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Why Are Companies Hoarding Cash?

Posted by Larry Doyle on February 11, 2010 8:20 AM |

In order for the economy to grow, for companies to hire, and for new employees to benefit, we need velocity in the money supply. The fact is, this velocity has slowed dramatically. Bloomberg highlights this stark reality on our economic landscape by writing, Jobless Suffer with Corporate Cash Climbing to $1.19 Trillion:

A majority of companies in the Standard & Poor’s 500 stock index increased cash to a combined $1.19 trillion while simultaneously reducing spending, keeping a jobs recovery on hold.

Caterpillar Inc., Eaton Corp., Walgreen Co. and General Electric Co. are among 260 companies that ended last quarter with $522 billion more than a year earlier after cutting capital spending by 42 percent. Economists say the dearth of investment is keeping the jobless rate at about 10 percent as the U.S. emerges from its worst recession since the 1930s.

“It’s not clear we are going to see the type of growth following this recession that we’ve seen in previous recessions,” Sandy Cutler, Eaton’s chief executive officer, said in an interview yesterday. That view “is leading people to be cautious as to their rate of reinvestment, and right in parallel with that, in terms of hiring additional employees.”

Why? Where are the bold executives who are willing to take the risk and deploy capital now when investment opportunities are much cheaper than a few years ago? What is holding these executives back? Four factors:

1. Banks are restraining credit and effectively hoarding cash themselves. Why? As I discussed the other night during my appearance on the Barry Farber Show, banks continue to hold an exorbitant amount of delinquent loans (mortgages, consumer loans, commercial real estate, corporate) and are concerned of an increasing default rate on these loans. Regulators are telling banks to increase capital reserves against these loans and expected losses.

2. A lack of attractive investment opportunities. There are plenty of opportunities to allocate cash and make investments, but CFOs and CIOs do not want to take on another company’s headache in the process. Bloomberg touches upon this, as Wade Miquelon, CFO of Walgreens states:

“It’s not great having money in the bank earning almost no interest, but we also want to be very smart and very driven” by return on invested capital, Miquelon said then. “Just because we’re generating cash doesn’t mean that we’re going to feel compelled to do something that doesn’t earn a good, robust return for the company and for the shareholder.”

3. Uncertainty in Washington. As much as President Obama may want to state that he is pro-business, the fact is the likelihood of increased costs and taxes associated with Obama’s agenda is anathema to corporate execs.

4. Career risk. As Warren Buffett has often stated, when people are fearful, it is time to be greedy. When people are greedy, it is time to be fearful. Buffett recently bought Burlington Northern. His reasoning? He is making a bet on the long term prospects for the U.S. economy. Most CFOs do not have Buffett’s deep pockets personally or professionally to make those types of investments and are not about to risk their own careers in the process.

LD






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