This is basic, though forgotten, accounting: Cash is king. Having a line of credit reduces risks in a business, but relying on that credit increases risk. Credit itself is a measure of risk. The fact is that risk has been mispriced for so long, businesses decided it was acceptable to rely on credit. Risk is being repriced, and people who bet on risk are finding out that you can’t win that bet every time.

Small Business

So, what can you do? As a business manager, you can maintain positive cash flow. If you are already in the hole, I’m sorry, but your number might be up. If you have a cushion, then maintaining positive cash flow will help build that cushion. This will mean layoffs or pay cuts. Unless you are the auto industry, running a profitable business with good cash flow is a requirement to stay in business.

Employee

Pay off debt. Demonstrate value to your employer. The principle is the same: build a cushion and maintain positive cash flow. If you are a homeowner that is seriously underwater and are having difficulties making payments to the point where you are running up your credit cards, you need to assess your situation rationally. It may be necessary to become a renter for a decade. Just as a business would sell off factories and lay off workers, you need to downsize your living expenses.

Risk Management

If you were running a (good) hedge fund, you would increase leverage on bets where risk was low, and decrease leverage on risky bets. American consumers and businesses are trying to do the opposite: they are borrowing more as risk increases. This is what LTCM did in the ’90s. LTCM was a bad hedge fund. The end result for those that increase leverage for increased risk is always the same: spectacular failure.