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The new financial world order.

No longer penned behind national boundaries, capital now moves with the speed of light. Nonetheless, with the U.S. banking industry in turmoil and the heavy demands placed on the capital markets by Eastern Europe and the CIS, is there sufficient funding available to finance economic expansion?

Capital. It is as elemental to business as gasoline is to a car. Among CEOs the subject ultimately arises: Is there enough capital to finance economic expansion? And if so, what will it cost? Attempting to answer such questions, participants at our most recent roundtable convened to fashion a vision of the new financial world order and to determine the factors that speed or slow the worldwide movement of funds.

Until recently, steel and concrete factories were the physical evidence of investment and wealth. But in the new order, capital is more mobile. "Borders that were once the cause of wars are now becoming more porous," former Citibank CEO Walter Wriston recently observed. "Money moves over, around, and through them with the speed of light. The flows of capital are now in the range of 30-50 times greater than world trade." Wriston might have added that massive capital pools seem almost tidally attracted to the points of highest return. Conversely, capital moves away from regulation and restriction as surely as like magnetic poles repel one another. Such "first principles" of the new order pull capital into the global system and forge immutable bonds between individual economies.

In the U.S., observers are encouraged by the reliquification of business and consumers following a decade-long orgy of credit and debt. Visa International's Chuck Russell says the trend is paving the way for another surge of consumer spending sometime in 1993.

But domestic capital markets have been badly shaken by turmoil in the banking industry and the tightening of federal regulations in the wake of the savings and loan debacle and the failure of such giant institutions as Bank of New England. Some observers maintain bankers have been running under a yellow light, precipitating a "credit crunch," a chronic condition in which the demand for many types of loans has outstripped supply.

Is there a dearth of credit? Some in Washington think so. In May, Treasury Deputy Secretary John Robson chided bankers for investing in government securities instead of making consumer and business loans. Consumers think so, too. Four of 10 people responding to a survey by American Banker, a daily trade newspaper, said credit has been harder to come by this year than last.

Nonetheless, only 17 percent of the 1,002 people surveyed by AB said they had actually been denied credit over the past two years. In the business arena, a study by consulting firm Arthur Andersen indicated that of roughly 300 smaller companies that recently applied for loans, 75 percent got them--about in line with industry norms. But the study also revealed that companies are being forced to meet much tougher underwriting standards, and that many were discouraged from even applying for loans. One possible interpretation: In the lending arena, there's more of a problem with demand that with supply.

"With the exception of the commercial and residential real estate market, I haven't witnessed a credit crunch at all," says Denis Brown, chairman and chief executive of Concurrent Computer and a roundtable participant. "In fact, I think we had a credit glut."

Meanwhile, even the perception of a pinch may damage ultrafragile business and consumer confidence, already battered by a flagging domestic recovery. Others note that any shortage of loans would be far more devastating to small and mid-sized corporations. Most of these--unlike larger firms--can't directly tap the equities market and depend more on banks for funds.

On the international side, meanwhile, several factors are rocking capital markets:

* Following a free-fall, the Tokyo stock market remains mired in the doldrums. Though Visa's Chuck Russell argues the decline isn't likely to significantly affect Japanese consumers or the middle market, partly because of Tokyo's commitment to full employment, there may be a chilling effect on Japan's direct foreign investment--for the U.S. and others, a crucial source of capital. How important is DFI? Consider the familiar U.S. companies now controlled or owned outright by foreigners: CBS Records (Japanese), Hardee's (Canadian), Brooks Brothers (British), Doubleday (German), and Carnation (Swiss). Notes Marie-France Houde, an official in OECD's International Investment and Services Division: "Transborder mergers and acquisitions have become the preferred method of investment."

* West Germany continues to pump a massive amount of deutsche marks into eastern Germany in the wake of unification. Net transfer payments this year are projected to reach DM180 billion ($127.8 billion). The effects of these transfer payments have rippled through the world economy. To battle inflation, the Bundesbank has kept German interest rates high. That, in turn, has hamstrung nascent recoveries elsewhere in Europe. Another problem: The high German rates are spurring investors to buy marks to invest in German bonds. Partly as a result, the dollar has slid precipitously. A weak dollar drives foreigners from markets where the U.S. Treasury sells its bonds and notes. And any further plunge in the dollar could prompt the Fed to drive up interest rates--further smothering an already tentative recovery.

* In addition to eastern Germany, other rebuilding and newly capitalist economies--particularly those elsewhere in Eastern Europe and in the CIS--are crowding out competitors in the fight for scarce capital resources. Spain, for example, has found it difficult to finance continued growth. "If Spain can't get money, how can Kenya, or Central and South America?" asks roundtable attendee Bill Rutherford, president of SGTRInternational, an investment management subsidiary of Societe Generale.

Whatever the obstacles, resourceful investment bankers will likely keep the capital faucet open with a variety of new products. Consider the "global equity offering," touted by some as the M&A of the 1990s. Under the approach, a lead firm mobilizes linked underwriting syndicates around the world. In May, General Motors raised a whopping $2.1 billion by selling 40 million shares in the U.S., 6 million in Britain, 4.5 million in Europe, and 4.5 million in the Far East. In this year's first half, international offerings totaled $14.9 billion, according to IFR Securities Data in London.

Technology, too, will continue to reshape the new financial order. Consider that some markets now trade 24 hours a day with online computer systems. Electronic Data Interchange transmits transaction documentation directly from corporation to corporation.

In the new order, the ante is creeping higher even as the globe shrinks. "We can send a message from San Francisco to Frankfurt cheaper and faster than you can send a message from Stuttgart to Frankfurt," observes Chuck Russell. "That presents us with some pretty incredible opportunities."


Charles T. Russell (Visa International): I'd like to look at consumers' reactions to the financial constraints of the 1990s and how those reactions will affect the credit card payment system and business in general.

I'm very bullish on the U.S. consumer. We're coming out of a recession now. The U.S. retail consumer is liquidating today. He is a much better money manager than most of those who are managing the government.

There is a lot of pent-up demand in all consumer sectors, including housing and automobiles, that will trickle down into day-to-day Visa purchases.

However, there are many long faces in the credit card business today, because the outstanding balances are plummeting, which means we will probably have to wait six to 12 months before the next consumer purchasing upswing.

I think consumers are well-educated. Everyone has heard the latest bankruptcy horror stories, but we must put them into perspective. Even before the liquidation started, when consumer debt was at what one might consider an all-time high as a percentage of disposable income, that level was no higher than it had been on several other occasions. But that's changed with liquidation.

Although consumer bankruptcy levels are at an all-time high, we know from extensive research and analysis that two-thirds of them are fraudulent or have been induced by aggressive lawyers. In some cases, lawyers are capitalizing on opportunity, demanding the client's last $500 in liquid assets to file the bankruptcy papers.

We at Visa studied this phenomenon--which is also manifesting itself in Japan--and we discovered the situation today is no worse than it ever was.

Of course, a few clouds do loom on the horizon. We need to bring our balance of payments under control. And the federal government has to be more fiscally responsible. I'm not a proponent of the balanced budget amendment, but the debt can't rage out of control indefinitely.

On the international scene, the situation is brighter. That's because there are many underdeveloped markets abroad, especially in Europe. We posted a 42 percent growth rate there last year.

With respect to Asia--outside of Japan--the situation is also encouraging. Singapore, Korea, and Taiwan are booming. The ability to raise capital in Hong Kong is incredible, despite the fact that China gains suzerainty over the colony in 1997.

Elsewhere in the Pacific Rim, we still have high hopes for the Japanese market, even considering the problems with the Nikkei. The stock market crash hasn't hit the consumer middle market yet, and it may never do so. Japan has a 100 percent employment policy. If that survives, the consumer retail market will thrive.

With respect to Mexico, I'm also bullish, largely because of the free-market policies of President Salinas de Gortari.


Denis R. Brown (Concurrent Computer): From an interest rate perspective, some say consumer spending is down because the credit card interest rate has held fairly high relative to the nominal interest rate. How do card rates affect consumer spending, and can anything be done to pump up consumer demand?

Russell: For people who are genuinely creditworthy, plenty of money is available at reasonable rates: between 6 percent and 14 percent. Banks shovel second mortgages out the door because they see them as a safe haven for funds they can't risk investing elsewhere.

We've never been able to figure a correlation between card usage and spending. Nonetheless, the credit card industry is becoming more aggressive with respect to rates. Because the cost of funds has decreased for banks, they're beginning to pass on some of the savings to their better borrowers. In addition, lower rates may help to bring customers on board.

J.P. Donlon (CE): Most consumers spend more than they save. Has that changed in recent years?

Russell: The U.S. consumer is the worst saver in the world, but he is richly rewarded by Congress for acting that way. He gets low interest rates and high tax rates on his savings, while he's given a tax break on his spending, some from the debt he incurs.

John A. Ueberroth (HAL): Especially in California, given the soft real estate market and strict regulations, many banks are very tentative about lending. Did we have a credit crunch?

Russell: There's certainly no liquidity problem among banks.

Brown: With the exception of the commercial and residential real estate market, I haven't witnessed a credit crunch at all. In fact, I think we had a credit glut.

I think the banks were being exceedingly cautious because the regulators were beating them over the head with a club. As soon as the beating stopped, lending began to open up.


William D. Rutherford (SGTR International): Switching to the international arena, let's look at the foreign reserves of some major countries. The current account balance is like a profit and loss statement of a country. If a country takes in more than it pays out, it shows an increase in its current account balance.

In 1983, the U.S. went from a current account deficit of $40 billion to high in 1987 of $160 billion. Last year, due to Desert Storm, we brought in a lot of money and reduced our current account balance. But in 1992, the deficit zoomed back up to $92 billion.

Oddly enough, even though Japan seems to be having broader economic problems, in terms of its current account balance, the country appears to be doing rather well. On the other hand, Germany has gone from a substantial lender ($46 billion in 1987) to a net borrower as a result of German unification and the changes in Eastern Europe. In the short- to medium-term, I think the U.S. will probably need to borrow money as well.

With all its problems at home, Japan will likely begin to cut down direct investments in the U.S. But its indirect investments--including purchases of Treasuries and investments in banking--will continue to be strong.

I think Europe will continue to invest in the U.S. because it is an attractive market. Tax rates are good, the dollar is low, the U.S. worker is productive, and corporate America has good work rules.

It follows, then, that European banks will become more aggressive players in the U.S. The 1980s was the decade of the Japanese banks, the 1990s will be the decade of the European banks, because they have money and capital ratios. That will further squeeze the U.S. banking sector.

Longer term, I see the U.S. moving into a current account surplus, with Germany and Japan heading toward a deficit. Because of the aging populations in Germany and Japan, their savings rates may tend to decline. Investment in local plants and equipment will decrease, because there will be fewer workers.

What does this mean for interest rates? Right now, we see a large demand for capital from Russia, Eastern Europe, eastern Germany, and lesser developed countries around the world. That puts pressure on capital markets. But interest rates are already high around the world. In the U.S. today, short-term Treasuries are over 3 percent, but longer-term issues are over 7 percent, about a 400 basis point difference.

It appears the market senses that rates are going to increase. Aside from supply and demand, another factor may be the expectation of inflation. The higher the debt of the country, the higher the possibility of inflation. In the U.S., we don't see much in our numbers today about inflation, but, nevertheless, there is a large debt burden hanging over us.

Ronald L. Kehrli (R & R Marketing): Do you see the bulk of Europe's investments in the U.S. coming in the form of debt, equity, or a combination of both?

Rutherford: On the indirect side, the purchase of Treasuries and corporate debt provide an opportunity for diversification. On the direct side--comprising investment in plants, equipment, and real estate--it's also a diversification opportunity, but with the added lure of an attractive, large, and open market.

Brown: You mention capital market needs of the ex-communist world. Who will fund this restructuring of civilization?

Rutherford: That is certainly a big problem. Undeveloped countries that need capital are going to find it difficult to obtain. When the Wall crumbled in Germany, one of the biggest losers was Spain. Spain suddenly found the money it used to receive being funneled into Eastern Europe. If Spain can't get the money, how can Kenya? Or the other African nations? Or Central and South America?


Robert J. Fien (Stone Construction): One issue we haven't discussed is the differences in relationships between banks and industry in the U.S. and abroad. When a manufacturer works with a bank in the U.S., they oftentimes seem to be at logger-heads--unable to cooperate to get a deal done. On the other hand, in Japan and Germany, banks are partners with industry. Members of the banking industry sit on many boards of directors.

If you borrow or are working with European or Japanese banks, do they have that same philosophy as it relates to investment in the U.S.?

Rutherford: From what I've seen, most don't want to take a position on boards in the U.S.

Brown: Concurrent Computer deals with five banks in Japan to fund our working capital needs in our Japanese subsidiary, and we've found that Japanese banks treat American or foreign investors on an adversarial basis--much the way American banks conduct business with industry.

However, as soon as a Japanese partner comes on board--in our case, Nippon Steel--the attitude changes.


Donlon: Larry, how do the trends we've been talking about affect the mergers and acquisitions market?

Lawrence W. Leighton (UI USA): Chuck spoke earlier about the reliquification of consumers. Well, we're seeing corporations reliquifying as well, raising large amounts of equity in the public market. In addition, corporations are managing more for cash flow--that's the magic word these days. That leaves them poised to grow internally and externally.

Let's take a look at some relevant numbers. In 1989, the total dollar value of mergers and acquisitions--just talking about U.S.--was a little more than $230 billion. In that year, the total dollar value of U.S. public equity offerings was $36 billion. In 1991, that M&A number was down very significantly to $90 billion, while U.S. public equity offerings increased significantly to $83 billion. Clearly, we had a dramatic crossing of lines and significant reliquification.

I also think most of us equate M&A activity with that in the 1980s. But the '80s were an aberration: We likely won't see many more deals of the magnitude of when J.P. Morgan put U.S. Steel together.

Ultimately, the reasons motivating activity in M&A are classic: Companies need to strengthen their competitive position, which they can do by increasing market share, adding volume and size to their product lines, and beefing up their global position. The question becomes: Will it cost me more to acquire another company that puts me into a particular business, or to build a company from scratch?

As companies become more discrete and focus on their particular strengths, we'll see more divestitures and acquisitions. In fact, divestiture feeds another form of acquisition: You have to sell a business unit or asset to someone for whom that company makes more sense.

The difference between the 1980s and the 1990s is focus. In the last decade, many acquisitions were completed for ego reasons, for size. Today, companies look at their business and ask: "What business do we want to be in?" They say: "We'll acquire to feed the strengths of our business and shed business lines that do not fit."

Donlon: Do you think the '90s will be the age of equity over debt?

Leighton: I think we'll see both. It will depend on the particular deal.


Arnold Pollard (CE): A few years ago, one of our roundtable participants predicted the amount of cross-border M&A activity would increase. Was he right?

Leighton: Yes. Of course, it all depends on which border you look at. Up until six months ago, major European companies were interested in coming to the U.S. Now they are increasingly focused on Europe--especially Eastern Europe. It's only natural. A German company thinks: "Should we buy another company in the U.S., or should we look next door at Hungary, Czechoslovakia, and Poland?" Answer: "Let's get on the train and go to Warsaw."

Russell Banks (Grow Group): Perhaps, but Europe is said to be very interested in mid-sized U.S. corporations, primarily for two reasons: the favorable rate of exchange and good U.S. management.

Leighton: That's true about medium-sized companies. But the large corporations say they have to focus within Europe.

Donlon: Are acquisitions in Europe becoming increasingly more aggressive?

Leighton: I do some work for a French company, which went into Ireland and engineered one of the most aggressive takeovers the Irish had ever seen--using Irish lawyers and Irish investment bankers. Indeed, companies are coming to the U.S. and learning some very aggressive takeover techniques.


Pollard: What sorts of changes do you expect in the finance industry over the next decade or so?

Russell: We will see a substantial reduction in the use of cash. Advances in technology today make it easy for consumers to complete transactions electronically through the use of a card.

I'd also count heavily on the elimination of currency differences through technology. We have a universal currency today: It's initiated on a card and delivered in bytes through a piece of copper wire or glass. How you denominate it is irrelevant.

In line with the reduction in he use of cash, at least in the middle market, I think you'll see a greater "disintermediation," because the same systems that can move money around can also move information. Companies today that can't directly tap the capital markets will conceivably be able to make their own markets and become less dependent on banks. Banks will be used primarily for borrowing purposes.

Rutherford: I think we'll see more international borrowing through securities markets. Banks will become more global. There will be more international underwritings.

Commerce is a global game now, borders and trade barriers increasingly are tumbling down. In the years to come, finance will continue to move in the same direction.
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Copyright 1992, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Title Annotation:CE Roundtable
Publication:Chief Executive (U.S.)
Article Type:Panel Discussion
Date:Oct 1, 1992
Previous Article:A CEO rethinks the role of board director.
Next Article:Tracking pay for performance.

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