Credit crunch, recession, what impact will this have on engineering firms?

30 October 2008

In the last month, we have all learnt a lot about the credit crunch, investment banks, multi-billion dollar rescue packages and bail-outs. While the long-term impact is unknown, most predictions seem bleak. Martyn Day asks if engineering firms will have to tighten their belts

I am sure that, like me, you have been addicted to the news this last month, reading about the financial crisis that’s hit the planet. The numbers involved in the Wall Street bailout of $7billion, and billions in fees paid to shore up British banks and building societies, have been beyond my comprehension. It all makes paying £5 for a glass of wine in London seem pretty good value.

We went from credit crunch and talk of recession to the financial equivalent of Armageddon in a matter of weeks, and now we are left trying to work out what the hell all this will mean looking forward.
For that, you need to have some knowledge of how we reached this disaster point in the first place.

Whenever I have trouble understanding ‘City things’, I always turn to my school friend, Wyn, who used to trade things called ‘Swaps’ and then moved into risk management. He trained as an engineer, being very good at maths and science, but got tempted by the dark side after graduating, heading for the bright lights and financial rewards of banking, rather than working on an oil rig.

I remember about four or five years ago Wyn tried to explain to me how there was too much debt in the system, and how the whole of this CDO (Collateralised Debt Obligation) market was going to end in tears because nobody knew what they were worth and boards of banks didn’t understand their liabilities as the products were too complex. He also pointed out that most of the bankers he was meeting had never actually traded through a recession or been through a financial crisis. I think it’s fair to say that most have that experience now.

Low interest rates over a long period of time, coupled with lax lending criteria, have enabled individuals and companies to leverage up the amount of debt they can take on, and this expansion in cash availability has fuelled some good times for us, our economies and bankers’ bonuses. This debt was packaged up and sold to all sorts of financial firms, and when the defaults started nobody knew who had what liability.

The banks stopped trusting each other, refusing to trade with one another, leading to intervention by national governments. We don’t know how this rescue plan is going to play out or how much confidence these moves will bring, but the UK and the US have done a good job of nationalising a large proportion of the mortgage debt. Still, it’s likely that interest rates will go up and mortgages will suck even more money out of people’s expendable income, leading to further drops in demand for products.

So what does all this mean? The banks’ appetite for lending money has gone and will not return for a long time, so engineering companies that have cash in the bank are in a good position, while those that have been debt-fuelled in the past will start finding it difficult. Already automotive manufacturers in the US have gone to the government and asked for access to $25billion in loans for new tooling as Wall Street doesn’t see them as a safe investment.

Undoubtedly people are cutting back on their purchases at the moment and a brand new car, coupled with the current price of petrol, isn’t high on the list, so automotive will certainly see tough times. In the States, Chrysler has already stopped offering leased purchases. GM’s problems are well known: it announced a $10billion cost cutting plan and $5billion in asset sales to shore up its liquidity. We may well see some big automotive names vanish.

The biggest worry is the lack of investment that comes with tough times, but there’s no reason why this should inhibit innovation as there’s always a market for good ideas

But it’s not all bad news. Firms such as John Deere and Caterpillar have run their businesses cautiously, watching their cash flow and building assets. Many manufacturers have become more efficient users of capital. Engineering firms have followed companies like Toyota and reduced capital spending by getting rid of inventory and shrinking the floor space needed for production.

The George W Bush war on terror has been good to most defense companies, which have significant amounts of cash on their balance sheets after several years of strong earnings. Profits have been fuelled by high-level Pentagon spending on Iraq and Afghanistan and new weapons programmes. That’s not to say a forecasted drop in demand isn’t going to hurt, but the primary reaction is mainly a reduction in expansion plans and delays on acquisitions.

From the engineer’s perspective, recessions have always meant having to do more with less. Fortunately, as most software is on subscription these days, you will always have access to the latest and greatest tools. Being skilled in the use of any of the popular modeling and analysis tools makes you eminently employable as our industry has been facing a shortfall of engineers for many years.

The only ‘IT casualties’ I know of so far have been in the back-offices of banks, of which there are now substantially fewer. The biggest worry is the lack of investment that comes with tough times, but there’s no reason why this should inhibit innovation as there’s always a market for good ideas.

In conversations with my banking friend, discussing economic bubbles and Blair and Brown’s claims of ‘The end of boom and bust’ cycles, Wyn told me, “The only way to end boom and bust cycles is if you can get rid of greed - and I don’t know any way of doing that.” Despite what our procrastinating politicians choose to tell us, the backlash of greed has struck again. We will always have these cycles and we have to cope as best we can, however painful or brutal the next two or three years are.

 

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