Just-in-time strategies for managing inventories, the importance of which were highlighted by Henry Ford in the 1920s, remain vital for many businesses. The less time materials have to be stored, the less money is tied up in such storage costs and the higher profits can be.
One area where such a mindset has singularly failed, however, is as an approach for managing finances. Indeed, for much of this decade, there was an assumption, at banks as well as industrial companies, that short-term funds would always be plentiful.
Early on in the decade there had been a warning about overreliance on commercial paper markets, where money is borrowed for up to a year, after the collapse of Enron and WorldCom shattered confidence and left companies struggling to raise funds. Those lessons were not widely absorbed, however, and short-term funding became widespread among companies, as well as banks.
The risks of short-term funding have really hit home in the past year. After the collapse of Lehman Brothers in September 2008, the biggest bankruptcy in US corporate history, the short-term debt it had sold to investors proved to be worthless. Much of this was owned by money market funds, and confidence in this sector plunged after these “safe” investments were suddenly loss-making. Banks could no longer roll over maturing debt, and neither could the likes of General Electric. The US government had to step in.
Banks have been able to weather the storm through selling an avalanche of debt with government guarantees. Companies where chief executive officers used to delegate debt management to chief financial officers or corporate treasurers have made balance sheet management a boardroom priority. In the same way that CEOs know where their share price trades, most CEOs these days also know the details of the company’s debt repayment schedule.
The result has been a dramatic shift in corporate financing habits, illustrated by the sharp increase in long-term bond issuance.
Indeed, one of the trends for investment grade companies, those that are seen as less risky as they do not have large amounts of debt relative to equity, has been the replacement of bank credit lines, which often serve as back-up to short-term bond finance. For the first time this year in both Europe and the US, the amount of money raised in the bond markets has exceeded that in the bank loan market. Thomson Reuters says almost $900bn was borrowed in the euro and dollar markets by investment grade companies this year, compared with $474bn in loan.
As well as the concerns about relying on short-term debt, the shift reflects the decline in banks’ lending appetite. As the bank capital depleted by hundreds of billions of dollars of losses on subprime mortgage exposure and other losses from the credit bubble is rebuilt, lending continues to be difficult. One of the big clashes between governments and banks has been around this very issue. Even as banks are rebuilding profits due to government help, they are still hoarding funds. This pressure is not expected to ease next year, further emphasizing the need for companies to find other sources of funds. Bond investors, from pension funds to individual buyers, have been keen to buy “safe” corporate bonds, although the appeal may start to fade when interest rates rise.
There are two reasons why banks will remain reluctant to lend next year.
First, they have to refinance a huge amount of debt, estimated by Moody’s Investors Service at $10000bn between now and 2015. Second, there are potential further losses on the many assets accumulated. The Institute of International Finance says that the assets owned by the five largest US banks have grown to $8300bn this year, up from $2600bn in 1999. These now represent 60% of US gross domestic product. In the UK, the biggest five banks own assets worth four times as much as GDP, and in the euro zone the big five banks’ assets represent 88% of GDP.
In 2010, governments and banks need to borrow huge amounts. Companies, too, need to tap bond investors as bank lending shrinks further. “Just-in-time” strategies leave companies vulnerable to supply shocks: when the supply chain is disrupted for any reason, such as a hurricane, the entire operation can grind to a halt. In the bond markets in the coming years, there are likely to be plenty of supply shocks too, and rising tensions as banks, governments and companies search and compete for funding from a finite pool of bond investors.