Rebecca Wilder…Financial Times/alphaville
Financial Times/alphaville’s Cardiff Garcia uses Rebecca Wilder’s post Evaluating the “excess” in the US corporate financial balance.
What to make of the excess savings (aka boatloads of cash) that remain on US corporate balance sheets?
In trying to answer this question, economist Rebecca Wilder has used data from the Fed’s latest flow of funds report to update the following graph, originally taken from JP Morgan research:
For the whole article follow the link.
A lot (if not most) of the cash on “US” corporate financial balance sheets is held by offshore subsidiaries and cannot be returned for domestic investment without paying corporate taxes (35%?). Effectively, then, this cash is not available for domestic investment.
Also we are seeing the new normal of corp finance. 2008 revealed that the old mantra of run lean because you can always borrow to be untrue. So any reasable corp treasurer will want to have enough cash on hand to run several months without borrowing. (Recall commercial paper dried up in sept and oct 2008) No one seems to recognize that the events of that time proved that money may well not be available to borrow if a run on the bank is happening when you try to borrow. (We had a run on Money Market Funds, which dried up the commercial paper market in the process)
Also, companies that are not lucky enough to be able to access commercial paper markets have revolving credit lines with banks. These agreement oftentimes contain loan covenants tied to a trigger level on the company stock price. If there is a market crash and the stock gets nailed bad enough, the revolving loan deactivates and destroys money!
This is somewhat reminiscent of the response of Asian nations to the Asian financial crisis. If lenders cut you off when you, or they, or somebody down the road, runs into trouble, well that’s an awful lot of circumstances that could lead to your financial distruction, so best not to ever depend on lenders. (The IMF made things worse. In most ways, the Fed did not. Progress.) The result, though, is imbalance. Asian nations under-consume in order to build up reserves. Turns out, that’s the only way that reserves can be built up, and US firms are under-consuming capital equipment and labor in order to build reserves. There were suggestions in the depths of the financial crisis that the government should become a lender to non-financial firms on a large scale, but the answer was “no, that’s socialism.” If the government had shown that credit would be available when lenders fail to lend, we might see smaller cash piles now.
This is somewhat reminiscent of the response of Asian nations to the Asian financial crisis. If lenders cut you off when you, or they, or somebody down the road, runs into trouble, well that’s an awful lot of circumstances that could lead to your financial distruction, so best not to ever depend on lenders. (The IMF made things worse. In most ways, the Fed did not. Progress.) The result, though, is imbalance. Asian nations under-consume in order to build up reserves. Turns out, that’s the only way that reserves can be built up, and US firms are under-consuming capital equipment and labor in order to build reserves. There were suggestions in the depths of the financial crisis that the government should become a lender to non-financial firms on a large scale, but the answer was “no, that’s socialism.” If the government had shown that credit would be available when lenders fail to lend, we might see smaller cash piles now.
– Edit – Moderate
One further thought, a tiny one, I suspect. There is a very large batch of corporate debt across the quality spectrum set to mature over the next 3 years. The rush to issue corporate debt we are seeing right now is in part a rush to refinance debt that will mature fairly soon, while the refinancing is good.
It may be that some of the cash being hoarded now is a precaution against being unable to roll over corporate debt at terms as favorable as CFOs hope. If we run into a sudden widening in spreads before the pile of maturing debt can be refinanced, then corporations can simply pay off maturing debt and wait for better times in which to issue more.
If that is a partial explanation of what is going on, then the cash mountain will be eroded over time. Financial issues only account for one side of things, though. Firms won’t invest if they don’t see good opportunities, and slow growth means limited opportunity.
Couldn’t a significant part of the problem be that balance sheets are overstated? Valuing “assets” at 100% of cost when in reality the true value is much lower in an open market transaction seems to be a factor. How large, is anyone’s best guess.
nanuet
That depends whether it is a financial or non-financial company. Financials have to have “assets” to be allowed to function as a business. A contraction in asset valuation will greatly contract the amount of biz they can do.
With non-financials, fixed assets are just there. That’s what they use to get sales revenues, and within limits, sales revenue can go up and down irregardless of how assets are valued on the balance sheet. (i.e. , think casino)
Cedric Regula
I gues I should have been clearer. I was referring to financials particularly. It may well be true that demand is not there for lending; I’m somewhat sceptical. Repairing the balance sheets and getting reserves up at discount rates seems to be at play here. There’s no downside in borrowing short term and buying Treausries. Though rates are contracting which might force the financials to start lending and assuming some real risk.
nanute
ok. Yes, banks are in the biz of doing the “carry trade” right now. And the gov has relaxed mark to market rules so the banks can pretend to be solvent and do the carry trade and make some money from low risk maturity mismatch. Next the Fed is considering doing a large doses of QE2 to flatline the yield curve. We’ll have to see what that does. Then if interest rates ever do go up for any reason, bank balance sheets implode because they are holding all this low interest paper, and we get GD 2.1. Wash, rinse and repeat. We may have the next Microsoft on our hands!
I love it when a plan comes together.
The mountains of cash, though, are “cash”. There is certainly room for repo to be based on some nasty underlying thing, but in general terms, cash is highly liquid, short-term, no-problem stuff. An MBS isn’t cash. CMBS? ABS? Not cash. So while some of that “cash” we keep hearing about may be created out of optimism, much of it is in a CD someplace.
You sure? If the cash is pre-2008, then I’m fine with that. The point to the cash mountain is that it’s a new mountain. The logic (whether correct or not) is that it’s being held against some potential future “splat”. I can’t think of why cash would naturally only accumulate overseas or why holding cash overseas represents a better approach to hedging against a bad future event that holding cash in the US.
Cedric (can I leave off Regula)?
The Fed is considering a large dose of QE 2 to flatline the yield curve? They’re going to call it the Titanic! Will it flatten the yield curve? Well I guess that depends on what it(the Fed) pays for the assets relative to mark to market. If the Fed pays full value for assets that are worth 20-40 cents on the dollar, might this have the effect of putting upward pressure on rates when the Fed needs to issue new securities? I’m not saying I’m opposed to the QE per se. If there are no demands by the government for paying above market for risky, possibly worthless assets, it may stabalize the financial sector to the detriment of the governments ability to borrow at anti-inflationary rates going forward. Maybe that’s the plan. Or, am I all wet here?
Except the cash doesn’t belong to the bank, and can be withdrawn(or shorter term CDs, repos come due), or rates have to increase to keep it there. They use most of it to by longer term treasuries, MBS or whatever fancied them in the securitized market place. They ladder it of course, to lessen maturity mismatch, but the 5 year treasury just sold at 1.25%, so it’s hard to make money that way.
So if the economy ever gets better, we are doomed. Their cost of money goes up, and asset values shrink. You would suppose they’ve done this in the history of banking already, but I keep thinking the problem may be worse this time.
nanuet
Sure. What you are describing was what they did for QE1. They basically traded cash for illiquid mortgage stuff, bought good MBS to force down mortgage rates, and bought treasuries because they were worried that the large fiscal deficit may crowd out private borrowing. All to the tune of 1.7 trillion, and that didn’t include TARP which was the Treasury contribution. Then the FDIC mopped up what didn’t survive.
For QE2 they are talking just buying treasuries, maybe a trillion over a course of a year as they deem necessary. They estimate that may shave 10-20 basis points off a 2.5% 10 year treasury. So I guess that’s not flatline, but then we are supposed to believe that that action is “fixing the economy”.
Then we should also cross our fingers and hope that Arabs, Chinese, Wall Street, commodity traders and currency traders don’t find fault with the strategy.
Cedric
(It’s not critical, but it’s nanute. nanuet is in NY, as am I, but no connection.) Thanks for the lesson. Are you telling me there isn’t any more illiquid, and toxic derivitaves on the books? And is the intent of “flattening” the yield cure to force the financial instituitons back in to the real economy? Doesn’t prolonging the inevitable just have a compound effect on paying the cost associated with the systemic problem? I’m certainly not advocating “let them fail.” The cost to the overall economy just seems very expensive in real terms. The creditors need to absorb some of the cost. You bought it, you own it.
nanute,
I get occasional bouts of dyslexia.
I don’t know for sure, but they probably still have a lot of impaired assets. CMBS being one that’s still coming.
I think the Fed’s intent, from their public comments, is to spur loan demand with lower rates, and also have everyone refi (biz too) that can and lower interest costs.
I think some at the Fed want to re-flate all assets, and stimulate the economy back to boom GDP and employment. But I want a porsche and the girlfriend wants a pony….
Many people think creditors (which is mostly holders of various kinds of bonds in a securitized world, and they mean worldwide too) need to take “haircuts” before the economic engine can run properly again.
Me too. (the dyslexia) I’m sorry for making it an issue. I got my haircut yesterday, bought my wife a pony, and I’m trying to do my part. Thank you so much for being kind enough to engage me on the subject.
Nanute