So, the US Federal Reserve (broadly equivalent to the Bank of England – it influences the availability and cost of money and credit in the US economy) is about to bail out Fanny Mae and Freddie Mac, the two largest US mortgage providers. This comes on the back of the Bank of England helping, in no small way, Northern Rock.
One rule for them, another rule for us
In reality, in general economic terms, these companies (especially Northern Rock) should, in our world have had a receiver been appointed, and have gone out of business. Luckily for them, governments seem to think that banks and mortgage companies underpin modern day economies and that, if they fail, distrust in the market would make investors like you and me so nervous that we’d take our money out of the system causing the economies to collapse.
But, in our world, governments are not prepared to underwrite failing companies and we have seen in the last few months several high profile failures running into trouble.
Rising from the ashes
Typically these companies reappear a few days later as new companies (one might call them Failed Company 2008 Ltd), Phoenixed from the ashes having, it seems, shed their burden of debt so they can continue to trade.
Let’s have a look at how this can happen and the consequences.
Cause and effect
When companies run into trouble it normally means that the market is saying they either have too high a cost base and/or are not pricing their product correctly. Let’s take post production, for instance.
Currently, there are too many companies chasing too little business. They are having their budgets cut by the television companies. This forces down the price of jobs and, eventually, something has to give. The economy is telling us that, in Darwin’s terms, it is survival of the fittest; several companies are no longer fit.
In theory, unfit companies fail. Their work is then shared among the fitter companies who consolidate their position. The world continues with a new look.
Unfortunately the law, and common business practice, now allow people to circumvent this economic reality. Now I am not saying that any of the next few steps are ever thought through in advance; stuff happens. And it often happens like this.
The route to ashes
Let’s call the company Phoenix. Phoenix spends huge amounts of money on new edit suites. It takes on new staff and, probably, a telecine suite. It is now the new best thing since sliced bread.
But Phoenix now has huge debt and a large salary package to maintain. Somewhere along the line, it does not meet its business forecasts, perhaps because work is not coming in quickly enough, or the costs of funding its debt are rising, or many other everyday, unsurprising reasons.
It goes along to its bank and asks for extended facilities. The bank, in the current climate, says no. Phoenix is in a quandary. It cuts its prices to get work. (This also affects its competitors, the prudent companies, as you’ll see below.)
Phoenix continues to suffer as it now can’t bring in enough cash to service its debt. VAT and PAYE are due at the end of month, so it stops paying its crown debt (owed to the government in taxes). Business continues to slow down, it decides to continue to not pay its VAT and PAYE bills and then starts not paying the leasing companies for the debt it originally took on to expand. In desperation it cuts prices even more (this further effects the prudent competitor companies). Then, bang; Phoenix goes into receivership.
Rising from the ashes
Two days later, having shed some staff (the state – that’s you and me – pays the redundancy costs) and having left its debts (VAT, PAYE, advertising, creditors, lighting, heating, electricity, blah, blah, blah) in the shell of the old company, opens up as a new company – let’s call it Phoenix Risen – with its leasing debt rescheduled by the leasing companies. Phoenix Risen carries on trading.
But at what cost? The market was telling it that it was uneconomic. It has pushed down market prices for everyone else – their fitter competitors, companies which are paying their leasing debt, their crown debt and their creditors – yet they are allowed to walk free.
Just a soap box theory?
I may sound as though I am on a soap box this month but is this system fair?
Going back to the first paragraph, Gordon Brown is not going to bail out Peter Savage if I make some wrong decisions in my lending – so why should companies be allowed to run up huge numbers of creditors then ditch their unfit companies – and then carry on? It is against all free market arguments.
Maybe you have gone through a receivership and can show me the benefits. Maybe you have been affected by a receivership or, worse, maybe a receivership has caused you to go out of business. It would be good to hear your comments.
If you would like to comment on this article, or any in the series, write to Peter Savage at firstname.lastname@example.org or contribute to the blog at www.azule.co.uk/articles.asp where you can also read previous articles in this series.