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Rollover
Events in Asia provide an elegant illustration of the fine line between "rolling over" a debt and getting rolled.
The lesson is especially useful for the wiseguys here in the States who think the Asian borrowers and their bankers everywhere should be punished, and that their financial foolishness is the "can't happen here" variety -- at least now that those silly Savings and Loans are gone.
Guess again. The Korean flu can strike anywhere, even in American homes.
To "roll over" a debt is to replace a debt due for payment with a new debt, as opposed to paying it off in cash. Rollovers are commonplace -- essential -- in any economy, and there is nothing in rollovers unique to the global economy or electronic money. The practice is as old as the concept of the IOU.
The United States Treasury is a leading practitioner. Every Monday, the Treasury rolls over about $30 billion in T-bills due for payment (more than a third of our national debt comes due in less than a year, every year) with money received from the sale of new T-bills. If the investment community worldwide wanted its cash instead of more T-bills, we would be in the same shape as South Korea.
Rule one of rollovers: it's a confidence game. If your bankers believe in you, they'll roll over your loans. Confidence among banks is contagious, both pro and con.
The second rule of rollovers is one of the great fantasies in banking: it's safer to make a short term loan than a long term one. It is true, to a degree: less can go wrong with a borrower in a short period of time than in a long time.
However, bankers being human, and bankers after all, greed combines with laziness to transform reasonable, risk-limiting short term loans into an endless string of rollovers which in sum are indistinguishable from a risky long term loan. Long term re-rolling has the added disadvantage that both banker and borrower are lulled to sleep by the arrangement. A big home for short term perpetual rollers, like commercial paper and CDs: your money market fund.
Banker: "We've reviewed your quarterly financials, and we won't be able to renew your loan next Monday."
Borrower: "You can't be serious! We have had this line of credit with you for five years, and you know we don't have the cash. Could we have more time?"
Banker: "Renegotiate? I'm afraid our regulators take a very dim view of concessions on troubled loans. You've got 10 days to find another bank -- it shouldn't be too hard to find another short term loan."
Next banker: "You've slipped a little latelyÉ, so our rate will be stiff, and we can only go a year, but I think it will be approved. Say, what will you use the proceeds for? To pay off MegabancÉ oh, myÉ I don't think our board will like thatÉ at all."
How foolish of both parties, you're thinking. The bank declining to roll over will wind up with the desks and wastebaskets of a bankrupt company, and no cash. Welcome to South Korea.
Other than the Treasury, banks, big corporations and municipalities -- tough enough to look after themselves -- the most common re-rolled short term debt in the U.S. is the home equity line of credit.
Next time you are fishing through records at tax time, have a look at the maturity date on your line. Also, have a look at the promissory note to see how often the bank gets to review your financials, and check to see if there is any assurance of automatic renewal (usually annually, and not hardly).
Long term amortized mortgages, whether firsts or seconds or thirds, even if adjustable rate, can't be called. You can get in trouble, but if you make the payments, the lender can't roll you.
There is of course the nouveau exception in mortgages: the wondrous "5/25" or "7/23" balloon loans, in which lender and borrower assume that natural law prevents interest rates from rising five percent at an inconvenient future moment. But that's another story. Not even South Korea has that kind of deal.
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