Friday, January 9, 2009

Larry Melby, Thoughts from an Entrepreneur, "I smell a Rat"

Larry, Please give us your thoughts on this Economic Meltdown.
Larry ran a successful staffing firm for many years and he has
been an advocate for special needs employees as well as a delegate
to the White House Conference on Small Business.


The first thing that I feel has often been left out of the discussion is that the people in charge of dealing with this mountain of debt were piloting the plane when it hit the mountain. Yet we put them in charge of raising bigger mountains. It does not make sense to me. Back in the spring of 2008, I heard about the derivatives problem and it was then pegged at $62 tri. (Is that the abbreviation of ‘trillion’?) I cannot comprehend that amount of money as it is over 4 times our Gross Domestic Product. I also never understood derivatives. It seemed to me like a huge gambling program played by the rich.

Now we find that while everybody was watching their chips, the bank vanished.

Back in 1998, there was the unraveling of Long Term Capital Management. I would have thought that regulators would have put some controls in place at that time, but obviously, they didn’t. This is an even further concern since we have had both the republicans and democrats in charge of the regulators since then. Who is watching the regulators?

Does anybody know what will happen when these derivatives do unravel? Who is going to be left holding the bag and how will it be decided?

For some time it has seemed that we have too many insiders in charge of their own industries. The financial melt down just confirms that. Standard and Poor’s, Moody’s and Fitch’s all have their fingerprints on the mortgage crash. I have to believe that if I could see this crash coming before 2005, when I sold my house, then these people who were paid to know should have known. I smell a rat, but like LTCM in 1998, there is little movement toward an investigation and indictments. The most plausible reason is that without these rating agencies, fund managers would have to do real research and they don’t want that responsibility. You still have to believe, however, that if I knew that the rating agencies were complicit with the mortgage bundlers in creating AAA ratings, then these “Masters of the Universe” knew. It is obvious that they were also fairly certain that they would not get into any trouble. I read late last spring, although I can’t remember where, that a manager at one of the rating agencies told his workers that they would all “be rich and retired” before the bubble burst. I also read, but did not bookmark, that when asked about a mortgage rating from Fitch’s, “What will happen if real estate prices go down?” The answer was, “Our models don’t allow for that.”

Finally, what about sharpening our intuition, or as you put it, watching for the tiger? With this, my being a living troglodyte really shows. The most important thing that business people can do now is to limit their debt. Our firm was the only one in our industry that did not factor our receivables. I always thought that running your company on borrowed money made the banker your partner. A partner who did not share your goals and didn’t care about you or your people—truly the tiger. It shows now, when perfectly good companies are having their loans called. Our company’s cash management plan called for using a line of credit in the summer, when sales were expanding and paying it off when sales slowed and receivables caught up at the start of the new year. Another aspect of our company’s cash flow was that all of the bonuses were paid on collections, not sales. The bonuses shrank by half for every 30 days that a debt went unpaid and were zero after 90 days. (Bonuses also made up half of the compensation for all of our salaried people.) This put the people in charge of sales also in charge of collections.

Here is my advice for those who survive this downturn:

o Pay down your debts so that any time you borrow it is for an increase in activities that will generate the additional funds needed to repay the debt and you know exactly when you will repay.
o Discipline your customers to a 30 day or less pay cycle. You are not their banker and you can not afford them as a customer if they think you are. If you have the best service, they will be back.
o Orient your entire work force, especially salespeople, to the idea that the money has to get into the bank before you can use it.

3 comments:

Al Walsh said...

It's impossible to know who will pay the tab when the derivatives collapse. It's a private market. I think the Fed knows, but they're not talking. Given the size of the market (and even that is only a guess based upon snippets of info that have leaked out) it has the caspability of bringing the economy to it's knees. Scares the heck oout of me.

Debt is always a dangerous game - just as it is in our personal lives. I always councel businessmen to run their companies like "Hasidic Rug Merchants", making every penny count and financing growth from profits. Sometimes debt is a good tool - but should be used sparingly. Right now, it's an incredibly dangerous game.

I work with entrepreneurs for a living. These are the most dangerous economic times I've seen in my lifetime. To the entrepreneurs, paraphrasing Elmer Fudd: "Be vewy, vewy careful".

Al Walsh said...

I smell a rat alright, and it's the size of Wall Street.

Anonymous said...

haha...Larry, good to see you're still kicking. I like your blog.
Will add to my faves.

of course you remember me, I worked for you for 9 years.

Ron S.