THREATS TO BUSINESS INSOLVENCY IN TIMES OF OVERLAPPING CRISES[a]
This
paper will address what are
considered threats to business insolvency in times of overlapping crises. Debt
crisis, recession and deflation in a global stage of financial thrombosis represent a multidirectional challenge unprecedented in
history for all economic agents. Over-indebted states, widespread loss of economic activity, food and energy crises and inflation that distorts not only economic variables but also habits of producers and
consumers, point to a change in the social cycle that It increases the vulnerabilities of companies
and exposes them to various risks.
Risk is the
probability of a security incident occurring, materializing a threat and
causing losses that, if not contained, lead to the disappearance of the company.
On the other hand, a threat is any action that takes advantage of a vulnerability
to threaten the security of a system[i] or
structure. In particular, the potential negative effect on some of the elements of the
undertaking as an economic operator.
From the proposed
perspective, vulnerabilities become relevant, which are nothing more than the conditions and characteristics of an
organization that make it susceptible to threats, especially those that enhance
or aggravate insolvency and are
exogenous in nature, compromising its sustainability and future. Taking
risks rampantly in all contexts has consequences.
I. BUSINESS INSOLVENCY DOES NOT
ASSIMILATE TO SOVEREIGN INSOLVENCY
The first
threat to be analyzed is the sovereign debt crisis. [ii]
While all economic operators are subject
to cycles, they arenot comparable to insolvencies. They move at different stagesofany business
cycle and their market impacts differ,
as does their treatment.
It is enough to consider that in corporate insolvency the
rights of creditors are very defined within the framework of an insolvency law,
unlike what happens in the sovereign, where creditors have neither court nor
defined procedure for the protection of their claims. There is a strong reluctance in the global
theater to a sovereign insolvency law, which is why debt restructuring
engineering is inadequate.
Unlike what happens in the private sector, countries do not go bankrupt
and that gives greater confidence for chronic indebtedness, even if it means
stagnation. Moreover, all governments rationally make decisions of this nature,
knowing that the default will have to be borne by a future government. What is
economically necessary is often politicallycorrect. This short-term view
explains the failure of many populists national economies.
Anne Kruger, in a report
to the IMF in 2002, argued that the problem of how to deal with situations in
which sovereign debt is unsustainable became more pressing in the eighties,
when private capital flows—composed mostly of loans from private banks to
sovereign entities—increased much more than official flows.
Subsequently, in the
nineties, there was an explosive growth in private flows, both in the form of
bonds and bank loans. This diversity of debt instruments makes it even more
difficult to handle situations where sovereign debt has become unsustainable.
This [iii]
interaction between the different types of crises, undoubtedly impact the
company and although it may not cause insolvency, it cannot enhance it.
Crises can be exchange, debt, or banking. Thus, it can be observed that the
run on deposits generates a demand for assets (currency crisis), which in turn
affects the balance sheets of banks producing a mismatch (banking crisis). The
sovereign debt crisis causes the lack of access to credit in the market
(exchange rate crisis) which in turn leads to an increase in foreign currency
debt. In summary, as some authors point out, these crises cause, separately or
acting jointly, loss of liquidity, credit retraction, contractionary monetary
policy and fall in GDP[iv] ,
affecting private solvency.
The debt crisis is
not only a consequence of another type of crisis, but also a cause. The fall in
GDP because of a monetary depreciation andloss of reserves causes an increase
in the risk premium (country risk) that impacts deteriorating solvency.
Given this
scenario, investors seek better assets and returns, which induces the sovereign
not to raise enough funds to refinance liabilities and declare their default. In the domestic sector, this produces credit
constraints and lack of liquidity that affect the normal business development.
By any of these paths,
it is warned that private enterprise and society in general, suffer the
consequences. It is the so-called social cost: recession, cutting the chain of
payments, unemployment, poverty. For example, the social costs of the
"lost decade" (1980) for Latin America were substantial. According to
ECLAC estimates, the incidence of poverty increased sharply between 1980 and
1990, from 40.5 per cent to 48.3 per cent of the population.[v]
These days the World Bank warned that the economy is heading towards recession and "a series of financial crises in emerging and developing markets that would do lasting damage. "The cause would be in the strong monetaryadjustment aimed at reducing the risks of inflation that worsen the current economic slowdown. The combination of monetary and fiscal tightening could lead to a sharpfall in activity.[vi]
In this scenario, it would be
prudent for heavily indebted countries to drastically reduce public spending,
as Ecuador recently did. Because there are few financing options, due to rising
global interest rates, emerging markets are prevented from taking advantage of
the global bond market. Voluntary restructuring is necessary in these contexts[vii]. For the case of the South African countryrestructuringor the debt with China, to be able to manage and even control certain local economic
variables that suffer from the international context:
rise in interest rates, inflation and economic slowdown. The
new abnormality will be for many countries the crucial management of the fiscal deficit.
Undoubtedly, today as
yesterday, the rise in the price of the dollar means problems for the economies
of the world. This translates into
slowing growth and problems with inflation and its derivatives. Banking is not without risk. [viii] In
the early 1980s, Argentina's private banking system, which
had experienced explosive growth since 1977, was severely rocked by the bankruptcy of the
country's two largest commercial banks and the near insolvency of many other
banks and finance companies. [ix] That ephetum spillover compromised private
sector companies, which were
suddenly sunk in a context of significant credit constraint.
In March 1980 the banking crisis broke
out in Argentina with the liquidation of the Regional Exchange Bank. Thefall of
this bank pushes a banking crisis in the country, in an adverse context for all of Latin America in
terms of sovereign debt crisis. Inthe photo you can see BIR savers claiming
their deposits.
The crisis
experienced today by three companies in the non-banking financial sector in
Mexico, such as Unifin, Crédito Real and Alphacredit, has set
off alarms in the market and requires, in the face of this reminiscence of
1980, some attention. Markets are
flashing red given the overlapping
conditions of vulnerability. It should
be remembered that what lubricates the crisis by the slope, is the lack of
confidence in decisions and the official absence of transparent information.
Its "avalanche" effect is impetuous and there are few signs that
manage to warn of disaster in time, because snow, like banking crises, always
slides violently and once started, its arrest is not easy.
In this situation, vulnerabilities increase. A stronger
dollar makes the debts that emerging-market governments and companies have
incurred in U.S. dollars more expensive to repay. Emerging-market
governments have $83 billion in emerging-market debt maturing at the end of next year, according to
data from the Institute of International Finance covering 32 countries. This is
a fact that companies should observe as they enter the year 2023, because the
signs of tension are widespread.[x]
The poor control of risk and excessive credit and spending by authorities, fitnot only with countries in default, but with banks and companies. In other words, all economic agents suffer disparate effects. That is why it is important that business units manage risk control and evaluate the situation, especially in countries where economic and political improvisation produce serious distortions to the economy and impact on business costs (inflation, exchange controls, export withholdings, credit restrictions) this translates into job cuts, negative expectations of investment, industrial contraction and changing consumer preferences. ][xi]
Threats do not discriminate on
company size. Ford said it is paying more for parts and materials to
offset the effects of inflation. Higher payouts
added about $1 billion in unexpected costs in the third quarter. The company said in July that it was facing
inflationary pressures that would affect a variety of costs, totaling about $3
billion for the year. [xii]
These levels of distortion modify any planned plan.
As several sectors, especially startups, are doing in exceptional situations[xiii], exceptional measures must be taken. Start-ups are questioning all aspects of the business, including their staffing levels and sustained access to capital for the coming months. Crises change the ways business is approached. Financial conditions are acting as an obstacle to any business projection affecting solvency, [xiv] depending on debt levels.
These
levels of indebtedness also differ between the economic blocs; hence the
forecasts are different and the decisions to be taken as well. For example, the
US has a high level of debt: 150% of GDP and corporate indebtedness is also
high. Specialists observe for the coming months, a potential increase in
delinquency, growing problems and probable fall of companies (corporate
bankruptcies). While, in Asia, they
have a very high level of savings, a large reserve of domestic capital that
allows them to self-finance and not depend so much on external flows such as
Latin America or the US private sector. [xv] When easy money disappears, problems appear.
What is the context facing
companies in the face of a sovereign debt crisis? As currencies lose value, inflation rates
rise. The money that emerging market countries borrowed at "low"
interest rates in US dollars becomes a growing mountain of debt and a time bomb
that forces them to manage on the edge of
the abyss.
If the theater of
operations is not bad enough, foreign investors, to escape the ravages of
currency depreciation, run into the hills. The State is left without
financing and so are companies. [xvi] Undoubtedly, credit restriction runs in all
directions, which is why obre-indebtedness, default with sovereign debt
restructuring, bank failures and depressed investment are serious threats to business
efficiency.
According to economists, over-indebtedness is inevitable.
It is the natural tendency of all economic agents who postpone until tomorrow
the payment of the outstanding invoice. [xvii] It
happens that each of these bills has its own vice and propitiate innumerable
economic phenomena, which, like germs, spread very quickly throughout the
social body. This situation of economic gridlock causes great damage to
companies because it affects their ability to develop, causing solvency crises,
which, without adequate therapy, can degenerate into hypertrophy first and then
into financial collapse.
The debt crises of the seventies and
eighties were painful experiences, which have not been properly studied in the
financial education of Latin American countries. Economic history, which many political establishments
repudiate, taught that these countries had large burdens of foreign currency debt. At that time, the world economy was
going through serious "imbalances" that led to high levels of
inflation, so the US Federal Reserve decided, as today, to increase interest
rates to contain this process.
The consequences were severe sovereign debt crises and hyperinflationary processes (Argentina 1989, Mexico 1982, 1987) that devastated the private sector. The region began to recover only in 1989, following a massive restructuring of external debt promoted by then-US Treasury Secretary Nicholas Brady. [xviii] When countries cannot borrow by issuing colored papers, bonds, etc., they resort to syndicated loans, as in the 1980s that as was pointed out so many bad experiences brought. Coincidence or not, specialists indicate that the strategy now followed by the Fed is largely based on the lessons of those years.[xix]
Syndicated loans, grouped among a group of lenders, were the dominant source of private foreign financing for emerging markets until the Latin American debt crisis of the 1980s. [xx] Those times have returned, in the face of a global situation that restricts credit and forces many countries with weak economic structures to continue borrowing due to the lack of fiscal discipline. Private sector companies need to pay more attention to this stage in financial and industrial history.
Losing patience and deciding without caution or based on
predictions, can cause sudden death or business collapse. Hastecan lead tothe closure of the company,
its sale or liquidation in less time than one believes. The deadlines of governments to enter into rescue
agreements with international credit organizations, in the face of an episode
of debt crisis, are not those of companies, which, at all times, are left to their own devices
and will have to make economic decisions
in a context of higher inflation, recession and default.
Banking crises, skyrocketing inflation,
sovereign debt defaults, and economic booms and busts find a common origin in
monetary instability. Each of these evils inspires calls for policy
changes, many of which threaten free societies. Karl Schiller, Germany's
finance minister from 1966 to 1972, got the point right when he observed that
"stability is not everything, but without stability, everything is
nothing."[xxi]
The
bankruptcy of Lehman Brothers took place on September 15, 2008 in the USA. It
is considered the starting point of the financial crisis, no public funds were
allocated for its rescue ashappened withNorthern Rock in the United Kingdom. This dilemma of governments can
perhaps be repeated in the immediate future.
The view
of the banks in this scenario is very articulated. Acrisis is beginning and therefore
increases the forecasts of insolvencies in the face of the tightening of monetary policy that causes higher financing
costs and limits the demand for loans, while credit losses rise.[xxii]
That a group of banking regulators
appointed by the US president is considering “new rules to require large
regional banks" to join the
financial buffers that could be used in times of crisis, isa preemptive sign
that should be considered by companies in their projections for the coming
months. Accordingto analysts, they
include regional companies increasing long-term debt that can help absorb
losses in the event of their own insolvency.[xxiii]
It is worth asking whether
preventive measures of this nature are necessary. Is its cost justified...? The answer would be yes. The
reason is that the constant growth of certain companies and banks has
introduced new risks into the financial system. Thebalance sheets in
some cases are so large that it may be difficult to liquidate such a company in
an orderly manner if one fails. [xxiv] The current economic context requires cutting threats
and prioritizing all types of early warning.
Governments might well ask: How many companies or
banks should disappear? Is it a matter
of quantity, complexity or quality? The
risk of prolonging the crisis and
weighing on productivity can lead to an economic collapse in the private
sector, with its social effects. [xxv] It
is preferable in these cases to have flexible legal tools that allow
to cushion crises or give companies with economic imbalances or in business
insolvency, timely channels that favor restructuring.
It is the market itself that will determine
by a process of creative destruction which continue and which do not.
That banking regulators are pushing plans for banks to be liquidated without a government bailout gives an
idea that the authorities are considering the possibility of encountering
a "black swan of magnitude" that implies, as in 2008, to come to the rescue of certain companies or
banks, considered "essential" with public funds. Situation that
in the current context would aggravate all economic indices, so they are
inviting them to issue long-term debt as a possible way out. It is time to
address instruments to manage "perceived
risks" because the threat of having economic conglomerates too large to fail
is not a fiction, it is a reality.
A sensitive fact to consider is that
there are currently many central banks increasing
the interest rate, which implies a broad expansionary wave of that monetary
policy. Adan
Tooze [xxvi]
points out that as far as
advanced economies are concerned, the era of globalization since the 1990s has
been one of disinflation and monetary expansion by central banks. Now that
balance is being reversed, and on a global scale.
[a] The full version of this article was published on the author's profile on linkedin October 2022
https://www.linkedin.com/in/especialista-derecho-insolvencia/
Notes: Introductión and part I
[i] Threats vs.
Vulnerability, do you know how they differ? https://www.incibe.es/
[ii] We define the debt crisis as An economic phenomenon that countries are going through, dDue to funding problems and indebtedness. Normaly related to difficulties in the payment of their commitments or management of Interest rates. https://economipedia.com/
[iii] https://www.imf.org/es/News/Articles/2015/09/28/04/53/sp111202
[iv] Cosentino, Adrián, and other. Ob. cit., p. 215
[v] Jose Antonio Ocampo Barbara Stallings and others. "The Latin American debt crisis from the historical perspective" ECLAC – UNITED NATIONS 2014, p. 42 ff.
[vi] Andrew Duehren "World Bank warns of global recession next year if central banks raise interest rates too high” https://www.wsj.com/ 15.09.2022
[vii] Sara Schaefer Muñoz and Ryan Dube, "Ecuador reaches agreement with China to restructure its debt" https://www.wsj.com/ 19.09.2022
[viii] Chelsey Dulaney, Megumi Fujikawa and Rebecca Feng, "The rise of the dollar means problems for global economies" in https://www.wsj.com/ 18.09.2022
[ix] By Jone of Onis “Argentine banking system shaken by major bankruptcies in last month" 28.0.1980 at www.nytimes.com
[x] Chelsey Dulaney, Megumi Fujikawa and Rebecca Feng cit.,
[xi] The world is falling apart": the harsh diagnosis of startups in the midst of the crisis on Wall Street" https://www.infobae.com/ 17/05/2022.
[xii] Nora Eckert, “Ford warns parts shortage, higher supplier costs are expected to hurt profits" www.wsj.com 19.09.2022.
[xiii] This is the name given to a start-up, usually with a high technological component, with great growth possibilities and that, in general, supports an innovative idea that stands out from the general line of the market. The search for constant innovation often characterizes these entrepreneurs, who know how to take advantage of the opportunity presented by new digital technologies linked to an innovative business idea. https://www.bbva.com/
[xiv] Natalia Kidd y Carlos Meneses, “La war unleashed by Putin strikes and divides the Summit of the Americas" in https://www.diariodecuyo.com.ar/ 3/06/2022.
[xv] Martín Redrado, "Dollars go like water between your fingers to the Central Bank" https://www.infobae.com/ 5.06.2022
[xvi] Steve H Hanke Ob. Cit.
[xvii] Alan Minc "The challenge of the future" Barcelona 1986 p. 48
[xviii] Ernesto Winter, ¿Will the Fed to strangle America Latin? https://www.realinstitutoelcano.org/
[xix] Nick Timiraos, “Jerome Powell's Inflation Whisperer: Paul Volcker” https://www.wsj.com/ 19.09.2022
[xx]Chelsey Dulaney"Countries," Countries low-income They resort to loans Banking Risksthem" https://www.wsj.com/ 2.08.2022
[xxi] Steve H Hanke, "The floating exchange rates add to economic uncertainty" in https://www.wsj.com/
[xxii] Cristina Hidalgo, "Santander, the European bank that raises the forecasts the most..." in https://www.economiadigital.es
[xxiii] Andrew Ackerman, “Large regional banks could face new rules to deal with a crisis" in www.wsj.com 18.09.2022.
[xxiv] Andrew Ackerman ob. cit.,
[xxv] Oscar Gimenez, "How many companies must die...? https://www.elconfidencial.com/ 03.09.2022.
[xxvi] Adan Tooze, “LThe first global deflation has begun, and it's unclear how painful it will be." in https://www.nytimes.com/ 4.10.2022.
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