Debt equals no investing - for years to come
Way back, Warren Buffett earned renown as a backer to family businesses, whose cash flow funded his adventures on the stock market. The insurance sector later provided him with a similar opportunity. But, these days, his Berkshire Hathaway group likes to hunt big game in the banking sector.
Its latest deal involves Bank of America, which has been in great need of a powerful friend, amid talk it had not set aside enough capital against its portfolio of toxic mortgage loans.
To get Buffett on board, BofA allowed Berkshire Hathaway to subscribe for $5 billion of preferred stock on a handsome fixed yield of 6%. It was also given $5 billion of share warrants at a price of $7.14 apiece. At the end of the week, the bank’s shares closed at $7.78, providing Buffett with an instant profit of 9%.
As was the case with his family business deals, BofA deal provides Buffett with short-term cash flow he can put to work elsewhere, as well as a long-term investment opportunity.
It is worrying that one of the biggest banks in the US should have been forced to concede terms like these, not long after it was taking an upbeat approach to the possibility of paying higher dividends to its shareholders.
Worse, no one other than Buffett was prepared to step up to the plate, in contrast to 2008, when an array of sovereign wealth funds were queuing up to take part in a stream of bank rescue packages.
But this is not an era for corporate heroes. As Richard Koo, chief economist at the Nomura Research Institute, has pointed out, corporations and individuals are more concerned with minimising debt than maximising profits following a credit crisis. And debt workouts like these can take decades, as Japan has discovered in recent years and the US found out in its 1930s depression.
Rather than seeking to reinvest their revenue surpluses, during this process, companies cut back staffing and capital investment. This ends up undermining the economy, but survival is paramount.
They are not only anxious about whether people will buy their goods. They also fret that banks (like BofA) will fail to supply them with working capital because of their balance sheets are also creaking.
Governments have stepped in to support the financial system. But this has only led to worries about sovereign debts, future austerity and tougher regulation. This summer, for the first time since 2008, banks have been finding it hard to raise capital in the money markets to fund their shorter and longer term needs. It is unclear quite how they can afford to boost their capital ratios, to the extent required by regulators.
In the meantime, capital is building up on corporate balance sheets. Bank deposits by individuals have hit record levels, with house purchases out of favour. You can see anxiety in the soaring price of gold and the popularity of covered bonds, which force borrowers to offer greater security to lenders. You can sense concern in the reluctance of companies to make takeover bids and their decision to return cash to shareholders, in the absence of any other ideas.
Large sums are also piling up in US Treasury bills because investors are so reluctant to take a view on the private sector. It all amounts to reckless conservatism, which will throw up outstanding investment opportunities at some point. But not just yet.
