A cash security blanket for US corporates

FT.com

In normal circumstances, the antics of America's corporate treasurers should not worry Washington politicians. After all, corporate treasurers are like the supply chain managers of the financial world: decent, unassuming people, who prefer to stay out of the limelight, handling the crucial-but-dull role of handling company finances.

But these days, the world is not "normal”; on the contrary, five long years after the financial crisis first erupted, capital markets remain dysfunctional and western economies sluggish, at best. So if Washington policymakers want to understand why the US bond markets are behaving so strangely – or the world feels so gloomy ahead of the 2012 presidential election – they should take a closer look at those treasury folk.

This week, for example, the Association for Finance Professionals, the body representing US treasurers, released its latest survey on the mood this spring. And this makes sobering reading for investors and politicians alike.

The issue at stake revolves around what companies are doing with their cash. Before 2007, as the AFP survey shows, most companies kept their spare cash at modest levels – and corporate treasurers put this into capital markets instruments and banks to earn a reasonable return. But these days, companies are stuffed with unused cash: 41 per cent of treasurers say this has grown over the past year, and most expect further growth.

That is partly because many US companies are profitable. But it is also because they are holding on to this money, rather than spending it on productive investments or giving it to shareholders, so fearful are they about the future. Cash has thus become like a corporate security blanket, something executives cling to in frightening times.

In some senses, all of this is already well known. What is less widely appreciated is that companies are not just refusing to use their money to invest in tangible ventures but they are running scared from the capital markets too. In 2006, the AFP says, corporate treasuries placed a mere 23 per cent of their funds in banks. But last year, the proportion of funds sitting in banks doubled – and this year it rose above 50 per cent.

That switch has partly occurred because treasurers are eschewing capital market products, since they think that the returns are too low to justify the risk. Indeed, even when the corporate treasurers are investing in the capital markets, they are acting in a flighty – uncommitted – manner. Instead of buying long-term instruments, they are buying more ultra-short-term debt, and most treasurers expect to reduce that duration further. After all, the flat yield curve provides little incentive to buy longer-term debt, and the world is so uncertain that treasurers do not see the point of making long-term bets.

But the other factor that is prompting this flight towards the bank is a perception that bank deposits are relatively safe, if they are Federal Deposit Insurance Corp insured. Thus, the favourite destination for treasurers now is a non-interest bearing account, which carries a FDIC stamp. Never mind that this is producing negative returns; it does at least promise to return the cash. And that is important in a world where 98 per cent of treasurers are now also telling the AFP that their top priority is to protect their money, not earn yield.

Now, if you want to be an optimist, it is possible to hope this is simply a short-term phenomenon. After all there are endless issues for corporate treasurers and everyone else to worry about this summer. And since central banks are still loosening monetary policy the yield on safe(ish) debt is ultra low. If this changes, however, the treasurers could return to the capital markets again. History suggests that greed usually triumphs fear in the end.

And yet it is also possible to imagine a more pessimistic scenario; what the AFP is reporting may herald a much bigger behavioural shift. Most notably, the cumulative impact of the shocks of the last five years may now have scarred, and scared, company executives to such a degree that they may have become addicted to their cash security blankets. If so, it could take years before they really start feeling confident enough to take long-term investment bets again. The velocity at which money moves around the system – and cash is used in a productive way – may have now slowed in a more permanently; doubly so since the banks themselves are very risk averse and wary of lending.

Perhaps this is no bad thing. After all, in the credit bubble, the velocity of money soared in dangerous ways. But a world where money has slower velocity is also a place where it will be harder to produce growth. Little wonder, then, that treasury yields are so low, or that so many investment managers feel so challenged. This corporate 'freeze' may be subtle but it is painful indeed.

Copyright The Financial Times Limited 2012.