One important thing to note is how cash reserves are vital to stop a financial crisis. If you look at the Chinese banks in the 1990’s. They were totally insolvent with liabilities far in excess of assets, yet there was no crisis. Now compare Bear-Stearns and Lehman Brothers. A year ago they seemed to be doing fine, and the time between when they started having problems and the time in which they died was less than a week.
The reason for this was cash. Even though the Chinese banks were insolvent, they have about 50% of their assets in either cash or government securities. Standard fraction for commercial banks in the US is 10%. Standard for IB’s such as Lehman and Bear-Stearns was 3%. What this meant was that the Chinese banks had lots of time. When people went to the bank to get their money, their money was there, and that kept other people from lining up demanding their money. So the Chinese banks had about five years to figure out what to do, and then about 10 years to actually do something. By contrast Lehman and Bear-Stearns had one week between problem and destruction.
There are two implications for American management theory:
1) American management theory does not like companies holding large amounts of cash, since cash is a waste, and you can easily borrow money from the money markets if you need it. Chinese companies hoard cash, and they will often take out loans just to have cash available, which is absurd from an American standpoint.
It looks inefficient, and it *is* inefficient, but it does create a huge weakness in the American financial system. One analogy is that of a big diesel generator. It’s stupid and inefficient for most people to have a big diesel generator if you are connected to a reliable power grid. However if the power grid is very unreliable, people are more likely to have these diesel generators. Same with cash, American companies can very easily borrow money from the money markets from commercial paper markets. So keeping cash around is a waste. However, in October, the power very nearly went out, and if Treasury hadn’t intervened to prop up the money markets, we would have had a huge disaster as the power goes out and no one has any diesel generators.
2) Americans are a “get it done and fix it now” people. It’s the culture of thirty second microwave popcorn. This is good, but it also has one weakness. Americans like to fix the problem once and for all, and really hate things that just paper over the problem. If you are bleeding cash, then having large amounts of cash doesn’t solve anything. The Chinese banks still needed a government bailout as did Lehman, so having cash seems to be irrelevant.
However it isn’t. Time is important factor in crisis, and having cash doesn’t solve your problems, but it gives you time to solve your problems, and having time gives you more options. If you have ten years to solve a problem as did the Chinese banks, you can do more things than if you have a weekend which was the case with Bear-Stearns and Lehman.