Invoking an analogy of Australia's financial system with extremely different views of America"s most decadent mecca would seem somewhat nebulous but these are weird times.
The question is whether Australians, when it comes to house prices, mortgages and the quality of financial regulation are hallucinating on multiple drugs, drinking ourselves to death or partying in a make believe world of girls, fast cars and rock? Whichever, we've got to take a very good look at ourselves, so let's get in that room of mirrors.
I was in Vegas for the ASF conference recently. Rather than being amongst US bankers on a junket which is how it felt on my last visit at the beginning of 2007, I found myself amongst a group of very hard working people determined to radically improve the structure of securitisation and to bring back this market bigger and better. There was a very strong emphasis on facing the facts of what went wrong. An extreme contrast with the small Australian contingent who presented to a very small audience and would appear to have been in la la land, ie. one of the above delusional states!
We in the Australian financial system and everyone else must now face the facts and act or see a very large part of our population out of work for a very long time or burdened with debts they'll never be able to repay. Australia is now in a very similar position to the US in 2006 and is heading for a similar fall out with little we can do to stop it but we can cushion the blow.
Let's look at a simple comparison between US and Australian mortgagors today. Mortgage rates in both countries are currently about the same ie 5% pa but after that the similarities end. US borrowers can fix the 5% for 30 years with the option to refinance if rates decrease further. Australian borrowers are totally exposed to significant rises in interest rates in the coming years especially first home buyers taking advantage of the FHO grant. US mortgagors are only exposed using around 30% of pretax income on mortgage payments, over 40% is considered severe mortgage stress. Whilst in Australia it is over 50% on average at current interest rate levels which are the lowest in 40 years and almost certainly will not be maintained at this level. Australian borrowers are not only hugely exposed to interest rate increases but also inflationary effects as there is little headroom for a significant number of borrowers who have little excess income after living expenses. It's the principal that is the problem ie house prices are too high relative to income. Australian borrowers are baring enormous risk with serviceability requirements on their mortgages being more than extreme stress levels on any reasonable standard.
The Australian Government is bribing hard working young Australians into getting into a lifetime of debt with the significant probability of going bankrupt. Who is going to bail these people out when global effects drive up both interest rates and inflation in Australia? What will happen to house prices when this scenario transpires?
We need to get real, real quick! At this stage I think Elvis is the front runner. Partying for years in a make believe world creating not a rock star but an overweight has been who can't get through the day without artificial support. Long live the king! Or is it going to be the realisation by Nicholas that there is no getting out of your addiction so you may as well just gorge yourself on a continuous supply of hard liquor until the tragedy plays out to its inevitable end? But what about the drug fueled Hunter? We need a little more info on this decision, Matilda.
Without the obvious future risks being burdened by normal borrowers, there is still so much more risk already embedded in the system that it is almost guaranteed that systemic failure in the housing and financial markets will occur. Defaults have already risen significantly in Australia and whilst not yet comparable to the US or the UK, enough losses are currently in the system to ensure that the two main mortgage insurers in the country will fail without significant capital injection from their shareholders. As these insurers are taking the risk on about 50% of the mortgages in Australia (the riskier half as well), the financial system must suffer badly. The elephant is in the room. Everyone I talk to who knows anything about mortgage finance in Australia knows this to be the case. But what is happening to address the issue? Nothing, because it is someone else s problem. Well, not for too much longer.
If you have a sense of de ja vu then you are correct. This is all circa late 2006 USA. Massive payment risk on over qualified borrowers who cannot withstand interest rate increases, plus systemic risk throughout the banking system and under capitalised financial risk takers. I'm sorry, but hell's a comin' for many Australians, who will be sent down the river of bankruptcy due to the gross ignorance of politicians and extreme self interest of greed driven bankers.
But we can be like Hunter, the gonzo tell it like it is journo. Go at it hard, keep it weird but keep it short. If you we are going to party like its 2009, then fill the tank with every concoction you can find and push the body to the limit. But when you feel reality starting to kick in, get out before the drugs, the cops or some other extreme weirdness takes a permanent hold. Who wants to end up dead from substance abuse in Vegas whether its on the toilet in a penthouse or some slum dive? Its best avoided.
If I was the great journalist and defender of human rights, I'd be leading us out of the abyss of chronic realty alcoholism and bulimia. Cancel the FHOG bribe, save the poor borrowers from the swine that got them into a life of slavery to lenders and simply regulate for a capital weighting based on mortgage serviceability (which believe it or not does not exist). House prices down, system stable and maybe the ugly duckling gets to keep his job.
Yes Matilda, whilst the final fallout is unknown, the front runner is clear but don't tell Tin Tin about that pack of vicious vampire bats circling his head, he'll see them soon enough!
Monday, March 23, 2009
Tuesday, February 3, 2009
What would you do about the GFC? Be Delusional?
Now that Kevin Rudd has released the latest stimulus package in response to the GFC its a little clearer where this government is heading in tackling the fundamental problems in the global economic system. That's right,on the road to no where, at full throttle and with no breaks!
Does anyone have the guts to stand up in Australia and admit the real problems that must be addressed now or we'll have a generation of children working their arses to the bone to pay for the excess of their parents and grand parents? The only politician in my memory to tell the truth was the great Master Blaster. The man responsible for 3 great life improving events for Australians. He opened up Australia's financial system to more competition whilst floating the A$. He introduced compulsory saving through superannuation. Paul Keating was also the only politician to not pander to hand outs to the middle class and declare "a recession we had to have". Ridiculed then and widely since, but history has demonstrated that he was correct. He laid the platform for the enormous boom we have had since the mid 90s but not the excesses. He did actually "bring home the bacon".
Our current PM is scared shitless of being a one termer and will do anything to delay the the inevitable and buy votes. His sales pitch in the last 48 hours has been nothing more than; we have 2 choices, to do something or to do nothing, so we are doing something. Que? This is a debt driven depression which the world has not seen before. So historic responses and lessons are not precedents to use to resolve the fundamental issues today. For nearly 15 years we have transferred debt from Government to the private sector and then pumped it to a bloated hog. The package announced by Rudd is some transfer of debt from the private sector back to Government but mostly just more spending financed by debt to be repaid on the never never!In very simple terms, the solution proposed is the same as the cause. Like feeding the carcass of the bloated hog to the pigs to bring home the bacon!
A further basic question, "If we really need the announced, very important and significant improvements in infrastructure, why weren't these projects undertaken in the good times?"
Now I know you've been on the edge of your bar stools in anticipation so here are my suggestions as to what should be done in response to the GFC plus some related commentary in justification.
1. It's bad regulation and legislation that got us into this mess so let's do something about this first ie Fix it!
- Remove the bank guarantee for deposits above $50,000 or charge a guarantee fee. Incentivising investors to put money into banks at the expense of other investment alternatives is very bad policy which distorts the choices in the economy for proper risk reward investing. The Government was yelling from the rooftops how strong the Australian financial system and our banks were and then abandoned this rhetoric by applying an unpaid for guarantee to bank deposits. Too little thought with too much haste, "Mr Rudd how could you?"
- Stop the First Home Owner grants now! Use the money by handing it to councils and other infrastructure providers of new land subdivisions for housing to pay for the housing infrastructure and other taxes. Under the current housing affordability scenario this grant is nothing more than a bribe to get people into debt that they may not be able to afford. At best it is an attempt to maintain false house valuations at the new owners expense. Another version of the Ponzi scheme but actually perpetrated by our benevolent Governments!
-Remove any legislative reference to requirements for credit ratings on investment or indeed anything else. This type of regulation is absurd. Regulators have no idea how ratings are derived and have no means to make the rating agencies accountable for their mistakes. Rating agency services should not be cemented into the system with no accountability as it leads eventually to abuse. Heh wait a minute, isn't this just what happened?
- Enforce new APRA capital adequacy rules for banks across all bank assets from 1 Jan 2009. This is very technical but for mortgages anyway, it would show that most of our banks are under capitalised although this could be balanced by other positive effects. Previous inadequate regulation must be changed with the new rules being clearly transparent and fixed.
- We should never legislate for rules governing disclosure to investors because it is impossible to keep legislated proper disclosure requirements which are in effect a dynamic system. We should legislate to require industry bodies to have disclosure requirements which are maintained. The only real rule you need is that if an issuer etc does not follow industry standards on disclosure either up front or on an ongoing basis then this must also be disclosed.
2.Resource ASIC to enforce our current laws. David Coe, Gordon Fell, Eddie Groves, Phil Sullivan and many others need to be brought before the courts and seen to be found guilt or not in full view of the public. Tin Tin has been bleating on about confidence and writing useless rhetoric on the failures of capitalism when he fails miserably to resource the very agency which could be clearly demonstrating that our current laws work and that investors can have confidence in the system, A very simple thing. It would seem to me that journos like Michael West and Ian Verrender amongst a number of others are doing the Government's work. The public on the other hand is now so cynical about the system that these tainted and probably criminal clowns are treated as a side show. Entertainment with little accountability. No wonder everyone is diving for cover and putting their money into overly cheap government guaranteed deposits.
3. Stop the middle class welfare handouts and cut taxes!When you have too much debt, certainty of long term cashflow to manage and repay that debt is critical. Forget fiscal stimulus with borrowed money is no more than pork barreling for votes. It will make things worse. Long term locked in income tax and GST cuts provide a stable increase in borrowers ability to systematically reduce debt and with confidence increase expenditure. Of course locked in long term tax cuts removes fiscal power from the government which is the only reason the politicians are opposing this essential measure.
4. The Federal Government should guarantee to the lender a first loss to everyone's mortgage at 1 Jan 2009 of 20%. No I have neither lost my mind nor changed my ideals. But before I explain my position, I have some commentary on a deceptive article on Australian housing I read earlier this week.
Chris Joye wrote an article in The Business Spectator in response to the recently published Housing Affordability report for the USA, Canada, UK and Australia which showed clearly on a regional basis that Australia has some of the most unaffordable housing on the globe. Firstly young Chris tried in vain to establish that the author had conflicts of interests due to some connection with work done for property developers. Whilst I did not get the conflict I did get the fact that Chris was less than full on his disclosure of his conflict. Chris's connection with the Rismark businesses does not spell out that these businesses rely primarily on speculative investments in the Australian housing market. Success is directly related to prices either going up or at least the perception that they will. So no greater conflict of interest on this subject could possibly exist. But what really got me was the use of irrelevant historical statistics and analysis to justify his position and the reference to the ratio of of median house prices to median family income as a crude measure. This cannot go unchallenged. Let me tell you a story.
Few perhaps know that Chris likes to race motor bikes across country sort of like the Dakar rally. Well so does my cousin Dave, we should all remember him for his simple philosophy on taking investment advice. Well Chris and Dave were going to take part in a race across the Simpson Desert, just the two of them. So Dave turns up on a 30 year old Kawasaki 900 stripped to the bone with the the biggest off road bike tyres anyone has ever seen. A pretty crude outfit to be sure. Chris on the other hand, turns up on the latest and largest Bultaco trail bike, carbon fiber frame and with electronics that until recently were only found in expensive luxury cars. It was a sweltering 40 degree plus day. It would take 2 days to get across with a fuel, food and water stop at the end of the first day.
Dave looks at Chris and says, "That's a pretty sophisticated set up you've got there Chris, very impressive. But what extra work have you done on your bike?"
Chris says, "I don't need anything else. This bike has been tested on the best tracks in Europe and I have a fuel gauge that is so sophisticated that it can tell me that I have enough fuel to just get me the stopover point if I travel at a certain speed across this terrain."
"That's mighty impressive" says Dave "But I'm just not that sophisticated. All I did was strip out all the excess weight and use that benefit to reinforce the chassis. Gear it down to a lower torque and reseal the engine so the sand wont get in. I'm also bringing some water, food, extra fuel and this." As he pulls out a 2 foot shifting spanner. "Fix anything on this bike with this even change a tyre. What extras you bringing Chris?"
" No need Dave," he grins, "with this sophisticated piece of machinery it will get me to our stop point safe and sound"
"For your sake Chris I really hope so. I may be a bipolar, ex-alcoholic, leader of the pack but I'm not stupid. Do you know that in this heat the release valve on your fuel tank can open right up and your fuel can vaporise and be sucked right out"
No response but no grin either from Chris.
"You know Chris I did bring another piece of equipment. its a simple fuel gauge, not sophisticated but very reliable"
"What's that Dave?"
"Its called a stick. Watch as I put it in my fuel tank and take it out. Be damned Chris see that mark on the stick. Its telling me that there's fuel in my tank but some fuel has vaporised so I better top it up or we sure not getting to where we want to go. I notice that your sophisticated fuel gauge says your tank is full Chris. Lots of things go haywire in this heat. Maybe you should use my stick to check. Sure hate for your sophisticated gauge to be wrong. Sort of life or death. This is the Simpson Desert Chris, not Bondi Beach! What are you going to do Chris, rely on your sophisticated equipment or use my very crude but reliable stick?"
Chris still hasn't made his decision but I hope a few get the point of my lengthy story. The only reliable guide on where house prices should be relates directly to how much people can and indeed should pay. I really do not think that Christopher Joye believes his own bullshit but I do think that you can be conflicted into distorting the facts and hard wiring is difficult to change.
However I do not think that those Australians heavily in debt especially those who lose their jobs should bare the major impact on house price correction. The first loss guarantee provided by the Government if called upon would be repayable by the borrower through a HECS type arrangement whereby repayment is required only when it can be afforded. A guarantee fee would be charged through the interest rate on the mortgage. If all the other measures above were to be adopted, house prices would correct to affordable levels without innocents being burnt too much.
Yes Matilda, I do respect a politician, there are things that can be done to alleviate the GFC, remember the sun and always bring your stick!
Morgij
Does anyone have the guts to stand up in Australia and admit the real problems that must be addressed now or we'll have a generation of children working their arses to the bone to pay for the excess of their parents and grand parents? The only politician in my memory to tell the truth was the great Master Blaster. The man responsible for 3 great life improving events for Australians. He opened up Australia's financial system to more competition whilst floating the A$. He introduced compulsory saving through superannuation. Paul Keating was also the only politician to not pander to hand outs to the middle class and declare "a recession we had to have". Ridiculed then and widely since, but history has demonstrated that he was correct. He laid the platform for the enormous boom we have had since the mid 90s but not the excesses. He did actually "bring home the bacon".
Our current PM is scared shitless of being a one termer and will do anything to delay the the inevitable and buy votes. His sales pitch in the last 48 hours has been nothing more than; we have 2 choices, to do something or to do nothing, so we are doing something. Que? This is a debt driven depression which the world has not seen before. So historic responses and lessons are not precedents to use to resolve the fundamental issues today. For nearly 15 years we have transferred debt from Government to the private sector and then pumped it to a bloated hog. The package announced by Rudd is some transfer of debt from the private sector back to Government but mostly just more spending financed by debt to be repaid on the never never!In very simple terms, the solution proposed is the same as the cause. Like feeding the carcass of the bloated hog to the pigs to bring home the bacon!
A further basic question, "If we really need the announced, very important and significant improvements in infrastructure, why weren't these projects undertaken in the good times?"
Now I know you've been on the edge of your bar stools in anticipation so here are my suggestions as to what should be done in response to the GFC plus some related commentary in justification.
1. It's bad regulation and legislation that got us into this mess so let's do something about this first ie Fix it!
- Remove the bank guarantee for deposits above $50,000 or charge a guarantee fee. Incentivising investors to put money into banks at the expense of other investment alternatives is very bad policy which distorts the choices in the economy for proper risk reward investing. The Government was yelling from the rooftops how strong the Australian financial system and our banks were and then abandoned this rhetoric by applying an unpaid for guarantee to bank deposits. Too little thought with too much haste, "Mr Rudd how could you?"
- Stop the First Home Owner grants now! Use the money by handing it to councils and other infrastructure providers of new land subdivisions for housing to pay for the housing infrastructure and other taxes. Under the current housing affordability scenario this grant is nothing more than a bribe to get people into debt that they may not be able to afford. At best it is an attempt to maintain false house valuations at the new owners expense. Another version of the Ponzi scheme but actually perpetrated by our benevolent Governments!
-Remove any legislative reference to requirements for credit ratings on investment or indeed anything else. This type of regulation is absurd. Regulators have no idea how ratings are derived and have no means to make the rating agencies accountable for their mistakes. Rating agency services should not be cemented into the system with no accountability as it leads eventually to abuse. Heh wait a minute, isn't this just what happened?
- Enforce new APRA capital adequacy rules for banks across all bank assets from 1 Jan 2009. This is very technical but for mortgages anyway, it would show that most of our banks are under capitalised although this could be balanced by other positive effects. Previous inadequate regulation must be changed with the new rules being clearly transparent and fixed.
- We should never legislate for rules governing disclosure to investors because it is impossible to keep legislated proper disclosure requirements which are in effect a dynamic system. We should legislate to require industry bodies to have disclosure requirements which are maintained. The only real rule you need is that if an issuer etc does not follow industry standards on disclosure either up front or on an ongoing basis then this must also be disclosed.
2.Resource ASIC to enforce our current laws. David Coe, Gordon Fell, Eddie Groves, Phil Sullivan and many others need to be brought before the courts and seen to be found guilt or not in full view of the public. Tin Tin has been bleating on about confidence and writing useless rhetoric on the failures of capitalism when he fails miserably to resource the very agency which could be clearly demonstrating that our current laws work and that investors can have confidence in the system, A very simple thing. It would seem to me that journos like Michael West and Ian Verrender amongst a number of others are doing the Government's work. The public on the other hand is now so cynical about the system that these tainted and probably criminal clowns are treated as a side show. Entertainment with little accountability. No wonder everyone is diving for cover and putting their money into overly cheap government guaranteed deposits.
3. Stop the middle class welfare handouts and cut taxes!When you have too much debt, certainty of long term cashflow to manage and repay that debt is critical. Forget fiscal stimulus with borrowed money is no more than pork barreling for votes. It will make things worse. Long term locked in income tax and GST cuts provide a stable increase in borrowers ability to systematically reduce debt and with confidence increase expenditure. Of course locked in long term tax cuts removes fiscal power from the government which is the only reason the politicians are opposing this essential measure.
4. The Federal Government should guarantee to the lender a first loss to everyone's mortgage at 1 Jan 2009 of 20%. No I have neither lost my mind nor changed my ideals. But before I explain my position, I have some commentary on a deceptive article on Australian housing I read earlier this week.
Chris Joye wrote an article in The Business Spectator in response to the recently published Housing Affordability report for the USA, Canada, UK and Australia which showed clearly on a regional basis that Australia has some of the most unaffordable housing on the globe. Firstly young Chris tried in vain to establish that the author had conflicts of interests due to some connection with work done for property developers. Whilst I did not get the conflict I did get the fact that Chris was less than full on his disclosure of his conflict. Chris's connection with the Rismark businesses does not spell out that these businesses rely primarily on speculative investments in the Australian housing market. Success is directly related to prices either going up or at least the perception that they will. So no greater conflict of interest on this subject could possibly exist. But what really got me was the use of irrelevant historical statistics and analysis to justify his position and the reference to the ratio of of median house prices to median family income as a crude measure. This cannot go unchallenged. Let me tell you a story.
Few perhaps know that Chris likes to race motor bikes across country sort of like the Dakar rally. Well so does my cousin Dave, we should all remember him for his simple philosophy on taking investment advice. Well Chris and Dave were going to take part in a race across the Simpson Desert, just the two of them. So Dave turns up on a 30 year old Kawasaki 900 stripped to the bone with the the biggest off road bike tyres anyone has ever seen. A pretty crude outfit to be sure. Chris on the other hand, turns up on the latest and largest Bultaco trail bike, carbon fiber frame and with electronics that until recently were only found in expensive luxury cars. It was a sweltering 40 degree plus day. It would take 2 days to get across with a fuel, food and water stop at the end of the first day.
Dave looks at Chris and says, "That's a pretty sophisticated set up you've got there Chris, very impressive. But what extra work have you done on your bike?"
Chris says, "I don't need anything else. This bike has been tested on the best tracks in Europe and I have a fuel gauge that is so sophisticated that it can tell me that I have enough fuel to just get me the stopover point if I travel at a certain speed across this terrain."
"That's mighty impressive" says Dave "But I'm just not that sophisticated. All I did was strip out all the excess weight and use that benefit to reinforce the chassis. Gear it down to a lower torque and reseal the engine so the sand wont get in. I'm also bringing some water, food, extra fuel and this." As he pulls out a 2 foot shifting spanner. "Fix anything on this bike with this even change a tyre. What extras you bringing Chris?"
" No need Dave," he grins, "with this sophisticated piece of machinery it will get me to our stop point safe and sound"
"For your sake Chris I really hope so. I may be a bipolar, ex-alcoholic, leader of the pack but I'm not stupid. Do you know that in this heat the release valve on your fuel tank can open right up and your fuel can vaporise and be sucked right out"
No response but no grin either from Chris.
"You know Chris I did bring another piece of equipment. its a simple fuel gauge, not sophisticated but very reliable"
"What's that Dave?"
"Its called a stick. Watch as I put it in my fuel tank and take it out. Be damned Chris see that mark on the stick. Its telling me that there's fuel in my tank but some fuel has vaporised so I better top it up or we sure not getting to where we want to go. I notice that your sophisticated fuel gauge says your tank is full Chris. Lots of things go haywire in this heat. Maybe you should use my stick to check. Sure hate for your sophisticated gauge to be wrong. Sort of life or death. This is the Simpson Desert Chris, not Bondi Beach! What are you going to do Chris, rely on your sophisticated equipment or use my very crude but reliable stick?"
Chris still hasn't made his decision but I hope a few get the point of my lengthy story. The only reliable guide on where house prices should be relates directly to how much people can and indeed should pay. I really do not think that Christopher Joye believes his own bullshit but I do think that you can be conflicted into distorting the facts and hard wiring is difficult to change.
However I do not think that those Australians heavily in debt especially those who lose their jobs should bare the major impact on house price correction. The first loss guarantee provided by the Government if called upon would be repayable by the borrower through a HECS type arrangement whereby repayment is required only when it can be afforded. A guarantee fee would be charged through the interest rate on the mortgage. If all the other measures above were to be adopted, house prices would correct to affordable levels without innocents being burnt too much.
Yes Matilda, I do respect a politician, there are things that can be done to alleviate the GFC, remember the sun and always bring your stick!
Morgij
Wednesday, January 14, 2009
Experience and Lesson on Investments
Our Experiences Scientific studies continually debunk any nature versus nurture argument to support the notion that it is clearly both. So what we have experienced is just as important about who we are than our genetic make-up. But perhaps it's what we chose to learn from the experiences of others that defines us most of all.
I read a quote the other day, " Innovation starts with a stupid question". Very insightful I thought but perhaps without an experience to give it some substance could be just as quickly forgotten and irrelevant.
A number of years ago I was on one of those executive courses where you do some strange group activities. I have always liked these events because no matter how poorly run there's usually something different to be learned. On this occasion, a group of 10 were doing a communication/leadership exercise. Without speaking or grunting etc and with only a stick and a tin can I had to direct the other 9 people around an outside maze within 15 minutes. The challenge was that the 9 were blindfolded!
We had 10 minutes to prepare how to achieve this task. As you'd expect the first 5 minutes achieved absolutely nothing as all 10 tried to give their opinions at once. Then an almost epiphanis moment occurred when everyone fell silent realising that we were getting absolutely nowhere. At that point, in the silence a late great friend of mine asked that silly question, "Couldn't we use the sun?" After the nano seconds it took for everyone of the other 9 to think , "What a useless fuckwit comment!", someone started talking about using a code by banging the stick on the can, blah blah blah.
Although we took the whole thing very seriously, tried hard, and did make progress we failed miserably in the task. Half way through the exercise and out of complete frustration I started thinking that we had limited ourselves far too much, we needed an extra source of reference. That's right, the sun! However, the remarkable thing was that this revelation dawned on everyone as they revealed later. My mate was right but as one we had dismissed him out of hand without a second thought. Who were the real fuckwits? ! Unfortunately my mate, Dave (another one), is no longer with us but he lives on in me because whenever I assume that some one has asked a stupid question, I stop for just that second to remember the sun. It just may be worth listening to.
Lessons on Defining Investment If the following is useful to any reader, then great> But I need to write this down so that I can have some automatic discipline when I hear or read about "Investments". Experience tells me that investing is a specific thing but that often other acts of parting with your money are also defined as investments when they are not. Two other things that are wrongly termed investments are, speculation and buying assets. A fourth category is how gearing can change what you think you are doing quite considerably. Short descriptions do make a difference of where something sits in our brains and whther we have automatic warning signals.
I define "Investments" as putting money into an enterprise which does things, makes widgets, invents something or manages stuff. In other words creates wealth by effort, expertise, skill and innovation. Capitalism at its best with resultant benefits to all. Although it can be either high or low risk, investments are generally controlled risk and interesting. Perhaps strangely to some, I put matched short selling in to the investment category.
"Speculation" on the other hand is completely different. For all investors with the same limited capacity of an individual, speculation is nothing more than gambling. Speculating on the market price of commodities, indexes or assets is a risky venture. Buying shares in Exxon is an investment but buying oil futures is speculation. Buying shares in Qantas is an investment but buying an interest in the Allco aircraft residual book is speculation. This may be obvious but some things can get a little confusing. Writing open position put or call options on stocks or indexes is rash speculation no matter how smart we think we are. Closed option positions of the same stock or index can be smart investing. Individuals should steer clear of any significant speculation of their weailth but some speculation is a very good thing especially the ponies on Saturday as this can be lots of fun.
"Buying an asset" is different from investing or speculation and it is important to define the difference. Depositing money in a bank is an asset. Buying government debt or any debt which could be termed investment grade is an asset. Purchasing real property to either rent or live in is actually an asset purchase not an investment. However, to use one's skills or labour to improve the property would be an investment. As individuals, a significant part of our wealth should always be in assets.
The fourth category, "Gearing" or some other derivative which achieves the same. These added extras are the bombs waiting to blow our dreams if used badly. There is nothing wrong with debt. I love debt. In fact it is absolutely necessary to lubricate the wheels of capitalism and commerce. Its the purpose and terms which will kill us. Borrowing against investments can change the whole game to pure speculation. Maxing the margin loans covering your portfolio as the market increases to extract cash because you don't want to pay capital gains tax turns investments into speculation. Maintaining a modest level of gearing would not. Buying real property covered by debt which can only be fully serviced by an increase in value or income is speculation. Gearing against any asset purchase, even government bonds, where repayment can be triggered by change in the market value of the asset no matter how extreme is speculation.
One thing the GFC has revealed in spades is the deception that many resorted to to get people to part with their money. City Pacific through enticing people into their first mortgage fund were fraudulent in their description of the risk. By presenting the first mortgage fund as "an asset" when it was speculation, these people breached every requirement of a responsible manager. These funds were used to lend to property developments at future completed valuations. Part investment because the borrowers were building something but pure speculation because repayment of principal and interest was based on the properties being sold at the forecast valuation with recourse to no other party with the ability to repay. Storm Financial were as fraudulent or incompetent in their advice and consequently geared many into what was pure speculation of an individual's entire wealth
We need to ask a simple first question when being asked to part with our money. Is it an asset, an investment or speculation and what liability are you trying to sucker me into that will blow me out of the water?
This all may sound trite or smug hindsight finger pointing but my point is not what we may or may not have done. It is that as humans we categorize things and tend to think of everything in that category as behaving the same. So if we and the broader commentators refer to things as investments or assets when those things are actually speculation, even the smartest guys in the room tend to severely play down the risks. So names do make a difference and that is my experience.
As another thought you can use the same descriptions to many things in life. Take a look at your life partner or the like and ask your self, "Are they an asset, an investment or am I purely speculating?"
Yes Matilda, our experiences define us but more importantly use the experiences of others to ask the right simple questions so that we don't become the victim
Morgij
I read a quote the other day, " Innovation starts with a stupid question". Very insightful I thought but perhaps without an experience to give it some substance could be just as quickly forgotten and irrelevant.
A number of years ago I was on one of those executive courses where you do some strange group activities. I have always liked these events because no matter how poorly run there's usually something different to be learned. On this occasion, a group of 10 were doing a communication/leadership exercise. Without speaking or grunting etc and with only a stick and a tin can I had to direct the other 9 people around an outside maze within 15 minutes. The challenge was that the 9 were blindfolded!
We had 10 minutes to prepare how to achieve this task. As you'd expect the first 5 minutes achieved absolutely nothing as all 10 tried to give their opinions at once. Then an almost epiphanis moment occurred when everyone fell silent realising that we were getting absolutely nowhere. At that point, in the silence a late great friend of mine asked that silly question, "Couldn't we use the sun?" After the nano seconds it took for everyone of the other 9 to think , "What a useless fuckwit comment!", someone started talking about using a code by banging the stick on the can, blah blah blah.
Although we took the whole thing very seriously, tried hard, and did make progress we failed miserably in the task. Half way through the exercise and out of complete frustration I started thinking that we had limited ourselves far too much, we needed an extra source of reference. That's right, the sun! However, the remarkable thing was that this revelation dawned on everyone as they revealed later. My mate was right but as one we had dismissed him out of hand without a second thought. Who were the real fuckwits? ! Unfortunately my mate, Dave (another one), is no longer with us but he lives on in me because whenever I assume that some one has asked a stupid question, I stop for just that second to remember the sun. It just may be worth listening to.
Lessons on Defining Investment If the following is useful to any reader, then great> But I need to write this down so that I can have some automatic discipline when I hear or read about "Investments". Experience tells me that investing is a specific thing but that often other acts of parting with your money are also defined as investments when they are not. Two other things that are wrongly termed investments are, speculation and buying assets. A fourth category is how gearing can change what you think you are doing quite considerably. Short descriptions do make a difference of where something sits in our brains and whther we have automatic warning signals.
I define "Investments" as putting money into an enterprise which does things, makes widgets, invents something or manages stuff. In other words creates wealth by effort, expertise, skill and innovation. Capitalism at its best with resultant benefits to all. Although it can be either high or low risk, investments are generally controlled risk and interesting. Perhaps strangely to some, I put matched short selling in to the investment category.
"Speculation" on the other hand is completely different. For all investors with the same limited capacity of an individual, speculation is nothing more than gambling. Speculating on the market price of commodities, indexes or assets is a risky venture. Buying shares in Exxon is an investment but buying oil futures is speculation. Buying shares in Qantas is an investment but buying an interest in the Allco aircraft residual book is speculation. This may be obvious but some things can get a little confusing. Writing open position put or call options on stocks or indexes is rash speculation no matter how smart we think we are. Closed option positions of the same stock or index can be smart investing. Individuals should steer clear of any significant speculation of their weailth but some speculation is a very good thing especially the ponies on Saturday as this can be lots of fun.
"Buying an asset" is different from investing or speculation and it is important to define the difference. Depositing money in a bank is an asset. Buying government debt or any debt which could be termed investment grade is an asset. Purchasing real property to either rent or live in is actually an asset purchase not an investment. However, to use one's skills or labour to improve the property would be an investment. As individuals, a significant part of our wealth should always be in assets.
The fourth category, "Gearing" or some other derivative which achieves the same. These added extras are the bombs waiting to blow our dreams if used badly. There is nothing wrong with debt. I love debt. In fact it is absolutely necessary to lubricate the wheels of capitalism and commerce. Its the purpose and terms which will kill us. Borrowing against investments can change the whole game to pure speculation. Maxing the margin loans covering your portfolio as the market increases to extract cash because you don't want to pay capital gains tax turns investments into speculation. Maintaining a modest level of gearing would not. Buying real property covered by debt which can only be fully serviced by an increase in value or income is speculation. Gearing against any asset purchase, even government bonds, where repayment can be triggered by change in the market value of the asset no matter how extreme is speculation.
One thing the GFC has revealed in spades is the deception that many resorted to to get people to part with their money. City Pacific through enticing people into their first mortgage fund were fraudulent in their description of the risk. By presenting the first mortgage fund as "an asset" when it was speculation, these people breached every requirement of a responsible manager. These funds were used to lend to property developments at future completed valuations. Part investment because the borrowers were building something but pure speculation because repayment of principal and interest was based on the properties being sold at the forecast valuation with recourse to no other party with the ability to repay. Storm Financial were as fraudulent or incompetent in their advice and consequently geared many into what was pure speculation of an individual's entire wealth
We need to ask a simple first question when being asked to part with our money. Is it an asset, an investment or speculation and what liability are you trying to sucker me into that will blow me out of the water?
This all may sound trite or smug hindsight finger pointing but my point is not what we may or may not have done. It is that as humans we categorize things and tend to think of everything in that category as behaving the same. So if we and the broader commentators refer to things as investments or assets when those things are actually speculation, even the smartest guys in the room tend to severely play down the risks. So names do make a difference and that is my experience.
As another thought you can use the same descriptions to many things in life. Take a look at your life partner or the like and ask your self, "Are they an asset, an investment or am I purely speculating?"
Yes Matilda, our experiences define us but more importantly use the experiences of others to ask the right simple questions so that we don't become the victim
Morgij
Wednesday, January 7, 2009
The Delusion-Markets are Not Predictable
I love this time of year because of the laughs I get around commentators' predictions on what will happen in financial markets over the next 12 months. When not taken seriously, this exercise can be genuinely funny because it truly demonstrates how little we do actually know. Although those that take it seriously are almost always bound to be wrong. Or a different view comes from a renowned market economist of the 80s, Ray Block, who once told me, "I think that I must be the most successful economist of all time. I am so accurate and people take so much notice of me, that my predictions of market movements are always wrong!" Ray did have a sense of humour, but he also had a point.
However, there are those rare times when an intimate knowledge of how financial systems work can deliver predictions which will be fulfilled and where little can be done to stop or change. Are we in one of those rare times?
My predictions for 2009:
Australian House Prices At times we need to hear something repeatedly, like a child, before it sinks in. House prices have fallen and will continue to fall.
In Australia our brains are hardwired to believe that house prices will not fall or indeed that owning a house will create wealth through price increases with little risk. Nevertheless, whilst substantial natural resistance exists in Australia, median house prices will continue to fall through 2009 in all 8 major regions. The irresistible force behind this prediction is the reduction in the availability of and eligibility for credit for new buyers.
The only real dramatic event that happened to me in my time in the QLD police force was being strangled to unconsciousness by a person with lot more strength than I had then or now. A very surreal experience heightened at the point when the inevitability of my helplessness took hold. Anyone who wants to sell a house in 2009 may very well experience the same sort of thing. Clearly I at least maintained a pulse and so will the housing market but some things we just can't fight.
The Cash Rate and Bank Deposit Rates We are 3 months into the very new situation of deposits and wholesale debt of ADI's being guaranteed by the Federal Govt. Just 2 years and 9 months to go of bad policy designed to stifle innovation, subjugate the financial system to semi govt control and incentivising investment into low productive activities. Bad or unenforced regulation got us into this mess which clearly justifies more of the same. Politicians and bureaucrats being primarily motivated by power will grab more when they can just, for the sake of it. But this is very bad for us white hats!
All ADIs will need to increase capital (see below) but will also be expected (or attempt) to maintain return on capital. A combination of capital raising, asset growth reduction, increased lending margins and reduction in deposit rates will be used to strengthen ADI/bank balance sheets for the new world.
However, this paradigm only incentivises interest rates to head towards zero in Australia. The RBA will chase it's tail down to between 1% and 2% by the end of 2009 with bank deposit rates at relative levels. I am no Nostradamus on this one, we have enough global precedents to look at.
Listed Australian Banks and Other Financial Companies. Probably all Australian listed ADIs will survive 2009 most with stronger balance sheets, if not their P&Ls. However, this will not translate into value for current shareholders. As stated above, Aussie banks will need to raise capital and lots of it. Westpac needs to raise $5bn because of the St George purchase just to get up to speed with the other 3 majors. Do the math, its true. Both Suncorp and Bendigo will have much larger losses than either provided or indicated from their property development and residential books. But just as importantly, if there is to be any real growth in lending than extra capital is needed. Capital is now very expensive and will only be raised at the expense of existing shareholders. This is the only give point to maintain a healthy banking system with or without govt intervention.
Sadly, Macquarie will not survive as an independent listed company. It will have a major liquidity event during 2009 which will require it to be "rescued". The millionaires factory will severely burn many but mostly their own. MBL shareholders will receive very little but it will survive.
Shareholders in financial companies will suffer more than most but don't be too aggressive in your bets. Just buy modest amounts of slightly out of the money put options maturing in the 2nd half. I hope at least a few of my readers have been short since I first advised to be short financials at the end of October. About an average 25% fall since then and a round of capital raisings. Much much more to follow.
ASIC Prosecutions and Rating Agencies Not a single one of the criminals from Allco, ABC, MFS, City Pacific et al will be successfully prosecuted or indeed go to trial during 2009. Rather than running around waving their genitals in the air about more regulation, our second rate politicians should be simply enforcing or providing resources to enforce the current laws. These are actions that will actually put confidence back into the system and allow people to invest in a little more risk without the fear of being ripped off!
All the major rating agencies in this country fall into the same general category, perhaps not criminal, but certainly professionally negligent. These businesses are continuing to rip off investors by patently inaccurate ratings. They need to clean up their act on a lot of detail and admit where and why they got it wrong. My very confident prediction is they will not do this and their credibility will slide to new low levels..
What should be we invest in, in 2009? Do not invest directly or indirectly in any hard assets. No property, things made of metal or concrete, hard or soft technology, or commodities of any sort. Invest directly in well managed consumer receivables or businesses backed by these types of receivables. For individuals to invest directly may be difficult but an analysis of many listed funds and companies will throw up numerous opportunities. I can hear people's minds ticking over that I am being somewhat inconsistent. OK, invest in rental property when rent pays the interest. It also follows that if my predictions on financials are correct then once you have exercised your puts in October, with those tidy profits pin your ears back, parlay up and buy!
Yes Matilda, perhaps there are times when predictions can be made with confidence. Only substantial further government interference in the system could change this confidence. The questions are, are we confident and can we use that confidence to build our futures or at least keep our sanity for the year ahead?
Morgij.
However, there are those rare times when an intimate knowledge of how financial systems work can deliver predictions which will be fulfilled and where little can be done to stop or change. Are we in one of those rare times?
My predictions for 2009:
Australian House Prices At times we need to hear something repeatedly, like a child, before it sinks in. House prices have fallen and will continue to fall.
In Australia our brains are hardwired to believe that house prices will not fall or indeed that owning a house will create wealth through price increases with little risk. Nevertheless, whilst substantial natural resistance exists in Australia, median house prices will continue to fall through 2009 in all 8 major regions. The irresistible force behind this prediction is the reduction in the availability of and eligibility for credit for new buyers.
The only real dramatic event that happened to me in my time in the QLD police force was being strangled to unconsciousness by a person with lot more strength than I had then or now. A very surreal experience heightened at the point when the inevitability of my helplessness took hold. Anyone who wants to sell a house in 2009 may very well experience the same sort of thing. Clearly I at least maintained a pulse and so will the housing market but some things we just can't fight.
The Cash Rate and Bank Deposit Rates We are 3 months into the very new situation of deposits and wholesale debt of ADI's being guaranteed by the Federal Govt. Just 2 years and 9 months to go of bad policy designed to stifle innovation, subjugate the financial system to semi govt control and incentivising investment into low productive activities. Bad or unenforced regulation got us into this mess which clearly justifies more of the same. Politicians and bureaucrats being primarily motivated by power will grab more when they can just, for the sake of it. But this is very bad for us white hats!
All ADIs will need to increase capital (see below) but will also be expected (or attempt) to maintain return on capital. A combination of capital raising, asset growth reduction, increased lending margins and reduction in deposit rates will be used to strengthen ADI/bank balance sheets for the new world.
However, this paradigm only incentivises interest rates to head towards zero in Australia. The RBA will chase it's tail down to between 1% and 2% by the end of 2009 with bank deposit rates at relative levels. I am no Nostradamus on this one, we have enough global precedents to look at.
Listed Australian Banks and Other Financial Companies. Probably all Australian listed ADIs will survive 2009 most with stronger balance sheets, if not their P&Ls. However, this will not translate into value for current shareholders. As stated above, Aussie banks will need to raise capital and lots of it. Westpac needs to raise $5bn because of the St George purchase just to get up to speed with the other 3 majors. Do the math, its true. Both Suncorp and Bendigo will have much larger losses than either provided or indicated from their property development and residential books. But just as importantly, if there is to be any real growth in lending than extra capital is needed. Capital is now very expensive and will only be raised at the expense of existing shareholders. This is the only give point to maintain a healthy banking system with or without govt intervention.
Sadly, Macquarie will not survive as an independent listed company. It will have a major liquidity event during 2009 which will require it to be "rescued". The millionaires factory will severely burn many but mostly their own. MBL shareholders will receive very little but it will survive.
Shareholders in financial companies will suffer more than most but don't be too aggressive in your bets. Just buy modest amounts of slightly out of the money put options maturing in the 2nd half. I hope at least a few of my readers have been short since I first advised to be short financials at the end of October. About an average 25% fall since then and a round of capital raisings. Much much more to follow.
ASIC Prosecutions and Rating Agencies Not a single one of the criminals from Allco, ABC, MFS, City Pacific et al will be successfully prosecuted or indeed go to trial during 2009. Rather than running around waving their genitals in the air about more regulation, our second rate politicians should be simply enforcing or providing resources to enforce the current laws. These are actions that will actually put confidence back into the system and allow people to invest in a little more risk without the fear of being ripped off!
All the major rating agencies in this country fall into the same general category, perhaps not criminal, but certainly professionally negligent. These businesses are continuing to rip off investors by patently inaccurate ratings. They need to clean up their act on a lot of detail and admit where and why they got it wrong. My very confident prediction is they will not do this and their credibility will slide to new low levels..
What should be we invest in, in 2009? Do not invest directly or indirectly in any hard assets. No property, things made of metal or concrete, hard or soft technology, or commodities of any sort. Invest directly in well managed consumer receivables or businesses backed by these types of receivables. For individuals to invest directly may be difficult but an analysis of many listed funds and companies will throw up numerous opportunities. I can hear people's minds ticking over that I am being somewhat inconsistent. OK, invest in rental property when rent pays the interest. It also follows that if my predictions on financials are correct then once you have exercised your puts in October, with those tidy profits pin your ears back, parlay up and buy!
Yes Matilda, perhaps there are times when predictions can be made with confidence. Only substantial further government interference in the system could change this confidence. The questions are, are we confident and can we use that confidence to build our futures or at least keep our sanity for the year ahead?
Morgij.
Thursday, December 18, 2008
The Delusion- All's Fair in Business
This last few weeks has seen enormous numbers words printed all around the world about excessive banker salaries, banks mismanagement of loan risks, corporate failures due to obvious business model failure and blatant investor rip-offs but not within the seedier side of global business but mainstream credible organisations. My question is how has this been happening and allowed to continue for so long? Words like greed, massive egos, criminal intent etc are descriptions of acts which may describe why but do not describe how.
Without over simplifying things I'd like to use my observations to answer how. There are three types of unwritten contracts that society operates under to function well and grow. Market contracts, social contracts, political/ government contracts and then mixtures of these. There are of course laws and regulations which support society but these contracts are unwritten and support how we should behave in different circumstances.
Market contracts govern straight business deals. Buying and selling of goods and many services are governed by the simple rule, "Let the buyer beware". Nothing is owed between the parties then the deal being transacted. Most of business even banking is governed by market contracts with little or no exchange of emotion between the parties. Most employment contracts are market contracts, work your hours, do your job, get paid the exact amount owed and we're all happy. Market contracts are very good for a functioning democratic capitalist society. They promote competition, reward hard work and the delivery of exactly the good or service paid for. However, the essence of a market contract is that terms are precise with the understanding that each side understands those terms with no recourse after the event unless there is a breach of those terms.
Social Contracts are almost the antithesis of the market contract because they are imprecise and long lasting. Social contracts are all about give and take depending on the circumstances, are long lasting and generally about treating people how we want to be treated depending on the relationship. I suppose the pinnacle of social contracts is marriage and our relationship with our children. But social contracts from every level rule our daily lives. They are all ruled by various levels of responsibility and equal give and take. Have you ever had the experience of seeing a person in the street on a regular basis and although you have never spoken you start to exchange hellos or even nods. Then one day they start ignoring you completely. It is a strange unpleasant experience because they have broken the small social contract between you and them. These things are very important to us!
Political/Government Contract. I am not going to discuss this here as I am not sure what it is. If anything it has broken down completely a long time ago.
Sociomarket contracts are those contracts which blend business with social responsibilities and it is these arrangements which I believe are at the bottom of how some "very bad behaviour" has occurred. Sociomarket contacts occur in business where the benefits to each side are achieved over a long time and where situations can change dramatically over time. Examples would be where a business is raising funds to invest on behalf of others (especially so where those investors are retail). Many employment contracts where the employee is in a developing business, inputs significant intellectual property or excessive effort. And of course many business banking relationships where the support of the bank and the ultimate success of the business brings benefits to both sides far exceeding the underlying loan contract. Or just combine all three and you have a description of numerous finance and investment businesses which have now failed.
Sociomarket contracts come with huge responsibilities between all participants to be honest and act to enhance how the relationships work and not just for self interest. The terms of thees arrangements cannot possibly be written down to cover most, let alone all contingencies or even in a way that all participants can be sure to understand the arrangements. If we act as if these arrangements are market contracts then failure is a certainty. Of course worse still, many understand the nature of sociomarket contracts and then seek to exploit the situation. Often this is because these types can not succeed in the the dog eat dog world of the market. The alphas and other carnivores that want to run with the pack but don't have the ability, slink at the back and try to kill the young, the weak or injured not of the prey but their own.
The Point to WHY and HOW! My observations is that a large amount of bad behaviour was the result of gross jealousy (the Why) and the simple ability to deliberately exploit sociomarket contracts (the How). Through the 90s and beyond the capitalist model had made many people legitimately very wealthy. Everyone wanted a piece of the action but few had the true ability to achieve it. Exploiting retail investors, employees, business partners, customers, and borrowers was just too easy and tempting for many wannabes. Don't get me wrong, i am not suggesting that the capitalist model should be more social driven. Its just that many circumstances rely on unwritten contracts of good behaviour where it is easy to exploit the participants and if this occurs the business or venture will fail without exception with any exploitation being of a temporary benefit at best. The reality for any rational being is, "Why go there in the first place?".
$US/$A FX Rate. I have had a little feedback over the last week or so from a few of my very valuable readers regarding the temporary strengthening of the $A. Although it has been a little weaker in the last few days, this has nothing to do with commodities or sentiment which will continue to have little real effect. It is a balance sheet issue. Aussie banks have been doing $US govt guaranteed debt raising. Therefore they or other counterparties were buying $A. There will still be a large net selling of $A from repaying US$ over the next few years. Keep short the $A.
Bendigo/Adelaide Bank Capital Raising. CBA did not get away with its gross mismanagement of its capital raising in the last week and the mistimed disclosure of important future write-offs. For now it looks like Bendigo Bank has not been blow torched by either investors or the media. The investor presentation disclosure about the potential loan write offs in the Bendigo loan book was the absolute minimum which is disgraceful in this market. Disclosure only of historical average LVR levels on its 90+ arrears book is just absolutely useless information dressed up as relevant good news. Bendigo Bank will announce a significant increase in its provision for bad debts when it makes it half year results announcement. This is information which it already has. The capital raising was at a 20% discount to market. Bendigo will need a lot more capital which will dilute existing shareholder value through out 2009. The bank will survive but at the expense of many small shareholders.
Yes Matilda, bad behaviour occurs, but the results are predictable and that's where we can profit. Talking of predictions Matilda, first blog of 2009 my arse will be further put on the line by my predictions for the year but until then merry Christmas and a very happy new year!
Morgij
Without over simplifying things I'd like to use my observations to answer how. There are three types of unwritten contracts that society operates under to function well and grow. Market contracts, social contracts, political/ government contracts and then mixtures of these. There are of course laws and regulations which support society but these contracts are unwritten and support how we should behave in different circumstances.
Market contracts govern straight business deals. Buying and selling of goods and many services are governed by the simple rule, "Let the buyer beware". Nothing is owed between the parties then the deal being transacted. Most of business even banking is governed by market contracts with little or no exchange of emotion between the parties. Most employment contracts are market contracts, work your hours, do your job, get paid the exact amount owed and we're all happy. Market contracts are very good for a functioning democratic capitalist society. They promote competition, reward hard work and the delivery of exactly the good or service paid for. However, the essence of a market contract is that terms are precise with the understanding that each side understands those terms with no recourse after the event unless there is a breach of those terms.
Social Contracts are almost the antithesis of the market contract because they are imprecise and long lasting. Social contracts are all about give and take depending on the circumstances, are long lasting and generally about treating people how we want to be treated depending on the relationship. I suppose the pinnacle of social contracts is marriage and our relationship with our children. But social contracts from every level rule our daily lives. They are all ruled by various levels of responsibility and equal give and take. Have you ever had the experience of seeing a person in the street on a regular basis and although you have never spoken you start to exchange hellos or even nods. Then one day they start ignoring you completely. It is a strange unpleasant experience because they have broken the small social contract between you and them. These things are very important to us!
Political/Government Contract. I am not going to discuss this here as I am not sure what it is. If anything it has broken down completely a long time ago.
Sociomarket contracts are those contracts which blend business with social responsibilities and it is these arrangements which I believe are at the bottom of how some "very bad behaviour" has occurred. Sociomarket contacts occur in business where the benefits to each side are achieved over a long time and where situations can change dramatically over time. Examples would be where a business is raising funds to invest on behalf of others (especially so where those investors are retail). Many employment contracts where the employee is in a developing business, inputs significant intellectual property or excessive effort. And of course many business banking relationships where the support of the bank and the ultimate success of the business brings benefits to both sides far exceeding the underlying loan contract. Or just combine all three and you have a description of numerous finance and investment businesses which have now failed.
Sociomarket contracts come with huge responsibilities between all participants to be honest and act to enhance how the relationships work and not just for self interest. The terms of thees arrangements cannot possibly be written down to cover most, let alone all contingencies or even in a way that all participants can be sure to understand the arrangements. If we act as if these arrangements are market contracts then failure is a certainty. Of course worse still, many understand the nature of sociomarket contracts and then seek to exploit the situation. Often this is because these types can not succeed in the the dog eat dog world of the market. The alphas and other carnivores that want to run with the pack but don't have the ability, slink at the back and try to kill the young, the weak or injured not of the prey but their own.
The Point to WHY and HOW! My observations is that a large amount of bad behaviour was the result of gross jealousy (the Why) and the simple ability to deliberately exploit sociomarket contracts (the How). Through the 90s and beyond the capitalist model had made many people legitimately very wealthy. Everyone wanted a piece of the action but few had the true ability to achieve it. Exploiting retail investors, employees, business partners, customers, and borrowers was just too easy and tempting for many wannabes. Don't get me wrong, i am not suggesting that the capitalist model should be more social driven. Its just that many circumstances rely on unwritten contracts of good behaviour where it is easy to exploit the participants and if this occurs the business or venture will fail without exception with any exploitation being of a temporary benefit at best. The reality for any rational being is, "Why go there in the first place?".
$US/$A FX Rate. I have had a little feedback over the last week or so from a few of my very valuable readers regarding the temporary strengthening of the $A. Although it has been a little weaker in the last few days, this has nothing to do with commodities or sentiment which will continue to have little real effect. It is a balance sheet issue. Aussie banks have been doing $US govt guaranteed debt raising. Therefore they or other counterparties were buying $A. There will still be a large net selling of $A from repaying US$ over the next few years. Keep short the $A.
Bendigo/Adelaide Bank Capital Raising. CBA did not get away with its gross mismanagement of its capital raising in the last week and the mistimed disclosure of important future write-offs. For now it looks like Bendigo Bank has not been blow torched by either investors or the media. The investor presentation disclosure about the potential loan write offs in the Bendigo loan book was the absolute minimum which is disgraceful in this market. Disclosure only of historical average LVR levels on its 90+ arrears book is just absolutely useless information dressed up as relevant good news. Bendigo Bank will announce a significant increase in its provision for bad debts when it makes it half year results announcement. This is information which it already has. The capital raising was at a 20% discount to market. Bendigo will need a lot more capital which will dilute existing shareholder value through out 2009. The bank will survive but at the expense of many small shareholders.
Yes Matilda, bad behaviour occurs, but the results are predictable and that's where we can profit. Talking of predictions Matilda, first blog of 2009 my arse will be further put on the line by my predictions for the year but until then merry Christmas and a very happy new year!
Morgij
Wednesday, December 10, 2008
No Delusion-Acknowledgements, Brickbats and Bouquets
This week brings a temporary halt to my rantings about parts of the financial system to acknowledge some interesting market developments, speeches and commentary, still with emotion though.
The former Governor of the RBA, Ian Macfarlane. I must lead with Ian's public rant about bankers salaries ie the greatest financial scam of all time. Obviously I agree but its reassuring to hear those views from a prominewnt and now independent commentator. Ian just did not go far enough, using the word "criminal" and mentioning names of people and organisations may have got the public's interest a tad higher. A very large bouquet to Ian as opposed to the incumbent, but see below.
The overated columnist from the SMH, Ross Gittins. You'll recall Ross was the "independent" commentator taking the advice of vested interest economists and invoking the supply/demand argument in support of house prices not dropping. He was also guilty of insulting every victim of current and future retrenchments by asserting that people being retrenched wouldn't have mortgages because they could not afford them. Although this git is very well named, I wish to positively acknowledge his road to Damascus change. Ross has got the point, its a balance sheet issue. Neither interest rates nor an increasing population will support house prices. The problem is the repayment of principal which as a country cannot be done without decreasing debt levels and asset prices. I am so proud of you Ross!
The credible gonzo columnist from the SMH, Michael West. Whilst Westie can be more entertaining than factual sometimes, his articles on Allco and City Pacific were pretty insightful. The coincidence with my previous blog and his "alpha male" expression plus other comments in the articles were a little too coincidental so I'll take a little flattery and suggest that Michael has been reading this blog. Anyway its very good that someone in the public arena continues to expose these scam artists and con men for exactly what they are.
The New York Times for the headline, "Can we trust the figures coming out of China?" Dah! This is like asking Al Capone and his successors whether they reported the correct income to the tax man. China is a Mafioso styled society with all the criminal intent that involves. Democracy may not be perfect but its the best system we have and I still have no intention of giving any cu does to a country which spurns democracy, hands out golden paydays for the cronies and suppresses free speech and any protest. China, you're goin' down!
To Eddie J Pinto former Chief Credit Officer with Fannie Mae. Eddie has testified in the US that Fannie wrote $1.6 trillion of Alt A and sub prime loans. All of which should never have been written by these government sponsored organisations. I have pointed out the bad regulation behind Fannie and Fredie which promoted this behaviour but its good to see some honesty. We have not seen that honesty in Australia yet. I'm sure that we'll have to wait a while before APRA admits that the mortgage insurers have been insuring a large amount of loans for ADIs in Australia which are also sub prime. The sideshow on this will be very interesting for those not burnt by it.
To The Economist article "Popping Sounds". This one page article captures Australia's house price position for all to see. It is simply comparing the house prices and growth of 20 developed countries including China and South Africa. The comparison shows that only South Africa(?), Spain and Ireland have had larger house price growth than Australia since 1997 with Britain a close 5th. The US in fact had about half the growth than Australia. A little research will tell you what is happening to house prices in Spain, Ireland and Britain. Forget any other reasoning, do you honestly think that Australia will head this list in 2009 and for many years thereafter? Westpac's Bill Evans would certainly like us to believe such crap!
To the erstwhile PM of Australia Kevin Rudd. He is worthy of mention not for the $10bn hand out that started to pay this week but the statement that every, parent, carer or pensioner should use this middle class welfare to spend, spend, spend! Irresponsible in the extreme and utterly self serving. Clearly he takes his economic advice from Gerry Harvey. The other confused part of this garble, is the encouragement to buy crappy toys for "the grand children" but don't be irresponsible and drink or gamble it away. Whatever the actual intent, to spend money on products which are 100% Australian made, being served by 100% Australian labour, I would have thought was good. This would produce more of the short term benefits for Australia that the hand out was aimed at. Much more than buying some plastic or electronic crap made in China from Gerry at Harvey Norman. Perhaps the bar persons of the country should unite and point this out to Tin Tin.
Lastly, to the current Governor of the RBA, Glen Stevens. Clear evidence emerged during the week that the economy had negative growth in the September quarter with agricultural exports excluded. The fact that in the previous quarter this guardian of Australia's monetary policy actually increased interest rates demonstrates his and his colleagues gross lack of understanding of the true state of the Australian economy. Anyone with their eyes wide open which of course many of us did have, were saying that the last two increases were absolutely unnecessary. But that is not the only crime of this buffoon. He made a speech during the week saying that our problems were all about confidence and following the PM's lead, to go out and spend and life will return to the good old times. Perhaps he uses Gerry Harvey as his advisor as well. I can only think that this man can not be stupid enough to believe that rhetoric. Perhaps his evil but simple plan is to do what every public servant in the country does as part of their job description ie protect your arse. You see if he can just get people to spend, spend spend before Christmas and just head off negative growth in this quarter than perhaps we'll all forget about both his negligent interest rate increases in the first half of the year and his lack of grasp on the true state of the economy. This frees him up to blame whatever disaster becomes us in 2009 to the GFC which of course by then is way out of his and Kevin's hands and their ability to influence. A pox on you Glen!
Yes Matilda, there are good guys, bad guys and just plain fools. Its our task to work out who is what.
Morgij
The former Governor of the RBA, Ian Macfarlane. I must lead with Ian's public rant about bankers salaries ie the greatest financial scam of all time. Obviously I agree but its reassuring to hear those views from a prominewnt and now independent commentator. Ian just did not go far enough, using the word "criminal" and mentioning names of people and organisations may have got the public's interest a tad higher. A very large bouquet to Ian as opposed to the incumbent, but see below.
The overated columnist from the SMH, Ross Gittins. You'll recall Ross was the "independent" commentator taking the advice of vested interest economists and invoking the supply/demand argument in support of house prices not dropping. He was also guilty of insulting every victim of current and future retrenchments by asserting that people being retrenched wouldn't have mortgages because they could not afford them. Although this git is very well named, I wish to positively acknowledge his road to Damascus change. Ross has got the point, its a balance sheet issue. Neither interest rates nor an increasing population will support house prices. The problem is the repayment of principal which as a country cannot be done without decreasing debt levels and asset prices. I am so proud of you Ross!
The credible gonzo columnist from the SMH, Michael West. Whilst Westie can be more entertaining than factual sometimes, his articles on Allco and City Pacific were pretty insightful. The coincidence with my previous blog and his "alpha male" expression plus other comments in the articles were a little too coincidental so I'll take a little flattery and suggest that Michael has been reading this blog. Anyway its very good that someone in the public arena continues to expose these scam artists and con men for exactly what they are.
The New York Times for the headline, "Can we trust the figures coming out of China?" Dah! This is like asking Al Capone and his successors whether they reported the correct income to the tax man. China is a Mafioso styled society with all the criminal intent that involves. Democracy may not be perfect but its the best system we have and I still have no intention of giving any cu does to a country which spurns democracy, hands out golden paydays for the cronies and suppresses free speech and any protest. China, you're goin' down!
To Eddie J Pinto former Chief Credit Officer with Fannie Mae. Eddie has testified in the US that Fannie wrote $1.6 trillion of Alt A and sub prime loans. All of which should never have been written by these government sponsored organisations. I have pointed out the bad regulation behind Fannie and Fredie which promoted this behaviour but its good to see some honesty. We have not seen that honesty in Australia yet. I'm sure that we'll have to wait a while before APRA admits that the mortgage insurers have been insuring a large amount of loans for ADIs in Australia which are also sub prime. The sideshow on this will be very interesting for those not burnt by it.
To The Economist article "Popping Sounds". This one page article captures Australia's house price position for all to see. It is simply comparing the house prices and growth of 20 developed countries including China and South Africa. The comparison shows that only South Africa(?), Spain and Ireland have had larger house price growth than Australia since 1997 with Britain a close 5th. The US in fact had about half the growth than Australia. A little research will tell you what is happening to house prices in Spain, Ireland and Britain. Forget any other reasoning, do you honestly think that Australia will head this list in 2009 and for many years thereafter? Westpac's Bill Evans would certainly like us to believe such crap!
To the erstwhile PM of Australia Kevin Rudd. He is worthy of mention not for the $10bn hand out that started to pay this week but the statement that every, parent, carer or pensioner should use this middle class welfare to spend, spend, spend! Irresponsible in the extreme and utterly self serving. Clearly he takes his economic advice from Gerry Harvey. The other confused part of this garble, is the encouragement to buy crappy toys for "the grand children" but don't be irresponsible and drink or gamble it away. Whatever the actual intent, to spend money on products which are 100% Australian made, being served by 100% Australian labour, I would have thought was good. This would produce more of the short term benefits for Australia that the hand out was aimed at. Much more than buying some plastic or electronic crap made in China from Gerry at Harvey Norman. Perhaps the bar persons of the country should unite and point this out to Tin Tin.
Lastly, to the current Governor of the RBA, Glen Stevens. Clear evidence emerged during the week that the economy had negative growth in the September quarter with agricultural exports excluded. The fact that in the previous quarter this guardian of Australia's monetary policy actually increased interest rates demonstrates his and his colleagues gross lack of understanding of the true state of the Australian economy. Anyone with their eyes wide open which of course many of us did have, were saying that the last two increases were absolutely unnecessary. But that is not the only crime of this buffoon. He made a speech during the week saying that our problems were all about confidence and following the PM's lead, to go out and spend and life will return to the good old times. Perhaps he uses Gerry Harvey as his advisor as well. I can only think that this man can not be stupid enough to believe that rhetoric. Perhaps his evil but simple plan is to do what every public servant in the country does as part of their job description ie protect your arse. You see if he can just get people to spend, spend spend before Christmas and just head off negative growth in this quarter than perhaps we'll all forget about both his negligent interest rate increases in the first half of the year and his lack of grasp on the true state of the economy. This frees him up to blame whatever disaster becomes us in 2009 to the GFC which of course by then is way out of his and Kevin's hands and their ability to influence. A pox on you Glen!
Yes Matilda, there are good guys, bad guys and just plain fools. Its our task to work out who is what.
Morgij
Tuesday, December 2, 2008
The Delusion- We're all on the same side!
We are born and are able to grow up and actually live full lives because of "society". People, systems, interactions with friends, family, partners and all we come into contact with is the society which has evolved over countless generations. Through out history there are endless examples of failed societies and some examples of strange successes eg pirate society of the 16th and 17th centuries. Historians and anthropologists build their careers around the study of past events and societies and I apologise in advance for the simplicity of what I am about to write about. I am no expert but my observations tell me that societies, tribes, teams, families all work well when its members have a common goal.
"being on the same page", "we're all on the same side', "heading in the same direction", 'singing from the same hymn sheet", "rooting for the same team". The expressions are vast but I do think it simply comes down to the fact that a successful group must have all members interests aligned. From that point the possibilities are endless but this of course can be used for both good and evil.
There is a nigger in the wood pile in all this society stuff which is the basis of my premise. From primeval tribes to modern society the alpha male has nothing but his own interests at heart and would rather destroy the group than work on aligning interests that don't centre on him being the alpha. Of course, a group can be successful for a period with the alpha's dominance so long as that aligns with the rest of the groups interests. However this is survival, not success or growth. Ancient societies must have continually evolved to become us and our modern definitions of success and growth. So something different must have occurred to keep the alphas at bay. However, the development of primitive families and the emergence very quickly in evolutionary terms of intelligence is not what this blog is about. But I will write about that some day. No, this is a short essay on how the alpha male got the chance to stuff the global financial system and took it.
No corporation can develop a sustainable business model without the alignment of all stake holders. Whether you make widgets or lend money, a good business manager can balance the interests of shareholders with employees and her own to ensure that the business is successful, grows and rewards all stakeholders (including customers) with what they deserve. Mmmm, there's that word again which I have used before to describe where we are going. But the financial system is in tatters because alpha males yet again distorted who was deserving, obviously in favour of alpha males. Whilst giving the impression of massive success the actions of a few in authority within the global financial system were doomed to tragic failure even at the expense of the whole tribe.
How the hell did this happen and what the f?>": am I talking about?
Through all cycles good, bad and indifferent, individuals in business have always tried to gain an advantage for themselves, legally or illegally, with ultimate drastic consequences for themselves and other stakeholders. The antics of many were seriously amusing and shocking as described in Liar's Poker about the 80's and before that the labour unions of the 60s and 70s. But I just love the Enron example. "The smartest guys in the room" Known everywhere for their predatory behaviour across most of the organisation with no regard for any other stakeholder except themselves. Behaviour that was not just about profit but aimed at crushing anyone they could for the sake of gang type approval. Nevertheless the consequences of their actions was isolated and ultimately severely punished. During the next 7 years however, the moons aligned, the stars were in the seventh heaven and those latent alphas aligned their interests to perpetrate a fraud so massive it defies description. Along the way they crushed any opposition but mostly they bribed themselves a new generation of support from vocal and brash "smartest guys in the room".
Nearly every significant financial institution in the world participated but led mostly by the semi regulated investment banks in every corner of the globe. In the aftermath of the dotcom bubble and sadly 9/11, market conditions were perfect for the alphas to dominate their financial organisations and their shareholders. The scam is simple. Lend long, fund short and package up structured investments for sale without care or responsibility as to the accuracy of the models or risk of what was sold. Now add to this the final two steps. First PV the unknown or illusory profits using valuation models that you control, then as does every criminal organisation known to man, distribute these ill gotten gains to everyone starting from the bottom up with a multiplier effect to the top godfather. Quickly we had a situation where the illusory profits were so large that the godfathers were paying themselves massive undeserved amounts as the top of the pyramid. No one could ever possibly justify the massive annual payments to the head honchos at these organisations. But why would any underling complain in any meaningful way as they to were usually paid far more than they deserved. Shareholders played in this game through the stockmarkets of the globe believing that they were being made rich which of course if you were one of the very few to not be left holding the bag, was probably correct. Buyers, customers, borrowers and clients all were cajoled into believing in the same game. The alphas had temporarily pulled it off as they had in all previous great dynasties through out history. They convinced the stakeholders that all interests were aligned but that is never the case when the carnivores dominate as everything else is just prey.
Am I being too dramatic, simplistic or unfair? No way Matilda! Strip away the noise, the excuses, the exceptions and and our inability to believe that such a massive scam could occur and the above description is exactly what happened. The only justice we'll see out of the all whole tragedy is that so many alphas believed their own bullshit or invincibility that not only did they continually invest back into the scam but geared themselves into it with disasterous consequences. I can only think that this was rationalised on the basis that such actions would perpetuate the scam whilst disguising the underlying ruse.
Now back to how interests were misaligned.It could be argued that the pursuit of higher profits and growth with products that investors and borrowers demanded was the ultimate alignment of interest. Sadly this conclusion only makes sense for the financially unskilled, but happily for the alphas it was believed. The missing ingredient of course is risk and to be simple two major types of risk which we'll call P&L and balance sheet. Of course the negligent or criminal managers at the head of these organisations were there to understand and manage these risks but didn't thereby misaligning interests.
Let's look at the P&L risk first as it is a little easier to understand. There are many risks to profits within a financial organisation but the one that stands from the crowd is credit risk. Descriptions that the crisis was caused in the US sub prime market where bad underwriting standards and predatory lending led to writing bad loans do not get to the heart of the matter. I am absolutely positive that almost no one wanted or intended to write bad loans. But the system was set up to actually incentivise everyone to take more risk because the managers of the organisations were not awake to the faults in the system or chose to ignore them. The most notable example although extreme, was lending 125% of value on stated income (ie no Proof) in US markets where there is no recourse to borrowers. Without being like the mainstream press and and positioning the borrower as a single mother with 5 kids and an invalid mother, most of these borrowers were very street savy whilst perhaps on the uneducated end of the market but not all. Again Matilda think about it, the borrower has a massive liability but probably money in her pocket, a chance to repay and make money if prices continue to rise but for no god's sake a ability to walk away if things get tough. Any fool would realise that if property prices plummet the probability of default is 100%. The rating agencies in what must be described as collective gross negligence assess the probability of default under a AAA stress to be about 20%. This single incorrect assessment led to the cost of those mortgages being way below what they should have been. What followed was normal game theory everyone in the origination and packaging process was incentivised to write the more risky business. Risk managers at financial institutions which promoted and packaged these products were also grossly negligent because these people had the opportunity to both identify the stop the anomaly but didn't. There is nothing wrong with risky lending but it must be priced for the risk and with terms and conditions which make it only acceptable in extreme circumstances. Not to actually create situations where risky lending was incentivised. Many other examples could be quoted in the US and Australian markets where risk managers chose not to properly assess risk and pricing. Was this just too hard or costly for them? Probably, in which case garrote the turds now! Just wait for the Aussie fall out from unaffordable mortgages over the next year or so.
Moving to the balance sheet where the real misalignment of interest occurred, I find it impossible not to be very passionate about what happened. The simple yet apparently genius balance sheet management policies of so many of these financial institutions was to borrow short where borrowing margins were low and too lend long where interest charges were higher. It must have been sheer genius to justify the pay scale. Well I have another simple business model which states that liquidity risk is a bigger risk than credit risk will ever be and if you do not adequately protect the business against this risk an event will occur that will destroy your business. The more a market collectively winds up the fund short lend long model, the quicker the death event will occur. The negligent turds running these organisations did or should have known this but deliberately did not disclose or played down this risk to all other stakeholders thereby misaligning interests through deceit. We can make all the excuses in the world about why this plan was necessary and acceptable but the fact remains that the biggest credit bubble in history is now being deflated and those running the financial organisations that inflated the bubble were paying themselves massive amounts for adopting the "genius plan".
I cannot go on Matilda. There is too much to say on the topic. I could be very specific on organisations and people, but why, both should be evident to anyone with a little research. These people deserve whipping, stripped of all assets and worse but this wont happen. No good will come from what the alphas have done as it never has in the past.
Morgij
"being on the same page", "we're all on the same side', "heading in the same direction", 'singing from the same hymn sheet", "rooting for the same team". The expressions are vast but I do think it simply comes down to the fact that a successful group must have all members interests aligned. From that point the possibilities are endless but this of course can be used for both good and evil.
There is a nigger in the wood pile in all this society stuff which is the basis of my premise. From primeval tribes to modern society the alpha male has nothing but his own interests at heart and would rather destroy the group than work on aligning interests that don't centre on him being the alpha. Of course, a group can be successful for a period with the alpha's dominance so long as that aligns with the rest of the groups interests. However this is survival, not success or growth. Ancient societies must have continually evolved to become us and our modern definitions of success and growth. So something different must have occurred to keep the alphas at bay. However, the development of primitive families and the emergence very quickly in evolutionary terms of intelligence is not what this blog is about. But I will write about that some day. No, this is a short essay on how the alpha male got the chance to stuff the global financial system and took it.
No corporation can develop a sustainable business model without the alignment of all stake holders. Whether you make widgets or lend money, a good business manager can balance the interests of shareholders with employees and her own to ensure that the business is successful, grows and rewards all stakeholders (including customers) with what they deserve. Mmmm, there's that word again which I have used before to describe where we are going. But the financial system is in tatters because alpha males yet again distorted who was deserving, obviously in favour of alpha males. Whilst giving the impression of massive success the actions of a few in authority within the global financial system were doomed to tragic failure even at the expense of the whole tribe.
How the hell did this happen and what the f?>": am I talking about?
Through all cycles good, bad and indifferent, individuals in business have always tried to gain an advantage for themselves, legally or illegally, with ultimate drastic consequences for themselves and other stakeholders. The antics of many were seriously amusing and shocking as described in Liar's Poker about the 80's and before that the labour unions of the 60s and 70s. But I just love the Enron example. "The smartest guys in the room" Known everywhere for their predatory behaviour across most of the organisation with no regard for any other stakeholder except themselves. Behaviour that was not just about profit but aimed at crushing anyone they could for the sake of gang type approval. Nevertheless the consequences of their actions was isolated and ultimately severely punished. During the next 7 years however, the moons aligned, the stars were in the seventh heaven and those latent alphas aligned their interests to perpetrate a fraud so massive it defies description. Along the way they crushed any opposition but mostly they bribed themselves a new generation of support from vocal and brash "smartest guys in the room".
Nearly every significant financial institution in the world participated but led mostly by the semi regulated investment banks in every corner of the globe. In the aftermath of the dotcom bubble and sadly 9/11, market conditions were perfect for the alphas to dominate their financial organisations and their shareholders. The scam is simple. Lend long, fund short and package up structured investments for sale without care or responsibility as to the accuracy of the models or risk of what was sold. Now add to this the final two steps. First PV the unknown or illusory profits using valuation models that you control, then as does every criminal organisation known to man, distribute these ill gotten gains to everyone starting from the bottom up with a multiplier effect to the top godfather. Quickly we had a situation where the illusory profits were so large that the godfathers were paying themselves massive undeserved amounts as the top of the pyramid. No one could ever possibly justify the massive annual payments to the head honchos at these organisations. But why would any underling complain in any meaningful way as they to were usually paid far more than they deserved. Shareholders played in this game through the stockmarkets of the globe believing that they were being made rich which of course if you were one of the very few to not be left holding the bag, was probably correct. Buyers, customers, borrowers and clients all were cajoled into believing in the same game. The alphas had temporarily pulled it off as they had in all previous great dynasties through out history. They convinced the stakeholders that all interests were aligned but that is never the case when the carnivores dominate as everything else is just prey.
Am I being too dramatic, simplistic or unfair? No way Matilda! Strip away the noise, the excuses, the exceptions and and our inability to believe that such a massive scam could occur and the above description is exactly what happened. The only justice we'll see out of the all whole tragedy is that so many alphas believed their own bullshit or invincibility that not only did they continually invest back into the scam but geared themselves into it with disasterous consequences. I can only think that this was rationalised on the basis that such actions would perpetuate the scam whilst disguising the underlying ruse.
Now back to how interests were misaligned.It could be argued that the pursuit of higher profits and growth with products that investors and borrowers demanded was the ultimate alignment of interest. Sadly this conclusion only makes sense for the financially unskilled, but happily for the alphas it was believed. The missing ingredient of course is risk and to be simple two major types of risk which we'll call P&L and balance sheet. Of course the negligent or criminal managers at the head of these organisations were there to understand and manage these risks but didn't thereby misaligning interests.
Let's look at the P&L risk first as it is a little easier to understand. There are many risks to profits within a financial organisation but the one that stands from the crowd is credit risk. Descriptions that the crisis was caused in the US sub prime market where bad underwriting standards and predatory lending led to writing bad loans do not get to the heart of the matter. I am absolutely positive that almost no one wanted or intended to write bad loans. But the system was set up to actually incentivise everyone to take more risk because the managers of the organisations were not awake to the faults in the system or chose to ignore them. The most notable example although extreme, was lending 125% of value on stated income (ie no Proof) in US markets where there is no recourse to borrowers. Without being like the mainstream press and and positioning the borrower as a single mother with 5 kids and an invalid mother, most of these borrowers were very street savy whilst perhaps on the uneducated end of the market but not all. Again Matilda think about it, the borrower has a massive liability but probably money in her pocket, a chance to repay and make money if prices continue to rise but for no god's sake a ability to walk away if things get tough. Any fool would realise that if property prices plummet the probability of default is 100%. The rating agencies in what must be described as collective gross negligence assess the probability of default under a AAA stress to be about 20%. This single incorrect assessment led to the cost of those mortgages being way below what they should have been. What followed was normal game theory everyone in the origination and packaging process was incentivised to write the more risky business. Risk managers at financial institutions which promoted and packaged these products were also grossly negligent because these people had the opportunity to both identify the stop the anomaly but didn't. There is nothing wrong with risky lending but it must be priced for the risk and with terms and conditions which make it only acceptable in extreme circumstances. Not to actually create situations where risky lending was incentivised. Many other examples could be quoted in the US and Australian markets where risk managers chose not to properly assess risk and pricing. Was this just too hard or costly for them? Probably, in which case garrote the turds now! Just wait for the Aussie fall out from unaffordable mortgages over the next year or so.
Moving to the balance sheet where the real misalignment of interest occurred, I find it impossible not to be very passionate about what happened. The simple yet apparently genius balance sheet management policies of so many of these financial institutions was to borrow short where borrowing margins were low and too lend long where interest charges were higher. It must have been sheer genius to justify the pay scale. Well I have another simple business model which states that liquidity risk is a bigger risk than credit risk will ever be and if you do not adequately protect the business against this risk an event will occur that will destroy your business. The more a market collectively winds up the fund short lend long model, the quicker the death event will occur. The negligent turds running these organisations did or should have known this but deliberately did not disclose or played down this risk to all other stakeholders thereby misaligning interests through deceit. We can make all the excuses in the world about why this plan was necessary and acceptable but the fact remains that the biggest credit bubble in history is now being deflated and those running the financial organisations that inflated the bubble were paying themselves massive amounts for adopting the "genius plan".
I cannot go on Matilda. There is too much to say on the topic. I could be very specific on organisations and people, but why, both should be evident to anyone with a little research. These people deserve whipping, stripped of all assets and worse but this wont happen. No good will come from what the alphas have done as it never has in the past.
Morgij
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