Editorial: Beware the good times

A teacher was reading the story of Chicken Little to her class. “…And Chicken
Little went up to the farmer and said, ‘The sky is falling! The sky is
falling!’” she read. The teacher then asked her class, “And what do you think
the farmer said?” Little Johnny stuck up his hand: “He said, ‘Holy shit! A
talking chicken!’”

The point is, when the sun is shining, nobody is interested in what
scaremongers are saying. No one wants to trade with merchants of doom. The least
popular person is the party-pooper who tells you that not only have you had too
much to drink, but that you’ve been mixing your drinks and that’s really bad. Or
the forecasters whose prognostications of house price crashes trade headline
space in the Daily Mail with the statisticians who prove we’ve never
had it so good. A rising tide lifts all boats; it’s only when the tide goes out
that you see the rocks ­ or, as Warren Buffett puts it more graphically, when
the tide goes out you see who has been swimming naked. (That’s enough analogies
­ Ed.)

When things are going well, it’s no time to think about what might happen if
things suddenly don’t go well. Except, of course, that that’s the perfect time
to do so, ­ but everyone is far too busy trying to make money to bother thinking
about what happens later.

Twenty years ago a financial hurricane ripped through the stock market,
blowing 20% off the FTSE-100 index in just 48 hours. And no, nobody saw it
coming. The City tempest damaged portfolios ­ but also got rid of a lot of
froth-inducing practices. Ill-founded mergers and acquisitions were exposed as
fragile artifices; suddenly companies rediscovered the importance of cash
generation. Institutions that had hungrily agreed to take fees to underwrite
BP’s share sale squealed so loudly when the price collapsed that the government
pulled the issue ­ but the City’s ‘My word is my bond’ reputation was severely
battered. “People rely on booms but don’t know when to sell,” one FD told us ten
years ago when we did a retrospective piece on the Crash of ’87.

A recent research report by Kroll goes a long way to highlighting the hidden
dangers of long, bull business cycles. Economic stability is great, but can lead
to excessive leverage; huge market liquidity meant that even companies that
can’t repay their debts are able to secure new finance; business complexity
creates opportunities as well as potentially great dangers. Underperformance
doesn’t count as failure ­ – not until things turn south, anyway.

As one FTSE-250 internal auditor put it in the report, “Understanding the
totality of operational risk that a business is exposed to is quite difficult.
Some businesses tend to put it in the ‘too hard to do’ box and hope it will go
away. When it does emerge they find it very hard to respond to.” Nobody likes a
killjoy, but he does have a point.