Back to basics.
There is a growing realization that this recession is different from all the others since the end of the war in 1945. All the other recessions, no matter what their duration, were due to dislocations, mainly in supply-demand cycles. The current recession, whether it's a single- or double-dip phenomenon, is more of a complete about-face. It's back to basics, and a collapse of the structure so carefully built over the years.
The 1990s are, and will be, a whole new environment for liquidity. Cash will be king in this decade. Rate will no longer guarantee a supply of cash. Witness the problems of Westinghouse Credit and Citibank as they struggle to maintain liquidity despite their assets.
What does this mean for financial executives? Is the economy heading for a double-dip recession? Will there be an improvement soon? Or will things get worse? What advice is best?
There are many schools of thought and many opinions, but no certainty. Hence, the objective is to chart a course of action that meets today's needs without depending on any specific economic scenario in the next six to 12 months.
What, then, are the guidelines for the financial executive to meet this uncertain future?
As with most situations, the future is written in the past. A short look at financial history since the 1940s will put focus on the current situation.
THE FUTURE IN THE PAST
Just after the war, a major expansion began as family building blossomed. Growth occurred in all sectors-homes, cars, consumer goods, transportation, electronics, and even taxation revenue. The recessions of the 1950s and 1960s were essentially inventory adjustments in the absence of rigorous business-cycle control mechanisms. By the early 1960s, finance took on new dimensions with the invention of the CD. Treasurers began to move towards control over corporate cash, moving in the direction of less dependence on banks as a source of cash and more towards self-generated debt and self-placed Investment.
In the 1970s, the advent of instantaneous funds transfer anywhere, in any currency, provided the path for greater corporate control of cash, investment, and debt. By the dawn of the 1980s, the stage was set.
Corporations began placing their own instruments on the market and borrowed less from banks; banks chased high-yield loans and increased the range of services offered to increase profit; junk-bond financing provided an easy path to cash; restructuring was a greater source of wealth than business growth; and the voodoo economic gospel of supply-side debt gave no heed to the cost of debt. The results were predictable: the collapse of major banks; the S&L debacle; gigantic trade imbalances with Japan and Germany; excessive national deficits; and the current liquidity crunch. As the baby boomers came of age, the boom-and the boom mentality-faded.
In the 1980s, in the triple attempt to increase debt, lower its cost, and give corporate control over cash, commercial paper volume rose dramatically. The lower cost of borrowing made possible by commercial paper led to an increase in volume of more than 1,700 percent over the last 20 years alone. The outstanding paper has risen from $33 billion in 1970 to $567 billion at the end of 1990, a compounded growth rate of greater than 15 percent a year! And the use of commercial paper programs shifted as they began to be used to replace long-term debt.
Many corporations swung to commercial paper portfolios for a major part of their total debt. But shorter terms also meant increased turnover, which in turn increased liquidity risk. More companies than ever before also issued commercial paper to finance short-term needs. So, not only did the volume of commercial paper rise dramatically in recent years as more organizations entered the market, but maturities shortened and an medium-term issues rapidly replaced long-term issues. In fact, medium-term debt is often quoted as far out as 30 years ! With the help of electronic transfer systems, interactive real-time computer systems, and automated treasury systems, corporations increasingly became their own banks, seeking to maximize return on investment while minimizing cost of debt. Keeping idle balances at zero, or close to it, became the objective. Perfect in theory; superb in boom times; risky in any liquidity crisis.
The last four decades may now be looked on as times of easy money, even if the cost was often high, as it was in the early 1980s. Now the cost is low, but cash will not necessarily come. Greater attention must be paid to exactly how much cash is needed, when, and who is a likely source. Investors must be courted and preserved. Without them, all the effort at self-funding will come to nought. Not only will the cost of debt spiral, but the amount of debt will assuredly be curtailed. This will lead to an unbelievable crunch, which, in turn, will cause a reduced credit rating, which will then trigger a greater crunch. This cycle will intensify the crunch. That's what's happening now.
TOO FRAGILE FOR ADVENTURES
Europe's and japan's economies are not as vulnerable as the U.S. economy. In both countries, short-term obligations did not become a dominant means of raising cash. Companies used bank lines of credit, albeit with more flexibility than in the U.S. in terms of syndication, drawdowns, and standby lines, to meet their cash needs, rather than short-term commercial loans. Hence, the japanese and European banks maintained their position of long-range growth through loan income, while American banks stressed immediate growth through high-yield loans and service-fee arrangements.
In the U.S. today, banks need better loans, and business needs more cash. So it is back to basics. Bank rates are now low, and terms can certainly be longer than a few days. Stability is not only called for, but possible. We have gone full circle from banks as sources of cash, to corporations becoming banks, to banks once again fulfilling their traditional role.
The pace of movement in the back-to-basics cycle will accelerate. Government policy will certainly intensify towards strengthening the base of the banking system, and government policy will most certainly move to alleviate the credit crunch for corporations. I can predict that investment and job creation tax benefits will most likely be tried. As the new expansion occurs, cash will be needed. It is vital that the growth be slow, steady, and stable. If we return to the financial high jinks of the 1980s, we could destroy the whole regeneration process, and even trigger a third dip into the recessionary cycle. Our banking and credit systems are too fragile for financial adventurism.
For the savvy financial executive, the nostrum is a simple set of rules. While the ABCs may be obvious to everyone, their execution is not simple. Indeed, going back to these basics may be more than many financial executives will support. The rules are these:
* Don't borrow more than the organization can handle. Debt, after all, must be repaid, and excessive debt burdens can destroy.
* Safe growth and profit come from building a sound business and not from restructuring.
* The American economy was the strongest in the world, and the United States was the largest creditor in the world until the 1980s. Restructuring, excessive debt, and the quest for quick riches have led to a weak economy and have made the United States the largest debtor in the world. Going back to basics will resurrect growth in the United States and reverse the cycles of the 1980s.
SLOW, STEADY, AND STABLE
Debt will always be with us. Borrowing is not the problem. It is how much and on what basis, and especially term. And, of course, the ability to repay is vital.
Strategic debt management and liquidity risk management depend both on a real-time system measuring business needs and operations as they occur and on an immediate weighing of total cash requirements of an organization. Such cash requirements must include short-, medium- and long-term debt, investment, and cash. This is true for both borrowers and investors. Today's computer-based, real-time systems are control devices that provide more certainty than ever available in the past. Traditional accounting processes on a periodic basis are snapshots of positions at a specific date, always in arrears, and are not really suitable in today's environment. Debt is a function of the treasury in order to meet cash needs of the present, not the past. Realtime control is essential! The closer the measurement and the reaction to the event, the smaller the variation beyond the norm and the smaller the risk of a liquidity crunch, excess debt costs, or missed investment opportunities.
Some organizations have achieved full integration of their financial systems, thereby providing cash position on a real-time basis that is used to establish targets for the amount of debt or investment needed and the timing of such borrowing or investment. Although such integration is not yet commonplace, it is a process that will accelerate for at least the remainder of this decade.
The objective is to have all the cash in use at all times. Any surplus cash must be invested for the maximum period of time at the greatest return; shortfalls must be covered by borrowings for the shortest periods of time at the lowest rates.
The modem approach to cash management requires close attention to correlating the cash needs of the organization with the cash available in the marketplace. To be more specific, good relations with investors, or debt customers, must be a high priority. Without buyers of debt, there are no borrowings, credit is stagnant, and progress halts. This is Financial Management 101; it is basic. But the concept was largely forgotten or ignored in the 1980s. Today's recession is the fruit.
So, liquidity is more vital today than ever. What is the safest course of action now? Pay attention to business, and borrow the least amount necessary and for the longest term possible. Invest carefully. Watch the cash flow. In other words, slow, steady, and stable. Not very exciting, but certainly profitable. That's the way America was built. Adventure comes in new business, new dreams, and new invention. Disaster comes from reckless and irresponsible fiscal action. A steady hand leads to profit. The alternative can be a fiscal collapse!
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|Title Annotation:||Financing; banking industry|
|Author:||Martino, Rocco L.|
|Date:||Jan 1, 1992|
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