Mattel is in the same fix as funds holding collateralized mortgage obligations. Both find it difficult to sell their products because potential buyers don’t know what they are getting. While concerns about safety hurt the sales of any consumer product, uncertain credit risks blight sales of financial securities even more.
In both cases, businesses were careless in sourcing products they want to sell to others. They did not perform due diligence in verifying that what they offer for sale is as safe as claimed. Both are paying a price.
Mattel may have a few quarters of lower profits, as consumers avoid its products and it absorbs the cost of recalling millions of tainted toys. But it is not leveraged the way many financial institutions are. It is not likely to collapse. But even if it did, its failure would not bring other toy companies down with it.
Yes, news of lead-contaminated toy cars or baby bibs might lead consumers to shun buying similar products made by others. There may be a “flight to quality.” People will avoid cheap, no-brand imported toys in addition to the specific ones recalled. But overall household spending on toys probably won’t drop much.
The situation is grimmer in securities markets. Though nice to have, toys are not a necessity. Safe investments and available credit for both households and businesses are more critical to our well being. But unlike buying food or electricity, investing in mutual funds and making loans can be deferred.
“Cash is king” during times of fear. Households that might add to their mutual funds can keep cash in FDIC-insured savings instead.
A bank with funds available for loan can refrain from making a loan to a business that under usual conditions, it would readily make.
Mattel is a reputable company that reportedly puts care into safety and product sourcing. It operates its own factories in China, yet it still buys products and materials from many vendors. It was careful, but not careful enough.
Similarly, many collateralized mortgage obligations are safe. Most households make their mortgage payments every month. The securities such payments back are good ones.
Innovations in creating new debt-backed securities with varying degrees of risk were not necessarily deceptive. Reputable firms believed they had found new ways to match risk with willingness to accept it. Capital could be used more productively.
In the long run, they probably were right. In the short run, they certainly are not.
Just as Mattel made unwarranted assumptions about the safety of purchases from vendors, many financial firms made unwarranted assumptions about the risk of the securities they were buying. The resulting fear is slowing the gears of the economy and will do so for some time, regardless of how much oil the Fed pumps in to ease the friction.
© 2007 Edward Lotterman
Chanarambie Consulting, Inc.