Collateral damage

“What the crisis in the credit market means for everyone else”

The Boston Consultancy Group has issued a publication in October 2008 on the implications of the credit crisis. Given the dramatic events in the capital markets everyone is wondering what will happen next and what it means for the wider economy. The background of the crisis is highlighted in both the capital marked and the broader economy. This well recognized consulting group gives insight in their thoughts about what the crisis will mean for the real economy.  Recommendations are given on how to deal with the difficult times ahead.

The modern financial system rests on three pillars: capital, liquidity, and confidence. Unprecedented losses have depleted financial institutions capital faster than their ability to raise new capital. Illiquid capital markets have made it hard for them to finance their own debt. Falling confidence has damaged inter-bank lending and made depositors jittery. Not since the crash of 1929 has the global financial system been subject to such a severe shock.

The credit crisis is the consequence of aggressive risk taking by highly leveraged financial institutions which funded unsustainable economic growth, particularly in the U.S. Underlying this dynamic were three widely held misconceptions: that the creditworthiness of borrowers was strong, that investors were sophisticated and that the credit risk was widely distributed.

The credit crisis is taking place against the backdrop of the long term rise in consumer indebtedness in the U.S. For years, U.S. consumers have been living beyond their means. The wide availability of cheap debt was a key factor in fuelling the growth of the U.S. economy and to the degree that that economy has been an engine of global economic expansion. 

The combination of less available (and more expensive) credit with stagnant or even declining demand will hurt even healthy companies. The expected decline in demand and likely fall in capacity utilization will cause companies to cut back on new investments in capacity and expansion, stalling growth still further. It will also reduce their need for external capital. On the supply side, even those companies who want to invest will find available credit scarce and more expensive.

The specifics most companies will likely face in real economy are: no access to funds; significantly higher costs of capital; weak stock markets; bonus for cash; reduced cash flow; credit losses; significant balance sheet risks; bursting of the profit bubble; continued volatility; protectionism; wave of industry consolidation; more government intervention; re-regulation and change in consumer behaviour. Every industry will be affected but the US remains the world’s most flexible economy.

How to deal with the difficult times ahead? The Boston Consultancy Group gives some tips which are explained in the article: Watch your cash; reduce trade credit; start working on capital initiatives; restructure your debt; develop a stress test scenario; act now on cost and organisational efficiency; reassess your investment program; re-evaluate off shore manufacturing; adapt product portfolio; look for out of the pricing box; divest non-core business; engage in selective mergers and acquisitions; manage financial policies and investor messaging; look for opportunities; install a crisis monitoring team and plan for the upturn.

Companies taking these measures will not only be better placed to master the current turmoil and the likely recession, they will also have a substantial opportunity to take advantage of the changing environment, emerging ahead of the competition as the current crisis unwinds.

To read the complete article: http://www.bcg.com/impact_expertise/publications/files/Collateral_Damage_Part_I_Oct08.pdf