Will a Superabundance of Capital Lead to an M&A Boom?

Posted on February 17, 2013

Authored by John Mason

“Bain & Company, the consultancy, forecasts a ‘superabundance of capital’ between now and 2020. In a recent report it argued that markets would be distorted by surpluses in Asian and Middle Eastern countries and private investment funds.

“It estimates that the world’s financial assets will outbalance its domestic product by ten to one – it will have $900 trillion of financial assets compared with $90 trillion of GDP – by 2020. The result will be a ‘world that is structurally awash in capital’ chasing few opportunities.

“‘Capital superabundance will increase the frequency, intensity, size and longevity of asset bubbles. The propensity for bubbles to form will be magnified as yield-hungry investors race to put capital into assets that show the potential to generate superior returns,’ the report concludes.”

These words from John Gapper appeared over the weekend in the Financial Times of London.

The signs of this possibility, according to Gapper, are two: first, the presence of lots and lots of cash on the balance sheets of corporations, hedge funds, and other financial interests; and second, the apparent movement in the buyout and acquisition market that reflects a growing belief among international investors that the US economy is stabilizing, the eurozone crisis has reached its final stages, and that elsewhere in the world economic recovery continues and capital flows are increasing. Apparently with these events, the desire to take on more risk has risen.

I have written for three years or so about the build up of cash on the balance sheets of corporations. Companies that never had issued long-term debt before took advantage of exceedingly low interest rates to increase their cache of money. The basic reasoning behind this buildup was that these financially sound firms would “make a killing” as the United States economy began to grow faster … read the rest

August 2012 – The Future of Small Business Financing

Posted on August 23, 2012

Everyone loves small business.

At least that’s what the politicians want you to believe.

The reality is different. Small business is under attack from every quarter. Government policies favor large banks and large multinational businesses. Credit is tight and the banks favor the larger borrowers. Increased regulations stifle innovation and protect large incumbents that can afford teams of lawyers and lobbyists.

What’s the little guy to do? Waiting for the politicians to change the system is wishful thinking. Smart business people find ways to prosper in every environment.


And the current environment is not great for small firms. The Federal Reserve Senior Loan Officer survey has recently confirmed what we have suspected for some time: banks have been more generous in easing underwriting requirements for larger companies than they have been for smaller companies. Paynet, which maintains data on 17 million small business loans, reports that lending conditions for small firms have deteriorated in recent months after two years of bounce back from the 2009 bottom.  For additional details go to the full article on Capital Matters.


Financial Market Risk
And there’s a risk that things could get a lot worse for businesses that don’t tie down their financing soon.  We just published an article on Seeking Alpha that has received a great deal of attention with more than 14,400 page views so far. Our thesis is that the Fed’s zero interest rate policy has led to a situation where longer term treasury bonds are trading at yield levels that provide a spread to inflation far below the historical norms. Markets eventually return to their mean and often overshoot it so there is growing risk in the longer term debt market. Our concern is two-fold. First, that individual investors need to be aware of the potential impact of this return to the mean … read the rest

A Swan Blacker Than The Darkest Night

Posted on August 18, 2012

Interest Rates Rise at 2652% Annualized Rate! That’s probably a headline you will not see in the Wall Street Journal and it’s certainly a bit over the top, but those are the facts. From July 18 to August 17, the interest rate on the two-year Treasury jumped from .22% to .29%. That’s a 32% one month increase and works out to an annual jump of 2652% if you compound the increase monthly. Just to be fair the ten-year rate “only” rose from 1.52% to 1.81% or about 19% over the same period. With the magic of compound interest that generates a far more benign 713% annualized rate rise.

If you haven’t already done the math, those growth rates would take you to a 43.8% annual interest rate on the two year a year from now and a 12.9% interest rate on the ten year at that point. Of course that is not going to happen. Most likely we’ve just seen a random fluctuation in an overbought market. The Fed has promised to keep interest rates low for an extended period after all.

We’ve been saying for some time that the seeds have been planted for a move into a period of stagflation comparable to what we saw from the mid-1960’s and the 1970’s. That move, which transformed the benign inflation of the 1950’s to a raging inferno by the end of the period, eventually took Treasury rates for the 10 year to unheard of levels of 15% by the end of the 1970’s. This resulted in a collapse of the bond market and the eventual failure of entire savings and loan industry in the United States in the 1980s.

The United States and most of the developed world have benefited tremendously over the past 30 years from a steady drop in long-term bond rates.… read the rest

QE Anyone?

Posted on August 10, 2012

If anyone doubts we are moving to more monetary accommodation, take a look at the excerpt below from last night’s U.S. Financial Data release from the St. Louis Fed. The lower right hand corner reflects the most recent trends.

In June, we posted an article indicating a seeming correlation between the trend in direction and magnitude of U.S. M2 growth and U.S. economic activity. The decline in the M2 growth rate has now turned, and is headed up again, as you can see below, but the turn is not as dramatic as the growth in the Monetary Base.

We’ve previously stated our concern that the U.S. could be heading into a period of rapidly increasing inflation, similar to that experienced in the early 1970s that led to many years of stagflation, only ending with Mr. Volcker’s monetary castor oil. We’ve got all the ingredients, including this summer’s rapid runup in commodity prices. The past twelve month the GDP price deflator has dropped from 2.4% to 1.9% on an annual basis, averaging a bit above the Fed’s 2% target. 2-3% is in the range where the 1970’s inflation began to take off. Yet, we’re in a period where many, if not most, observers have been talking recession and increased likelihood of deflation. Real inflation will come as a black swan for many, with significant implications for both fixed income and equity markets.

Could the current round of easing be the spark that finally ignites the inflationary flame? There are lots of reasons to suspect that’s possible. Calculated Risk just supported a growing belief that housing may finally be bottoming. Declining home prices have been a primary force that’s kept inflation in check for the past few years. Add to that a renewed commodity spiral, annual wage inflation in China hitting 13-15% and evidence that the read the rest

Are We Measuring the Wrong Money Supply … Again?

Posted on June 12, 2012

Back in 2008 we wrote that the U. S. was facing a serious credit squeeze in part because we had failed to take into account some important structural changes in the credit markets: i.e. the rapid growth and subsequent collapse of the Shadow Banking system. Since then the Fed and the Treasury have spent enormous resources addressing the impact of that collapse through the purchase of assets from financial institutions, the nationalization of Fannie and Freddie and numerous other actions to prop up the housing market in hopes of repairing shrunken balance sheets throughout the economy.

We may be suffering from a different, but equally portentous, issue today arising from another misreading of what the term money really means. In response to our recent article on Fed tightening since the fall of 2011, John Lounsbury, Managing Editor of econintersect.com, made a very astute observation:

You do not mention it in your article but is it possible that the Fed has not been taking a sufficiently global view and has insufficiently reacted to a recessing Europe and a rapidly slowing Asia? India just dropped to a GDP growth rate below anything seen during the Great Financial Crisis. The manufacturing numbers in China have been flirting with contraction for several months. If the Fed reacts to these factors after they have gained a solid foothold, doesn’t that likely increase the magnitude of the yo-yo swings?

The U.S. dollar is without question the world’s reserve currency and the current problems of the Euro have only served to cement that position. Given the global demand for $100 bills, in many parts of the globe the dollar is not only the reserve currency, but the defacto physical currency as well. Yet we continue to look at money as a national, or in the case of the Euro, regional … read the rest

Are Derivatives Accounting Rules Helping the Big Banks Overstate Their Earnings?

Posted on November 21, 2011

Profits do not mean the same thing for the major banks as they do for ordinary businesses.  If you manufacture or distribute widgets, calculating your profit on a sale is pretty straightforward.  What did it cost to acquire or make the widget? What did you sell it for?  The difference is profit.  For a broker/dealer it works pretty much the same way.  What did the bond cost me?  What commissions did I pay?  The difference is profit.

Now consider the case of the major money center banks.  Thanks to the repeal of Glass Steagall they are in the position to act not only as a broker dealer, but also as a principal, holding the financial instruments they create in their long-term investment book.  During the heyday of the mortgage securitization boom, this permitted the banks to package bundles of mortgages into mortgage-backed securities (MBS), booking a hefty spread in the process.  The MBSs could then be repackaged as collateralized debt obligations (CDO) and the CDOs could then be re-repackaged an infinite number of times as synthetic CDOs thanks to the magic of credit default swaps.

At each step of the process the bank earned a hefty origination spread, the investment bankers, brokers, lawyers and a myriad of consultants and rating agencies made their commissions and fees and everyone was happy, at least as long as the securities could be pawned off to some Norwegian village north of the Artic Circle.  At some point the music stopped and the Norwegians went back to hunting reindeer, but not so the bankers.

Thanks to the repeal of Glass Steagall the banks were able to find new customers for the convoluted structures their well-oiled machines were churning out by the hundreds: they held them on their own books.  By booking the securities at “retail” this process enabled the … read the rest

Just What is Quantitative Easing About Anyway?

Posted on January 1, 2011

Quantitative Easing 2

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It has become quite fashionable for commentators and blaring TV ads to assume that the United States is rapidly printing money, which will inevitably lead to hyperinflation and a debasement of the dollar as a global currency.  All you have to do is look at the increasingly volatile (some might say speculative) chart of gold prices over the last decade and particularly over the past several years to see that many investors have bet with their bank accounts that this will be the case.

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I will admit to an inclination to being as susceptible as the next person to the suspicion that the western world is in for some significant inflation looking forward.  Yet this belief must be based, not on demonstrable proof, but on an innate faith that politicians will invariably do the wrong thing, given the choice.  In a December 5 interview on 60 Minutes, Chairman Bernanke of the Federal Reserve, conducted in my opinion the most candid discussion ever to slip from the lips of a Fed Chairman.  He made a very forceful case that, far from inflating the currency, the Fed is fighting a very real risk that the U. S. could fall into a serious deflation.  Without equivocation Bernanke indicated that QE II (the purchase of long term Treasury Bonds by the Federal Reserve) is not inflationary and has not created an explosion of the money supply.  He went on to say that, were inflation to rear its ugly head, the Fed could raise interest rates “in fifteen minutes” if necessary.

So what are the facts for Mr. Bernanke’s case?  First, the Money Supply as measured by M2 (currency plus bank demand and time deposits excluding large CDs) is not growing very fast

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After a brief period of rapid growth … read the rest

Categories: Economic Stimulus, Economics, Federal Reserve

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We’re Seven Months into the Great Mess. What’s Going to Happen Next?

Posted on April 14, 2009

Seven months ago (Monday September 15, 2008) we learned of the failure of Lehman Brothers and soon thereafter the sale of Merrill Lynch and the bailout of AIG.  These events were the culmination of a series of market shocks that had started with the demise of the sub-prime loan market, had accelerated with the collapse of the leveraged loan market starting in August 2007 and had included the takeover of Bear Stearns in March 2008.  But September 15, 2008 is the current era’s equivalent of 1929’s Black Monday.

Since September we have witnessed dramatic governmental actions designed to prevent the current crisis from descending into a downward spiral reminiscent of the 1930s.  For the moment, the stock market seems to be giving these actions (as well as our charismatic new President) a vote of confidence.  We’re also hearing from some of our clients that their operations improved in March and that they are more optimistic about their businesses looking toward the summer.  Another “green shoot” is the middle market M&A market, where I spend much of my time.  The M&A market has definitely improved since the first of the year and indications are that it will remain reasonably strong for a while, at least for profitable companies in favored industries such as government contracting, IT services and health care.

So what is the economic scorecard to date and what can we expect to see going forward?

1)    The World economy is in the midst of the first major global recession of the postwar era.  Global trade has been collapsed for many of the major exporters, particularly China, Japan and Germany.

china-exports1

While there have been some recent hints that the rate of decline is slowing (the second derivative of negative growth) or even bouncing a little, world trade is still an area of significant concern.  … read the rest

How Much Risk is the Treasury Really Assuming from the Financial Institutions?

Posted on April 7, 2009

What does it really mean to talk about saving “the banks”?  The Treasury would like us to have a mental picture of Jimmy Stewart in It’s a Wonderful Life, protecting the savings and mortgages of the good citizens of Bedford Falls.  In truth, for all material purposes, the current Public Private Investment Plan (PPIP) is about saving four mammoth financial institutions considered too big to fail, BankAmerica, Citicorp, J. P. Morgan Chase, and Wells Fargo.

These financial behemoths, each as large as a significant number of the world’s national economies, bear as much relationship to the Bedford Falls Building and Loan as a rowboat does to the Titanic.  For public consumption, however, it is convenient for the Treasury to continue to describe its efforts as a rescue of “the banks”;   rescuing hydra-headed financial giants just doesn’t have quite the same ring.  Additionally by lumping these institutions under the category of “banks” the Treasury can continue the fiction that the bailout is about “getting the banks lending again.”

Notwithstanding this fiction, as we showed last week, even Secretary Geithner has abandoned the pretense that the PPIP program is about encouraging direct bank lending in the traditional sense of taking deposits and making loans, admitting that the primary purpose of PPIP is to restore the strength of these wholesale institutions so that they can restart the private securitization markets that fueled the credit bubble earlier in the decade.  So here’s the plan.  Just remove the toxic assets from the books of the financial giants and the system will be restored to its former picture of robust health.  Hopefully the PPIP will be sufficient to fund the fix.  If not the Treasury can use its proposed new liquidation authority, invest few hundred billion dollars more to fill the gaps and sell the freshly minted “clean” … read the rest

Categories: Bailouts, Banks, Business Survival, Business Turnarounds, Distress, Economics

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Geithner Told it Straight (But you really had to listen)

Posted on March 29, 2009

This morning (March 29) Treasury Secretary Geithner appeared on Meet the Press to explain his plan for rescue of the financial system.  He described a series of actions to not only fix the banks, but to get the securitization markets working as well.  For perhaps the first time we heard a (relatively) clear rationale explaining how the Treasury expects the toxic asset rescue plan to lead to the restoration of credit for consumers and entrepreneurial business.

The interview started with an explanation of the difference between bank lending and securitization.  Per Geithner, “Typically somewhat less than half of lending for business and consumers comes from the securitization markets.”  As I have written previously the current financial crisis was created by an explosion of debt to unsustainable levels in great part through the mechanisms of the shadow banking system, which includes the securitization markets.  This created a massive amount of liquidity, much of which was not captured in traditional measures of the Money Supply.  The collapse of these mechanisms beginning in August 2007 created the credit crunch.  Sec. Geithner believes that, until these non-bank markets are restored, the financial system can’t be fixed.

There’s been much loose talk in the media claiming that lending to small business entrepreneurs can’t be restored until the toxic assets come off the balance sheets of the banks.  Here is what Geithner said on the subject of the toxic asset bailout:

“This is a better way to get these markets working again.  Let me just      step back for one second.  What we’re trying to do is get the entire financial system – our complicated financial system – working again so that we get credit where it needs to go in the economy.  And that requires strengthening our banking system.  It requires making sure there is enough capital in the … read the rest

Categories: Banks

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