By Dwight Cass
Nearly every core treasury function would be affected by the $600 billion problem.
In late November, CEOs from a host of leading US companies—including Goldman Sachs, Home Depot, Merck, Coca-Cola, Caterpillar and Yahoo! —tramped down to Washington DC to urge President Obama and Congress to pass legislation to avoid the so-called fiscal cliff. The punitive package of tax increases and spending cuts, estimated to be worth around $600 billion, or roughly 4 percent of GDP, will go into effect on January 1 if an agreement is not signed before then. The tax increases alone amount to more than 3 percent of GDP, and would represent the largest tax hike since 1968, which precipitated a recession in 1969, according to BlackRock.
Worries about the cliff are widespread among finance professionals. In a survey of 949 attendees at an Association of Financial Professionals conference in mid-October, nearly half said the government’s main priority should be to implement changes to avoid the fiscal cliff. A like percentage expects the fiscal cliff to weaken their businesses.
The CEOs making the rounds in Washington emphasized the importance of reaching an agreement to avert the cliff sooner, rather than later, explaining that many businesses have already sharply reduced capital spending and curtailed hiring due to the uncertainty. If no agreement is reached, the CEOs and their lobbyists told the White House and legislators that the current slow economic recovery would be tipped into recession.
The Congressional Budget Office backed up this assessment in a report in August: An Update to the Budget and Economic Outlook: Fiscal Years 2012 to 2022. The CBO says if the cliff is triggered:
- The deficit will shrink to an estimated $641 billion in fiscal year 2013 (or 4.0 percent of GDP), almost $500 billion less than the shortfall in 2012.
- Such fiscal tightening will lead to economic conditions in 2013 that will probably be considered a recession, with real GDP declining by 0.5 percent between the fourth quarter of 2012 and the fourth quarter of 2013 and the unemployment rate rising to about 9 percent in the second half of calendar year 2013.
Economists point out that US fiscal policy is in a de facto tightening mode due to the final wind-down of the spending from the 2009 stimulus. Monetary policy is unavailable, with the Fed’s near-ZIRP policy and repeated rounds of bond buying leaving it with no big guns left.
Meanwhile, market volatility tied to fiscal cliff headlines has increased markedly since the election with the ongoing gamesmanship between the administration and House Republicans. For example, on November 29, Markit credit analysts wrote: “Spreads are tightening on the back of comments from Republican Speaker of the House John Boehner, who said he was optimistic that the fiscal crisis can be averted ‘sooner rather than later’. This has more than offset earlier, more downbeat comments from Harry Reid, the Democratic leader of the Senate. The conflicting
statements underline how the markets remain beholden to fiscal cliff headlines and we can expect more volatility in the next few weeks.”
Worries about the fiscal cliff are already affecting some sectors. According to the November Fed Beige Book, these include tourism, transportation, software and commercial real estate.
Devilish Details
In terms of treasury functions, the fiscal cliff has potential consequences for capital raising, cash management, foreign exchange management and supply chain management.
Capital Raising. Corporates have been refinancing and raising capital at attractive terms in 2012, as reflected in the growing number of covenant lite loans in the mix and the improvements in investor risk appetite, which has boosted the leveraged loan market and the junk bond markets in the US and Europe.
If the fiscal cliff is triggered, or even if negotiations go to the 11th hour, investor risk appetite, both in the US and globally, will most likely abate. In fact, Australian Treasurer Wayne Swan said in mid-November that the fiscal cliff was the biggest threat to the fragile world economic recovery. There is already a strong Treasury bond bid; the fiscal cliff will probably accelerate the flight to quality and reinflate the Treasury bubble, leaving lower quality corporate credits with less support.
The rating agencies have begun issuing reports on what industries they believe will be hardest hit by the fiscal cliff. Healthcare, and sectors that depend on consumer disposable income, such as retail, will see credit deterioration, according to various ratings analyses. Capital raising for some borrowers in these industries will become more expensive.
Cash Investment Management. Credit concerns could also dial back treasurers’ dalliance with higher-risk cash investments. They could also affect issuers in the commercial paper and repo markets, as well as change the relative attractiveness of different types of collateral.
Cash Forecasting. Uncertainty regarding cash flows from customers will complicate an already difficult task.
FX Management. The fiscal cliff in the US, combined with the Eurozone debt crisis, could bring a significant degree of volatility to the dollar/euro and other major base pair markets.
Supply Chain Management. Procurement risk management and supply chain credit analyses will become more important as an economic downturn takes its toll on suppliers.
Preparing for the Worst
Although respondents to a recent survey of treasurers by TreaSolution said they were not making changes to their liquidity arrangements and other treasury policies in anticipation of the fiscal cliff, a host of companies are taking steps nonetheless to help their major shareholders avoid large dividend tax hits.
Some 112 companies had issued special dividends as of the end of November, according to Markit, and another 20 are planning to do so by year-end. Some of these are truly sizeable. Costco said it would pay a $3 billion special dividend to shareholders on November 28, according to Reuters, which added that as of September 9, Costco had $3.5 billion in cash and cash equivalents on its balance sheet. The warehouse retail company said it will issue bonds to fund the dividend.
A consumer retailer leveraging up to dispense cash to shareholders on the eve of a potential severe consumer-demand-driven recession is executing a counterintuitive strategy, to say the least. It remains to be seen whether this disbursement of liquidity will be looked back upon with regret in a year’s time, or whether tax-avoiding shareholders will feel vindicated.
While the TreaSolution survey indicates that treasurers are taking a wait-and-see approach, US bank relationship managers are seeing an increase in corporate inquiries about the terms of existing revolvers, and whether the fiscal cliff would cause any problems in accessing liquidity.
The fiscal cliff could be a severe enough event to have a profound effect on treasury operations, or it could be a damp squib. It will be impossible to determine just how problematic it could be until the political uncertainty surrounding the negotiations subsides. Currently, that uncertainty is the main problem—causing corporate finance officials to pull in their horns in anticipation of a drop off the cliff. Unfortunately, even if a negotiated solution emerges in time, the loss of value caused by that uncertainty probably couldn’t be recouped.