In Today's U.S. Economy, Cash is King
As Credit Markets Have Ground To A Halt, Liquidity Is Paramount
Oct 5, 2008
After having consulted on the phone this week with Warren Buffett and hearing how job lay-offs and little access to credit was beginning to affect Mr. and Mrs John Q. Public, on Friday enough Republicans and Democrats in the U.S. House agreed to vote yes for the up to $700 billion bailout deal which had been overwhelmingly passed by lawmakers in the U.S. Senate and was hurriedly signed into law by President George W. Bush. But at this point, for most Americans the ultimate waiting game begins now. Will this bailout plan calling for the U.S. Treasury to buy up to $700 billion worth of toxic mortgage backed securities work and stabilize the U.S. economy, or is this just a temporary stop on a long downward spiraling road to recession?
Warren Buffett's Advice to Lawmakers
Buffett's consummate advice to lawmakers as he talked to a Fox News Business reporter, was said to be for Congress to pass the bailout deal as he warned that markets were in a "dangerous situation and on the verge of breaking down." Having recently made a significant investment with a substantial infusion of capital to the tune of $5 billion to Goldman Sachs and a similar deal that he worked out with GE might have played a role in the advice he gave. But according to Buffett his first investment was a bet on Goldman Sachs and not on the market as a whole, as he commented in phone interview on Fox Business, "We have been approached by a lot of financial firms and Goldman Sachs is one I have a lot of confidence in. I like the people and I like the economics of their business and I like the deal that was offered to us." When asked if Goldman Sachs would have failed without the investment of Buffett's company Berkshire Hathaway Inc., Buffett said, "it is helpful to them to have this investment but I am really not interested in putting my money into businesses that are going to fail."
Why Everyone on Wall Street Wants to Deleverage
In the same Fox News Business interview, according to Buffett, " We are all on kind of a thin edge and it all depends on Congress how this economy comes out of this. So, I would say that everyone on Wall Street wants to deleverage, they want to be very careful about getting their funding lined up, and they want more capital." Deleveraging is when companies attempt to decrease their financial leverage. One of the ways they seek to accomplish this is to immediately pay off any existing debt on its balance sheet. Companies will often take on excessive amounts of debt to initiate growth, however, using leverage substantially increases the riskiness of the firm. And if leverage does not grow the firm as planned, the risk can become too much for the company to bear, and will then be at significant risk of defaulting.
Worst Market Since 1929
In concluding the Fox News Business interview Buffet seemed skeptical that even with the bailout legislation put in place by Congress and commented that he along with many other experts believe the U.S. economy and financial markets will still be in dire straits and voiced his agreement with this assessment when he commented that, "We are looking over a precipitous cliff in terms of the economic condition of the country for the next few years and its really like if Congress doesn't help us on this then heaven help us."
Another leading U.S. businessman who seems to share Buffet's concern is Nevilel Isdell, Chairman, Board of Directors The Coca-Cola Company who according to Fox News Business stated this week that, "This is the greatest financial crisis since 1929." Buffett did not seem to want to qualify that particular assessment during his interview on Fox News, but he did say that, "The U.S. Treasury sold $40 billion worth of seven day treasury bills at a yield of one-twentieth- of one-percent. And that is the safest the most liquid asset there is, and that means that we are six basis points away from the most attractive thing they can do with their money is placing it under their mattress."
Capitalizing on the Woes of a Global Business
According to a recent article in London's Financial Times, in addition to his deal with Goldman Sachs, Buffett has also announced that he will buy $3 billion of preferred shares in General Electric as part of a $15 billion capital-raising event by America's largest conglomerate and oldest member on the big board of the Dow Jones Industrials. GE's financial arm has been plagued by poor performance and with the recent volatility in the market GE's position had become weak. In addition to arranging the private financing, GE had to announce a series of bolstering moves to strengthen its position and these included suspending its share buyback program and making a forecast that the company would probably not increase its dividend this year for the first time in almost 30 years.
Cash Buys More Right Now
In a subsequent interview with Charlie Rose, the Oracle of Omaha commented on how having $42.9 billion dollars in cash reserves in Berkshire Hathaway helps to make him nimble in terms of moving on a good opportunity, when he said, "We want to use cash, and the reason we didn't use our cash say two years ago was we just didn't find things that were that attractive. But when people talk about cash being king, it's not king if it just sits there and never does anything. But, there are times when cash buys more than at other times and this is one of the times when it buys a fair amount more, and so we use it. Buffett went on to say, "You want to be greedy when others are fearful and you want to be fearful when others are greedy."
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