A cure for liquidity managers' subprime insomnia?

• Author: Gallanis, Mike
• Position: Treasury

U.S. corporate financial professionals responsible for liquidity management are sitting on a historically huge mountain of cash, and the subprime mortgage situation is making them very nervous about how they are investing it. Fortunately, there is a remedy that should help many liquidity managers get a better night's sleep; it's called "getting back to basics."

Total U.S. corporate liquidity now exceeds $5.6 trillion, according results of Treasury Strategies' 2007 Corporate Liquidity Research Program. That continues a growth trend that has seen the total liquidity number rise by nearly $2 trillion since 2000, including another 3 percent increase from 2006 to 2007.

With all that cash to invest, liquidity managers are understandably concerned due to the recent turmoil in the financial markets.

In the U.S., about $1 trillion in sub-prime mortgages have been underwritten in just the last couple of years. Mortgages representing about half that dollar amount are expected to have their interest rates boosted in the next two years by 2 percent to 4 percent, leading to more defaults. Many of these subprime mortgages have been repackaged and sold to corporate investors, structured investment vehicles and financial institutions, and are held in bond funds, enhanced cash funds, money market funds and local government investment pools (LGIPs).

What's making corporate liquidity managers nervous is the difficulty in discerning who holds the impaired securities. Problems with these mortgages have surfaced worldwide across a range of asset classes, and rating agencies have lost credibility, in many cases, by downgrading securities only after defaults have occurred. The situation can be compared to the card game "Old Maid," as corporate liquidity managers are looking to avoid getting stuck with a losing card.

The Initial Corporate Response

The desire to avoid subprime mortgage exposure has triggered a flight to quality among corporate investors and a restructuring of many short-term portfolios. Many liquidity managers, for instance, are shortening maturities and avoiding asset-based commercial paper.

Companies are favoring more traditional, conservative vehicles. Some companies that manage their own portfolios are moving their short-term cash into funds, bank deposits or Treasury securities; exiting enhanced cash funds and LGIPs and investing in money market funds, bank deposits or Treasuries; moving cash from bank deposits into money market funds and...