Borrowers and lenders must share the responsibility for financial fiascos which have occurred on both sides of the Atlantic, writes Robert Heller.
Inside every boom there is a bust screaming to get out. When that happens, more than economic activity takes a plunge: so do reputations, balance sheet totals, and financial and management theories. When the latter start sinking out of sight, their revealed folly appears so deep that previous adoption by certifiably sane human beings becomes difficult to credit. Did bankers ever really believe that it was perfectly safe to lend billions not on the security of the borrower but on that of the assets which he was proposing to buy?
For that matter, were the borrowers actually convinced that the consequent hair-raising levels of gearing mattered not, so long as the cash flow covered the interest rate, no matter how high? Over-borrowing should have been shunned, for the elementary reason that a decline in overgeared profitability can destroy the net worth of shareholders.
Nobody who still holds shares in Saatchi and Saatchi will need reminders on that score: the bankers' proposals for "reconstruction" will rob the equity owners of 70% of their company. Note that the killer was a Euro-convertible, brilliantly conceived by the company's advisers: it proved as fatal as another financiers' wheeze, the repurchase of 40% of IBC, which helped greatly to destroy virtually the entire value of that company's equity. In less dramatic cases the damage lies in collapsed share prices rather than massacred equity, but the financial pain is much the same.
It is not eased by the knowledge that the bankers who aided and abetted these exercises have suffered as much as anybody. Yet those same bankers are people to whom managements are supposed to turn for sage guidance.
If the western economies emerge unscathed from the current fine mess, to what degree of unimaginable disaster will the next boom lead? In theory, salvation lies in the hands of managements themselves. They need only mind their own businesses, exercise tight financial controls, keep debt levels right down, cherish their customers, develop their people, innovate in both products and processes, and stay fully alert to changes in the marketplace and in technology.
That is a short list but a tall order. Plenty of companies have sailed through the post-war booms without being seduced far from the necessities. Yet at one extreme a genuinely creative entrepreneur like Rupert Murdoch veered off into over-expansion and over-borrowing which have become as life threatening as the antics of Alan Bond. In consequence the News Corporation equity is now valued at little more than half a billion: that is an eighth of the capitalisation of Thomson, whose giveaway sale of its newspaper interests was the booster for Murdoch's sensational rise in the 1980s.