Are Companies Able to Function Without Loans?
Note from Paul Solman: We haven’t had a “guest vetter” here at the Business Desk for some months. But interviewing MIT’s Simon Johnson the other day for a piece on ‘good bank vs. bad bank’ and being an enthusiast of his financial crisis blog, I thought I’d ask him to weigh in on some of your questions. We’ll be posting answers throughout the week.
Question/Comment: Borrowing money to buy new equipment, to upgrade, etc, makes lots of sense. Borrowing money to pay rent and to make payroll sounds a lot like an individual who has to use a payday loan center to borrow against his paycheck. With the collapse of the “Commercial Paper Market” last fall, it became apparent to me that ALL of the major corporations, banks, and many municipalities are unable to function without their SuperSize Payday Loan center. Am I wrong?
Paul Solman: Pretty much. The commercial paper market is for short-term borrowing. Say you’re a new company with great people and a (seemingly) great idea. You can raise money either by giving away ownership in your company — selling shares of it — or you can borrow: for rent, to make payroll, etc.
And even if you’re an old company, you want your money working for you, no? You’re betting that you can earn more than the going rate of interest. So you put the money to work and borrow — in the commercial paper market, say — to tide you over.
Simon Johnson: Even the most solvent, profitable firms can do better with a loan. Think about your neighborhood grocery store – they’ve got to pay for deliveries before you pick the stuff off the shelf and pay. Of course, the grocery store can ask their suppliers to wait for payment, but then the suppliers are giving the store a loan and how do the suppliers finance that? (Answer: commercial paper or a revolving bank loan and the like)
And workers really like to be paid cash, so not much chance of a loan from them.