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Be wary of conflating corporate cash with the LP cash backing VC companies. Companies are holding record amounts of cash because (1) it is seen as insurance for

by 001sky 13y ago

Be wary of conflating corporate cash with the LP cash backing VC companies. Companies are holding record amounts of cash because (1) it is seen as insurance for financial shock-event; and (2) low interest rates do not penalize them for holding it. If interest rates were 7%, shareholders would be demanding minimal cash on balance sheets. But with money @ 0.25%, the BOD is telling investors the "option value" is worth the minimal carry cost to the company in terms of FCF and/or NI. On the other hand, the sources of VC (LP) have excess liquidity they do not want to hold as cash. If they had 7% <paid> on cash they would hold some cash as insurance; but with 0.25% (6.75% forgone) the cost of this insurancs is too high. This is exactly opposite dynamic of the corporate case. So, you see companies hoarding cash and LPs trying to get rid of it. But for VCs and valuations, it is the LP's dynamics (excess liquidity) which are relevant. The corporate cash piles have second-order effects (via M&A), but the central source of liquidity is driven by LPs wanting to be fully invested. (There is also the issue of spread/total rate which pushes LPs deeper into the risk spectrum to meet threshold returns. This effect drives allocation to equity vs bonds, and equity market liquidity has carry-through for VC exits both at the iPo and m&a level.)

pdonis 13y ago
> Don't confuse corporate cash with the cash backing VC companies. Actually my post wasn't talking about either: it was talking about all the reserves the banks are holding at the Fed instead of lending them out. Technically those aren't cash since banks can't just hand them to you with no strings attached; they have to give them to you as a loan. Corporate cash, OTOH, could be paid out as dividends directly, though you're correct that that's not going to happen with rates where they are now.
- 001sky 13y ago
  Banks are hoding cash for the same reason as corporates. The cash is cheaply financed by low-cost debt and it has utility as an insurance-liquidity-pool-of-last resort in the case of a policy reversal by the Fed. For argument's sake, assume debt is mis-priced right now relative to equity. If you believe that, and you are a bank, what you do is increase ROE through increasing leverage (shor debt markets+long equity). So, if you are a bank you borrow and buy back shares. Or, you borrow and keep shares at a minimum/flat. On the other side of your ledger, if you are a bank and you believe debt is mis-priced, the last thing you want to be doing is going long credit (to customers). So, what you should expect is increasing debt/equity ratio and flat/decreasing proportion of long-credit/total assets. The "stingy credit" allegation is perfectly rational if you make the assumption that debt is fundamentally mis-priced as an asset class. That is the essential assuption Wilson is making to explain why money is chasing equity/pe/vc. The only open issue is whether or not the assumption is correct. If we look at policy, when regulators ring-fence reserve and increase the reserve level, they are forcing the banks to sell-equity. The reason they are doing this is because--assuming equity is mis-priced--they understand that banks will leverage up. The problem with banks leveraging up increasingly over time is policy hysterisis. If the fed policy results in increasing bank leverage, the baking system will become increasing more "brittle". This tie the hands of the Fed--when they move to revert policy--they will risk creating a problem due to having added "brittleness" to the financial system. So, even the fed is acting as if the assumption about debt pricing is true. That being said, it is a more difficult case to explain from first principles whether or not debt is truly mis-priced as an asset class. But the analysis can be followed as far as I can tell simpley based on the binary assimpyion (yes/no). And one of those assumptinos seems to explain alot, while the other faces a harder time making sense of the data we are seeing. From your piece: The hope is that the lower interest rates will encourage people and businesses to take out more loans and thereby start spending again. What we are seeing is opportunistic borrowing for financial engineering. We are not seeing 1:1 borrowing to spending on operating expenses or PPE. We are seeing borrowing that is being spent on share-buy-backs and/or cash-stockpiles that maked increasing leverage ratios more operationally risk-tolerant. (And it seems this is true for corporates and financials, at least to a first order approximation.)

by 001sky 13y ago

pdonis 13y ago

> Don't confuse corporate cash with the cash backing VC companies. Actually my post wasn't talking about either: it was talking about all the reserves the banks are holding at the Fed instead of lending them out. Technically those aren't cash since banks can't just hand them to you with no strings attached; they have to give them to you as a loan. Corporate cash, OTOH, could be paid out as dividends directly, though you're correct that that's not going to happen with rates where they are now.

001sky 13y ago
Banks are hoding cash for the same reason as corporates. The cash is cheaply financed by low-cost debt and it has utility as an insurance-liquidity-pool-of-last resort in the case of a policy reversal by the Fed. For argument's sake, assume debt is mis-priced right now relative to equity. If you believe that, and you are a bank, what you do is increase ROE through increasing leverage (shor debt markets+long equity). So, if you are a bank you borrow and buy back shares. Or, you borrow and keep shares at a minimum/flat. On the other side of your ledger, if you are a bank and you believe debt is mis-priced, the last thing you want to be doing is going long credit (to customers). So, what you should expect is increasing debt/equity ratio and flat/decreasing proportion of long-credit/total assets. The "stingy credit" allegation is perfectly rational if you make the assumption that debt is fundamentally mis-priced as an asset class. That is the essential assuption Wilson is making to explain why money is chasing equity/pe/vc. The only open issue is whether or not the assumption is correct. If we look at policy, when regulators ring-fence reserve and increase the reserve level, they are forcing the banks to sell-equity. The reason they are doing this is because--assuming equity is mis-priced--they understand that banks will leverage up. The problem with banks leveraging up increasingly over time is policy hysterisis. If the fed policy results in increasing bank leverage, the baking system will become increasing more "brittle". This tie the hands of the Fed--when they move to revert policy--they will risk creating a problem due to having added "brittleness" to the financial system. So, even the fed is acting as if the assumption about debt pricing is true. That being said, it is a more difficult case to explain from first principles whether or not debt is truly mis-priced as an asset class. But the analysis can be followed as far as I can tell simpley based on the binary assimpyion (yes/no). And one of those assumptinos seems to explain alot, while the other faces a harder time making sense of the data we are seeing. From your piece: The hope is that the lower interest rates will encourage people and businesses to take out more loans and thereby start spending again. What we are seeing is opportunistic borrowing for financial engineering. We are not seeing 1:1 borrowing to spending on operating expenses or PPE. We are seeing borrowing that is being spent on share-buy-backs and/or cash-stockpiles that maked increasing leverage ratios more operationally risk-tolerant. (And it seems this is true for corporates and financials, at least to a first order approximation.)