Modern pop culture has brought us everything from flash mob PR stunts, Ali G, and Avid Merrion, to Vicky Pollard and more cowbell. The supposedly niche language and intonation are supposed to confirm your membership of the cool club but, in fact, only serve to confirm your conformity with the prevailing cultural wind. That said, all these people can't be wrong. In an effort to convey a more pressing issue, I'll glean a hidden gem from the video vault... The Chewbacka Defence.
With the cold wind of recession blowing down the high street of UK Inc, there is now an even greater need for the risk taking trailblazers of the entrepreneurial world, to step forward and seize the moment. This is only possible with the backing of the UK banking industry. Even the simple process of buying a house requires a bank to play ball and, provide realistic funding. At the moment, most of the UK banks are passing on the Bank of England base-rate cuts to existing mortgage holders on their standard variable rate. This is a positive step however, it is undermined and slightly negated by their unwillingness to extend new mortgage deals with rates that reflect the aggressive nature of the BOE rate cuts. This unattractive general funding situation that is being sustained by all of the main high street banks, en-bloc, only serves to exacerbate the malaise of the UK housing market.
The general public have copped that something is amiss and that there is something wrong with the banks reluctance to provide mortgages in the same ballpark as the Bank of England base rate. No one, however seems to have figured out why. The banks seem to have an eminently plausible (yet frustrating) excuse. The excuse that the UK banks dish out, ad-nauseum, to the mainstream UK media is that 3mth sterling Libor (the average rate that at which banks will lend sterling to each other over 3 months - London InterBank Offered Rate) continues to lag the collapse in BOE base rates. This is the real level at which they fund themselves in normal market conditions (when the much famed money markets actually work). This rate is published daily by a suitably reputable institution called the British Bankers Association and is accepted as gospel by all as the last word in British finance. No one, however, seems to have asked where this calculation comes from. Now seems a good time to explain the chewbacka defence...
In an episode of the hugely popular animated comedy series, South Park, Chef (Isaac Hayes) is being represented by the famous lawyer Johnnie Cochrane in a legal case against a record company. In order to convince the jury to find in favour of his client, he employs what is famously described, by the commentator of the live coverage of the trial, as the Chewbacka defence. This basically involves Cochrane begging the question of why Chewie would chose to live on Endor....
"Why would a Wookiee, an eight-foot tall Wookiee, want to live on Endor, with a bunch of two-foot tall Ewoks? That does not make sense! But more important, you have to ask yourself: What does this have to do with this case? Nothing. Ladies and gentlemen, it has nothing to do with this case! It does not make sense! Look at me. I'm a lawyer defending a musician against a big major record company, and I'm talkin' about Chewbacca! Does that make sense? Ladies and gentlemen, I am not making any sense! None of this makes sense! And so you have to remember, when you're in that jury room deliberatin' and conjugatin' the Emancipation Proclamation, [approaches and softens] does it make sense? No! Ladies and gentlemen of this supposed jury, it does not make sense! If Chewbacca lives on Endor, you must acquit! The defense rests."
As amusing as this is, it parodies the ridiculous distractions that popular culture will fall for so that the wool can be pulled over their eyes. OJ Simpson was guilty as sin and is only now being brought to justice. The jury in his original trial fell for a smoke and mirrors distraction by a well-polished shyster and, acquitted the movie star. Now the UK public and parliament are falling for a similar trick.
The British Bankers Association calculate daily Libor rates by computing an average of the rates quoted by the main UK banks at which they would lend to each other. So, the excuse they are using as the reason they can't provide realistic new lending rates to home buyers and small businesses is controlled by themselves. Meanwhile they can raise as much cash as they like through bond issues guaranteed by the UK treasury. Therefore, they can afford to leave this rate, at which they lend cash to each other, well above the BOE base rate. This is basically a cartel of banks setting 3 month Libor at a sufficiently high rate to discourage any new lending and cream off extra margin from anyone prepared to pay the extortionate rate. So far, no one has called their bluff.
UK banks have taken substantial UK taxpayer money in order to survive and now, they are feeding us the chewbacka defence in order to fob us off. I think its about time Alistair Darling read up on the fundamentals of Libor and made a call to the heads of UK banking Inc. The game is up - turn the tap back on..!
WNcG
Thursday, 11 December 2008
Wednesday, 10 December 2008
The Cost of Misguided Conscience
For the past couple of months, the saga of the Detroit auto industry soap opera has been played out on the steps and in the hallowed halls of Capitol Hill. Last week, the CEO's of the big three arrived in Washington in the most frugal offering their ailing production lines could muster, in a vain attempt to create an air of modesty to their gas-guzzling product line and so suggest worthiness for their brazen bailout begging. Their desperate tugging of administrative heart-strings has veered from jingoistic promotion of national pride in the US auto industry to ransom demands, in the shape of apocalyptic predictions for the fate of Detroit society. Whatever cards they've played, a certain degree of success has been achieved in the shape of a proposed $18bn grant from funds set aside for the promotion of green industry. Some may find this a fantastic display of the US administration's well-hidden, killer sense of humour but, the truth is possibly a lot sadder than that.
For decades, Capitol Hill has pandered to the demands of both the ludicrously powerful Union of Auto Workers (UAW) and the resultant demands for protectionist government policy from the big three auto companies as they struggled to meet the exorbitant demands of the UAW. Each quarter given to both parties in Detroit has ironically added up to digging a massive hole for them to jump right into. The support for the demands of the UAW and the protectionist policy for the companies themselves has made the indigenous US auto industry completely non-viable as a going concern. They don't make money and haven't done so for a long time. Meanwhile, the Asian auto manufacturers are able to manufacture, distribute, and sell cars in the US and, make a profit. The main reason for this is that their operations are non-unionised. This latest shot in the arm for the US car manufacturers is well below the $25-50bn they say they need to 'restructure' their operations and so, will probably only serve to help them limp on for another 3-6 months before they come back asking for more. It is no more than a 'pity-hit' before the US auto junkies finally expire. It seems the collective conscience of the suits on Capitol Hill finally came to bear in their decision making and so, their guilt in allowing this mess to develop may lead them to give into the demanding 'crack-baby' of American industry one last time.
There has been much call for the Auto manufacturers to be given some of Hank Paulson's TARP funds however, in order for them to qualify, they would need to be a bank - not a car manufacturer. This is not as ridiculous a plan as it may seem. GM has a rather large subsidiary, called GMAC, which acts as a finance company for its dealerships. Those buying a new GM car can get immediate financing for their new Hummer in the car showroom and drive out of the car lot minutes later. Given the unprofitable nature of their manufacturing operations, GM chose to use the cheap leverage available through the last economic boom cycle (sound familiar?) to take a leaf out of Tesco's business model and pile these financing deals high so that they could reap the minuscule margins on each sale. And so, as the days of cheap cash came to an end, so did their business model.
The latest twist in the Mid-Westenders saga came to a head today. Because GMAC is a finance company, it aint far away from being a bank. In order to qualify as a bank, they would have to meet minimum regulatory ratios for the leverage on their balance sheet. They needed to tender for a range of bond issues (debt) and offer to buy them back from the investors. The latest results from the tender process came back today and were light-years away from reaching a high enough acceptance of the tender from the bond holders (only 22%). As GM have admitted they have no room for manoeuvre with regards to the price they are willing to pay for the debt, it is unlikely they will be able to increase that tender acceptance rate. That means, they have little chance of meeting the minimum requirements for being a bank and so, little hope of qualifying for TARP funding from Hank Paulson. Put plainly.... No Bank, No TARP. They are doomed to chapter 11 and bankruptcy.
So, it would seem, this $18bn 'green industry' grant, if passed, will lead to nothing more than where they would have been if they didn't get it in the first place - bankruptcy court. The people of Detroit would have been better served if this money was kept back to deal with the fall out from the inevitable redundancies that will follow once real restructuring is done in the attempt to salvage something of the remnants of the US auto industry. Instead, if it is passed, the $18bn will only end up adding a few cents (if its not all spent) onto the recovery value of each bond/loan owned by the various hedge funds and distressed bond funds (vulture investors) that have flocked to the feeding frenzy that has kicked off around the still-breathing carcass of Michigan's first city.
The US administration have put a price of $18bn on their guilty conscience for the part they played in getting Detroit to this point. They would prefer to burn billions of dollars of US taxpayers money in an attempt to distract voters into thinking they did all they could for Detroit, rather than admit their part in leading it to its own self-destruction. Despite the depressing conclusion that looms on the horizon, this is a hoop that America has to jump through. A difficult and cathartic growing pain that will help the American dream evolve into its next manifestation. The sacrificial nature of its impending demise may ultimately ensure the next developmental stage in capitalism however, the difference between Coventry in 1940 and Detroit in 2008 would seem to be the small matter of $18bn of public money. I only hope its legacy is even half as significant....
"Don't do it Guv'nor!"
WNcG
For decades, Capitol Hill has pandered to the demands of both the ludicrously powerful Union of Auto Workers (UAW) and the resultant demands for protectionist government policy from the big three auto companies as they struggled to meet the exorbitant demands of the UAW. Each quarter given to both parties in Detroit has ironically added up to digging a massive hole for them to jump right into. The support for the demands of the UAW and the protectionist policy for the companies themselves has made the indigenous US auto industry completely non-viable as a going concern. They don't make money and haven't done so for a long time. Meanwhile, the Asian auto manufacturers are able to manufacture, distribute, and sell cars in the US and, make a profit. The main reason for this is that their operations are non-unionised. This latest shot in the arm for the US car manufacturers is well below the $25-50bn they say they need to 'restructure' their operations and so, will probably only serve to help them limp on for another 3-6 months before they come back asking for more. It is no more than a 'pity-hit' before the US auto junkies finally expire. It seems the collective conscience of the suits on Capitol Hill finally came to bear in their decision making and so, their guilt in allowing this mess to develop may lead them to give into the demanding 'crack-baby' of American industry one last time.
There has been much call for the Auto manufacturers to be given some of Hank Paulson's TARP funds however, in order for them to qualify, they would need to be a bank - not a car manufacturer. This is not as ridiculous a plan as it may seem. GM has a rather large subsidiary, called GMAC, which acts as a finance company for its dealerships. Those buying a new GM car can get immediate financing for their new Hummer in the car showroom and drive out of the car lot minutes later. Given the unprofitable nature of their manufacturing operations, GM chose to use the cheap leverage available through the last economic boom cycle (sound familiar?) to take a leaf out of Tesco's business model and pile these financing deals high so that they could reap the minuscule margins on each sale. And so, as the days of cheap cash came to an end, so did their business model.
The latest twist in the Mid-Westenders saga came to a head today. Because GMAC is a finance company, it aint far away from being a bank. In order to qualify as a bank, they would have to meet minimum regulatory ratios for the leverage on their balance sheet. They needed to tender for a range of bond issues (debt) and offer to buy them back from the investors. The latest results from the tender process came back today and were light-years away from reaching a high enough acceptance of the tender from the bond holders (only 22%). As GM have admitted they have no room for manoeuvre with regards to the price they are willing to pay for the debt, it is unlikely they will be able to increase that tender acceptance rate. That means, they have little chance of meeting the minimum requirements for being a bank and so, little hope of qualifying for TARP funding from Hank Paulson. Put plainly.... No Bank, No TARP. They are doomed to chapter 11 and bankruptcy.
So, it would seem, this $18bn 'green industry' grant, if passed, will lead to nothing more than where they would have been if they didn't get it in the first place - bankruptcy court. The people of Detroit would have been better served if this money was kept back to deal with the fall out from the inevitable redundancies that will follow once real restructuring is done in the attempt to salvage something of the remnants of the US auto industry. Instead, if it is passed, the $18bn will only end up adding a few cents (if its not all spent) onto the recovery value of each bond/loan owned by the various hedge funds and distressed bond funds (vulture investors) that have flocked to the feeding frenzy that has kicked off around the still-breathing carcass of Michigan's first city.
The US administration have put a price of $18bn on their guilty conscience for the part they played in getting Detroit to this point. They would prefer to burn billions of dollars of US taxpayers money in an attempt to distract voters into thinking they did all they could for Detroit, rather than admit their part in leading it to its own self-destruction. Despite the depressing conclusion that looms on the horizon, this is a hoop that America has to jump through. A difficult and cathartic growing pain that will help the American dream evolve into its next manifestation. The sacrificial nature of its impending demise may ultimately ensure the next developmental stage in capitalism however, the difference between Coventry in 1940 and Detroit in 2008 would seem to be the small matter of $18bn of public money. I only hope its legacy is even half as significant....
"Don't do it Guv'nor!"
WNcG
Saturday, 6 December 2008
Capitalism, communism, and the Socialist Cause
There have been a lot of opportunistic comments made by a lot of bitter people around the world regarding the merits (or lack thereof) and supposed flaws with the fundamental concept of capitalism. Any I have heard, including the recent tripe peddled by the Dail representative of the Irish Socialist party regarding the supposed failure of capitalism, have completely missed the point and, seem to have lost track of the positive role that socialism can play in the 21st century western world.
The current global economic malaise is universally accepted to have been caused by a myopic overdose on cheap cash and an explosive increase in general levels of leverage. However, the roots of this crisis are found, ironically, in working class America. The incessant demands of bank equity holders for increased growth in earnings and profits led management in US banks to lower standards for those seeking mortgages. This gave birth to the type of parasitic breed of mortgage brokers that thought it was a good idea to give a mortgage to an unemployed single mum, just released from San Quentin. While we, in Europe, can hardly scoff at the americans, we didn't quite reach this level of reckless lending. That said, RBS shareholders may disagree with that last statement in light of Ulster Bank's funding of Sean Dunne's eye-watering €274mm purchase of the Ballsbridge Jury's site (rumour has it that the keys are in the post!).
The American dream was originally conceived to promote the idea that anybody who was driven and committed to hard work could 'make it' in the USA. This admirable concept is still valid in the 21st century and is completely compatible with the basic concept of capitalism however, its true meaning has been muddled through the last economic boom cycle. In a period of economic growth and prosperity, the financial gulf between the 'haves' and 'have-nots' is magnified and so, it is inevitable for those left behind to feel hard-done-by. The result of this situation in the US was for the general public to believe that it was a fundamental part of the American dream for every US citizen to have the right to own their own home. This mis-quoted bending of the American dream led the US to inadvertently stray into communism.
The fundamental premise of capitalism is that there are winners and losers, and therefore that we are not all equally deserving of the spoils of economic prosperity. This lapse in concentration by the US led to people, with no hope in hell of being able to make repayments, getting mortgages. These time-bomb mortgages started to explode in early 2007 and led us to the current situation. Even at that stage, the damage was done and there was no going back.
Capitalism hasn't failed - we've failed it. Our collective lack of control led us to turn full-circle and all the way back around to communism. While we are all equals as people and citizens, we are not all economic equals. There are those who are driven and work hard for what they aspire towards, and there are those with no interest in contributing towards society. The role of socialism in the 21st century should be to ensure a frictionless path for those coming from an economically challenged background to succeed in climbing the ladder of prosperity, as long as they have enough drive and determination. True capitalism knows nothing about race, class, religion, or creed. It should reward those who work hard enough for it. Equally, it should allow those who take their foot off the gas, to slide back down again. If we can remember these principles and make sure we never again completely lose control like we have done, capitalism can a positive force again. Likewise, if equity investors can have a realistic attitude towards the benefits of prudence in running a business, the management of banks may not be driven to (and rewarded for) reckless lending in search of endless earnings growth. It is arguably this complicity by the pension and insurance fund managers of the world (equity investors in the banks) in the irresponsible stewardship of global banking that allowed this to happen.
The Joe Higgins (Irish Socialist party TD) of this world must realise that their role in the 21st century is not to wallow in schadenfreude by sticking the boot into capitalism but, to fight for the rights of those born into economically disadvantaged backgrounds. To make sure that there are no glass ceilings to impede the progress of anyone willing to work hard enough to succeed. Meanwhile, the morons in the equity market need to realise that sometimes consolidation and control is better than revenue growth by any means.
WNgC
The current global economic malaise is universally accepted to have been caused by a myopic overdose on cheap cash and an explosive increase in general levels of leverage. However, the roots of this crisis are found, ironically, in working class America. The incessant demands of bank equity holders for increased growth in earnings and profits led management in US banks to lower standards for those seeking mortgages. This gave birth to the type of parasitic breed of mortgage brokers that thought it was a good idea to give a mortgage to an unemployed single mum, just released from San Quentin. While we, in Europe, can hardly scoff at the americans, we didn't quite reach this level of reckless lending. That said, RBS shareholders may disagree with that last statement in light of Ulster Bank's funding of Sean Dunne's eye-watering €274mm purchase of the Ballsbridge Jury's site (rumour has it that the keys are in the post!).
The American dream was originally conceived to promote the idea that anybody who was driven and committed to hard work could 'make it' in the USA. This admirable concept is still valid in the 21st century and is completely compatible with the basic concept of capitalism however, its true meaning has been muddled through the last economic boom cycle. In a period of economic growth and prosperity, the financial gulf between the 'haves' and 'have-nots' is magnified and so, it is inevitable for those left behind to feel hard-done-by. The result of this situation in the US was for the general public to believe that it was a fundamental part of the American dream for every US citizen to have the right to own their own home. This mis-quoted bending of the American dream led the US to inadvertently stray into communism.
The fundamental premise of capitalism is that there are winners and losers, and therefore that we are not all equally deserving of the spoils of economic prosperity. This lapse in concentration by the US led to people, with no hope in hell of being able to make repayments, getting mortgages. These time-bomb mortgages started to explode in early 2007 and led us to the current situation. Even at that stage, the damage was done and there was no going back.
Capitalism hasn't failed - we've failed it. Our collective lack of control led us to turn full-circle and all the way back around to communism. While we are all equals as people and citizens, we are not all economic equals. There are those who are driven and work hard for what they aspire towards, and there are those with no interest in contributing towards society. The role of socialism in the 21st century should be to ensure a frictionless path for those coming from an economically challenged background to succeed in climbing the ladder of prosperity, as long as they have enough drive and determination. True capitalism knows nothing about race, class, religion, or creed. It should reward those who work hard enough for it. Equally, it should allow those who take their foot off the gas, to slide back down again. If we can remember these principles and make sure we never again completely lose control like we have done, capitalism can a positive force again. Likewise, if equity investors can have a realistic attitude towards the benefits of prudence in running a business, the management of banks may not be driven to (and rewarded for) reckless lending in search of endless earnings growth. It is arguably this complicity by the pension and insurance fund managers of the world (equity investors in the banks) in the irresponsible stewardship of global banking that allowed this to happen.
The Joe Higgins (Irish Socialist party TD) of this world must realise that their role in the 21st century is not to wallow in schadenfreude by sticking the boot into capitalism but, to fight for the rights of those born into economically disadvantaged backgrounds. To make sure that there are no glass ceilings to impede the progress of anyone willing to work hard enough to succeed. Meanwhile, the morons in the equity market need to realise that sometimes consolidation and control is better than revenue growth by any means.
WNgC
Wednesday, 3 December 2008
The Death of Leverage (and equities)
The single most empowering aspect of the boom that has just burst was the accommodating nature of leverage to allow anyone with the smallest amount of capital to take massive exposure to almost any investment opportunity and reap the resulting magnified benefits thereof. Leverage, however, is also the corrosive element that has (and will have eventually) destroyed the same swashbuckling investors now that the bubble has burst. The magnifying benefit of leverage in a bull market can also wipe you out when the tide turns.
The recent collapse of the commodity market was indirectly caused by the general deterioration of the global consumer environment but, directly caused by the evaporation of credit for the various hedge fund speculators who had pumped the market up in anticipation of an ever-increasing consumer demand for all things limited in supply (e.g. oil for cars & plastic, copper for house wiring, tungsten for consumer electronics, etc). However, the inflated values for all of these commodities was completely underpinned by the ability of these speculators to maintain leverage from financial institutions. When this could no longer be provided by the various financial institutions, the speculators had to unwind their positions. The equity market in general is no different...
Equity is, in essence, a leveraged investment. It is reliant upon a financial institution providing credit (or financing) to the business in order for equity investors to control and run a large operation for a much smaller investment. In buoyant times of cheap financing, this is very advantageous however, in more economically challenging times, the access to this financing is very difficult. The return on cash invested seen by equity investors over the past few years will not be seen for many years to come. Leverage is dead for now, and so with it, are the extraordinary equity dividend yields of yore. Leveraged companies will need to deleverage and even those with moderate leverage will find the cost of this leverage more expensive and therefore, an increasingly negative force on profits. Western world Inc will find it difficult to produce profits as it chooses between deleveraging or paying the increased interest cost on its existing debt. Bottom line, equities will produce little dividend over the next few years and should be considered only for their optionality on future profits.
So, if equities wont produce much return, what will...? Well, a step up the ladder on the corporate balance sheet is into its debt and, out of equity. No matter how much the company produces, its debt interest has to be paid - otherwise, it defaults and, goes into bankruptcy. In order for a company to survive, it must service (pay interest/coupons on) its debt. If leverage is dead and corporates must reduce their borrowing then, owning bonds (debt) in a company, which is able to continue business in this economic environment, is a fixed return in an ever-improving risk-profile. Either it continues to pay the interest or, it refinances and you get paid back. Either way (and especially for currently distressed companies) you get a decent return. The only caveat is to do your home work and pick the companies that will limp-on through this economic slump and still be here on the other side.
Bill Gross agrees - corporate bonds are the investment of the next few years. Whether you make an average return or a killing depends on whether you stick with investment grade companies that need little deleveraging or, you pick the right lottery numbers in the high yield universe. Eyes-down on the bingo cards!
The recent collapse of the commodity market was indirectly caused by the general deterioration of the global consumer environment but, directly caused by the evaporation of credit for the various hedge fund speculators who had pumped the market up in anticipation of an ever-increasing consumer demand for all things limited in supply (e.g. oil for cars & plastic, copper for house wiring, tungsten for consumer electronics, etc). However, the inflated values for all of these commodities was completely underpinned by the ability of these speculators to maintain leverage from financial institutions. When this could no longer be provided by the various financial institutions, the speculators had to unwind their positions. The equity market in general is no different...
Equity is, in essence, a leveraged investment. It is reliant upon a financial institution providing credit (or financing) to the business in order for equity investors to control and run a large operation for a much smaller investment. In buoyant times of cheap financing, this is very advantageous however, in more economically challenging times, the access to this financing is very difficult. The return on cash invested seen by equity investors over the past few years will not be seen for many years to come. Leverage is dead for now, and so with it, are the extraordinary equity dividend yields of yore. Leveraged companies will need to deleverage and even those with moderate leverage will find the cost of this leverage more expensive and therefore, an increasingly negative force on profits. Western world Inc will find it difficult to produce profits as it chooses between deleveraging or paying the increased interest cost on its existing debt. Bottom line, equities will produce little dividend over the next few years and should be considered only for their optionality on future profits.
So, if equities wont produce much return, what will...? Well, a step up the ladder on the corporate balance sheet is into its debt and, out of equity. No matter how much the company produces, its debt interest has to be paid - otherwise, it defaults and, goes into bankruptcy. In order for a company to survive, it must service (pay interest/coupons on) its debt. If leverage is dead and corporates must reduce their borrowing then, owning bonds (debt) in a company, which is able to continue business in this economic environment, is a fixed return in an ever-improving risk-profile. Either it continues to pay the interest or, it refinances and you get paid back. Either way (and especially for currently distressed companies) you get a decent return. The only caveat is to do your home work and pick the companies that will limp-on through this economic slump and still be here on the other side.
Bill Gross agrees - corporate bonds are the investment of the next few years. Whether you make an average return or a killing depends on whether you stick with investment grade companies that need little deleveraging or, you pick the right lottery numbers in the high yield universe. Eyes-down on the bingo cards!
Friday, 28 November 2008
Private Equity & Public Investments
For a long time through the last economic cycle and the bull market that it produced, there has been a quiet, shadowy force operating underneath the radar of the average man in the street, fanning the flames of the burning stock market rally. Private equity is a term oft used but, mostly misunderstood (at best). It was used almost everyday, as a rumour in the equity market, to pump a stock up and sustain generous premiums for many more equities above their realistic book value. This secretive group of financial magicians seemed happy to pay above the odds for companies to take them private and then sell them a few years later for handsome profits. The original concept behind private equity was for a sophisticated group of investors to take an underperforming asset private, make the necessary difficult changes to improve its profitability, and then sell it back to the stock market investors for a tidy profit. However, in the last few years, this practice was dumbed down and profits made were almost exclusively down to the magic that is leverage. Cheap cash.
Private equity firms have, for some time now, exclusively practised the art of leveraged buy-outs (LBO's) as a means of buying publicly listed companies with borrowed money. They take a moderately leveraged company, listed on the stock exchange, and buy it with money borrowed from banks, using the company itself as the security - much the same as how you might buy a house. Most publicly quoted companies are leveraged about 3-5 times. This means that it has borrowings (or debt) 3-5 times the amount of equity invested by the shareholders. After an LBO, a company may have this leverage increased by a factor of up to 4 times that. This means that the private equity firm has to invest far less money in the company but, owns and controls it entirely. Over the subsequent 2-3 years they use cashflow from the company's operations to pay down this increased debt at a much faster rate than usual and so, deleverage the company back to its original level of debt. When they then sell the company, usually by re-listing it on the stock exchange, they will have tripled or quadrupled their original investment. This simple process meant that the old practices of streamlining and updating a companies processes and operations of a company in order to increase its value were made an unnecessary hassle. Cheap cash made the process very easy and so, as long as a company has decent cash flow, it was up for grabs. Not anymore.
Recent economic deterioration has turned off the tap on cheap cash and now, these private equity magicians have to roll up their sleeves, dust off the old management text books, and go back to basics. Nearly all of the debt used to finance these LBO's have maturities between 2 and 5 years and so, need to be refinanced or repaid once it matures. Banks are currently struggling to recapitalise their own balance sheets and leverage has become a dirty word. These LBO'd companies now have to find a way to deleverage fast, or the private equity companies that own them will walk away, lose their investment, and let the company default on the debt. A lot of this debt was restructured into large structures and then sold to various institutional investors like hedge funds, insurance companies and, other banks. They may find themselves being the ultimate owner of these companies but, if so, the private equity gurus will have lost their investment entirely. This pressure may not be a bad thing - it tends to sharpen the mind.
While the existing investments of private equity firms may be under threat, future investments can no longer follow the LBO model. In order to ensure a future for themselves, PE firms will have to find another way to make money. Many are now aware that any investment will have a longer turnaround time and will require them to make real improvements in the operations and profitability of their target companies in order to flip them for a profit. The obvious new hunting ground for any management guru looking for an underperforming asset would therefore seem to be the banking world. Recent approaches by PE giants of the likes of KKR and the Carlyle Group, towards Bank of Ireland have been met with some nervous reaction. Their reputation as aggressive asset-strippers have many people worried however, we must remember that the incumbent management have hardly overwhelmed the investment community. Strong, aggressive management may be exactly what some ailing banks need. Also if, in the event of LBO companies defaulting on their debt, they end up owning some of these leveraged enterprises, they will need management who know how to run them too. The US auto industry may also be a prime target for the type of business process reorganisation that private equity used to specialise in.
Many of the people running these private equity companies are some of the finest management minds of their generation and so, forcing them to go back to their basic management skills to improve the operations and so, the profitability of the companies they have invested in, can't be a bad thing. The death of cheap cash may have wiped a large chunk off the value of stock markets all over the world but, it may also have heralded the rebirth of old-fashioned good management principles. A well run company will make a profit and so, be worth something. Anyone remember that one?
Private equity firms have, for some time now, exclusively practised the art of leveraged buy-outs (LBO's) as a means of buying publicly listed companies with borrowed money. They take a moderately leveraged company, listed on the stock exchange, and buy it with money borrowed from banks, using the company itself as the security - much the same as how you might buy a house. Most publicly quoted companies are leveraged about 3-5 times. This means that it has borrowings (or debt) 3-5 times the amount of equity invested by the shareholders. After an LBO, a company may have this leverage increased by a factor of up to 4 times that. This means that the private equity firm has to invest far less money in the company but, owns and controls it entirely. Over the subsequent 2-3 years they use cashflow from the company's operations to pay down this increased debt at a much faster rate than usual and so, deleverage the company back to its original level of debt. When they then sell the company, usually by re-listing it on the stock exchange, they will have tripled or quadrupled their original investment. This simple process meant that the old practices of streamlining and updating a companies processes and operations of a company in order to increase its value were made an unnecessary hassle. Cheap cash made the process very easy and so, as long as a company has decent cash flow, it was up for grabs. Not anymore.
Recent economic deterioration has turned off the tap on cheap cash and now, these private equity magicians have to roll up their sleeves, dust off the old management text books, and go back to basics. Nearly all of the debt used to finance these LBO's have maturities between 2 and 5 years and so, need to be refinanced or repaid once it matures. Banks are currently struggling to recapitalise their own balance sheets and leverage has become a dirty word. These LBO'd companies now have to find a way to deleverage fast, or the private equity companies that own them will walk away, lose their investment, and let the company default on the debt. A lot of this debt was restructured into large structures and then sold to various institutional investors like hedge funds, insurance companies and, other banks. They may find themselves being the ultimate owner of these companies but, if so, the private equity gurus will have lost their investment entirely. This pressure may not be a bad thing - it tends to sharpen the mind.
While the existing investments of private equity firms may be under threat, future investments can no longer follow the LBO model. In order to ensure a future for themselves, PE firms will have to find another way to make money. Many are now aware that any investment will have a longer turnaround time and will require them to make real improvements in the operations and profitability of their target companies in order to flip them for a profit. The obvious new hunting ground for any management guru looking for an underperforming asset would therefore seem to be the banking world. Recent approaches by PE giants of the likes of KKR and the Carlyle Group, towards Bank of Ireland have been met with some nervous reaction. Their reputation as aggressive asset-strippers have many people worried however, we must remember that the incumbent management have hardly overwhelmed the investment community. Strong, aggressive management may be exactly what some ailing banks need. Also if, in the event of LBO companies defaulting on their debt, they end up owning some of these leveraged enterprises, they will need management who know how to run them too. The US auto industry may also be a prime target for the type of business process reorganisation that private equity used to specialise in.
Many of the people running these private equity companies are some of the finest management minds of their generation and so, forcing them to go back to their basic management skills to improve the operations and so, the profitability of the companies they have invested in, can't be a bad thing. The death of cheap cash may have wiped a large chunk off the value of stock markets all over the world but, it may also have heralded the rebirth of old-fashioned good management principles. A well run company will make a profit and so, be worth something. Anyone remember that one?
Tuesday, 25 November 2008
Workers of the world.... Wise up!
At the turn of the 20th Century, the industrial revolution in Britain was breaking new ground in the as-yet-unknown field of socio-economics. The human compromises made in the name of global economic domination would eventually create a new left-of-centre politic to balance the then hitherto unchallenged affluent right. Union movements, the Labour party and, minimum working standards for manual labour ensued. Recognition of, and fair treatment for, the individual employees that keep large enterprises running is only fair. This is a natural progression in the socio-economic development of any society or economy. The spoils of entrepreneurial endeavour can only be enjoyed with the fair treatment and remuneration of the labour that makes it possible.
This stage of development in a society is reached at different stages and times and only ever happens in a painfully and naturally cathartic manner. The 1984 Union Carbide chemical disaster in Bhopal, India, is a perfectly painful example of sub-standard worker safety in developing economic regions. The chemical leak, which killed thousands of people within days, was caused by fundamental deficiencies in safety systems which would never be
tolerated in the USA at that time. Union Carbide managed to extricate themselves from this disaster by dint of a $450mm payment, which was covered by insurance, and sailed off into the sunset. India learned a lot from this and so, its own socio-economic development moved on to ensure better conditions and safeguards for her manual workforce.
Union pressure on private enterprise to protect the interests of skilled and manual employees holds an important place in the socio-economic development of every nation. Most countries see it holding a constant, yet evolving, presence within their economy, in order to protect the rights and interests of all participants (including skilled and manual labour) in their economy. That said, as a country's general level of affluence increases, it's ability to support certain industry changes and so with it, must the labourforce. As the cost of living in a country increases, so must the wages its workers are paid. This overhead is one of the largest costs for any industry and so, will go a long way towards deciding the profitability of any company and, ultimately, the viability of industry at large.
In the 1980's, the viability of coal mining in the UK became terminal and so, the cathartic period of painful strikes, depression and, ultimately, the breaking of the unions by Thatcher's conservative government ensued. For all the upheaval, and continued economic difficulty felt in certain parts of the UK, this was generally perceived to be unavoidable and vital to the development of the UK as an economy. The industry was no longer competitive with foreign alternatives and could not survive. The UK had to bite the bullet and, re-train and re-educate its workforce.
The American auto industry represents roughly 4% of US GDP and it's three largest employers are Ford, General Motors and, Chrysler. These companies are all well known as household names for their struggles as industrial giants of the old American economy. GM's share of the US market has fallen over the last 30 years from about 50% to a mere 20% and, its position as the world's largest car manufacturer has been lost to Japan's Toyota. This is only partly due to the gas-guzzling incompatibility of its fleet with the eye-watering volatility in gasoline prices over recent years. The average difference in production price between a car made by GM and a car made by Toyota is roughly $2,000. This makes for a staggering disadvantage for the likes of GM when competing for the business of the man in the street. The extra production cost must be factored into the sticker price on the forecourt, otherwise it eats into the already thin profit margin. In the case of the big three US auto manufacturers, this profit margin is rendered negligible at best, and negative frequently. For a long time through the latest economic boom, they were happy to sell cars for no profit, in order to lock the buyer into a finance plan. The business model was more of a large finance company, with a small manufacturing subsidiary, than the other way around. Cheap leverage allowed the likes of GM to pile these finance agreements high and shave off a thin margin on each one. Now that leverage is no longer available, the business model is defunct. While a rising tide lifts all boats, including GM's, now that the tide has gone back out again, it seems GM were swimming without any trunks.
This higher cost base is almost exclusively created by staggeringly egregious worker conditions demanded, and achieved, by the United Auto Workers of America (UAW) which represent the unionised workforce of the big three US car manufacturers. Such is the staggeringly powerful nature of the employment conditions enjoyed by employees of Ford, GM, and Chrysler that even the concession of generic drugs, instead of branded medication, within the employee health insurance agreements, would make a 10-figure difference to the combined annual overheads of the 3 car makers. Put simply, the unions have made their business completely unprofitable. In contrast, the US-based manufacturing operations of the Asian competition are all profitable businesses in their own right, employing over 110,000 workers and, crucially, are not unionised.
Many other industries manage to preserve their economic viability within developed and affluent countries because of an inherent understanding of these basic financial requirements, by their respective unions, for the long-term survival of the companies that employ their members. Countries like Germany and France consistently manage to maintain a profitable manufacturing base due to the realistic attitude of their labour unions and a frugal control over inflation and personal debt. Without these fundamental socio-economic qualities, a viable manufacturing base is near impossible.
The big three US car makers last week went to Washington to ask for a $25bn share of Hank Paulson's TARP rescue fund. If current trading conditions are maintained, $25bn should keep them in operation for another 6 months before they burn through it and come back for another $25bn. The inevitable path to disaster is pretty evident, and $50bn would be the cost of the one-way ticket. Forcing them into bankruptcy, and the protection from creditors that Chapter 11 legislation provides, would allow them to restructure their business and obligations entirely, and force the unions to renegotiate their employment conditions. This would obviously lead to a large amount of redundancies in Detroit however, $25bn spent on re-training and re-educating this workforce would provide far better long-term value-for-money than a few more months in the sun (sic).
I'm all for the left-of-centre political ideals that protect the little guy, push for better public healthcare, ensure nurses and teachers make a decent wage, and stop society completely forgetting some basic human principles. That said, unions must realise the necessity for the industry in which they operate to be viable. Otherwise, they can drag a whole economy down with them.
As I mentioned in a previous article, Detroit will be the Coventry of the US economic bailout. The James Connolly of its socio-economic development. Somewhere along the way, Motown lost its soul. Lets hope the rest of America still has some.
WNgC
This stage of development in a society is reached at different stages and times and only ever happens in a painfully and naturally cathartic manner. The 1984 Union Carbide chemical disaster in Bhopal, India, is a perfectly painful example of sub-standard worker safety in developing economic regions. The chemical leak, which killed thousands of people within days, was caused by fundamental deficiencies in safety systems which would never be
tolerated in the USA at that time. Union Carbide managed to extricate themselves from this disaster by dint of a $450mm payment, which was covered by insurance, and sailed off into the sunset. India learned a lot from this and so, its own socio-economic development moved on to ensure better conditions and safeguards for her manual workforce.
Union pressure on private enterprise to protect the interests of skilled and manual employees holds an important place in the socio-economic development of every nation. Most countries see it holding a constant, yet evolving, presence within their economy, in order to protect the rights and interests of all participants (including skilled and manual labour) in their economy. That said, as a country's general level of affluence increases, it's ability to support certain industry changes and so with it, must the labourforce. As the cost of living in a country increases, so must the wages its workers are paid. This overhead is one of the largest costs for any industry and so, will go a long way towards deciding the profitability of any company and, ultimately, the viability of industry at large.
In the 1980's, the viability of coal mining in the UK became terminal and so, the cathartic period of painful strikes, depression and, ultimately, the breaking of the unions by Thatcher's conservative government ensued. For all the upheaval, and continued economic difficulty felt in certain parts of the UK, this was generally perceived to be unavoidable and vital to the development of the UK as an economy. The industry was no longer competitive with foreign alternatives and could not survive. The UK had to bite the bullet and, re-train and re-educate its workforce.
The American auto industry represents roughly 4% of US GDP and it's three largest employers are Ford, General Motors and, Chrysler. These companies are all well known as household names for their struggles as industrial giants of the old American economy. GM's share of the US market has fallen over the last 30 years from about 50% to a mere 20% and, its position as the world's largest car manufacturer has been lost to Japan's Toyota. This is only partly due to the gas-guzzling incompatibility of its fleet with the eye-watering volatility in gasoline prices over recent years. The average difference in production price between a car made by GM and a car made by Toyota is roughly $2,000. This makes for a staggering disadvantage for the likes of GM when competing for the business of the man in the street. The extra production cost must be factored into the sticker price on the forecourt, otherwise it eats into the already thin profit margin. In the case of the big three US auto manufacturers, this profit margin is rendered negligible at best, and negative frequently. For a long time through the latest economic boom, they were happy to sell cars for no profit, in order to lock the buyer into a finance plan. The business model was more of a large finance company, with a small manufacturing subsidiary, than the other way around. Cheap leverage allowed the likes of GM to pile these finance agreements high and shave off a thin margin on each one. Now that leverage is no longer available, the business model is defunct. While a rising tide lifts all boats, including GM's, now that the tide has gone back out again, it seems GM were swimming without any trunks.
This higher cost base is almost exclusively created by staggeringly egregious worker conditions demanded, and achieved, by the United Auto Workers of America (UAW) which represent the unionised workforce of the big three US car manufacturers. Such is the staggeringly powerful nature of the employment conditions enjoyed by employees of Ford, GM, and Chrysler that even the concession of generic drugs, instead of branded medication, within the employee health insurance agreements, would make a 10-figure difference to the combined annual overheads of the 3 car makers. Put simply, the unions have made their business completely unprofitable. In contrast, the US-based manufacturing operations of the Asian competition are all profitable businesses in their own right, employing over 110,000 workers and, crucially, are not unionised.
Many other industries manage to preserve their economic viability within developed and affluent countries because of an inherent understanding of these basic financial requirements, by their respective unions, for the long-term survival of the companies that employ their members. Countries like Germany and France consistently manage to maintain a profitable manufacturing base due to the realistic attitude of their labour unions and a frugal control over inflation and personal debt. Without these fundamental socio-economic qualities, a viable manufacturing base is near impossible.
The big three US car makers last week went to Washington to ask for a $25bn share of Hank Paulson's TARP rescue fund. If current trading conditions are maintained, $25bn should keep them in operation for another 6 months before they burn through it and come back for another $25bn. The inevitable path to disaster is pretty evident, and $50bn would be the cost of the one-way ticket. Forcing them into bankruptcy, and the protection from creditors that Chapter 11 legislation provides, would allow them to restructure their business and obligations entirely, and force the unions to renegotiate their employment conditions. This would obviously lead to a large amount of redundancies in Detroit however, $25bn spent on re-training and re-educating this workforce would provide far better long-term value-for-money than a few more months in the sun (sic).
I'm all for the left-of-centre political ideals that protect the little guy, push for better public healthcare, ensure nurses and teachers make a decent wage, and stop society completely forgetting some basic human principles. That said, unions must realise the necessity for the industry in which they operate to be viable. Otherwise, they can drag a whole economy down with them.
As I mentioned in a previous article, Detroit will be the Coventry of the US economic bailout. The James Connolly of its socio-economic development. Somewhere along the way, Motown lost its soul. Lets hope the rest of America still has some.
WNgC
Monday, 13 October 2008
Capital erosion and the speculators conscience
As I've said a number of times in other entries on this blog, equity holders of banks have a responsibility to take the hit they deserve for the lack of intervention into the standards corporate governance exhibited by the executive boards of the vast majority of banks in various parts of the western world. As part-owners, they had the responsibility to voice their misgivings, pressurise the executive board or, at the very least, sell their shares if they didn't agree with the strategy or direction. If they did none of the above, they should shoulder the burden and feel the pain that their falling share price brings. This stance I maintain, and reiterate, to a certain point. Also, I realise now, this stance is based upon a certain assumption that the equity market understands why stock prices are falling fast and the potential circumstances in which a banks solvency can be stabilised and the potential for future profitability revived. I now fear this is not the case.
The current panic in most European banks stocks is predicated upon a lack of confidence in the short-term money markets, where financial institutions extend and take short-term cash funding to facilitate the day-to-day operations of the bank. It is based upon the obvious circumstance that some banks can find themselves with more money than they need at the end of any business day, and other with not enough. However it has also expanded into a market that banks have come to rely upon for short-term funding of their operations into which funds with a specific investment strategy to lend money for short periods and (usually) a small yield over Libor. Over the years, banks came to invest some of their cash into these funds in order to support its expansion so that it would (theoretically) become a very liquid and easy source of cash. The problem we are now realising is that it is completely predicated upon the assumption of complete faith in the borrowers over very short periods. which has now broken down.
The astronomic increase in the yield above Libor that some of these institutions are having to pay in order to get short-term cash is easily explained by the increased risk of their default in the near-term. The increased cost of this funding is obviously crippling for the profit margin of the banks and, in most cases, results in a day-to-day running loss from the operations.
The Irish Government's extension of a full guarantee of Irish bank debts and deposits resulted in a dramatic reduction in this overhead and, the UK government's extension of a blanket £250bn guarantee of short-term bank lending has also had a similar effect. So, this solves one problem, and stabilises the ship so that the clean-up can begin. The cost of clean-up will obviously have to be footed by the bank's shareholders however, what is the extent of the clean-up...? This is less clear.
The expected pain for bank shareholders has happened and, in my opinion, gone way too far. The lack of understanding of basic finance fundamentals by many within the equity markets has become a field day for the equity market speculators who have begun taking advantage of the lifting of the short-selling ban. The lack of leadership within the equity market investment community, and to a large extent, the pain already felt, has given the short-sellers free reign to push the equity markets down as no one is prepared to stand up and lift the banks out of the range of their ugly sticks. In the land of the blind, the man with one eye is king... Or, even the man who claims to have one eye.
The big problem with the extent of this sell-off is that it erodes the capitalisation ratios of the banks. This is the basic concept of owner equity vs debt in the company. A bit like the deposit vs debt ratio of your house and its mortgage. If the house is reducing in value, this erodes the equity you have in the house. For banks, the regulators require them to have a certain amount of equity at all times in the operation. So, if the stock price continues to erode, the capitalisation of the bank begins to come under threat. We have gone well past this stage on a lot of the bank stocks in Europe.
The short-sellers are banking upon the fear, of the regular equity investor, that these mortgages and leveraged loans, that occupy the most toxic positions on the balance sheets, will leave a huge hole once they are sold, come to refinance, or default. Within the UK and Ireland, the main worry is buy-to-let mortgages, non-conforming mortgages and, loans to property developers. These are now looking very risky and will probably end up costing a pretty penny in write downs but, the option value in owning the stock of the company with regards to future potential profits once the cycle turns again seems to have been completely forgotten. Also, there is the effect of overly negative opinions of conditions of the various bank balance sheets, versus some positive comparison for others. Sometimes these can be very polarised and a tad out of whack. But, perception is the key.
Take Goldman Sachs as a good example. Last year they rolled out their star-trader of the year as a mortgage trader called, Michael Swenson, who apparently was allowed to amass a short position (negative to the direction of the US mortgage market) so large that it contributed $4bn in profits to the Goldman record bottom line in 2007. At the same time, they were gathering an ever-increasing collection of illiquid assets that reached, in August of this year, $68bn in value. These assets occupy a space in the bank's balance sheet that is called the Level 3. This group of assets are deemed to be so illiquid that the bank is allowed to mark their value to an internal model and simply declare the value to the market with only cursory details as to the type of exposure they represent. So, was this short position an inspired punt or, was it simply a hedge for the toxic skeletons in the Goldman closet that is Level 3...?
For a long time, the exemplary reputation that Goldman enjoy held investors' confidence. Only in the last couple of months has the pandemic fear spread to their good selves. While Morgan Stanley scurried to find an equity investor and finally leaped at Mitsubishi UFJ, Goldman Sachs were playing it cool and talking to Warren Buffet. Buffet has been widely chronicled to have always craved to acceptance and acknowledgement of Wall Street. Especially, its golden boy, Goldman Sachs. It is quite possible that during negotiations Goldman, knowing Buffet's aversion to highly complicated financial risk, declined to show their balance sheet and made Warren realise that such was his reputation and theirs, that his investment of $5bn in their equity would be a self fulfilling prophesy in itself. No one would ever again doubt the financial nous of Goldman Sachs and they could side-step the worst of the financial meltdown.
Such is the decline in some of the European banks' stock prices that, there now exists a massive opportunity to take control of the future of European banking. However, in the midst of the blind panic, it would take a suicidal maniac to just invest in the stock. The only solution is to take the banks out of harms reach and off the stock market. So the short-selling speculators can no longer profit from the confusion.
The current market capitalisation of Bank of Ireland is about €2bn, and that of Allied Irish bank is about €2.5bn. The Irish government has kept their powder dry and now is the time to pounce. Take them private and nationalise them so they can be recapitalised in safe distance from the madness that has encapsulated the equity markets. Those equity lads simply haven't a clue what's going on.
WNgC
The current panic in most European banks stocks is predicated upon a lack of confidence in the short-term money markets, where financial institutions extend and take short-term cash funding to facilitate the day-to-day operations of the bank. It is based upon the obvious circumstance that some banks can find themselves with more money than they need at the end of any business day, and other with not enough. However it has also expanded into a market that banks have come to rely upon for short-term funding of their operations into which funds with a specific investment strategy to lend money for short periods and (usually) a small yield over Libor. Over the years, banks came to invest some of their cash into these funds in order to support its expansion so that it would (theoretically) become a very liquid and easy source of cash. The problem we are now realising is that it is completely predicated upon the assumption of complete faith in the borrowers over very short periods. which has now broken down.
The astronomic increase in the yield above Libor that some of these institutions are having to pay in order to get short-term cash is easily explained by the increased risk of their default in the near-term. The increased cost of this funding is obviously crippling for the profit margin of the banks and, in most cases, results in a day-to-day running loss from the operations.
The Irish Government's extension of a full guarantee of Irish bank debts and deposits resulted in a dramatic reduction in this overhead and, the UK government's extension of a blanket £250bn guarantee of short-term bank lending has also had a similar effect. So, this solves one problem, and stabilises the ship so that the clean-up can begin. The cost of clean-up will obviously have to be footed by the bank's shareholders however, what is the extent of the clean-up...? This is less clear.
The expected pain for bank shareholders has happened and, in my opinion, gone way too far. The lack of understanding of basic finance fundamentals by many within the equity markets has become a field day for the equity market speculators who have begun taking advantage of the lifting of the short-selling ban. The lack of leadership within the equity market investment community, and to a large extent, the pain already felt, has given the short-sellers free reign to push the equity markets down as no one is prepared to stand up and lift the banks out of the range of their ugly sticks. In the land of the blind, the man with one eye is king... Or, even the man who claims to have one eye.
The big problem with the extent of this sell-off is that it erodes the capitalisation ratios of the banks. This is the basic concept of owner equity vs debt in the company. A bit like the deposit vs debt ratio of your house and its mortgage. If the house is reducing in value, this erodes the equity you have in the house. For banks, the regulators require them to have a certain amount of equity at all times in the operation. So, if the stock price continues to erode, the capitalisation of the bank begins to come under threat. We have gone well past this stage on a lot of the bank stocks in Europe.
The short-sellers are banking upon the fear, of the regular equity investor, that these mortgages and leveraged loans, that occupy the most toxic positions on the balance sheets, will leave a huge hole once they are sold, come to refinance, or default. Within the UK and Ireland, the main worry is buy-to-let mortgages, non-conforming mortgages and, loans to property developers. These are now looking very risky and will probably end up costing a pretty penny in write downs but, the option value in owning the stock of the company with regards to future potential profits once the cycle turns again seems to have been completely forgotten. Also, there is the effect of overly negative opinions of conditions of the various bank balance sheets, versus some positive comparison for others. Sometimes these can be very polarised and a tad out of whack. But, perception is the key.
Take Goldman Sachs as a good example. Last year they rolled out their star-trader of the year as a mortgage trader called, Michael Swenson, who apparently was allowed to amass a short position (negative to the direction of the US mortgage market) so large that it contributed $4bn in profits to the Goldman record bottom line in 2007. At the same time, they were gathering an ever-increasing collection of illiquid assets that reached, in August of this year, $68bn in value. These assets occupy a space in the bank's balance sheet that is called the Level 3. This group of assets are deemed to be so illiquid that the bank is allowed to mark their value to an internal model and simply declare the value to the market with only cursory details as to the type of exposure they represent. So, was this short position an inspired punt or, was it simply a hedge for the toxic skeletons in the Goldman closet that is Level 3...?
For a long time, the exemplary reputation that Goldman enjoy held investors' confidence. Only in the last couple of months has the pandemic fear spread to their good selves. While Morgan Stanley scurried to find an equity investor and finally leaped at Mitsubishi UFJ, Goldman Sachs were playing it cool and talking to Warren Buffet. Buffet has been widely chronicled to have always craved to acceptance and acknowledgement of Wall Street. Especially, its golden boy, Goldman Sachs. It is quite possible that during negotiations Goldman, knowing Buffet's aversion to highly complicated financial risk, declined to show their balance sheet and made Warren realise that such was his reputation and theirs, that his investment of $5bn in their equity would be a self fulfilling prophesy in itself. No one would ever again doubt the financial nous of Goldman Sachs and they could side-step the worst of the financial meltdown.
Such is the decline in some of the European banks' stock prices that, there now exists a massive opportunity to take control of the future of European banking. However, in the midst of the blind panic, it would take a suicidal maniac to just invest in the stock. The only solution is to take the banks out of harms reach and off the stock market. So the short-selling speculators can no longer profit from the confusion.
The current market capitalisation of Bank of Ireland is about €2bn, and that of Allied Irish bank is about €2.5bn. The Irish government has kept their powder dry and now is the time to pounce. Take them private and nationalise them so they can be recapitalised in safe distance from the madness that has encapsulated the equity markets. Those equity lads simply haven't a clue what's going on.
WNgC
Thursday, 9 October 2008
Checking the wrong guage...
Right, so Hank's got his TARP(aulson) and Brown has nationalised UK banking Inc. The EU is guaranteeing banking deposits up to anything from €50k to €100, depending on the member state, and Ireland is extending the bank guarantee to the Irish operations of foreign owned banks. What happens next and how do we know if its working...? Lets look at the various measures of performance that could tell us.
Recently, mainstream media discovered a prime candidate for the role of Lee Harvey Oswold for this credit crisis. Strange and shady financial derivatives called credit default swaps (CDS), which are essentially bilateral financial contracts between two parties who beg to differ with regard to the creditworthiness of a specific corporate entity, have been dragged into the streets like a heretic in midst of the spanish inquisition. A credit default swap is expressed as the exchange (or swap) of a fixed rate (like an insurance premium) in exchange for a floating future payment (the makewhole difference between the recovery value of a company's loan or bond and its original value). Basically, its an insurance policy on the loan or bond of a company, in the event of its bankruptcy, for which the buyer pays a premium. This premium is considered an expression of the probability of the company going bankrupt - the higher the premium, the higher the likelihood of bankruptcy. The index of European financial CDS premiums (iTraxx Financial) first peaked at the end of July, last year, 6 weeks before the northern rock crisis made the UK even consider the possibility of a bank failure. The CDS market is a liquid and efficient measure of corporate credit worthiness and is a far more effective and informed indicator than the equity markets. CDS has been pilloried in the press as the root of all evil when, in fact, the source of much of the global bank balance sheet toxicity was actually the off-balance sheet structures that used CDS to take exposure to portfolios of corporate entities. These off-balance sheet structures are the result of teams of financiers and lawyers in banks finding structural loopholes in global company law and accounting practices, in order to further maximise its leverage - thus magnifying the exposure to extraordinary levels. The lax nature of regulatory oversight is the root of this issue, not CDS. Credit Default Swaps are in fact a reliable early warning device and a much more informed and reliable indicator of corporate health than the equity markets. The shell-company, off-balance-sheet structures that exploited their liquidity are the tragic result of a financial industry driven to ever-increasing lengths to generate respectable returns from ever-decreasingly yielding assets. As the bull market drives prices up, their yield diminishes.
Its already well established that the equity market completely failed to recognise this credit crisis on the horizon. Most equity analysts have acknowledged their complete ignorance as to the complicated nature of the various off-balance sheet vehicles operated by the banking industry and the structured assets that were contained therein. Yet, the entire mainstream media continues to focus obsessively on the Dow Jones and FTSE indices without considering what it is actually a measure of. Equity prices are, simplistically perhaps, a measure of expected future cashflows (dividends) of a company and as such, are a consensus prediction of how big a difference a company can generate between the cost of its inputs (overheads) and the price it can get for its finished product. For the banking industry, the finished product is basically the rate of interest it can get for extending credit and its main overhead is the rate at which it can borrow money (fund itself). This current crisis has been caused by the inability of banks to source funding at a low enough cost to remain solvent. The main source of this funding is the money markets, which is a very large open market for borrowing money and extending credit over a short term (typically 1 day to 3 months). This market relies on the ability of those extending credit to treat all those seeking funding with complete trust. The toxicity of global banking balance sheets has meant that most participants with funds to extend are reluctant to loan to anyone. This has caused the global money markets to effectively grind to a halt and make most banks and financial institutions to hoard cash, rather than loan it out - UBS are rumoured to be hoarding €1 trillion of cash that they are not offering into the money markets. This results in everyone chasing a smaller amount of cash, and those anything less than 100% kosher paying through the nose for even the shortest term of loan.
The day before the Irish government announced the banking guarantee, Anglo Irish Bank were sourcing funds in the money markets at an astonishing rate of 5.5% above euribor. To put this in perspective, most current tracker mortgages in Ireland are charged a rate of between 0.5% and 1% above euribor. It doesn't take a genius to see the problem there. The first thing Hank Paulson did when he got the first block of funds from the US treasury was to buy large swathes of commercial paper (short term loans) in the money markets, in order to push the cost of funding down. In Ireland, banks were immediately funding at greatly reduced rates in the money markets after the announcement of the government guarantee. These developments have had the initial benefit of ensuring the banks ability to continue operating in a solvent manner. There are many other steps for them to take before the rehabilitation is concluded. Toxic assets must be sold off by the banks, and the amount of leverage the banks utilise needs to be reduced by a comprehensive recapitalisation of their balance sheets. Only then can they look to start generating profits again. This process will cost money, which the banks will have to pay, and therefore, this will impact their bottom line profits. Given that, the equity market can expect very little in the way of dividends for the next few years from banks.
Bank stocks are weighted heavily within the FTSE 100 and so, comprise a large proportion of its value. If banks are not likely to make much profit for the foreseeable next few years, this index is bound to suffer badly regardless of the success of the bailout plans and so, is a completely irrelevant indicator as to the fortunes of the financial industry's rehabilitation. The focus by media on the FTSE is merely confusing the matter and telling us very little. We got into this mess because of the lack of attention paid towards the basic principles of finance and the credit market in particular. We will only know if we can repair the damage by monitoring the money and credit markets. The equity market tells us nothing useful at the moment - let's stop working ourselves into a tizzy by its inevitable decline.
WNgC
Recently, mainstream media discovered a prime candidate for the role of Lee Harvey Oswold for this credit crisis. Strange and shady financial derivatives called credit default swaps (CDS), which are essentially bilateral financial contracts between two parties who beg to differ with regard to the creditworthiness of a specific corporate entity, have been dragged into the streets like a heretic in midst of the spanish inquisition. A credit default swap is expressed as the exchange (or swap) of a fixed rate (like an insurance premium) in exchange for a floating future payment (the makewhole difference between the recovery value of a company's loan or bond and its original value). Basically, its an insurance policy on the loan or bond of a company, in the event of its bankruptcy, for which the buyer pays a premium. This premium is considered an expression of the probability of the company going bankrupt - the higher the premium, the higher the likelihood of bankruptcy. The index of European financial CDS premiums (iTraxx Financial) first peaked at the end of July, last year, 6 weeks before the northern rock crisis made the UK even consider the possibility of a bank failure. The CDS market is a liquid and efficient measure of corporate credit worthiness and is a far more effective and informed indicator than the equity markets. CDS has been pilloried in the press as the root of all evil when, in fact, the source of much of the global bank balance sheet toxicity was actually the off-balance sheet structures that used CDS to take exposure to portfolios of corporate entities. These off-balance sheet structures are the result of teams of financiers and lawyers in banks finding structural loopholes in global company law and accounting practices, in order to further maximise its leverage - thus magnifying the exposure to extraordinary levels. The lax nature of regulatory oversight is the root of this issue, not CDS. Credit Default Swaps are in fact a reliable early warning device and a much more informed and reliable indicator of corporate health than the equity markets. The shell-company, off-balance-sheet structures that exploited their liquidity are the tragic result of a financial industry driven to ever-increasing lengths to generate respectable returns from ever-decreasingly yielding assets. As the bull market drives prices up, their yield diminishes.
Its already well established that the equity market completely failed to recognise this credit crisis on the horizon. Most equity analysts have acknowledged their complete ignorance as to the complicated nature of the various off-balance sheet vehicles operated by the banking industry and the structured assets that were contained therein. Yet, the entire mainstream media continues to focus obsessively on the Dow Jones and FTSE indices without considering what it is actually a measure of. Equity prices are, simplistically perhaps, a measure of expected future cashflows (dividends) of a company and as such, are a consensus prediction of how big a difference a company can generate between the cost of its inputs (overheads) and the price it can get for its finished product. For the banking industry, the finished product is basically the rate of interest it can get for extending credit and its main overhead is the rate at which it can borrow money (fund itself). This current crisis has been caused by the inability of banks to source funding at a low enough cost to remain solvent. The main source of this funding is the money markets, which is a very large open market for borrowing money and extending credit over a short term (typically 1 day to 3 months). This market relies on the ability of those extending credit to treat all those seeking funding with complete trust. The toxicity of global banking balance sheets has meant that most participants with funds to extend are reluctant to loan to anyone. This has caused the global money markets to effectively grind to a halt and make most banks and financial institutions to hoard cash, rather than loan it out - UBS are rumoured to be hoarding €1 trillion of cash that they are not offering into the money markets. This results in everyone chasing a smaller amount of cash, and those anything less than 100% kosher paying through the nose for even the shortest term of loan.
The day before the Irish government announced the banking guarantee, Anglo Irish Bank were sourcing funds in the money markets at an astonishing rate of 5.5% above euribor. To put this in perspective, most current tracker mortgages in Ireland are charged a rate of between 0.5% and 1% above euribor. It doesn't take a genius to see the problem there. The first thing Hank Paulson did when he got the first block of funds from the US treasury was to buy large swathes of commercial paper (short term loans) in the money markets, in order to push the cost of funding down. In Ireland, banks were immediately funding at greatly reduced rates in the money markets after the announcement of the government guarantee. These developments have had the initial benefit of ensuring the banks ability to continue operating in a solvent manner. There are many other steps for them to take before the rehabilitation is concluded. Toxic assets must be sold off by the banks, and the amount of leverage the banks utilise needs to be reduced by a comprehensive recapitalisation of their balance sheets. Only then can they look to start generating profits again. This process will cost money, which the banks will have to pay, and therefore, this will impact their bottom line profits. Given that, the equity market can expect very little in the way of dividends for the next few years from banks.
Bank stocks are weighted heavily within the FTSE 100 and so, comprise a large proportion of its value. If banks are not likely to make much profit for the foreseeable next few years, this index is bound to suffer badly regardless of the success of the bailout plans and so, is a completely irrelevant indicator as to the fortunes of the financial industry's rehabilitation. The focus by media on the FTSE is merely confusing the matter and telling us very little. We got into this mess because of the lack of attention paid towards the basic principles of finance and the credit market in particular. We will only know if we can repair the damage by monitoring the money and credit markets. The equity market tells us nothing useful at the moment - let's stop working ourselves into a tizzy by its inevitable decline.
WNgC
Wednesday, 8 October 2008
Investment, ownership & responsibility
As I have written about in previous posts (http://waldorfswords.blogspot.com/2008/09/accountability-and-responsibility.html), the ownership of ordinary stock in a publicly listed company is not simply a silent investment. Investment in the stock, or equity, of a PLC intrinsicly represents a partial ownership of the company and so, a responsibility to direct the stewardship and management of the company in a profitable direction that also sits easy with their own moral and philosophical ideals. The idea that equity owners can complain about poor management and stewardship of a company after it falls to its knees is, frankly, obnoxious. If you don't understand what a company does, don't buy its stock. If you don't understand the strategy of a company's executive board, don't buy the stock. If you own stock and don't agree with the way its executives are running the company, sell the stock. Buying or holding the stock of a company, implicitly suggests that you agree with the executive board's strategy and completely understand what the company does. If you then find the company goes bankrupt, you have no one else to moan to, except yourself.
The various steps taken by the fiscal policy makers in the major economic regions around the world to enact their respective strategies have been notable by their subtle differences of substance and delivery. Smaller countries like Ireland, Spain, and Greece, have managed to swiftly exceed expectations and so, relieve a lot of panic and doubt. Larger countries like the US and the UK have obviously taken slightly longer however, the basic level of leadership across these countries has varied greatly.
Brian Cowen and, in the shadows, Charlie McCreevy, have probably shown themselves to be the boldest and bravest by announcing a full and unconditional government guarantee of indiginous Irish banks' deposits and dated debt. Hank Paulson has constructed an insightful solution to restoring mutual confidence amongst US banks by creating a garbage truck for the toxic assets that are currently taining US bank balance sheets. However, he has been held back by a congress, led by Nancy Pelosi, which failed to recognise its responsibility to make difficult decisions that are in the best interests of the country at large however negatively it may affect their immediate popularity. The delay in mobilising this bailout has caused it to become a disappointment for the markets. This delay and expectation mis-management has been overshadowed however, by Gordon Brown's procrastination over the UK solution. The agonising wait, inevitable leak, and subsequent delay of the UK bank bailout would never result in anything but disappointment. Wednesday's luke warm reaction to Brown's plan was as predictable as it was painful. It was even less surprising that it needed a follow-up global rate-cut extravaganza to steady the ship.
Various parts of the media have hailed the UK solution as Brown's finest moment and, there is no doubt that it is nothing if not bold and ambitious. However, the main objective of the plan has been flagged by both Darling and Brown as a recapitalisation of the UK banks' balance sheets as well as the re-establishment of confidence in their participation in money market activities for all other participants so that, they can revert to funding their operations at previous competitive levels. These goals may well end up being achieved but, a fundamental aspect of this plan completely undermines the first objective of this plan. By sliding in at preference share level in seniority on the UK banks' balance sheets, the UK government have given themselves first call on any potential dividends and, on the total assets in general. The fundamental concept of a company's equity price is as an expression of expected future cash flows, or dividends. If any potential dividends are hoovered up by preference shareholders (eg UK govt) first, this massively devalues the ordinary stock. Slotting themselves in at preference share level on the UK banks' balance sheet has effectively eliminated any motivation for the average investor to be an ordinary stockholder of these companies and so, diminished their ability to raise anymore equity capital. Which, in turn, reduces their ability to recapitalise.
By simply blanket guaranteeing its indigenous banks' debt and deposits, the Irish government has immediately stabilised the Irish banks' credit worthiness and so, unlocked a staggering amount of funding from third parties within the money markets (and outside Ireland) while, still retaining the option to invest the taxpayers' hard cash in their equity. They have yet to write a cheque to any of the banks while Gordon has already committed over £75bn of taxpayers money. The Irish guarantee has ensured that foreign money has flocked to fund the Irish banking system while, Gordon has already committed the UK taxpayer to massive equity interests in the UK banking sector. The former has successfully manipulated global capital markets while the latter has regressed UK society back to socialist fundamentals of the pre-Thatcher government.
Meanwhile, on mainland Europe, German industrial production rises by 3.4% in September from the previous year and France continues to tow the europhile party-line. Merkel and Sarkozy continue to blame blase Anglo-US attitudes to leverage while Trichet seemed hellbent on ignoring everything expect soon-to-be-extinct inflation. The thinly veiled strategy of tailoring European fiscal policy to suit the German economy has backfired spectacularly. Trichet's merciless insistence to ignore the faltering Irish, Spanish, Italian, and Greek economies by maintaining European base rates at 4.75% has completely eliminated any credibility he may have ever enjoyed. Today's rate cut, in tandem with the Fed, BOE and others can only have been agreed to under duress from someone like Bernanke. Ridiculously removed from reality perhaps but, Mervyn King has managed to say nothing on behalf of the BOE to the market over the past two weeks. Outstanding!
Bottom line is that Europe and the UK, has found itself seriously lacking in the leadership department. A slightly flawed but, well meaning, and speedy, effort will outperform a slightly flawed, poorly executed and delayed plan every time. Expectation management is the key to effective fiscal policy formulation. Disappoint and you will be sunk.
WnG
The various steps taken by the fiscal policy makers in the major economic regions around the world to enact their respective strategies have been notable by their subtle differences of substance and delivery. Smaller countries like Ireland, Spain, and Greece, have managed to swiftly exceed expectations and so, relieve a lot of panic and doubt. Larger countries like the US and the UK have obviously taken slightly longer however, the basic level of leadership across these countries has varied greatly.
Brian Cowen and, in the shadows, Charlie McCreevy, have probably shown themselves to be the boldest and bravest by announcing a full and unconditional government guarantee of indiginous Irish banks' deposits and dated debt. Hank Paulson has constructed an insightful solution to restoring mutual confidence amongst US banks by creating a garbage truck for the toxic assets that are currently taining US bank balance sheets. However, he has been held back by a congress, led by Nancy Pelosi, which failed to recognise its responsibility to make difficult decisions that are in the best interests of the country at large however negatively it may affect their immediate popularity. The delay in mobilising this bailout has caused it to become a disappointment for the markets. This delay and expectation mis-management has been overshadowed however, by Gordon Brown's procrastination over the UK solution. The agonising wait, inevitable leak, and subsequent delay of the UK bank bailout would never result in anything but disappointment. Wednesday's luke warm reaction to Brown's plan was as predictable as it was painful. It was even less surprising that it needed a follow-up global rate-cut extravaganza to steady the ship.
Various parts of the media have hailed the UK solution as Brown's finest moment and, there is no doubt that it is nothing if not bold and ambitious. However, the main objective of the plan has been flagged by both Darling and Brown as a recapitalisation of the UK banks' balance sheets as well as the re-establishment of confidence in their participation in money market activities for all other participants so that, they can revert to funding their operations at previous competitive levels. These goals may well end up being achieved but, a fundamental aspect of this plan completely undermines the first objective of this plan. By sliding in at preference share level in seniority on the UK banks' balance sheets, the UK government have given themselves first call on any potential dividends and, on the total assets in general. The fundamental concept of a company's equity price is as an expression of expected future cash flows, or dividends. If any potential dividends are hoovered up by preference shareholders (eg UK govt) first, this massively devalues the ordinary stock. Slotting themselves in at preference share level on the UK banks' balance sheet has effectively eliminated any motivation for the average investor to be an ordinary stockholder of these companies and so, diminished their ability to raise anymore equity capital. Which, in turn, reduces their ability to recapitalise.
By simply blanket guaranteeing its indigenous banks' debt and deposits, the Irish government has immediately stabilised the Irish banks' credit worthiness and so, unlocked a staggering amount of funding from third parties within the money markets (and outside Ireland) while, still retaining the option to invest the taxpayers' hard cash in their equity. They have yet to write a cheque to any of the banks while Gordon has already committed over £75bn of taxpayers money. The Irish guarantee has ensured that foreign money has flocked to fund the Irish banking system while, Gordon has already committed the UK taxpayer to massive equity interests in the UK banking sector. The former has successfully manipulated global capital markets while the latter has regressed UK society back to socialist fundamentals of the pre-Thatcher government.
Meanwhile, on mainland Europe, German industrial production rises by 3.4% in September from the previous year and France continues to tow the europhile party-line. Merkel and Sarkozy continue to blame blase Anglo-US attitudes to leverage while Trichet seemed hellbent on ignoring everything expect soon-to-be-extinct inflation. The thinly veiled strategy of tailoring European fiscal policy to suit the German economy has backfired spectacularly. Trichet's merciless insistence to ignore the faltering Irish, Spanish, Italian, and Greek economies by maintaining European base rates at 4.75% has completely eliminated any credibility he may have ever enjoyed. Today's rate cut, in tandem with the Fed, BOE and others can only have been agreed to under duress from someone like Bernanke. Ridiculously removed from reality perhaps but, Mervyn King has managed to say nothing on behalf of the BOE to the market over the past two weeks. Outstanding!
Bottom line is that Europe and the UK, has found itself seriously lacking in the leadership department. A slightly flawed but, well meaning, and speedy, effort will outperform a slightly flawed, poorly executed and delayed plan every time. Expectation management is the key to effective fiscal policy formulation. Disappoint and you will be sunk.
WnG
Tuesday, 7 October 2008
Between a rock and a hard place...
In the past 10 days, Ireland have unilaterally guaranteed their banks' deposits and dated senior and subordinated debt to the tune of €400bn; Greece have put a 100% guarantee on all Greek deposits; and Spain have upped their deposit guarantee to €100k per person and set up a €40bn fund to purchase distressed toxic assets from Spanish Banks.
All these steps have been taken in the midst of the senior European leaders from Germany, France, and the UK, convening pointless meeting after meeting. They've made vague statement after vague statement. Accused each other of causing the crisis in the first place and, finally, decided upon a pathetic €50k per person deposit guarantee. Jean-Claude Trichet has continued to obsess about inflation and insist that he has no part to play in helping to ease the crisis, while maintaining European base rates at 4.75%. As bad as this sounds, Mervyn King hasn't even bothered to comment for the past two weeks. However, the result is that the unilateral actions of countries like Ireland, Greece, and Spain, have completely undermined the authority of the ECB and the European Union as a concept. The vast majority of market participants view this as an inevitable backlash against the ECB's thinly veiled predilection to tailor fiscal policy to suit the German economy alone, while the smaller European countries struggle to cope.
The fallout would seem to be that the ECB has lost all credibility and the EU itself stands on extremely shaky ground. Gordon Brown and Alistair Darling have cemented themselves in the annals of history as infamous Hamlet-esque procrastinators, while the market panic in the City of London pointed firmly at the source of all that is rotten in the state of the UK economy (namely, confidence in anything). The pitfalls of disappointing the free market forces of equity and debt traders can be most acutely seen by the hesitation of US congress in passing their banking bailout bill. The relief that greeted the announcement of the Fed beginning to use its €700bn war chest in the US commercial paper market lasted all of 30 minutes, and the market then proceeded to fall again. The corollary of this reaction can be seen in the reaction of the Australian, Israeli, Spanish, and Irish markets to unexpectedly decisive intervention by their respective fiscal policy makers. If you promise the moon but, deliver the sun, the reaction is glorious in its relief. However, If you promise the moon, dither, delay, and finally deliver the moon, the free market forces will crush you with its disappointment.
While all this has been happening, possibly the most significant development has been in a non-EU country in the north Atlantic. Smack-bang in the middle of new US-Russian shipping routes revealed by the Arctic circle retreat and, on the front line of the old Cold War divide, Iceland has played a quietly significant part in global foreign policy for many years. A founding member of Nato and a geographically crucial ally of the US throughout World War II and the Cold War, Iceland has long been a crucial pawn on the international chess board.
It first came to significance during WWII when US military intelligence discovered Hitler's plans to use Iceland as a launch base for his V-2 missiles to attack American soil. Ever since, the US has kept the Icelandic nation close and have, bar a hiatus from 1946-1951, maintained a military presence there since 1940. Such has been the importance that US foreign policy has consistently placed on Iceland that, they were given a very generous share of the Marshall plan aid package at the end of the war, despite not one bomb landing on its soil. In 1952, the US intervened to solve a fishing rights dispute with the UK, which saw the banning of all imports of Iceland fish to the UK. Prompted by the offer by the Soviet Union of an oil-for-fish agreement, the US jumped to Iceland's side and politely made the UK see sense. In 1955, President Eisenhower publicly begged the question why the US didn't just buy up the entire export of Icelandic fish. In 1956, British authorities caved in to end the dispute and concluded that, to "increase the economic dependence of Iceland on the Soviet bloc would also strengthen the hands of the communists in Iceland, whose aim is to deny the United States the use of the vital air base at Keflavik and to bring about the withdrawal of Iceland from the North Atlantic Treaty Organisation." Echoes of a recent squirmish in the former easter-bloc.
Given this history, there has always been recognised within the credit markets, an implicit guarantee by the US to step into the breach to rescue Iceland in any major catastrophe. Today, the Icelandic Prime Minister, Geir Haarde, revealed that they "have not received the kind of support that we were requesting from our friends. So in a situation like that, one has to look for new friends." Most news agencies around the world assumed this barb to have been directed towards the EU however, it would seem they have all missed the reference to their historical 'friend', the US. The subsequent dash into the arms of Russia and the talks currently taking place to negotiate the terms of a €4.5bn loan are an inevitable product of the US economy's current malaise and a turning of the diplomatic screw by Moscow following the crushing of Georgia's petulant attempt to underline its alliance with Washington and, its desire to join NATO. Yet another example of the impossibility of fighting on multiple fronts, so explicity underlined by our Russian comrades.
We'll never know for sure what conditions will be placed on this loan but, should the US presence at Keflavik airport be 'encouraged' to discontinue, we could only conclude that Russia is taking every chance to flex its new found muscle in the direction of its long-time adversaries.
The Cold war is alive and well and the new front is in the north-Atlantic. While the credit crunch plays itself out, save a thought for how the political landscape is changing. Will the EU and the Euro survive? Will Ireland become an even more strategic US economic and military ally? And, will Norway finally crack open its breathtakingly large piggy bank to take advantage of the global equity market autumn sales? Only time will tell. Eyes-down on the bingo cards folks!
MNG
All these steps have been taken in the midst of the senior European leaders from Germany, France, and the UK, convening pointless meeting after meeting. They've made vague statement after vague statement. Accused each other of causing the crisis in the first place and, finally, decided upon a pathetic €50k per person deposit guarantee. Jean-Claude Trichet has continued to obsess about inflation and insist that he has no part to play in helping to ease the crisis, while maintaining European base rates at 4.75%. As bad as this sounds, Mervyn King hasn't even bothered to comment for the past two weeks. However, the result is that the unilateral actions of countries like Ireland, Greece, and Spain, have completely undermined the authority of the ECB and the European Union as a concept. The vast majority of market participants view this as an inevitable backlash against the ECB's thinly veiled predilection to tailor fiscal policy to suit the German economy alone, while the smaller European countries struggle to cope.
The fallout would seem to be that the ECB has lost all credibility and the EU itself stands on extremely shaky ground. Gordon Brown and Alistair Darling have cemented themselves in the annals of history as infamous Hamlet-esque procrastinators, while the market panic in the City of London pointed firmly at the source of all that is rotten in the state of the UK economy (namely, confidence in anything). The pitfalls of disappointing the free market forces of equity and debt traders can be most acutely seen by the hesitation of US congress in passing their banking bailout bill. The relief that greeted the announcement of the Fed beginning to use its €700bn war chest in the US commercial paper market lasted all of 30 minutes, and the market then proceeded to fall again. The corollary of this reaction can be seen in the reaction of the Australian, Israeli, Spanish, and Irish markets to unexpectedly decisive intervention by their respective fiscal policy makers. If you promise the moon but, deliver the sun, the reaction is glorious in its relief. However, If you promise the moon, dither, delay, and finally deliver the moon, the free market forces will crush you with its disappointment.
While all this has been happening, possibly the most significant development has been in a non-EU country in the north Atlantic. Smack-bang in the middle of new US-Russian shipping routes revealed by the Arctic circle retreat and, on the front line of the old Cold War divide, Iceland has played a quietly significant part in global foreign policy for many years. A founding member of Nato and a geographically crucial ally of the US throughout World War II and the Cold War, Iceland has long been a crucial pawn on the international chess board.
It first came to significance during WWII when US military intelligence discovered Hitler's plans to use Iceland as a launch base for his V-2 missiles to attack American soil. Ever since, the US has kept the Icelandic nation close and have, bar a hiatus from 1946-1951, maintained a military presence there since 1940. Such has been the importance that US foreign policy has consistently placed on Iceland that, they were given a very generous share of the Marshall plan aid package at the end of the war, despite not one bomb landing on its soil. In 1952, the US intervened to solve a fishing rights dispute with the UK, which saw the banning of all imports of Iceland fish to the UK. Prompted by the offer by the Soviet Union of an oil-for-fish agreement, the US jumped to Iceland's side and politely made the UK see sense. In 1955, President Eisenhower publicly begged the question why the US didn't just buy up the entire export of Icelandic fish. In 1956, British authorities caved in to end the dispute and concluded that, to "increase the economic dependence of Iceland on the Soviet bloc would also strengthen the hands of the communists in Iceland, whose aim is to deny the United States the use of the vital air base at Keflavik and to bring about the withdrawal of Iceland from the North Atlantic Treaty Organisation." Echoes of a recent squirmish in the former easter-bloc.
Given this history, there has always been recognised within the credit markets, an implicit guarantee by the US to step into the breach to rescue Iceland in any major catastrophe. Today, the Icelandic Prime Minister, Geir Haarde, revealed that they "have not received the kind of support that we were requesting from our friends. So in a situation like that, one has to look for new friends." Most news agencies around the world assumed this barb to have been directed towards the EU however, it would seem they have all missed the reference to their historical 'friend', the US. The subsequent dash into the arms of Russia and the talks currently taking place to negotiate the terms of a €4.5bn loan are an inevitable product of the US economy's current malaise and a turning of the diplomatic screw by Moscow following the crushing of Georgia's petulant attempt to underline its alliance with Washington and, its desire to join NATO. Yet another example of the impossibility of fighting on multiple fronts, so explicity underlined by our Russian comrades.
We'll never know for sure what conditions will be placed on this loan but, should the US presence at Keflavik airport be 'encouraged' to discontinue, we could only conclude that Russia is taking every chance to flex its new found muscle in the direction of its long-time adversaries.
The Cold war is alive and well and the new front is in the north-Atlantic. While the credit crunch plays itself out, save a thought for how the political landscape is changing. Will the EU and the Euro survive? Will Ireland become an even more strategic US economic and military ally? And, will Norway finally crack open its breathtakingly large piggy bank to take advantage of the global equity market autumn sales? Only time will tell. Eyes-down on the bingo cards folks!
MNG
Thursday, 25 September 2008
The elephant turns leader of the pack?
In a beachside villa somewhere on the northeastern coast of cuba, an octagenarian revolutionary turns on CNBC and has a good laugh to himself. His stock portfolio isn't traded on the NYSE, or the LSE - it hasn't even listed yet. But, when it does, it will soar.
For the past 10-15 years, Fidel Castro has invested over $1bn into a burgeoning national biotechnology industry. Cuban scientists have already developed a couple of dozen products, including monoclonal antibodies, streptokinase--a drug used to break up blood clots--and the world's only available vaccine against meningitis B, and under development are cancer vaccines and other compounds that would be considered cutting-edge in U.S. labs. In order to secure intellectual property rights, they have patented a whole host of drugs and treatments in the US through Canadian shell companies, set up with the help of the Canadian government. Once the long-standing and oft-criticised trade embargo is lifted by the US government, these drugs can go in front of the FDA for approval. No matter how tough the economic environment, people will buy the drugs to make them better. The US will make Cuba bigger than Pfizer.
Karl Marx's ultimate last laugh, and Fidel Castro's legacy to the Cuban people. Irony at its best.
MNG
For the past 10-15 years, Fidel Castro has invested over $1bn into a burgeoning national biotechnology industry. Cuban scientists have already developed a couple of dozen products, including monoclonal antibodies, streptokinase--a drug used to break up blood clots--and the world's only available vaccine against meningitis B, and under development are cancer vaccines and other compounds that would be considered cutting-edge in U.S. labs. In order to secure intellectual property rights, they have patented a whole host of drugs and treatments in the US through Canadian shell companies, set up with the help of the Canadian government. Once the long-standing and oft-criticised trade embargo is lifted by the US government, these drugs can go in front of the FDA for approval. No matter how tough the economic environment, people will buy the drugs to make them better. The US will make Cuba bigger than Pfizer.
Karl Marx's ultimate last laugh, and Fidel Castro's legacy to the Cuban people. Irony at its best.
MNG
Tuesday, 23 September 2008
Beneficiaries of the latest doom
The underlying cause of the credit crunch is really the oversupply of credit to those who ultimately could not service the debt. Banks are in business to profit from interest charged on money lent to individuals. Secured credit (like a mortgage) is normally a no-brainer for banks. For as long as the individual is able to service the debt, the bank makes profit and (normally) if they cease to be able to service the debt, the bank can always seize the asset placed as security (normally the house). So, in normal circumstances, any mortgage to a regular individual is an automatic 'yes' for any bank. If the average an in the street is honest, he would realise that the responsibility considering his ability to repay rests with himself and not the bank. It is fundamentally incumbant on every person to make every attempt to consider his/her ability to fulfill each and every financial committment they enter into.
Now, let's consider who benefitted from the proliferation of cheap credit. No doubt, executives and senior employees of banks, finance houses, private equity companies, and hedge funds alike, made a lot of money from leveraging investments to gain large returns by taking advantage of a high growth/low interest rate economic environment. However, we will get back to that. The other big beneficiaries are the average man in the street. He has been able to borrow money cheaply to buy the dream house and lifestyle that his parents could only dream of. As houses and property changed hands and individuals made money, the overall level of borrowing increased in the economy. People who made money from property spent it and benefitted the economy at large. Now that people are finding that they are over-leveraged and can't service their debt with higher rates, they whole cycle is unravelling.
Ultimately, any public money used to unburden banks of this toxic mortgage debt, is merely paying for the economic benefit the average Joe experienced during the boom period. Thus taxpayers money is ultimately paying for the inability of the average taxpayer to pay for his/her lifestyle over the previous 8-10 years.
We can all point fingers at the fat-cat greedy bankers who tricked us into buying that mercedes or, that villa in portugal, or that bottle of 1999 Cheval Blanc but, in reality, we are responsible for our own excesses and now its time to pay for them.
Start getting used to the bus - you'll be taking it for at least another year.
MNgC
Now, let's consider who benefitted from the proliferation of cheap credit. No doubt, executives and senior employees of banks, finance houses, private equity companies, and hedge funds alike, made a lot of money from leveraging investments to gain large returns by taking advantage of a high growth/low interest rate economic environment. However, we will get back to that. The other big beneficiaries are the average man in the street. He has been able to borrow money cheaply to buy the dream house and lifestyle that his parents could only dream of. As houses and property changed hands and individuals made money, the overall level of borrowing increased in the economy. People who made money from property spent it and benefitted the economy at large. Now that people are finding that they are over-leveraged and can't service their debt with higher rates, they whole cycle is unravelling.
Ultimately, any public money used to unburden banks of this toxic mortgage debt, is merely paying for the economic benefit the average Joe experienced during the boom period. Thus taxpayers money is ultimately paying for the inability of the average taxpayer to pay for his/her lifestyle over the previous 8-10 years.
We can all point fingers at the fat-cat greedy bankers who tricked us into buying that mercedes or, that villa in portugal, or that bottle of 1999 Cheval Blanc but, in reality, we are responsible for our own excesses and now its time to pay for them.
Start getting used to the bus - you'll be taking it for at least another year.
MNgC
Monday, 22 September 2008
Accountability and Responsibility
A wise woman once told me that you get the government you deserve. It is one's responsibility to carefully consider potential political representatives and exercise their right to vote. A low voter turnout is usually exploited by incumbant representatives. Antipathy on the part of an electorate and the inevitably careless stewardship of compacent government is the fault of every eligible voter within a democracy.
The same could be said with regard to the running of a company. The quintessential essence of any private enterprise is that the stewardship and resulting profits or losses thereof are the responsibility and reward of its owners. The difficulty associated with running any organisation by committee increases exponentially with size so, most companies appoint a board of managment which is ratified by the shareholders at each AGM. No less than the democratic process of electing a government, the formation of a board of management is one of the most vitally important consideration for the shareholders of any company. The most important consideration however, is whether the business activities of the company are understood and accepted by the shareholder. This is not always the case.
Much in the same way that the average person in the street is capable of taking a tip on a horse that they no nothing more than the name of, and put £10 to £20 pounds, or more, on the fortunes of its racing career, there are intelligent, hard-working people who will buy shares in a company with little more understanding of their operations than the knowledge of one of their high street brand names. When these companies then lose money or, even go bust, the same people who took little care in researching the operations of this company then cry foul and demand all manner of government intervention. The necessity for rules enforcing responsibile corporate governance is without reproach however, the failure of a company due to the shortcomings of its business model or, indeed, the execution thereof, is ultimately the fault of its shareholders. By owning shares in a company, a shareholder implicitly acknowledges their endorsement of its executive board and the business practices it employs.
The sage of Omaha, Warren Buffett, has always said he only ever invests in companies he understands. An investment philosophy the man in the street would do well to practice.
The same could be said with regard to the running of a company. The quintessential essence of any private enterprise is that the stewardship and resulting profits or losses thereof are the responsibility and reward of its owners. The difficulty associated with running any organisation by committee increases exponentially with size so, most companies appoint a board of managment which is ratified by the shareholders at each AGM. No less than the democratic process of electing a government, the formation of a board of management is one of the most vitally important consideration for the shareholders of any company. The most important consideration however, is whether the business activities of the company are understood and accepted by the shareholder. This is not always the case.
Much in the same way that the average person in the street is capable of taking a tip on a horse that they no nothing more than the name of, and put £10 to £20 pounds, or more, on the fortunes of its racing career, there are intelligent, hard-working people who will buy shares in a company with little more understanding of their operations than the knowledge of one of their high street brand names. When these companies then lose money or, even go bust, the same people who took little care in researching the operations of this company then cry foul and demand all manner of government intervention. The necessity for rules enforcing responsibile corporate governance is without reproach however, the failure of a company due to the shortcomings of its business model or, indeed, the execution thereof, is ultimately the fault of its shareholders. By owning shares in a company, a shareholder implicitly acknowledges their endorsement of its executive board and the business practices it employs.
The sage of Omaha, Warren Buffett, has always said he only ever invests in companies he understands. An investment philosophy the man in the street would do well to practice.
Subscribe to:
Posts (Atom)