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19 August 2011 @ 08:34 pm
Companies "hoarding cash": credit arbitrage.  
Occasionally I see comments about some company hoarding cash, often in a Keynesian context of how much better the economy would be if these companies would just spend everything they could.

But I don't think that's the relevant factor. It's probably more useful to think of it in terms of raising money in the credit markets. Companies don't have particularly smooth cash flows: Some quarters are better than others, and expenses can be quite uneven if they include big-ticket items like land purchases or acquiring other companies.

Many companies can borrow easily, particularly banks and bank-like entities with liquid collateral. But places at the other end of the spectrum (tech companies, for example) can't borrow as easily: the interest rates are higher, and it's harder to borrow at all.

So they do the next best thing: They retain some of their earnings (instead of paying dividends or some such), and invest that in the short-term money markets. In doing so, they buy the finance flexibility of a higher credit rating. Instead of borrowing at the last minute, they sell liquid securities, or just don't roll over short-term loans. So, to a degree, differences in borrowing ability or willingness to move investments around get arbitraged away.

This isn't just limited to companies: China's amassing of huge foreign-currency reserves could just be a workaround for the fact that foreign lenders aren't eager to loan into a less-transparent economy with a local currency.
(Anonymous) on August 23rd, 2011 01:31 am (UTC)
I'm not sure what you mean by the difference getting 'arbitraged away'; the company which has to pay a higher interest rate and/or live with shorter terms (and the attendant unpredictability), would probably perceive either one or a mixture as a 'cost' in the sense of representing an unpleasant hurdle they face due to their perceived-as-distressed capital situation; the difference between it and a tighter-spread borrower hasn't gone 'away' when a company holds cash reserves, it is precisely still there and that is the reason for the cash...though maybe you just mean that e.g. what they do with that cash i.e. money markets, dividends, whatever are efforts to help defray that cost as much as possible by doing the most intelligent thing they can with it, which I presume has to be true.

I think a more salient point is one you touched on: the unpredictability of cash flows. This holds more generally: liabilities can be unpredictable; technology can be unpredictable; fashion can be unpredictable; patents can be unpredictable; the legal environment can be unpredictable; the political environment can be unpredictable, taxes can be unpredictable...

Generally, in an environment (such as now?) in which companies find it more challenging to project out their future balance sheets, it would be the least surprising thing in the world to me to see them 'hoarding cash' in a way that might appear, to outside observers, as some sort of unexplainable, exogenous, greedy trend. But I would say that people who don't want so many companies 'hoarding cash' might do well to advocate for the stability and predictability of, at least, the regulatory/legal/taxation landscape companies find themselves facing and minimizing its arbitrary and/or malleable nature. Unfortunately I don't think I often see the former doing the latter, but what do I know, I'm biased too.

-Chris Cameron
jon_leonardjon_leonard on August 23rd, 2011 04:50 am (UTC)
Arbitraged in the sense that companies with different intrinsic credit situations wind up with fairly similiar costs to raise the next dollar.

A place like Goldman Sachs can borrow that dollar cheaply, while a place like Apple reduces their cash-market lending, with a margial opportunity cost essentially equal to Goldman's marginal borrowing cost. (They may even be providing that marginal dollar.)

The total cost to get there is quite different: Apple has amassed a huge pile of money to get there, and that's money that they'd spend somewhere else if the market rated their credit higher.
(Anonymous) on August 25th, 2011 04:30 am (UTC)
Ah..ok, got it. But like you say, to *get* to the point where the next dollar raised has a similar cost, they had to pay a larger upfront cost...so....that next dollar wasn't so cheap..no? It's like saying a low-FICO borrower can pay a similar mortgage rate to a high-FICO borrower by making a larger down payment and/or shorter term...

If your story is right as an explanation for the added 'hoarding cash' I gather we've been seeing, it implies there are a lot of companies out there who find it far more difficult to raise money through the credit markets than before. I'm not sure that is the case (apart from companies who've been downgraded/distressed obviously).

My story is less connected to the cost of credit per se and more connected to uncertainty (economic and political). I don't know who's more right, but it does seem to me (at least from what I see) that credit has gotten broadly cheap in the past year or two, generic spreads probably nearly down to pre-crisis levels (well, until this month and the U.S. downgrade etc). Anyway..