The Company Capital Keeps

The essayist Fran Leibowitz wrote a piece that I’ve always been fond of entitled: “On the propensity of good weather to frequent the better neighborhoods”.

Her argument breaks down pretty quickly on closer examination but it’s quite true that we find concentrations of wealth in places like Palm Beach and Aspen. There is a natural matching of value and resources that we can find expressed throughout both our economy and our society.

For example: it’s undeniable that some diamonds should be sold by Cartier and some should be sold by Zale.

And some corporate credit should be served by those with the lowest cost of capital while others will be more naturally served by higher-cost providers.

The AmEx Black Card holder will not likely be applying for a “payday” loan. And the individual in need of a few hundred dollars to tide him over to the next paycheck is unlikely to go looking for it at a Swiss private bank. There is a natural matching of cost of capital to credit quality.

The Receivables Exchange is an unusual entity in that the strongest Sellers and the weakest will find their transactions offered at the same time to the same providers of funds without the sort of “natural selection” that would otherwise typically separate them.

In another era we might say that GM and ABC Dependable Plumbing Co. wouldn’t be shopping for financing at the same counter. Today we might need a different example but the idea is still the same.

What are the implications of this unusual juxtaposition of transactions?

It’s probably too early to tell. But it appears that, at least in the early days of the experiment, there is a tendency for the low-cost-of-capital players to compress the range of returns that would be otherwise required to clear transactions.

As much as we might read about the scarcity of capital today, the fact that the return on cash deposits is essentially zero is causing some investors to reach for yield into areas whose risk is hardly minimal.

The “natural” providers of funds in those higher-risk markets can find themselves crowded out because their higher cost of capital makes competition with the new entrants imprudent or uneconomic.

I’ve written in prior posts about the desirability of a quality-rating system for TRE auctions. The various quality ratings would, in effect, represent different “counters” for different customers. I continue to believe that such a system will be required to support the exchange’s desired growth.

In the long run, the exchange needs to attract as broad a range of Buyers as it does Sellers. Buyers representing low cost of capital have a low cost for a reason. And that reason should eventually cause them to generally match their lower cost of capital to higher quality, lower yield transactions. The same should occur at the other “counters” at which the needs of Buyers and Sellers are matched.

If the higher cost of capital Buyers are crowded out of the transaction flow in the short run, the growth of the exchange will be impeded.

I initially thought that the fact that TRE came online at a time of major credit market disruption was an advantage for it. I’m no longer sure that is the case.

I remain a firm believer in the TRE concept and in the ultimate value of TRE as a powerful agent of positive change in our market. I now think that it’s going to take longer to mature than I did six months ago.