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It's amazing how a day can change everything. Until now, investors seemed convinced that Congress would come to a resolution about raising the debt ceiling and preventing the U.S. from defaulting on its debt. But yesterday, investors finally flinched -- and started thinking about the ramifications that even getting this close to a default could have not just on the government but also on U.S. businesses for years to come.
Yet in light of current events, the moves that many companies made in the aftermath of the financial crisis three years ago to raise cash now look incredibly smart. Although cash-rich companies have taken a lot of criticism from shareholders wanting them to deploy their financial resources more productively, any disruption in the credit markets resulting from a default will make them glad that those companies took the steps they did.
Now that deadlines are fast approaching without any apparent progress toward an agreement, corporate financial executives are scurrying to prepare themselves for what could happen next. Yesterday, The Wall Street Journal reported how companies such as Ford (NYSE: F ) , FMC (NYSE: FMC ) , and Eaton (NYSE: ETN ) have taken steps to ensure that they have the liquidity on hand to avoid any business disruptions.
With many continuing to believe that lawmakers will avoid default, these moves may seem unnecessary. But the Treasury market itself is handicapping the prospects for default -- and assigning a definite probability of a temporary disruption. Yesterday, rates on Treasury bills maturing on Aug. 4 -- the first maturity after the deadline set by Treasury officials for raising the debt ceiling -- quadrupled. Meanwhile, rates on T-bills maturing in late September stayed relatively flat, suggesting that everyone believes any crisis will end by then.
Of course, the bigger question for companies is what impact the debt crisis would have on the economic recovery. For instance, Ford has long sought to improve its credit rating to investment grade, but a fallback into recession could easily derail those plans.
An end to capital-raising
Another thing to keep in mind is that cash-rich companies could actually benefit from plummeting stock markets following a default. At the very least, falling share prices could lead Apple and Oracle (Nasdaq: ORCL ) to take advantage by implementing or adding to share-buyback programs. It could also help those and other companies with potential acquisition plans to pick up target companies more cheaply.
Those potential benefits help explain some recent moves that confused many investors. Over the past year, a host of companies, including top credit-quality issuers like Johnson & Johnson (NYSE: JNJ ) and IBM (NYSE: IBM ) , have issued new bonds to raise capital. Although some of these companies had immediate needs for the money they raised, both J&J and IBM have impressive amounts of cash on their balance sheets already and didn't appear to have any true need for the money.
Yet looking back, taking advantage of the opportunity to lock in low rates while they lasted could have been a stroke of genius. Although the companies may simply have intended to beat a coming gentle rise in interest rates whenever the Fed decided to tighten monetary policy, the potentially much more severe consequences of a U.S. default could clog the credit markets indefinitely and ratchet up borrowing costs for those companies that failed to get in while the getting was good.
Planning for contingencies
Uninvested cash always seems like a waste of financial resources during good times. But whether you're talking about a company keeping some extra cash on hand or the cash allocation in your own investment portfolio, the true value of keeping spare cash becomes clear only when a crisis hits. That's why having an emergency fund for your own finances is a key part of your financial security -- and why you should cut companies some slack for keeping enough money to handle the ever-increasing risks in the global economy.
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