Sean King

My photo
Knoxville, Tennessee, United States

Sunday, January 16, 2011

I recently had a short but interesting debate...

...with a colleague who insisted that corporations would soon begin to put their trillion dollar money cushion to work. He was confident that greed would keep them from simply sitting on their wallets.

I doubted his assertion. Here's one big reason why.

And, it wasn't just Citigroup that was within a day or two of running out of money. Bear Sterns and Lehman actually did hit the bottom of the cash barrel, and they are no longer with us today. It wasn't that these companies were bankrupt in the sense of their liabilities exceeding their assets, it's just that they had no cash with which to pay their employees, their creditors or their operating expenses. AIG was saved from a similar fate only by government intervention, but that intervention came at a massive cost--shareholders were forced to turn over 80% of the company's common stock to the government, a price that its former chairman has decried as usurious for what amounted to a temporary loan. Goldman Sachs, Morgan Stanley and others are only here today because of government intervention, though they managed to gain it at a lower, but still steep, cost.

And, it wasn't only financial institutions that were on the brink. Few realize that corporations historically kept insufficient cash on hand to pay their bills as they come due, preferring instead to invest excess liquidity in longer-term, more illiquid and presumably higher yielding investments, and tapping the commercial paper market ("money market") as needed to fund temporary cash shortfalls. However, in the panic of 2008, the commercial paper market unexpectedly seized up almost overnight! Even companies with excellent credit ratings and great balance sheets struggled to borrow money to meet their short term cash needs. And, almost nobody saw this coming collapse of the money markets coming. Consequently, dozens of major corporations, some of which were well-run, quality companies, were only weeks if not just a few days from bankruptcy. Just how close many came is well-documented though not widely understood and believed by the general public.

But one group who acutely understands just how scary things were is the CEO's and CFO's of the affected companies. Many came within hours of losing not only their jobs, but their entire net worth (which is often tied up on the stock of the companies they manage). Since then, many have vowed never to become overly dependent upon the commercial paper market again. Thus, companies have built cash stockpiles to insure that they have access to cash at all times.

This, and not concerns about future growth, is why companies sit on so much cash today, and it's why I'm confident they will continue to do so into the foreseeable future. I just don't think a recovering economy (even if it happens) is going to be enough to sucker these guys into spending down their cash anytime soon. After all, in late 2007 and early 2008, the outlook for the economy was widely viewed as excellent, and yet is still seized up.

No comments: