Subprime Mess: Is that a Mushroom Cloud in the Distance?

If you are like me you are having a difficult time getting your arms around the subprime crisis. I am not sure how bad it is; what it is going to do to me; and what action I should take, if any? I hear all of the problems in the news, but, as of yet, it hasn't affected me. Finally, I after much agnst I came up with an anology that helps me visualize the situation and how I should react.

Picture yourself standing outside your home. Fifty miles away, in the distance, you see a mushroom cloud from a nuclear blast rising into the atmosphere. Once you get over the initial shock you realize that it is far away from you. In fact, the sun is shining and everyone is going about their business.

The second thought that comes to your mind is: "I wonder which way the wind is blowing?" Is the nuclear fallout coming towards me or away? How bad is it going to be? For those individuals at ground zero it is pretty bad!

I visualize the subprime mess as a nuclear bomb that has exploded in our financal system. Personally, I don't have any direct contact with industries affected by the crisis. The sun is still shining on my business and we are making money. But I am keeping an eye on that mushroom cloud in the distance! I know that as it spreads through the economy some fallout will affect me. In the meantime, we are spending causiously, hiring selectively and marketing aggressively.

Banks Tighten Credit Standards

An article in todays' Wall Street Journal highlights the tightening of credit across the countries banking community. The author cites interviews with bankers indicating a change in the amount of risk that lenders are willing to take. Later in the article the author cites sources that say they haven't seen a credit crunch. So which is it?

The short answer is that it depends on your local market. How is the local economy performing and how competitive is your banking community? Regardless of the current lending environment you can count on banks' underwriting to become more conservative. Why? Because the federal banking regulators will begin to tighten the rules for the entire banking community not just local markets.

As a CFO or controller how can you prepare for this changing environment? The best way is to get your financial house in order. Imprvove your cash management reporting. Prepare a cash flow projection to give to your banker. Prepare a strategic plan to manage and predict your capital needs months in advance. Finally, take your banker to lunch. Let him know what is happening in your business so there will be no surprises.

By improving your cash management tools, forecasting your needs and communicating with your banker you can actually weather the coming credit crunch.

Don't Let Your Business Lose Money for Too Long!

Over the holidays we were asked by an investor to examine a company and determine if it could survive. We reviewed the financial records and met with management. At the end of our review both we and management agreed that we were about a year too late in saving the company! What difference does a year make?

What was different one year ago? The company had a profitable business surrounded by money losing products and high overhead. Action could have been taken to shed the unprofitable business, reduce expenses and grow the profitable sales. Unfortunately, time had run out!

One year ago the company had positive working capital and a good relationship with their vendors. Over the past year they consumed their cash and disappointed their vendors to the point that no one was willing to work with them. The best analogy would be to imagine you are flying an airplane and the engine stops. As the plane plummets toward the earth you don't wait until 1000 feet over the ground to bring it out of a dive! Same thing with a company!

If you find your company in a dive and losing money you should remember two rules:

Rule #1: Don't Lose Money!
Rule #2: See Rule #1!

It is imperative to take corrective action early in the crisis. Most entrepreneurs do not want to take one step backward. Unfortunately, it is sometimes necessary in order to survive a recession.

If They Will Buy Then I Will Sell!

Or stated another way, if I can sell it then buyer beware! That seems to have been the motto for the sub prime mortgage industry. Over the past five years a looming crisis has been in the making. Mortgage brokers would originate the loan then immediately pass on the risk to the investors. Few would keep the loans for a month let alone ninety days. Consequently, they were assuming little risk and had no incentive to police the quality of the loan.

Some people are questioning whose responsibility it was to police the market. At some point in the cycle someone needed to say no to the level of risk being assumed. Some say we should have government oversight. I say it is the job of Mr. Market!

The only thing that keeps people from taking stupid risks is the fear of loss. Until recently we haven't had that in the past five years. During this time period we have experienced low cost of capital, high liquidity and increasing productivity of employees. Now the market forces (i.e. losses) are policing the sub prime markets.

The real question is what other markets in the economy are in line to be disciplined? The economy is beginning to look like a slow moving train wreck. This scenario is not unlike the dot com bust where few of us were directly in the business but all of us were effected. Now is the time for entrepreneurs and their CFOs to take action to weather any possible storm.

Is the Tide Begining to Fall?

Today I attended a luncheon for the Turnaround Management Association of which I have been a member for approximately 10 years. During this time I have seen good economies and bad. For the past 3 years the economy has been so good that the TMA meetings looked like a Maytag repairmen convention. Today was different!

The room was packed with people I had not seen in 6 months. What was more thought provoking was the speaker. Not what he had to say but his recent career change.

Trained as a bankruptcy attorney the speaker had spent the last 6 years as an investment banker. Sometime during the year his firm was sold to Merrill Lynch. He recently left Merrill Lynch to join a major law firm. Doing what? Bankruptcy law!

So when the investment bankers start becoming bankruptcy attorneys maybe we should be watching the economy more closely!

Check out the warning signs of a company in trouble