One of the arguments that the optimists have been making is that corporate balance sheets are strong and businesses are therefore in good enough shape to weather a downturn.
Unfortunately, their reasoning involves a number of assumptions which may not hold water.
For one thing, the "it's all good" types continue to believe that we are headed for, at worst, a brief, garden-variety recession, whereas it seems more likely, based on the many indicators I've noted here at Financial Armageddon, that the downturn will be a painful and long-drawn-out affair.
They also seem to be discounting the dramatic impact that credit market turbulence is having on the entire economy, including the business sector. In "Corporate Liquidity Begins to Dry Up," Financial Week gives us the lowdown.
The credit crunch is taking a toll on corporate liquidity, as the soaring cost of debt—for both commercial paper and private placements—pinches the balance sheets of all but the most highly rated non-financial companies.
Cash and short-term investments of non-financial companies dropped by $250 billion in the second half of 2007, the first decline in the nine years that consultancy Treasury Strategies has been tracking the data.
Corporate liquidity had risen steadily, from $3.9 trillion in 1999 to $5.5 trillion in June 2007. But at the end of last year, it had fallen to $5.25 trillion, a 5% drop.
The findings are part of a survey of 135 corporate treasurers conducted by Treasury Strategies between July 1, 2007, and Jan. 1, 2008. Treasury Strategies then adjusted that data with findings from its annual survey of 600 corporate treasurers.
Anthony J. Carfang, a co-founder of Treasury Strategies, attributes much of the drop to a decline in commercial paper issuance. Many companies issue commercial paper not just to finance operations but to bolster the cash on their balance sheet. “As companies have tightened up, they’re shrinking balance sheets just a little bit by borrowing less,” Mr. Carfang said. “A lot of companies had been directly issuing commercial paper because it was easy to do, and keeping a little cash cushion as a result.”
But when the credit crunch began, it became expensive for all but the most highly rated companies to issue paper. As a result, he said, cash balances dropped.
For non-financial issuers of 30-day A2/P2 commercial paper, spreads jumped as high as 150 basis points in the second half of 2007, according to Federal Reserve data. Prior to that, spreads had hovered around 15 basis points for much of the last five years.
Commercial paper has become so expensive for some firms that they can’t issue it at all.
