Debt and the Maiden

Despite Real Madrid’s best efforts to buy everybody, I still consider this time of year, the first few weeks after the end of the season, to be unbearably slow. There is, however, one issue that doesn’t seem to be going away anytime soon: debt. The troubled world economy has pushed club finances to the forefront of public consciousness. The difficulty is, there are so many conflicting points of view on the implications of debt; depending on who you listen to a club could either be equipped to buy a new first eleven, or have their stadium turned into a strip mall by the end of the business day. In many cases, the opinions about a club’s financial situation seem to be taking place along partisan lines. The end result is, it’s rather difficult to make sense of all this.

In my opinion, the biggest disservice that the sensationalistic approach has done is to treat debt as an entirely new development while reducing it to its most literal definition. In basic terms, a person who buys a new refrigerator and a person who buys one of everything from the shoe department at Barney’s are both in debt; they are differentiated by their ability to pay back the debt with available future income. In other words, there is manageable and unmanageable debt.

Obviously, the finances of big business are more complicated than the personal finances of an individual, so identifying good and bad debt among football clubs is slightly more complicated. As I am far from an expert on the somnolent subject of economics, I decided to consult the lynchpin of modern free market theory, Adam Smith, finally allowing me to make a modicum of practical use out of my copy of The Wealth of Nations.

Smith argues for the concept of good and bad debt, which can be categorized by the purpose that money is borrowed for.

“The stock which is lent at interest is always considered as a capital by the lender. He expects that in due time it is to be restored to him, and that in the mean time the borrower is to pay him a certain annual rent for the use of it. The borrower may use it either as a capital, or as a stock reserved for immediate consumption. If he uses it as a capital, he employs it in the maintenance of productive laborers, who reproduce the value with a profit. He can, in this case, both restore the capital and pay the interest without alienating or encroaching upon any other source of revenue. If he uses it as a stock reserved for immediate consumption, he acts the part of a prodigal, and dissipates in the maintenance of the idle, what was destined for the support of the industrious. He can, in this case, neither restore the capital nor pay the interest, without either alienating or encroaching upon some other source of revenue.”

What this means is that debt can be prudently used to expand the profitability of an existing business, and that the debt can be repaid through the expanded profitability. The pre-debt finances or any other assets that the owner may have will not be affected by the debt. Bad debt, which Smith categorizes as idleness, is not being put to any use. Smith goes on to give an example of a country gentlemen indebted to merchants, having purchased items on credit, who borrows to pay the merchants. Having borrowed to pay one debt, the gentleman must pay back the second debt with existing income or assets, obviously leaving him with less than he started with.

We can see immediately why Liverpool and Manchester United are in a position of bad debt. Both clubs were purchased with borrowed money. Separate holding companies were established that the debt was loaded onto. This is a very clear case of encroaching upon some other source of revenue, as any profits made by the football club aspect of the business must be viewed in conjunction with the debts of the holding company. Further outlays of money on football related matters would contribute to the overall debt. The alternative is to spend less on football, which obviously affects the indebted team competitively. Conversely, Arsenal are considered to have good debt, as the large amount of money they borrowed went towards financing the Emirates Stadium, which is expected to produce the long term revenue required to manage the debt.

Of course, not all the examples of football debt are quite so clear cut. In terms of pure theory, Real Madrid is saddled with bad debt; they borrow money simply to spend on big name players. In actuality these purchases increase the club’s profile leading to more sponsorship money, more merchandise sold, more television money and, ideally, success on the field, which would reinforce the other avenues of profitability. Spending money on personnel is probably the most common form of football related debt. When a club like Real Madrid or Chelsea can guarantee perpetual success, the debt, even in astronomical amounts doesn’t seem incredibly dangerous. The big risk in attaching a business model to sporting competition affects the clubs that can’t say for sure what position in the table they’ll finish the season in. I believe this was the motivating factor behind the recent warning over many Spanish clubs’ finances.

Even though their shot at success took place nearly a decade ago, and that they are not the only club to fail (Parma, Fiorentina and Lazio spring to mind) in this way, shooting for the moon and ending up amongst the creditors is still known in many circles as “doing a Leeds.” By now the story is well known enough to be told in sentence fragments. Leeds spends money, has some success. Success doesn’t continue, revenue drops. Star players are sold cheaply. Club is relegated, revenue drops again. Club ends up in third division in financial ruin.

As long as indebted clubs maintain the position they have budgeted for, expect the status quo to remain unchanged. Things start breaking down when budgets are made with expectations, Champions league qualification for instance, that are not met. The emergence of Manchester City as a nouveau riche power is being discussed as a potential disaster for either City, or one of the current big four, as Manchester City’s ambitions include Champions League participation. Obviously, with a fifth team in the picture, someone is going to be left out in the cold. This risk also applies to smaller, aspiring clubs. To spend the money and not reach the heights required to pay it back is pretty much exactly what happened to Leeds. The big question here is, are the clubs that just outside the elite going to become averse to risk taking in this climate?

That the larger financial crisis has encroached onto football has thrown debt into the spotlight; it is certainly not a brand new phenomenon. I wouldn’t expect to see many big clubs going bankrupt at the drop of a hat, but the notion of having to sustain a minimum level of success to finance debts is the biggest danger for both the clubs involved, and football as a whole. At the risk of sounding repetitive, I think what we can really expect to result from all this is a further consolidation of power by the biggest clubs, who already have a financial advantage, and have the most to lose by falling from their current positions.

Category: Europe, Other

Tags: Europe, Other

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