easing the burden of servicing debts.

Individuals and specific companies will face problems, Mr. Jordan admits. But he doesn't expect the problems to be a serious national threat to the economy.

Further, Jordan sees the Fed as having already moved to inject more money into the economy, reducing the danger of a crash.

Allan Meltzer, a professor of economics and social science at Carnegie-Mellon University, says he doesn't anticipate anything more than a ``garden-variety recession.'' Unlike the situation before the major slump in 1981-82, the economy does not suffer from high business inventories, economic expansion continues in Western Europe and Japan, and inflation is far more moderate, he notes.

US Trust's Dr. O'Leary, however, is more worried. The economy is more leveraged, he says, with total outstanding debt at midyear amounting to $12.8 trillion, compared with $4.2 trillion at the end of 1979.

The rate of debt expansion has been declining, he admits. It was 7.4 percent in 1989 and 6.8 percent at an annual rate in the first half of 1990. But he believes the economy remains vulnerable to sagging commercial and residential real estate prices.

Further, he points to a $500 billion net reduction in nonfinancial corporate equity during the past several years, replaced by debt, much of it high-risk, high-yield ``junk bonds.''

The University of California's Mr. Pollin finds that growing income inequality in the US has worsened the risk from a high consumer-debt level. The wealthiest one-fifth of US families enjoyed increasing incomes during the 1980s and borrowed principally to support speculation in financial markets and maintain high consumption levels. The bottom four-fifths of families accumulated most of their debts on home mortgage loans, car loans, and credit cards. Those of average or low incomes were hit by a sharp decline in real wages and rising housing costs.

Already, mortgage foreclosures, delinquencies, and personal bankruptcies have risen, especially among the middle class and the poor, Pollin says. He would like the government to adopt policies to help the poor and those with moderate incomes - more affordable housing, support for savings and loan associations, and government policies less hostile to trade unions. He welcomes the budget package with its ``mild'' shift of the tax burden onto the rich.