I recently was chatting with a residential mortgage broker and learned that conventional mortgages, those that qualify for purchase by Fannie Mae, carry a higher interest rate than “jumbo” mortgages, those that are too large to conform to Fannie Mae requirements. For many years, conventional mortgages carried the lowest interest rates and borrowers who required larger mortgages paid a premium for the privilege. Today the market is inverted. Part of the reason has to do with higher charges imposed by Fannie Mae. There is also the possibility that the market perceives jumbo mortgage borrowers of higher credit quality than conventional borrowers. But another key factor is that there are more dollars seeking investment in mortgages than there are borrowers seeking mortgages.
A similar point was made in a recent article which reported that private equity funds are sitting on $1.5 trillion in cash held for investment. This hoard represents the highest amount on record, and more than double what it was just five years ago. In addition to that, there is an additional $156 billion dollars which investors have pulled out of stocks and into bonds and money market funds in 2019. And, of course, we read every day how the Federal Reserve is working to keep interest rates in check and supplying liquidity to various markets as their foreign counterparts do likewise even to the point in some cases of imposing negative interest rates.
Our world economy is awash in cash. From my conversations with clients, colleagues and fellow professionals, it appears that many businesses have very little need for that cash. More businesses today are able to grow without significant investment in capital assets. Cash flows have been aided by just in time inventory methods, direct distribution from manufacturer to end user, technology solutions which mitigate capital equipment requirements and cloud-based payment processing.
But the old axiom remains true—the best time to borrow money is when you have no need for it. Lenders love to lend money to companies when they are flush. And when a company actually needs to borrow, lenders start to get skittish. The same is true for companies considering a sale. It is much easier to hold value when selling is an option, rather than a requirement.
Seasons come and go. Markets ebb and flow. Abundant liquidity will in time abate and money will become tighter. The precipitating event or series of events that mark the shift will be clear to us all after the fact. I will be happy to point out the obvious signs of the changing tide in hindsight. Now is the season to stock up on cash. You may never need it, but too much cash is something I consider a high-level problem. On the other hand, if you need cash and can’t get it that won’t be fun at all.
Liquidity transactions have their costs: transaction fees, interest charges, taxes, etc. With equity transactions, the cost is less tangible. It is the risk that the market has not fully priced in asset values, which leads to the question: “How much have I left on the table?” That concern reminds me of the response of banker Baron Rothschild when asked how he accumulated his wealth. He reportedly said that he made his money “by selling too soon.”
A transaction that brings you liquidity that you never need is like the umbrella which you carry in anticipation of rain. If it never rains, you have suffered a modest inconvenience. But if the storm does come, you could end up much worse off than merely with a wet suit of clothes. There can be great benefit taking an action too soon.
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