Posts Tagged ‘money’

September 28th, 2010

Leave a comment

Basel III: Again and Again and Again…Maneuvre

So Basel III is finally with us…….phew……can’t wait for Basel IV. I’m not sure about a fifth one as that really would be a joke too far but then again if we can have a Rocky and Rambo V why not Basel V? We will really be up the creek when that one comes out. Is this one likely to change anything? No one seems to think so but then again 2 years ago I said the same thing about Basel II!!

It all comes down to leverage which now is well understood. The new capital requirements simply squeeze poorly capitalised banks a bit harder but really make sod all difference to the underlying problem which as we all know is excess credit creation. This credit creation is also known as money supply expansion. Are credit and money the same thing? well yes and no. When you get a new loan from the bank, you have received credit. This credit appears as money in your bank account and can be converted (though usually ins’t) into note and coin. But here’s the nub. Whilst money, the the form of note and coin, cannot be destroyed (ok you could burn it), when you pay back your loan that money is cancelled…in a puff of smoke. It only existed in your imagination. Of course that same “money” can be relent but new credit can always be created as long as there is enough “equity” in the bank…….come in Tier 1 capital and other assorted IOUs.

For example, the money supply in New Zealand has contracted by nearly $10bln in the period from Feb 09 to Jul 10. That’s why there’s no money in the economy……it’s goneski. But if we dealt in real money it would never disappear; once it was created it stayed in circulation or under your bed but it could not be destroyed.

The ability of banks to inflate and deflate the economy is still very much theirs with central banks acting like the lunatics they are by playing important games with their interest rates. They haven’t quite worked out the mess they made over the last 15 years by focusing on inflation and forgetting about asset prices, leverage and moral free speculation.

Gareth Morgan notes this in his take on it but again misses the real point, as does Basel 1,2 and 3 (and probably 4 and 5). It is the quality of money supplied into an economy that is the most important aspect of the economy. Copious amounts of speculative credit has blown out the “real” economy creating a mess which could take decades to unwind.

But we need to address this sooner or later….otherwise we will get the same maneuvering again ………or is it the same manuva?

June 24th, 2010

Leave a comment

Payback: When the Debt Collector Calls

We live in interesting times. Interesting in that we are slowly realising that we have spent way beyond our budget: in monetary terms of course but also ecological. We are consuming ecological resources at an increasingly rapid rate (see Al Bartlett’s fabulous work on Arithmetic, Population and Energy) and using ecosystem services well in advance of their ability to provide.

But it’s useful to sit back and consider the element of contract here. When we borrow we commit to a contract that is so ancient so as to be part of our very soul. From Faustus to Scrooge, the spiritual nature of this bargain is ever present. I must mention here the fabulous work by Margaret Attwood titled “Payback: Debt and the Shadow Side of Wealth“. It reminds me somewhat of Arundhati Roy’s venture into non-fiction in “The Cost of Living“. I like brilliant writers who veer off into interesting worldly issues and Attwood’s book has certainly inspired this post and much thought on the nature of debt itself.

It’s not the type of book I would expect from an author of fiction but it’s really a masterpiece on the understanding of debt and our long relationship with it. When we look at debt and debt slavery we realise it has been around since the beginning of time. The ability to hock one’s wife and child into servitude is not a recent phenomenon. The Faustian bargain is long known even if these days it’s for a consumer good (take your pick) on a 5 year no interest deal: no interest? do people actually believe that? Yes they do.

The focus is always on the weekly amount…..’oh that’s $15 a week. yes i can fit that into my budget”….shame it’s $15 a week forever!! and that television or sofa has cost you double, treble of even more than the advertised price…..oh and it’s worth sod all to sell.

Anyone remember Polonius? The father of Ophelia and general rambling windbag in the Kingdom of Denmark (That’s Hamlet for you who didn’t have the joys of Shakespeare at school).

“Neither a borrower nor a lender be”.

Famous words reprised many years later by Keynes at Bretton Woods when he proposed that countries should keep their trade accounts balanced as much as possible…..that applied to those in credit as well a debit.

And look where we are now……we’re at Payback time. But where is Mephistopheles? Who is going to do the collecting? To pay or not to pay? That is the question said Hamlet…perhaps.

The imbalances in the system are so great that there is no amount of money available to repay the debts. Perhaps they should all be written off as a bad idea and we should start again from scratch….but hark I hear Shylock coming…is there a pound of flesh available? Land…not transportable…but commodities from the land…maybe.

At some point the contract must be addressed; At some point a bargain must be made; At some point there will be the mother of all restructuring. Who will pay…now that really is the question.

June 21st, 2010

2 Comments

The Big Short and The Big Fraud

Time for a book review.

I’ve just finished Michael Lewis’s “The Big Short”. It’s an amazing book, not just because it informs us of the road to the subprime mess but he creates a story around the protagonists. He also manages to expose the whole wretched mess, the fictionalisation of risk and yield laid bare. He introduces us to the main players in the debacle through the eyes of a few weird and wonderful players who worked out that something was terribly wrong and bet against it. These colourful characters expose the whole damn scheme as nothing more than a paper pyramid.

As Lewis sums up the Collateralized Debt Obligation (CDO) on page 73:

“The CDO was, in effect, a credit laundering service for the residents of Lower Middle Class America. For Wall Street it was a machine that turned lead into gold”.

Simply put a CDO was a collection (a tower) of subprime loans that had miraculously transformed from junk status to triple A (AAA) credit and therefore it was investible by major funds (referred to in the book as dopey Germans).

So what was the short? Well on one hand you had investors who sold insurance on these debts defaulting. They believed (incorrectly) that it could never happen and therefore they were picking up free money. The shorters realised the were getting amazing odds on the loans defaulting and piled in.

At the bottom of this was an average person with no money and a big mortgage, usually 100% or more. Any fall in the price of their property would immediately put them in a default position. Yes it was a giant pyramid scheme. The real laugh is that even the guys going short didn’t really understand what it was they were shorting so opaque was the structure and process.

I recommend the book very highly. It’s a gripping read and manageable for the layperson.

You’re left wondering how the bankers got away with it. The answer given by the bankers (well laid out in Sorkin’s book) was that they were too big to fail.

This sets us up nicely for the next round.

P.S.

Today the SEC is launching a case against ICP Asset management for their role in handling CDO investments. Along with the case against Goldman Sachs we can expect more companies to be investigated for their role in this financial fraud. It will also be interesting to see when the rating agencies themselves will come under review. They were the ones who gave the AAA blessing to these products they really knew very little about. Makes you wonder about the whole darn shooting match!

June 11th, 2010

1 Comment

Leverage: The Silent Assassin

One of the greatest financial inventions is leverage: the ability to create an asset of value in excess of your original investment.

Simply put this is how you can buy a house with no deposit or a small one. Consider the reality of leverage:

You buy a house for $500,000 and put down a 10% deposit of $50,000.

In a few years (certainly recent times) you sell it for $600,000. You have just made $100,000 from an investment of $50,000…a 200% return. Of course you have to subtract your interest but that is what you would have paid in rent anyway or so the theory goes.

In recent years this has been the name of the game. Between 2000 and 2008 New Zealand house prices rose 169%……..!! Yes that’s an incredible number………21% per annum on average. No wonder people thought this was an easy game. No wonder leveraged investments in property became the biggest game in town. But hold on: we are talking about houses not tulips. How could such an unusual bout of asset inflation happen right under the noses of the inflation focused RBNZ.

Well house prices are not included in the CPI calculation. Call me old fashioned but that’s ridiculous.

The major problem with any bubble is that it ends. In this case NZ has not had the same end as the USA with its sub-prime mortgage induced property collapse though the NZ finance company sector did its best to compete.

But the leverage has not been washed out of the system yet. House prices have recovered from the 2008-9 fall and now are back up close to their historic highs. Why is this? Why hasn’t the NZ housing market fallen back to more realistic levels?

There’s no clear answer but I’d like to suggest one: It’s not in the interest of the banks for prices to fall heavily. Why? Because they are the ultimate owners of the housing stock. If they lend 90% to a borrower and the price of that house falls 10% then the borrower has lost their equity and the bank owns the rest. That’s how leverage works on the downside. If the price falls further than 10% the borrower is into negative equity. So far so normal. The bank will just hoover up any savings or other assets held by the borrower. But at some point the bank is left holding the security. Banks don’t like that very much so they seek to sell the asset and recover as much cash as possible. If the borrower cannot cover the loss then the bank has to write that off.

But in a bubble situation the banks have to be very careful not to knock down the price of all property. Otherwise their entire lending portfolio will take a hit not just the one loan which went bad. So banks have a vested interest in keeping prices from falling too far.

Back in 2008 I called for land prices to fall 30%. They haven’t yet but it’s simply a matter of time. In fact they only fell 8.5%…not much of a fall considering the enormity of the rise. Wages are not rising at a rate which can cover the compounding interest on the debt pile (see upcoming post on debt) so the strains of maintaining the illusion will continue to show through. Therefore the banks have a big part to play in making sure house prices do not rise or fall too much whilst they reorganise their lending practices.

What needs to happen? Well a reversion to traditional lending practices will come back into vogue: where you can borrow 2-3 times your salary. Imagine that. Median wage in Christchurch is somewhere between $30-40,000 depending where you look and the average house price is $360,000. Scary……so the banks who are operating on the interest/cash flow model (see upcoming post on definancialisation) will find switching back to the traditional model simply isn’t possible as house prices would fall by rather a lot. You couldn’t find a house for under $200,000 these days so we would have to see a severe correction, probably in excess of 30% though very low borrowing costs would help ease that.

It’s clear that the same financial practices that we have seen employed in the global bond markets have also been applied to residential lending. The valuation model shifted from the established practice of ability to repay the mortgage to the ability to cover the interest. Why? Because the price of the house would always go up. Really? Isn’t delusion fun. The fact is that prices did go up….and up…and up. As they say the market can be wrong a lot longer than you can be right.

All this creates a major dilemma for banks (who are probably aware, one hopes, of their position) and regulators who clearly are not (always happy to be surprised): How to withdraw leverage (which was a ponzi scheme) from the residential mortgage market without causing a crash? How to realise that we have been deluding ourselves as to the  ”value” of our houses. How can we explain that 169% rise? Did we suddenly become more wealthy? Er no our trade balance for the period March 2000-2008 was minus $30.7bln!!!!

No we simply revalued our property again and again for no reason other than the banks were happy to go with the valuations (also pushed it has to be said by overseas immigrants paying cash prices) which just kept going up. If house A in one street sold for 20% more then all the other houses must be worth 20% more. Housing became a commodity and so was able to enjoy the commodity style price action……….of course housing isn’t a commodity as people actually live in them. And that is what is keeping the market afloat…..but don’t look too hard at the numbers. They might make you wonder exactly what it all means.

More on that in the upcoming posts on debt and definancialisation.

June 8th, 2010

Leave a comment

3D View: Debt, Deleverage and Definancialisation

It’s taken me a long time to get round to this post. My eyes have been glued to the train wreck that is European fiscal management. Who could forget the financial gymnastics performed by many EU wanna-bees prior to EMU integration. 3% budget deficit….no problem said Greece….we have some very good accountants in Athens.

So the chickens have finally come home. And now the Euro project is in harms way. Or is this just the next stage in complete sovereign consilience? It’s fiscal consolidation or that’s the end of the road.

The real problem, if you look hard enough under the falling limbs of the EU forest, is simply debt and its modern bedfellow, leverage. The financial binge of the last decade, built upon market deregulation in the 80s, has simply finished. Apres le binge, le deluge as they might say in Paris. A bad hangover is one thing but watching bankers get on the big white telephone is no fun at all.

The debt binge primarily was brought about not so much by low interest rates (though that helped) but by the belief that capital gain was guaranteed. Stocks always go up in the long run, property always goes up in the long run…..don’t worry about income, just borrow as much as you can and buy an asset. These financial assets have become a magnet for all investors and, naturally, sellers of investment products. I wonder how many people are holding derivative products which allow them to catch the upside of the stock market with no risk unless the market falls 50%….oops. Certainly Mr Buffet has a few of those.

The return to a time when people invested in companies based on their fundamental performance and bought houses to live in is long overdue. That people cannot afford to buy a home is without doubt the result of excessive lending by banks over the last 30 years. This is the root cause of the problem. Banks have actually created the inflation we have seen in financial assets….unearned income to be exact. That asset price inflation has seen real wages fall heavily over the years consigning the average wage earner or those unable to access leveraged credit to a lifetime of renting and debt.

The maths of excessive leverage is the simple maths of compound interest….compounded.

As Paul Volcker noted in this recent piece,

“There was one great growth industry. Private debt relative to GDP nearly tripled in thirty years. Credit default swaps, invented little more than a decade ago, soared at their peak to a $60 trillion market, exceeding by a large multiple the amount of the underlying credits potentially hedged against default.”

The bottom line is very simple: we have spent our GDP already….for many years hence.

Now it’s payback time. The payback process could take many forms: bankruptcy, forced asset sales or a slow descent back to a normalized level of activity - actually living within our means. Stripping away the financial sector so it works for people and business rather than conspiring against them will be the first requirement: not so much regulation as reengineering.

Whichever route we take it will be a painful adjustment made worse by the fact that those who are in charge are actually responsible for perpetuating the current system or refusing to question and change it.

March 29th, 2010

Leave a comment

Real Food: Jamie goes Stateside

Jamie Oliver is a machine….he is one mad food revolutionary. His results from food change programmes in the UK have been tested and shown to raise educational standards….intuitively we know this but it’s very affriming to have some research to back it up.

Now he is taking his personal brand of straight talking to the heart of America’s chronic food related problem, Huntington, West Virginia. This five county metropolitan area was designated as the unhealthiest city in the nation. Nearly half the adults in the area are obese with heart and diabetes problems running alongside.

It’s tough love all the way from the Essex Crusader who keeps giving us the harsh cold truth: crap in, crap out.

Maybe we need him down here in NZ….

 

 

About

I’m a Londoner who moved to Christchurch, New Zealand in 2002. After studying economics and finance at Manchester University and a couple of years of backpacking, I ended up working in the financial markets in London. I traded the global financial markets on behalf of investment banks for 11 years. I write about the intersection of economic, social and environmental issues . My prime interest is in designing better systems to create a better world. I welcome comments and input.

Follow me on

 

Twitter

Blog archives