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
Friday, 16 January 2009
Thursday, 11 December 2008
The Chewbacka Defence
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
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
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
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