Outlook: There are not many things about the credit crunch that hand on heart I can claim to have seen coming, but I did repeatedly warn about the idiocy of share buybacks and leveraged takeovers. These fashions were in fact two halves of the same coin – they were about replacing equity with debt in the mistaken belief this was a more "efficient" use of capital.
All was fine as long as debt was cheap and plentiful. In some cases, leveraging the balance sheet in this way produced big short-term gains. But when things turned, making debt scarce and expensive, the "efficient balance sheet" became lethal. Having given all their capital away, companies are now in the process of desperately trying to get it all back again.
The queue of companies looking to tap shareholders and other investors for new equity is said to be unprecedented. Corporations are looking for hundreds of billions of dollars in fresh equity in a bid to pay down their debts. Those that can't raise it are being forced to sell assets at rock-bottom prices. Either way, excessive debt has predictably proved profoundly destructive of shareholder value.
Regulators propose counter-cyclical capital controls for banks, and economists urge something similar for macro-economic policy. Investors should ensure the same safeguards are built into corporate balance sheets for the long term. What were previously thought "safe" levels of leverage have proved life-threatening in a downturn. Haven't we learnt this lesson often enough? Do let's try to remember it this time.Reuse content