Are Corporations Sitting on Piles of Cash?

The Wall Street Journal claims U.S. Firms Build Up Record Cash Piles

U.S. companies are holding more cash in the bank than at any point on record, underscoring persistent worries about financial markets and about the sustainability of the economic recovery.

The Federal Reserve reported Thursday that nonfinancial companies had socked away $1.84 trillion in cash and other liquid assets as of the end of March, up 26% from a year earlier and the largest-ever increase in records going back to 1952. Cash made up about 7% of all company assets, including factories and financial investments, the highest level since 1963.

"Stockholders don't want them to keep sitting on cash at a zero return," said Paul Kasriel, an economist at Northern Trust. "They're going to use it," either to increase hiring and investment or to make payouts to shareholders in the form of dividends or share buybacks, he said.

Investors Punish Companies Spending Cash

The "companies are going to spend cash" theory sounds nice except for two things. The cash is not there in the first place (it's really debt), and Investors Say No to 'Let's Expand' Companies

Delta Air Lines executives spent much of an earnings conference call Monday parrying with analysts over the airline's plans to increase capacity by 1% to 3% in 2011, on top of this year's growth of 1% to 1.5%. Delta Chief Executive Richard Anderson said Delta is committed to "capacity restraint," but the stock fell 2.9% that day. The shares lost 2.3% for the week, compared with a 5.4% gain by the NYSE Arca Airline index.

United Airlines parent UAL Corp. got a pat on the back from analysts for its plans to keep capacity additions relatively muted. Its shares jumped 4.8% on Tuesday after UAL released earnings.

Sideline Cash = Corporate and Government Debt

That corporations are sitting in piles might be dandy if it were true, but unfortunately it is not an accurate representation, at least in an aggregate sense.

John Hussman mentioned the corporate cash situation in Cheering the Asset and Ignoring the Liability.

Put simply, there is a lot of apparent "cash on the sidelines" because the government and many corporations have issued enormous quantities of new debt, often with short maturities, while other corporations have purchased it. It is an equilibrium. The assets that are held in the right hand represent debt that is owed by the left. You cannot call that pile of short-term marketable securities an asset without calling it a liability. The cash on the sidelines is evidence of debt incurred to fund economic activity that is already in the past. It will remain "on the sidelines" until the debt is retired. The government debt has been issued to finance deficit spending. At the same time, a great deal of corporate debt has been issued over the past year apparently as a pre-emptive measure against the possibility of the capital markets freezing up again.

What's fascinating about the "corporate cash" argument is that few observers recognize that a great deal of this cash is not retained earnings but new debt issuance. Brett Arends of MarketWatch puts present levels of corporate cash in perspective: "According to the Federal Reserve, nonfinancial firms borrowed another $289 billion in the first quarter, taking their total domestic debts to $7.2 trillion, the highest level ever. That's up by $1.1 trillion since the first quarter of 2007; it's twice the level seen in the late 1990s. Central bank and Commerce Department data reveal that gross domestic debts of nonfinancial corporations now amount to 50% of GDP."

Corporate Cash Lie

The article Hussman referred to is one I have been meaning to link to for several days.

Please consider The biggest lie about U.S. companies

You may have heard recently that U.S. companies have emerged from the financial crisis in robust health, that they've paid down their debts, rebuilt their balance sheets and are sitting on growing piles of cash they are ready to invest in the economy.

You could hear this great news pretty much anywhere -- maybe from Bloomberg, which this spring hailed the "surprising strength" of corporate balance sheets. Or perhaps in the Washington Post, where Fareed Zakaria reported that top companies "have accumulated an astonishing $1.8 trillion of cash," leaving them in the best shape, by some measures, "in almost half a century."

Or you heard it from Dallas Federal Reserve President Richard Fisher, who recently said companies were "hoarding cash" but were afraid to start investing. Or on CNBC, where experts have been debating what these corporations are going to do with all their surplus loot. Will they raise dividends? Buy back shares? Launch a new wave of mergers and acquisitions?

It all sounds wonderful for investors and the U.S. economy. There's just one problem: It's a crock.

A look at the facts shows that companies only have "record amounts of cash" in the way that Subprime Suzy was flush with cash after that big refi back in 2005. So long as you don't look at the liabilities, the picture looks great. Hey, why not buy a Jacuzzi?

According to the Federal Reserve, nonfinancial firms borrowed another $289 billion in the first quarter, taking their total domestic debts to $7.2 trillion, the highest level ever. That's up by $1.1 trillion since the first quarter of 2007; it's twice the level seen in the late 1990s.

Central bank and Commerce Department data reveal that gross domestic debts of nonfinancial corporations now amount to 50% of GDP. That's a postwar record. In 1945, it was just 20%. Even at the credit-bubble peaks in the late 1980s and 2005-06, it was only around 45%.

So, in spite of what most are saying, corporations are not really holding tons of cash, ready at any moment to go on an investment or hiring spree.

Instead, corporations burnt by inability to raise cash during the 2008 credit bust are simply taking advantage of market conditions to raise cash levels now, at attractive rates, while they can.

Corporations raise cash in two instances

1. When they can
2. When they have to

After the corporate bond blowup in 2008, companies are wisely focusing on #1, while they still can. How much longer the market is willing to allow debt financing at favorable rates remains to be seen. When it stops, equities are likely to get clobbered.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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