What a ****** mess!
(but there’s worse yet to come!)
The Eurozone is close to imploding; the USA has reached its debt ceiling and there’s talk of being downgraded; UK inflation is double target rates; interest rates are as low as they can get; the economy is in a double dip (don’t try kidding me it’s not); the impact of government cuts is yet to hit the ‘real world’; the banks are not lending (again, don’t try to kid me!); government finances appear to be on an irreversible downwards spiral; the government has no strategy for growth: it’s difficult to see how things could get worse, even the weather is pretty awful!
People think that as an insolvency practitioner, it’s in my interests to spread doom and gloom, but really it’s not, we make more money as the economy comes out of recession. This bumping along the bottom and the doom and gloom enveloping the country does no one, not even IPs, any good – you only have to look at the share prices of some of my bigger, listed, competitors, who have seen their values fall by 80% over two years (Begbies Traynor); halve over the last 6 months (RSM Tenon); or halve in the last two months Fairpoint (Debt Free Direct to me and you). Unlike earlier recessions, which were far shorter, this one has already seen a minor bloodbath in the professional sectors, including the legal and insolvency professions, as well as the rest of the economy, but believe me, far, far worse is yet to come. Most businesses are not ready for it. Most cannot now prepare for it.
I don’t have the space here to raise all the points I’d really like to. Instead, I’ll just draw parallels between my experiences as an insolvency practitioner over the last quarter of a century and what I am seeing today.
‘Insolvency is divisive’
In my 25 years in insolvency, I can count on one hand and still have fingers to spare the instances when everyone pulled in the same direction once a company looks like becoming insolvent. It is pulled in different directions by customers, employees, landlords, directors and suppliers, all looking after their own interests. No one wins from this, everybody loses. And I am seeing the same thing happen today, but with countries. There simply just isn’t the willingess to work together to the degree needed, and there’s no one to force everyone to work together. The argument that ‘it will hurt you too, just not so much’ loses all weight because there is no trust. Maximising their control over their own finances becomes the principal driver.
‘A bad situation can quickly get out of control’
Companies can struggle for years under mountains of debt, putting off the decisions they should be making, hoping for something to come along to make it all right. Eventually though, the final straw causes things to come crashing down, far more spectacularly than everyone expects, with everyone saying they didn’t see it coming.
‘People will do anything to avoid making major decisions or big changes’
People are stubborn, companies and institutions are slow to change. Stubbornness, occasionally a virtue, becomes a major impediment to change. And people make everything, good or bad, happen. Sometimes you have to change the people at the top to make major changes happen. Leave the same people in control and they often just keep on digging, just with a smaller spade! And it’s always someone or something else’s fault.
‘If only we could borrow a little more, we’d be alright’
People see cash, or the lack of it, as the problem, when in reality the lack of cash is the symptom, not the root cause. People whose businesses are on the verge of going under are often still in denial, right up to the bitter end. Their only strategy is to somehow defer facing the problem head on, carrying on almost as they did before, hoping that somehow things will come right. But (and this is one of my favourite sayings) ‘hope is not a strategy’.
‘Sometimes in life you have to take a step backwards before you can move forwards again’
Sometimes, it’s inescapable, it is the only way. Taking that step back takes more courage than merely carrying on as normal. It requires a recognition that what went before was unsustainable and requires a leap of faith into the dark. Typically people have to be forced into a corner before they will take that necessary step back.
Let’s look at these in the context of today’s global problems.
A few days ago the US hit its national debt limit, of $14.3 trillion (that’s 14 followed by twelve zeros). The USA is bust, sure it doesn’t carry the same level of debt proportionally to some other countries, but it is bust, its ability to repay depends on future generations’ payment of its current debt. It cannot borrow money on the open market – China won’t lend it any more, Japan has its own problems. The US Senate released its report ‘Wall Street and the Financial Crisis: anatomy of a financial collapse’, a few months ago. 650 pages, two years in production, its purpose is to record the facts. Even here the party lines are firmly drawn up. They cannot agree on the causes, so what chance is there of the US doing what it needs to halt their borrowing binge? The Federal Reserve is now buying up virtually all of the new US government security issued, the vast majority of which is rolling over earlier debt or just paying interest, i.e. it’s dead money. The world has largely stopped lending to the US, that is except the UK which in the 10 months to April 2011 increased its holdings of US debt almost two and half fold to $333 billion, making it the third biggest holder after China and Japan. What do you think will happen to the value of your pension fund, your endowment, and the UK banks’ balance sheets if the rating agencies downgrade US debt as they are threatening? What would you say if you were asked to lend a few thousand pounds to your local credit addict? – well, too late, you have already done it!
The Eurozone is creaking, with the major players with ready access to cash questioning whether they should really be throwing more cash at other countries. Or if they do this time, when will it stop with this particular country or others? The UK’s direct exposure to problems in the European banks may only be small, but the extent of our indirect exposure is far more unclear. In the meantime, the banks are still not lending to SMEs. Here’s a link to the latest research by the ICAEW and for the Business Finance Taskforce. I suspect the low level of SME lending is due to a combination of things: the banks rebuilding their balance sheets in order to satisfy Basel III; the banks encouraging people not to apply for facilities unless there’s a very good chance of them being granted (massaging the figures to you and me); and people’s lack of trust in the banks. I expect Basel III, the third and probably not the last effort at reducing risk in the system, will hold back the upturn when it comes – I’ll go into this in a separate newsletter in due course. Suffice to say that, at this stage, with the banks too big to fail, the interdependence of the banks on each other not having diminished over time, and their being propped up by you and me in one way or another, we have the worst of all possible worlds.
So what’s this all leading to? I think that this bumping along the bottom is the best we can hope for for a long time to come. I cannot see any improvement coming for a good many years. Historically, the way to end recessions has been to have a good old fashioned war and a good bout of inflation. I cannot see the former happening: there are no real foes big enough to stimulate economies to the degree needed this time around. I can see inflation going up from the reported 4%, both in the short and long term, and that will hurt more some members of our society than others. Some even anticipate double digit infaltion rates: that could cure the world’s debt problems, but at what cost?
So how does a small business owner steer his business through all this turmoil? How does he manage risk? What opportunities does he take, what should he defer or turn away? How do you, his adviser, best support him? None of these are easy questions; there will be an awful lot of pressure on you, the adviser, over the next few years. Those advisers that best support their clients may see them prosper; those who don’t support their clients, do so only reactively or don’t look outside the box will see more of their clients failing, putting their own livelihood at risk. I’ll be running regular blogs going forward with tips on what your clients need to consider doing to steer themselves through these uncharted waters. I expect to challenge you, and I would like you to challenge me, because I really do not expect anyone to have all the right answers this time around. It’s really going to be tough!
What future is there for the legal profession?
A long time ago my father advised me to join one of the professions because they are ‘safe and well paid’. How things have changed! The last three years have seen the professions which are ‘transactional biased’ (such as the legal and insolvency profession) rather than compliance focussed (accountants) really struggle. Many firms have already been forced to merge with others, a few have already gone to the wall. It is clear that no profession is immune from this recession. The problem with the professions is fourfold: (1) there are too many people chasing too little work; (2) Here in the UK, people do not like paying for advice. Even if they get the result they desire, they will quibble at the price; (3) it is easy to take on overheads when times are good, but it’s not so easy reducing them when times are bad; and (4) the money made in the good times has been spent holding up the business for the last three years, there’s now nothing left in the coffers.
I don’t anticipate either the number of people trying to join the professions to reduce in the short term (currently there are 83 law graduates applying for each job); the number of transactions completed by either companies or individuals to increase (for the reasons set out above); people to wake up and suddenly (1) think they’ll seek advice and (2) be willing and able to pay a proper rate for it; or landlords and finance companies to willingly forgive debt owed by the professions. It all makes for a tough time for the legal profession, in particular for small firms with no niche. ‘Tesco law’ is almost an irrelevance for them, a good many will disappear before it’s really had any impact. The lucky firms may be able to merge their ‘big hitters’ into larger practices (obviously with little or nothing paid for goodwill or work in progress), but the rest will disintegrate, the partners and professional staff resurfacing as one man bands operating in a much smaller way, outsourcing their back office functions. I expect the legal profession to look very differently in a few years’ time. I hope that I am wrong, but fear the worst.
Why do I raise this now? I’ve noticed that there are a good many lawyers who converted to LLP or limited company status who have not yet filed their March or April 2011 accounts. Most took a good while to file their 2010 accounts, and they looked pretty awful. And I don’t expect the 2011 accounts will show any improvement. I guess those firms which stayed as partnerships don’t show any better position. At the level of expected cash burn, I suspect that many firms are now hitting the buffers, unable to pay the tax due at the end of this month or unable to cope with any extension of the recession. I have also heard of firms investigating TUPEing their support staff / function out, into third party operated service companies in what appears to be a desperate attempt to jettison costs. This demonstrates the gravity of the situation and reinforces my earlier statement above that these circumstances are divisive, because despite what Cameron says, people will look after themselves first.
A good number of solicitors locally have March or April as their year end, so I would expect them to know now how they did in their last financial year. Their senior people need to ask themselves now what steps they should be taking – there’s a urgency to this because HMRC and lenders are getting tougher because they know that in a meltdown scenario professional firms realise very little because their main assets have legs.
A good day for burying bad news?
A few days ago, while we were all talking about the phone hacking scandal, the Bank of America reported its biggest every quarterly loss – a whacking $9 billion! The loss represents a settlement reached with certain buyers of sub-prime mortgages they had packaged into mortgage backed securities, where B of A misled the buyers. You may recall from earlier newsletters that I suggested that the accountancy profession was at best ‘asleep at the wheel’. Am I the only one who would like to ask PWC, B of A’s auditors, given the level of charge in this quarter, why they thought B of A’s earlier accounts showed ‘a true and fair view’ and were prepared using the ‘accruals concept’, which typically sees losses recognised earlier rather than later. This shows two things. Firstly, not all the banks’ bad news is out – they are just spreading their losses over the number of years they can keep the litigation running for. Secondly, PWC need a copy of Frank Wood’s Business Accounting 1 in their library! (it’s about £30 from Amazon, a second hand copy is even cheaper!)
And finally, I apologise for the length of this newsletter, it’s been some time since I last wrote, and things are warming up more than a little on the global front. As always, please let me have your feedback on my ramblings – good or bad – and if you dispute or would like to add to anything I say, please drop me a line.
Thanks for taking the time to read this,
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