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!
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