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Faculty Focus

World's Economy Calls for Great – and Difficult – Decisions
by Brian "Duff" Bergquist
Executive-in-Residence

As part of Whitworth's Great Decisions lecture series, I just finished giving a presentation on the financial crisis. As I worked on my lecture, I took some time to reflect on my first year as Whitworth's executive-in-residence. It has been a very satisfying eight months. I've had the opportunity to engage students on an intellectual basis as well as to provide guidance as they prepare for the next step in their journeys. And it has been rewarding to see the seniors receive job offers and fulfill their first objectives.

The title of my Great Decisions presentation was "Narvik to Spokane with a Stop in Las Vegas Aboard the Financial Crisis Express." I left Lehman Brothers in the summer of 2007, one month before Bear Stearns' mortgage hedge funds collapsed, initiating the crisis. It gave me a chance to compare corporate America to the financial structures of the other countries involved and to draw some interesting conclusions.

Corporate America's balance sheets today are as healthy as they have been in the last 20 years. U.S. corporations hold more cash on their balance sheets today – $1.93 trillion at the end of December 2010 – than at any other time since the 1950s, and they are utilizing the least amount of leverage since 1995. Companies have made tough decisions and right-sized their businesses to match the economic environment. This was a painful process, and the result was a stubbornly high unemployment rate. But we have started to see some encouraging signs: Global mergers and acquisitions activity surpassed two trillion dollars in 2010 for the first time since 2007. M&A activity is expected to top three trillion in 2011. First-quarter 2011 activity continues this trend, but it has been influenced by geopolitical turmoil and the tragedy in Japan. The initial-public-offer market is also coming back to life as the appetite for new companies is starting to pick up. Several companies, including LinkedIn, Facebook, Groupon, Skype and Pandora, will go public this year. This is an encouraging sign as it signals that CEOs and other business leaders have increasing confidence in the direction of their businesses.

Corporations are starting to invest some of the earnings they had retained to protect themselves against continued economic weakness. Stock buybacks were up 174 percent in 2010 vs. 2009, at $359 billion, and 2011 is running at a higher rate than 2010. Corporations are also more likely to return cash to shareholders; the dividend payout ratio for S&P 500 companies is currently at 31.3 percent, a 20-year low. This does not necessarily indicate that the economy is going to grow at a rapid pace, but it does mean that business leaders closest to the market are confident enough in their short- to midterm outlook that they are willing to invest. Corporate America has made a lot of progress in healing the wounds caused by the financial and economic crisis.

The same can't be said for other countries involved in the crisis. The economic health of several European countries is moving in the opposite direction of that of U.S. corporations. The fiscal and economic crisis reduced revenue and highlighted the deteriorating debt burden – debt as a percentage of GDP – which many of these countries face. Portugal requested an E.U. bailout April 7 of around 80 billion euros or $115 billion. Ireland and Greece received bailout money last year. A condition of the bailout requires countries to cut spending and usually to raise taxes to meet a target figure for deficit as a percentage of GDP. The IMF target for Ireland is 3.8 percent in 2015.

The budget cuts required to meet these targets have caused unrest and protests across Europe. In March, London experienced protests against cuts to public services. The protests were reported to be the largest in the capital since 2003. Ironically, the rally centered around Oxford Street, the world-famous shopping area. It has also had an impact upon employment in Europe, as Greece and Ireland have unemployment rates of 13 percent, while Spain's is around 20 percent. The bailouts have not automatically eased the markets' views of the affected countries' finances. The CDS spread of credit default swaps in Greece traded at a record of 1,100 basis points on April 14. This spread indicates the market's belief that Greece will have to make further cuts and, most likely, to restructure its debt.

It's interesting to see corporate America's response to the financial and economic crisis compared to the response of other involved governments. The U.S. government is finally addressing the deficit, with both the Republicans and the Democrats advancing deficit-cutting plans. This will not be an easy process, and tough choices will have to be made. I think we should all buckle up and grab a bowl of popcorn because it's going to be an interesting and bumpy ride.

 

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