The seedy world of journalism is much like toilet paper. Readily available in most retail outlets, cheap, unreliable at times, and uplifting at others but, impossible to live without. One thing you can count on when it comes to journalists is, that you can never rely upon them to bail you out when the chips are down. They are there to sell newspapers, and that's it. The only thing you can do is make sure you your house is in order and there are no skeletons in the closet. There are many examples in the world of celebrity who can attest to this.
If you are going to solve a problem like the banking crisis, first of all there are two basic directions you can go down - public, or private. Do you maintain a bank's public equity listing so that access to global capital markets and potential funding in the future is preserved? Or, do you pull the bank off the stock market, nationalise it, and take it under the protective wing of the country's sovereign credit rating..?
If you privatise (nationalise) a bank, you remove it from the hyperbolic gaze of press hacks and so, the whims of the stock market forces. The cheap tabloid tattle that sells newspapers is fundamentally speculative in its nature but, feeds off smoke that can be portrayed as indicative of a real fire. Therefore your choice is to either make it absolutely clear that there is no fire or make sure no one even sees the smoke. A nationalised bank has no publicly quoted equity price and so, is not compelled to provide the level of public disclosure that endeavours to make the stock market as transparent as possible. As we all know, a little bit of knowledge is a dangerous thing and so, without this forced disclosure, it is also spared the blind panic that accompanies a volatile stock. Is the financial strength of a bank determined by its stock price or, is the stock price determined by its financial strength..? Far too often lately, in the global equity markets, the tail has been wagging the dog.
That said, a nationalised bank completely undermines the reasons for having a banking system in the first place. A banking system is designed to enable a free market economy and promote private enterprise. Government control and stewardship of such a system removes the Darwinian premise that ensures survival of the fittest. So, if you can't hide the smoke, you gotta put out the fire.
The current strategy of recapitalising bank balance sheets without dealing with the underlying problems, caused by the toxic structured assets on their books, is a muddled approach and lacks any clear understanding of what the government bailout plans are trying to achieve. As long as doubt remains as to the true value of the toxic assets on every bank's balance sheet, there will be smoke for the tabloid journalists to feed the panic on the stock market trading floors. This means that until these problem assets are removed or their true recovery value is determined, they will continue to weigh on the banks' stock prices and so, undermine their capitalisation ratios. Seeing as the crystal ball has not been invented yet, they must be extricated from the bank balance sheets. Until that is done, any public money used to purchase bank equity is a complete waste.
Greed is a fundamental human trait and not even a depression can completely eliminate it. If banks are cleansed of these cancerous tumours, they can then be 'encouraged' to turn the credit tap on again for viable private enterprise. It is fundamentally impossible for a state to directly finance entrepreneurial activity in its economy. A strong banking system is vital, and a national asset purchase program to fix bank balance sheets is the only solution.
As long as there are people living and breathing on this planet, there are opportunities for making money. Its now our job, collectively, to make sure we can identify the product or services that will be needed in this cycle. The ability to adapt and retrain so that we can take advantage of the next wave, is the real challenge that lies ahead. However, if there is no ability for the entrepreneurial minds within our economy to act on their foresight, someone else in another part of the world will - and their economy will reap the benefits that follow. Identify the demand, provide the supply, and everything else will follow. Simple!
Saturday, 31 January 2009
Saturday, 24 January 2009
Fractional Ownership & Bank Timeshares
If the origins of the current economic crisis could be encapsulated by one word, that best candidate would be leverage. The explosion of debt that over-extended every consumer and business in the western world has led us to a massive hangover now that the party is over, and morning has broken. The house party got out of control and now, in the cold light of day, our home is trashed. We can now either crack open another can and carry on or, pull on the marigold gloves and get busy with the vileda supermop.
But, before we start pouring salt on the red wine stain in the white shag pile, lets remember exactly what leverage is. Very simply (and please may those with even the most basic business knowledge humour me for a minute), leverage is the ratio of Debt to Debt + Equity for any enterprise or business. The debt portion of this ratio has got out of hand for almost every company and consumer in recent times and so, the fraction has exponentially veered towards the magic number 1 that signals insolvency, as the equity portion got dwarfed by cheap cash and easy finance. Now we are struggling to keep get this ratio back under control. The most high profile front in this struggle has been within the banking industry and the fight to control the capital ratios decimated by their highly leveraged balance sheets. Almost every country in the western world has furiously thrown money at their banks' equity and attempted to bolster this part of the ratio in order to recapitalise their balance sheets. This one way of doing it but, let's go back to 1st grade mathematics to see the other...
Fractions are a ratio of two numbers, a numerator on the top and, a denominator on the bottom. The ratio can be reduced by either increasing the denominator or, decreasing the numerator. In throwing billions of dollars/pounds/euros at their banks' equity, the US, UK and EU have obsessed about increasing the denominator. Raising more equity to recapitalise banks, does nothing to solve the root problem. Bank equities are exposed to the free market forces of the stock market which have simply pushed the equity valuation down further because the toxic debt instruments that caused the losses in the first place are still there and the problem hasn't been fixed yet. The equity portion of the bank leverage ratios is being eroded as fast as the government bail-out plans are pumping money into them. Call me crazy but, has anyone thought about reducing the numerator instead..?
In October of last year, the Swiss government pulled aside the UBS board of management for a bit of an honesty session, and the bankers revealed all the horrific skeletons in the embarrassing closet that their balance sheet had become. Once the beatings had finished, the government created the accounting equivalent of a toxic waste dump to stuff these illiquid debt securities into. This resulted in $60bn of damaged goods being transferred off the UBS balance sheet and into a Swiss-government-owned fund. In exchange, UBS invested $6bn in the equity of this fund, which would only generate a return if these assets recovered back above their transfer value. The $60bn of bad assets that were amputated from the UBS balance sheet would have been the most difficult to fund and so, the biggest strain on its capital ratios. Exorcising themselves of these troubled assets enabled UBS to eliminate the borrowings that were being used to finance these positions and so, dramatically reduce its leverage. This cleansing of the UBS balance sheet had the neat (not particularly my choice of adjective but that of the NY Times) effect of spectacularly reducing the numerator in its leverage ratio and also reassuring the equity market that the cancerous tumour had been successfully removed.
The beauty of this solution is in the value for money that the Swiss government has achieved in implementing this solution. They identified the root problems (toxic assets), isolated them (govt toxic asset fund), and gave UBS a new lease of life (clean balance sheet). This wasn't cheap but, it was very clean and definitive. The cost to the Swiss taxpayer (who are they anyway?) was capped ($60bn) and achieved exactly what they were looking for - a fresh start for Swiss banking. Removing the trouble-assets, and paying down the debt used to finance them, enabled UBS to reduce its dependence on the demon weakness that is leverage.
Let's compare this strategy to how Gordon Brown and Biffo Cowen have approached the crisis. The Irish government initially took the bold step of guaranteeing all the debt of the five major indigenous banks so that they could more easily fund the assets (good and bad) that sat on their balance sheets and then, the UK government began ploughing money into the equity of the UK banks. Both these approaches are basically an attempt to maintain the existing leverage ratios of the banks and hope that the problem sorts itself out. In Ireland, the hope was that by giving the banks easy access to cheap financing (in the shape of the government guarantee), the equity market would look favourably upon their equity prices and so, the denominator in their leverage ratios would cease to be impaired. In the UK, Gordon Brown simply decided to directly bolster the denominator in the banks' leverage ratio, by throwing money at the banks' equity. Both these strategies are flawed in that they simply seek to preserve the status quo rather than fix the root problem.
Effectively reducing a bank's leverage ratio (or even keeping it under control) is critically dependent upon stabilising one potentially very volatile factor - its equity price. This means that whatever strategy one employees, as long as the bank remains publicly quoted on a stock exchange, the value of its stock price (and so its equity market capitalisation) can fluctuate to reflect investor opinion of the strategy employed. The difference between tackling the top part of the leverage ratio and the bottom part is that the numerator (debt) is not open to outside influence so, any reduction effected is sustained. However, focusing on the bottom part of the leverage ratio by trying to bolster the bank's equity market capitalisation can be undermined directly by the equity market. The main problem with this strategy is that it leaves the onus upon the management of the bank to use the cash, given to them by the equity recapitalisation, to reduce debt and so, strengthen their balance sheet. However, within the UK at least, the banks are simply using the government bank guarantee to raise new debt and simply maintain the existing leverage, not reduce it. This mainly because the banks still can't face up to the real value of the toxic assets on their balance sheet. The indirect nature of this solution merely allows the banks to sustain the illusion and goes nowhere towards really solving the problem. Much like giving a junkie money to pay his dealer, the dependence remains.
Okay now, Gordon & Brian, if you manage to read this, let me spell it out really simply. Remember the ratio I was talking about - leverage? Well, making the bottom bit bigger so that the top bit doesn't look so bad, ain't no solution. If you force the banks to reduce leverage by taking the problem assets off them, the resulting clean nature of their balance sheets will mean they can use the government debt guarantee in the right manner - to raise more cash to give out as new loans and mortgages to the man in the street. As long as the banks sell the assets at a realistic value, into the government fund, the taxpayer will not be forced to overpay and may even benefit from any recovery in their value. Even if they end up being worthless, the cost to the taxpayer is capped. Any drop in the banks' equity price due to the write-downs on the loans they transfer into this fund, will be limited because, the underlying problem will have been extricated. A kind of financial root-canal therapy.
The proof is in the pudding and, all one has to do is go back to October, last year, and look at how Swiss and UK fortunes have diverged since then. Switzerland spent $60bn on UBS, in the same week that the UK government invested £37bn ($64bn at the time) in RBS, HBOS, and Lloyds stock. Most of the UK's £37bn was pumped into RBS and, since then, the UBS stock price has outperformed the RBS stock price by a massive 20%. Much like a rogue trader would double-down on a bad bet, last week Gordon Brown announced another £50bn of investment in UK bank stocks and, in Ireland, Biffo has had to nationalise Anglo Irish Bank. If tax were considered an investment in a country's fortunes, we should all be considering a change of fund manger or moving our money elsewhere. Only question remaining is, when are we all moving to the Alps..?
But, before we start pouring salt on the red wine stain in the white shag pile, lets remember exactly what leverage is. Very simply (and please may those with even the most basic business knowledge humour me for a minute), leverage is the ratio of Debt to Debt + Equity for any enterprise or business. The debt portion of this ratio has got out of hand for almost every company and consumer in recent times and so, the fraction has exponentially veered towards the magic number 1 that signals insolvency, as the equity portion got dwarfed by cheap cash and easy finance. Now we are struggling to keep get this ratio back under control. The most high profile front in this struggle has been within the banking industry and the fight to control the capital ratios decimated by their highly leveraged balance sheets. Almost every country in the western world has furiously thrown money at their banks' equity and attempted to bolster this part of the ratio in order to recapitalise their balance sheets. This one way of doing it but, let's go back to 1st grade mathematics to see the other...
Fractions are a ratio of two numbers, a numerator on the top and, a denominator on the bottom. The ratio can be reduced by either increasing the denominator or, decreasing the numerator. In throwing billions of dollars/pounds/euros at their banks' equity, the US, UK and EU have obsessed about increasing the denominator. Raising more equity to recapitalise banks, does nothing to solve the root problem. Bank equities are exposed to the free market forces of the stock market which have simply pushed the equity valuation down further because the toxic debt instruments that caused the losses in the first place are still there and the problem hasn't been fixed yet. The equity portion of the bank leverage ratios is being eroded as fast as the government bail-out plans are pumping money into them. Call me crazy but, has anyone thought about reducing the numerator instead..?
In October of last year, the Swiss government pulled aside the UBS board of management for a bit of an honesty session, and the bankers revealed all the horrific skeletons in the embarrassing closet that their balance sheet had become. Once the beatings had finished, the government created the accounting equivalent of a toxic waste dump to stuff these illiquid debt securities into. This resulted in $60bn of damaged goods being transferred off the UBS balance sheet and into a Swiss-government-owned fund. In exchange, UBS invested $6bn in the equity of this fund, which would only generate a return if these assets recovered back above their transfer value. The $60bn of bad assets that were amputated from the UBS balance sheet would have been the most difficult to fund and so, the biggest strain on its capital ratios. Exorcising themselves of these troubled assets enabled UBS to eliminate the borrowings that were being used to finance these positions and so, dramatically reduce its leverage. This cleansing of the UBS balance sheet had the neat (not particularly my choice of adjective but that of the NY Times) effect of spectacularly reducing the numerator in its leverage ratio and also reassuring the equity market that the cancerous tumour had been successfully removed.
The beauty of this solution is in the value for money that the Swiss government has achieved in implementing this solution. They identified the root problems (toxic assets), isolated them (govt toxic asset fund), and gave UBS a new lease of life (clean balance sheet). This wasn't cheap but, it was very clean and definitive. The cost to the Swiss taxpayer (who are they anyway?) was capped ($60bn) and achieved exactly what they were looking for - a fresh start for Swiss banking. Removing the trouble-assets, and paying down the debt used to finance them, enabled UBS to reduce its dependence on the demon weakness that is leverage.
Let's compare this strategy to how Gordon Brown and Biffo Cowen have approached the crisis. The Irish government initially took the bold step of guaranteeing all the debt of the five major indigenous banks so that they could more easily fund the assets (good and bad) that sat on their balance sheets and then, the UK government began ploughing money into the equity of the UK banks. Both these approaches are basically an attempt to maintain the existing leverage ratios of the banks and hope that the problem sorts itself out. In Ireland, the hope was that by giving the banks easy access to cheap financing (in the shape of the government guarantee), the equity market would look favourably upon their equity prices and so, the denominator in their leverage ratios would cease to be impaired. In the UK, Gordon Brown simply decided to directly bolster the denominator in the banks' leverage ratio, by throwing money at the banks' equity. Both these strategies are flawed in that they simply seek to preserve the status quo rather than fix the root problem.
Effectively reducing a bank's leverage ratio (or even keeping it under control) is critically dependent upon stabilising one potentially very volatile factor - its equity price. This means that whatever strategy one employees, as long as the bank remains publicly quoted on a stock exchange, the value of its stock price (and so its equity market capitalisation) can fluctuate to reflect investor opinion of the strategy employed. The difference between tackling the top part of the leverage ratio and the bottom part is that the numerator (debt) is not open to outside influence so, any reduction effected is sustained. However, focusing on the bottom part of the leverage ratio by trying to bolster the bank's equity market capitalisation can be undermined directly by the equity market. The main problem with this strategy is that it leaves the onus upon the management of the bank to use the cash, given to them by the equity recapitalisation, to reduce debt and so, strengthen their balance sheet. However, within the UK at least, the banks are simply using the government bank guarantee to raise new debt and simply maintain the existing leverage, not reduce it. This mainly because the banks still can't face up to the real value of the toxic assets on their balance sheet. The indirect nature of this solution merely allows the banks to sustain the illusion and goes nowhere towards really solving the problem. Much like giving a junkie money to pay his dealer, the dependence remains.
Okay now, Gordon & Brian, if you manage to read this, let me spell it out really simply. Remember the ratio I was talking about - leverage? Well, making the bottom bit bigger so that the top bit doesn't look so bad, ain't no solution. If you force the banks to reduce leverage by taking the problem assets off them, the resulting clean nature of their balance sheets will mean they can use the government debt guarantee in the right manner - to raise more cash to give out as new loans and mortgages to the man in the street. As long as the banks sell the assets at a realistic value, into the government fund, the taxpayer will not be forced to overpay and may even benefit from any recovery in their value. Even if they end up being worthless, the cost to the taxpayer is capped. Any drop in the banks' equity price due to the write-downs on the loans they transfer into this fund, will be limited because, the underlying problem will have been extricated. A kind of financial root-canal therapy.
The proof is in the pudding and, all one has to do is go back to October, last year, and look at how Swiss and UK fortunes have diverged since then. Switzerland spent $60bn on UBS, in the same week that the UK government invested £37bn ($64bn at the time) in RBS, HBOS, and Lloyds stock. Most of the UK's £37bn was pumped into RBS and, since then, the UBS stock price has outperformed the RBS stock price by a massive 20%. Much like a rogue trader would double-down on a bad bet, last week Gordon Brown announced another £50bn of investment in UK bank stocks and, in Ireland, Biffo has had to nationalise Anglo Irish Bank. If tax were considered an investment in a country's fortunes, we should all be considering a change of fund manger or moving our money elsewhere. Only question remaining is, when are we all moving to the Alps..?
Friday, 16 January 2009
Civic Duties, Carrots & Sticks
Long before the beginning of the end of the dream-sequence that was the Celtic Tiger, there were many concerned voices within Ireland bemoaning an apparent erosion of traditional values and cultural fabric within the Irish community.
While house prices in Dalkey sky-rocketed, and sales of boats/porsches/rolexes went through the roof, the youth in the working class communities of Dublin and Limerick flocked to organised crime and the drug trade. The root cause of this social polarisation could, arguably, be explained by the near extinction of any belief in the concept of civic duty. The Republic of Ireland is a young state and the immature nature of its socio-economic policy has undoubtedly contributed to our sudden fall from grace. A lotto-winner-esque selfish devotion to personal wealth can never build a legacy. Ironically, inspiring potential future competition is the only way the business glitterati can ensure their existence is sustained. Once the working class strata of society are convinced of their destiny to continue serving a social elite convinced of their perpetually privileged status, the economy fundamentally reaches its full capacity, and the only way is down.
Last June, I was lucky enough to visit the astonishingly beautiful hills and volcanoes of Rwanda. The first thing I noticed was the gushing pride that each and every Rwandan took in the appearance of the streets and countryside they lived in. There was not one scrap of litter or rubbish in sight. The patch of roadside in front of each clay and wattle hut that was home to the average Rwandan family is impeccably manicured and peppered with pretty flowerbeds. This remarkable civic pride is reinforced by innovative social policy that makes it law for every single Rwandan to spend the last Saturday morning of every month, picking up rubbish, cleaning-up public areas, weeding flowerbeds and re-painting walls in public areas. It is only one day a month but, the amazing sense of collective civic pride that it has engendered in a country that only 14 years ago was literally tearing itself apart, is nothing short of awe-inspiring.
I'm not sure if the world is capable of a seismic shift in its value structure that makes us all want to volunteer for the local soup kitchen. Unfortunately, the man in the street will always be predominately motivated by the filthy lucre. If ever we manage to get out of this mess, tax legislation will have to be structured towards financially motivating the 'haves' to give back to the communities that spawned them. Only then are those on the margins of society motivated to participate rather than opt-out and add to the ills of society. That's when an economic boom becomes a fundamental shift in a country's fortunes.
Capitalism does require winners and losers, 'haves' and 'have-nots' but, it is only sustainable if the passage from one end to the other of these polar strata is actually possible by following the rules of the game. If a young person from a working class community doesn't believe that they can rise to the ranks of the affluent upper-classes, no matter how hard they work, then society merely resembles a feudal state rather than a free market economy. Without this basic freedom to even influence one's destiny, bust will always inevitably follow boom.
The Chicago Boys, who masterminded General Pinochet's dismantling of Allende's socialist economy, had many admirers, including Margaret Thatcher who was then inspired to take on Arthur Skargill, and break the unions in the UK. The capitalist free-market ideology that they implanted into 1970's Chilean society was applauded widely in the western world and even resulted in one of the Boys, Robert Coase, winning the Nobel prize for economics. The subsequent discovery of the repressive nature of Pinochet's administration has since led to Coase's admission that the Chilean experiment was a failure. His conclusion was that a free-market economy cannot succeed without the free will of its people.
Socio-economic policy that guarantees status quo for the 'haves' and 'have-nots' can never create a truly free population that fundamentally believes in its individual ability to influence its own destiny. Until every member of society has the true choice to make something of themselves if they are prepared to work hard enough, there will always be an excuse for people to opt out. The downfall of every empire has its origins in the dissatisfaction of the masses with its share of the pie and, the paranoid ringfencing of the pie by the ruling classes. Thing is, if everyone could work their way towards a bigger slice, they would also make the pie bigger.
WNgC
While house prices in Dalkey sky-rocketed, and sales of boats/porsches/rolexes went through the roof, the youth in the working class communities of Dublin and Limerick flocked to organised crime and the drug trade. The root cause of this social polarisation could, arguably, be explained by the near extinction of any belief in the concept of civic duty. The Republic of Ireland is a young state and the immature nature of its socio-economic policy has undoubtedly contributed to our sudden fall from grace. A lotto-winner-esque selfish devotion to personal wealth can never build a legacy. Ironically, inspiring potential future competition is the only way the business glitterati can ensure their existence is sustained. Once the working class strata of society are convinced of their destiny to continue serving a social elite convinced of their perpetually privileged status, the economy fundamentally reaches its full capacity, and the only way is down.
Last June, I was lucky enough to visit the astonishingly beautiful hills and volcanoes of Rwanda. The first thing I noticed was the gushing pride that each and every Rwandan took in the appearance of the streets and countryside they lived in. There was not one scrap of litter or rubbish in sight. The patch of roadside in front of each clay and wattle hut that was home to the average Rwandan family is impeccably manicured and peppered with pretty flowerbeds. This remarkable civic pride is reinforced by innovative social policy that makes it law for every single Rwandan to spend the last Saturday morning of every month, picking up rubbish, cleaning-up public areas, weeding flowerbeds and re-painting walls in public areas. It is only one day a month but, the amazing sense of collective civic pride that it has engendered in a country that only 14 years ago was literally tearing itself apart, is nothing short of awe-inspiring.
I'm not sure if the world is capable of a seismic shift in its value structure that makes us all want to volunteer for the local soup kitchen. Unfortunately, the man in the street will always be predominately motivated by the filthy lucre. If ever we manage to get out of this mess, tax legislation will have to be structured towards financially motivating the 'haves' to give back to the communities that spawned them. Only then are those on the margins of society motivated to participate rather than opt-out and add to the ills of society. That's when an economic boom becomes a fundamental shift in a country's fortunes.
Capitalism does require winners and losers, 'haves' and 'have-nots' but, it is only sustainable if the passage from one end to the other of these polar strata is actually possible by following the rules of the game. If a young person from a working class community doesn't believe that they can rise to the ranks of the affluent upper-classes, no matter how hard they work, then society merely resembles a feudal state rather than a free market economy. Without this basic freedom to even influence one's destiny, bust will always inevitably follow boom.
The Chicago Boys, who masterminded General Pinochet's dismantling of Allende's socialist economy, had many admirers, including Margaret Thatcher who was then inspired to take on Arthur Skargill, and break the unions in the UK. The capitalist free-market ideology that they implanted into 1970's Chilean society was applauded widely in the western world and even resulted in one of the Boys, Robert Coase, winning the Nobel prize for economics. The subsequent discovery of the repressive nature of Pinochet's administration has since led to Coase's admission that the Chilean experiment was a failure. His conclusion was that a free-market economy cannot succeed without the free will of its people.
Socio-economic policy that guarantees status quo for the 'haves' and 'have-nots' can never create a truly free population that fundamentally believes in its individual ability to influence its own destiny. Until every member of society has the true choice to make something of themselves if they are prepared to work hard enough, there will always be an excuse for people to opt out. The downfall of every empire has its origins in the dissatisfaction of the masses with its share of the pie and, the paranoid ringfencing of the pie by the ruling classes. Thing is, if everyone could work their way towards a bigger slice, they would also make the pie bigger.
WNgC
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