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May 17, 201112:00 AMMad @ Mgmt

with Walter Simson

Blondes, banking, and banana peels

Blondes, banking, and banana peels

Mad @ Mgmt addresses the concerns of middle market companies, including banking, family and succession issues, turnarounds and performance improvement, and economic life in general. Walter Simson is founder and principal of Ventor Consulting, a firm dedicated to middle market companies.

I am speaking at Manufacturing Matters!, the annual conference sponsored by the Wisconsin Manufacturing Extension Partnership (WMEP). Thank goodness for WMEP. They see the challenges to American manufacturing and are setting their sights on a turnaround – of skills, R&D, exports, and funding.

Manufacturing makes up 11% to 13% (depending how and when you measure it) of the economy. Manufacturers are a key component to the middle market, the 6 million firms that employ 60 million people in this country.

Manufacturers, like the rest of the middle market, are recovering from an awful shock. Here's a picture of industrial production, courtesy of the St. Louis Fed:

simpson chart 1 5.17

See the shaded area? That's a recession. Manufacturers should avoid shaded areas the way blondes should avoid banana peels: even when you see them ahead, they can cause a nasty fall.

My talk at Manufacturing Matters! is on how to get capital in troubled times, so I reviewed the data to define those troubles. I make a living helping companies get back on track and the capital they need, but even I was shocked at the trends.

Basically, the story is this: In 2008, the investment banking world shut down because of a collapse in the essentially unregulated mortgage securities market, combined with a shutting off of credit to others because of the completely unregulated credit default swaps market.

A credit default swap is an unlicensed insurance contract that bets whether a company will be able to pay its bills. (Since there are buyers and sellers of credit default swaps, an interesting feature is that someone can bet for you to fail. Like an insurer selling you a fire policy, then debating with the fire department if they should respond to a call.) When companies holding swaps on Lehman Brothers, AIG, Bear Stearns, and others saw that there might be a glitch in those companies' ability to repay, they cut off additional credit.

Then, fear that some banks might be exposed to those companies restricted credit to all banks.

Here is a picture of the moment the investment banking world caused a cutoff of credit to productive America:

simson chart 2 5.17.11

The graph has the almost quaint title of "Tightening Standards."

Oh, really? When 75% of bankers are tightening their standards all at the same moment, it means they are clenching other things too.

The net of this is that small business has been through a period, which is not over despite the near normal levels on the standards picture, of being told:

a) they MAY not, or
b) they DO not

have credit at the bank.

That has resulted in this picture of declining loans:

simson chart 3 5.17.11

If I were from Wisconsin, a 25% decline in loans over a one-year period would be worthy of a loud "Holy Crap." I'm not, but I'll say it anyway.

We are not out of this situation. My clients are afraid for the consequences to them and to their communities of the consequences of lack of credit.

I am thinking of good folks: the truck dealer client who must replace his inventory financing, the restaurant-equipment company that wants to finance sales to willing customers, the software company that needs receivables financing to make payroll.

The middle market makes up 40% of GDP. We cannot treat our productive sector in this way. We must have clear and consistent policies that protect against
periodic, speculative upheavals like this. (I am old enough to remember the last one – in 1990, after the S&Ls blew up. Don't believe me? Find the shaded area on the charts.)

Let's be clear: The community and regional banks are not to blame. They are doing their best while dealing with huge practical pressures, including the decline in credit quality of formerly pristine borrowers. And I would ask them to join me in helping ensure that our moneyed class and our political class take this issue seriously. There is nothing as important to the country as the health of our middle market.

But as we speak, rather than deal with the economy, politicians of all stripes are talking to their supporters about all sorts of emotion-laden and non-productive cant.

If that continues, I see more banana peels in our path. They will bring a "shaded area" in our future, and the probable demise of a huge swath of our productive economy.

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