BLACK SWANS REQUIRE LARGE CASH RESERVES
One of the many business mistakes I've made in my career, and I've made a ton, involved not having a large enough cash reserve for an extremely rainy day. Today's inter-connected, lightning-fast business world requires a war chest much larger than previously thought prudent. Nassim Taleb's book, "The Black Swan," lays out the premise that all the impactful events in business, economics, and world history could have never been predicted. The book title emanates from the simple story of how European encyclopedias listed swans as only white until a global explorer discovered black swans and forced the scholars to change the facts. This true story is a metaphor for "we don't know what we don't know" and "we won't predict what has never happened before."
As a result of our blindness, the events that truly disrupt our organizations are always ones the consultants and the attorneys never imagined. One school of business builders totally shuns financial advisors, risk consultants, and economists because they never foresee the truly impactful events at the edges of the Bell Curve, except, of course, on subsequent talk shows giving their Monday Morning Quarterback analysis.
This is why in today's highly connected and highly regulated environment we require a much larger war chest of cash. I failed to predict a great black swan. with one of our earlier investment firms. I had prepared for terrible market swings and poor economies, and we had weathered many of these cycles over two decades. But I missed the government regulatory backlash after the 2008 Financial Crisis. Following this worst crisis since the 1929 Great Depression, the government regulatory state responded with never-before-seen fines, indictments, and forced closures. A common misperception is that the government did not exact a great revenge on the financial community. This perception was only correct for the large, visible Wall Street companies. For the rest of the community, the government closed over a thousand firms and brought a large number of civil and criminal actions against mid-tier and boutique firms and individuals. The large public corporations mostly wrote the government substantial checks (with shareholder dollars) anywhere from $10 million to Bank of America's $17 Billion in order to satisfy their regulatory investigations.
Our firm was caught in economic purgatory - too big to remain off the regulator radar screen, and too small to be able to write a substantial check to make the regulators move onto the next company. After resisting what we felt were baseless allegations, and us demanding arbitration hearings, we were suddenly notified that the last five years of our financials had been re-audited, and now we were mysteriously out of compliance. These were the same financials which had been audited annually by four separate regulators, but suddenly we now had our own Black Swan. We could not rectify these contested millions in the 48-hour window given and were, shockingly, out of business on Monday morning (See "Fall of MICG," Ash Press 2017, Amazon Books).
Today, it still seems impossible. I had let down so many employees, shareholders, and a community which had relied on our success. Multiple industry experts have advised me that if I would have had a war chest of $10-12 million in liquid cash to "write the check," our firm would have paid a fine and made it through this period. We had recently spent a great deal of our excess capital taking advantage of the market turmoil and purchasing successful investment practices from Merrill Lynch, UBS Securities, and multiple regional firms. But what I should have been doing was building up a large war chest in case I did not know what I did not know. The media had a frenzy incorrectly reporting that the company's closure was the result of nefarious hedge fund activities following the Bernie Madoff hysteria, but it was actually the mysterious re-audit. It was not having the cash on hand to write an immediate check.
Your war chest has to be cash - not investments, not credit lines, and not even money market accounts. During our 48-hour emergency, our regional and community banks had already suspended most firms' credit lines in an attempt to survive themselves, our hedge funds and real estate investments had suspended redemptions for our shares, and you might remember that even money market funds were frozen while we all discovered these not to be as daily liquid as we had believed. A friend of mine called me in a life and death panic, himself, only two weeks earlier claiming that Wachovia Bank had given him thirty days to repay his $16 million loan on his new condo development project even though he was in full compliance with all loan covenants. The small print allowed this during Black Swans. Yet even Wachovia did not survive. Gold and silver bars are also good options during these periods for a whole separate list of reasons (Another Post).
I have given you my personal experience, but let's look at other examples: Chipotle "food poisonings" derailing a tremendous growth story, sexual harassment allegations closing a number of smaller organizations, a previous Administration shutting down the pay-day lending industry and independent "for-pay" colleges based purely on its ideological preferences, and disruptive technology radically changing the future of retail, taxis, and truck drivers. We have all witnessed the successful restaurant crowded every night until suddenly the doors are closed because, even though they thought the P&L looked fine, they simply ran out of cash. Read Phil Knight's book, Shoe Dog, which details the numerous times Nike almost ceased to exist because the successful growth actually depleted the savings account.
Now my economist buddies will tell us that an oversized war chest of cash hurts the company growth rate, reduces our Return on Equity (ROE), and impairs a bunch of other fancy ratios we like to use. But, in today's world of big government, social media instant shaming and cyber bullying, and Black Swans coming at us from every direction, I urge you to consider maintaining a much larger war chest than you previously thought was prudent or conservative. Please learn from my mistakes.
"Whom the Gods wish to destroy they first call promising." - Cyril Connolly