At non-financial corporate businesses, the level of checkable deposits and currency has been growing rapidly, as Figure 7 shows. This could represent a form of “scarring” from the recession if it means that firms are less confident in raising funds from the market or financial intermediaries, and are now essentially more risk-averse and banking cash. While some risk aversion is clearly vital, a growing degree of risk aversion among non-financial corporate businesses may signal subdued investment behavior by firms – behavior that would, on net, lead to slower economic growth.

Recently, we have watched the deterioration in financial conditions extend beyond the subprime market.  Investors appear to have reassessed their outlook and their tolerance for risk, especially for structured financial products and for securities of highly leveraged firms.  Bond spreads--especially those for speculative-grade debt--widened substantially in June and July, and the volatility of equity prices increased as well.  In mid-August, following several events that led investors to believe that credit risks might be larger and more pervasive than previously thought, the functioning of financial markets, including short-term and interbank funding markets, became increasingly impaired.  Notably, many asset-backed commercial paper programs found rolling over their paper increasingly difficult.  To help restore orderly conditions, the Federal Reserve in recent weeks has increased the provision of reserves, cut the discount rate, and changed its usual discount-window lending practices in order to facilitate term borrowing, together with other measures. 

One of the most striking financial developments since 2001 has been the rapid increase in corporate holdings of cash and short-term securities.  Since the end of 2001, the ratio of cash holdings to assets has risen sharply (see exhibit).  This increase is even more pronounced when (on a consolidated basis) cash is measured relative to investment, defined as the sum of capital spending and research and development (R&D) spending during the preceding twelve months.  The ratio of cash to investment has averaged about 60 percent during the past few decades.  Generally, it is higher in recession periods, consistent with a strong precautionary savings motive by firms that face costly external financing (Almeida, Campello, and Weisbach, 2004).  And, in 2001, the ratio of cash to investment was already somewhat elevated.  But the ratio then soared to more than 150 percent by year-end 2004, as investment fell far short of cash flow from operations and net financing.  This juxtaposition is unusual when the economy is expanding. 

It is difficult to determine whether a corporation’s cash is held at home or abroad, but we know that significant holdings of cash are concentrated at large multinational firms.  In particular, the Board staff’s analysis (of Standard & Poor’s Compustat data) indicates that the ratio of cash to total assets at domestic-only companies rose slightly less than 20 percent between year-end 2001 and 2004.  At the same time, the cash intensity of balance sheets at multinational companies increased more than 50 percent.  Moreover, recent research has demonstrated a strong statistical link between the accumulation of cash and the estimated tax burden from repatriating foreign earnings (Hartzell, Titman, and Twite, 2006).

As a means of unlocking those offshore cash holdings, the Congress and the President provided U.S. companies a one-time opportunity--through the American Jobs Creation Act of 2004--to repatriate foreign profits at a much reduced statutory tax rate.  Indeed, Wall Street estimates indicate that many companies have capitalized on this opportunity: An extra $250 billion may have been repatriated during the past four quarters.  That estimate appears consistent with the recent pattern of distributions from foreign income reported in the Commerce Department’s international transactions data.