The price of everything

Whose default is it, anyway ?

 

“Government bonds are now an extremely poor investment.”

 

-       Société Générale Global Strategy Outlook, 1 December 2009.

 

As Detective ‘Dirty’ Harry Callahan once said, a good man always knows his limitations. The employees of investment banks are not always the first to concede to any kind of limits with regard to human intelligence, insight or fortune-telling. Bloomberg reported on Friday the opinion of [name withheld to avoid embarrassment], an interest rate strategist at [name of bank withheld to avoid embarrassment]. [Name withheld to avoid embarrassment] has just joined [name of bank withheld to avoid embarrassment] having previously worked at another bankrupt investment bank, namely [name of Wall Street bank withheld to avoid embarrassment]. His opinion is that US Treasury bonds are outrageously cheap and that next year will be the year of the bond. He may be right.

On the other hand, he may be catastrophically wrong. His employer, for example, which is effectively in government ownership having wrecked its own balance sheet and impoverished most of its shareholders, is also the UK bank with the single biggest exposure to the troubled holding company Dubai World. (As Shakespeare once said, when sorrows come, they come not single spies, but in battalions.) Never mind. His previous employer, a US investment bank that wrecked its own balance sheet and impoverished most of its shareholders, is now a unit of a commercial bank that itself required emergency government support. Never mind. You can’t necessarily be right all of the time. Or indeed any of the time.

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Chronicle of a death foretold

 

“It is just as if [then Chancellor] Norman Lamont had personally thrown entire hospitals and schools into the sea all afternoon.”

 

-       Central Banking magazine, on the UK’s defence of Sterling during the ERM crisis.

 

“When I was young, people called me a gambler. As the scale of my operations increased I became known as a speculator. Now I am called a banker. But I have been doing the same thing all the time.”

 

-       Sir Ernest Cassel, private banker to King Edward VII.

 

Last week we learned just how close we came to the brink. The Bank of England confirmed that both the Royal Bank of Scotland and Halifax Bank of Scotland – the Caledonian reputation for the prudent stewardship of money being perhaps modestly over-rated ?  – came within minutes of closing down their UK banking operations in October last year. It also disclosed for the very first time in public the existence of a £62bn emergency loan extended to the banks as lender of last resort.


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Eternal sunshine of the spotless bulls

“A great deal of intelligence can be invested in ignorance when the need for illusion is deep.”

 

-       Saul Bellow.

 

 

Human beings are suckers for narrative. We love to be entertained with great stories. But a problem arises when popular media subordinate all things to the cause of entertainment, a topic well addressed by the late Neil Postman in his critique of television, ‘Amusing ourselves to death’ (Methuen, 1987). Goodness knows what he felt about the Internet.

 

If we are suckers for narrative, we are also easily seduced by determined optimism, a topic comparably well handled by Barbara Ehrenreich in her study ‘Bright-Sided: how the relentless promotion of positive thinking has undermined America’ (Metropolitan Books, 2009). When relentless optimism mates with financial markets, the result is almost always a disaster.

 

Occasionally one comes across a message that is so well delivered that it demands to be repeated. The following is such a message, which was originally published in the form of a monthly letter to shareholders of the Edelweiss Fund by Tony Deden of Sage Capital Zurich AG. It is reprinted here, in part, with his kind permission.

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Triumph of the realists, Part II

“HBOS’ share price began to drop last summer when the City became nervous about its reliance on UK mortgages. There were denials that the firm was in crisis, which is always a terrible sign. In September 2008, the Big Four bank Lloyds bought HBOS after its boss, Victor Blank – this is the part you couldn’t make up – bumped into Gordon Brown at a drinks party and got him to give an assurance that a takeover would not be referred to the monopolies commission..

 

Most of us have had a few drinks at a party and done something embarrassing, usually along the lines of I’ve-always-fancied-you-isn’t-it-time-we-did-something-about-it, but let’s take comfort in the following truth: none of us has ever done anything as embarrassing as buying HBOS.”

 

-       John Lanchester, London Review of Books, “It’s Finished”, May 2009.

 

“Kenneth Feinberg, the Obama administration’s special master for executive compensation, said he is “very concerned” about the possibility his pay cuts may drive talent away from companies bailed out by US taxpayers.”

 

-       Bloomberg News, 12^th November 2009.

 

 

Well, with talent like that, who needs grubbily self-interested morons ? And yet in our Looking Glass world, the overarching policy mistakes just keep coming. Last week saw an announcement from the UK’s Nursing and Midwifery Council that from 2013, all would-be nurses will have to have a degree. Two thoughts spring to mind by way of response. One is that the current Labour government has done its damnedest to dilute the rigour of a university degree with its fatuous and statistically arbitrary objective of pushing 50% of the young population into higher “education,” resulting in a strangely underpowered graduate workforce that in some cases can barely read or write. The second is that the City has, for at least the past two decades, insisted that all front office positions should be held exclusively by graduates. That comparably arbitrary hurdle has not had a particularly successful outcome, in anything other than the narrowest economic and financial terms. From 2013, sick people may wish to try and heal themselves, or to self-medicate via random pharmaceutical internet sites, rather than take their chances on the NHS. Let us hope that at least some of those nursing graduates do not hold previous qualifications in economics.

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Indestructible

“Alternative 1: on average there is more than one ownership claim on each gold bar conforming to London Good Delivery.. Essentially, the market operates on a fractional reserve basis.. If it is true, the next phase in the gold bull market will be a religious experience for anyone unfortunate enough to be short of gold.”

 

-       Paul Mylchreest, ‘Thunder Road Report’, 15^th October 2009.

 

“Expect other nations, including those in the Middle East, to follow the lead of Hong Kong in bullion repatriation. This is a slow-release earthquake in both bullion and currency market terms.. Taking delivery is just not the done thing in bullion ownership. If it were to become a trend, then life in the COMEX warehouse coordination office and at various custodial banks in London is likely to become quite interesting.”

 

-       Ned Naylor-Leyland, Cheviot Asset Management, October 2009.

 

“I don’t think the question really is what is gold worth but what are currencies not worth.”

 

-       Shayne McGuire, Director of Global Research at the Teacher Retirement System of Texas, October 2009.

 

 

Having certainty about financial markets is difficult at the best of times, but right now it is impossible. Robert Shiller, Yale professor and co-creator of the S&P Case-Shiller Home Price Index, is intelligent enough to own up to huge uncertainty about the future. In an interview with Fox Business last week, he confessed,

 

“I am terribly conflicted. This is the most uncertain time that I can remember. Things are violating the laws that I learned.. The whole country is experiencing an upsurge but I don’t know what to make of it.”

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The merits of a slowdown

“Cheaper toys ‘are Christmas hits’ ”

 

-       BBC News website, 28 October 2009.

 

Stop all the clocks, wrote W.H. Auden once, and he had the right idea. One of the irritations of modern western society is an always-on consumption culture that lives not so much in the here-and-now but in the tomorrow-reported-as-yesterday. Or perhaps, in remembrance of George Orwell, we should allude to his definition of advertising: the rattling of a stick inside a swill bucket. Consumer time, in any case, now moves at an accelerated rate, especially when the forces of retailing, in ever more urgent pursuit of the almighty trading dollar, overcompensate for an economy debilitated by a banking bust. So we have to tolerate Christmas lights going up in Oxford Street before Halloween; newsreaders and politicians vying to be the first to wear their poppies with pride (Armistice Day, commemorated as it always has been, on November 11^th); and toys reported as Christmas hits before the end of October.

 

Markets are not immune to this sense of temporal acceleration; they have always tried to anticipate the future and price it in. But how much future, and what kind of future, is priced in now ? GMO’s Jeremy Grantham, who pretty much nailed the March equity lows, now reckons the US market is around 25% overpriced. Pimco’s Bill Gross reckons the six-month rally in risk assets (and not just equities, or bonds) “while still continuously supported by Fed and Treasury policymakers.. is likely at its pinnacle.” “Doesn’t it seem odd,” asks Grantham, “that we would be measurably overpriced once again, given that we face a seven-year future that almost everyone agrees will be tougher than normal ?” We can only shrug our shoulders and agree, drawing discrete attention to the new purveyors of moral hazard extraordinaire, namely the western governments that, acting through nominally independent central banks, have engineered interest rates down to zero, and are busily setting up government bond markets for a bust of biblical proportions once the market manipulation known as quantitative easing finally ends. Any individual investors currently being semi-officially ushered in to the stock market given the lack of credible alternatives by way of deposits or government bonds may have cause, in the fullness of time, to ask precisely whose wealth all this unprecedented monetary support has actually protected. Probably not their own, as we may yet see.

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Rage against the machine

 

“John Meriwether.. is in the process of setting up a new hedge fund – his third.”

 

-       The Financial Times.

 

“Fool me once, shame on you. Fool me twice, shame on me.”

 

-       Popular saying, though probably not in Greenwich, Connecticut.

 

 

A recent posting on the consistently excellent Naked Capitalism weblog (“Mainstream Media Reporting as Propaganda”) touches on one of the more frustrating aspects of the financial crisis – why have the media been so supine in the face of wholesale abuse of the public purse, and why have the bailouts not triggered broader social disquiet ? In both the US and the UK, money is being distributed to banks from taxpayers – involuntarily – then passing straight through those organisations and speedily excreted out the other side in the form of bonuses. On the former topic, journalist Matt Taibbi (of “vampire squid” fame) commented that

 

“It’s literally amazing to me that our press corps hasn’t yet managed to draw a distinction between good news on Wall Street for companies like Goldman, and good news in reality.

 

“I watched carefully the reporting of the Dow breaking 10,000.. and not anywhere did I see a major news organization include a paragraph of the “On the other hand, so.. what?” sort, one that might point out that unemployment is still at a staggering high, foreclosures are racing along at a terrifying clip, and real people are struggling more than ever. In fact the dichotomy between the economic health of ordinary people and the traditional “market indicators” is not merely a non-story, it is a sort of taboo — unmentionable in major news coverage.”

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Show me the (real) money

 

“And you thought you had broken even. If investors had bought gold when the Dow first closed above 10,000 in March 1999, they’d be up almost 280%. Put another way, Dow 10,000 a decade ago “cost” 36 ounces of gold, treating each Dow point as $1. When the Dow revisited that level Wednesday, it was worth only 9.276 ounces of gold. In oil terms, the Dow has gone from 609 barrels to 133.”

 

-       The Wall Street Journal on ‘Dow 10,000’.

 

 

There were somewhat half-hearted celebrations last week when an antediluvian stock index representing 30 companies selected by the editors of the Wall Street Journal crossed the 10,000 level. Again. This stock index, which is most affected by the change in the share price of an 85-year-old computer company, because it’s a price-based and not value-weighted index, has been here before – as the graph below shows:

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Here is Wisdom

 

“Another flaw in the human character is that everybody wants to build and nobody wants to do maintenance.”

 

-       Kurt Vonnegut.

 

 

The revelation came sometime during early 2000. It was in the form of Peter L. Bernstein’s “Against the Gods: the remarkable story of risk” (John Wiley, 1998). Sadly, Mr. Bernstein is no longer with us – he died during the summer – but his legacy is likely to outlive most of the financial institutions who never woke up to his message. Hidden within the pages of this outstanding book is an equally remarkable quote from another ‘Renaissance man’, Daniel Bernoulli. In 1738 Bernoulli effectively launched the science of behavioural finance with the following insight:

 

For a wealthy investor, the practical utility of any gain in portfolio value inversely relates to the size of the portfolio.


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Doing business the Puritan way

 

“Astrology developed into a strange discipline – a mixture of careful observations, mathematics and record keeping – with fuzzy thinking and pious fraud.”

 

-       Carl Sagan, from the TV series ‘Cosmos’.

 

 

The late Carl Sagan was talking about astrology, but with those references to observation, mathematics, record-keeping, fuzzy thinking and outright fraud, he might just as well have been referring to economic theory. Or banking, for that matter. Magical thinking masquerading as knowledge – with hypotheses stolen from the physical sciences – is just one of the factors behind a financial crisis that, contrary to popular opinion, lives with us still, slowly continuing to drip poison into the real economy.

 

Another factor, which we suggest has been less closely examined, is the role of ownership and management. In an outstanding book (“The Puritan Gift – reclaiming the American dream amidst global financial chaos” by Kenneth and William Hopper; I.B. Tauris & Co, 2009) the authors make a convincing case that it was bad management and deviation from the long-established principles of innovation and discipline that were / are really at the heart of the banking crisis. The Hoppers define the Puritan Gift as “a rare ability to create organizations that serve a useful purpose, and to manage them well.” As opposed to organizations that serve no useful purpose, and managing them into the ground. Lehman Brothers, anybody ?

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Still stuck in the woods

“Midway on our life's journey, I found myself / In dark woods, the right road lost.”

- Translation of the opening lines of Dante's "Divine Comedy".

There's a rumour going round that the financial crisis is over and that the world economy has recovered from the banking shock of 2008. Calm analysis of banking losses to date versus capital raised would tend to disprove the former thesis – see the table below (with a hat-tip to Eoin Treacy of Fullermoney)..

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Top gearing

 

“Remember, that credit is money.”

 

-       Benjamin Franklin.

 

 

About 15 years ago, an older relative who enjoyed considerable status and influence within her local community expressed some surprise about how her bank account operated. She had always assumed that the banknotes that she deposited within her account would literally be kept in some kind of vault for safe keeping and left untouched. She fully expected to see the very same notes whenever she made a withdrawal. The idea that her money would be reused and lent on by the bank – and that the bank notes that returned would not likely be “hers” – came as something of a revelation to her. (Quite how bank depositors manage to earn interest was evidently not something that she unduly worried about. But given that current savers now earn essentially nothing, perhaps her lack of concern on the topic is more widely shared.)

 

Banks and banking are certainly poorly understood. Given the severity of the crisis, we can say with some confidence that banking is poorly understood even by bankers. The widespread unfamiliarity with the workings of the banking system may even be a good thing, for a while. For as Henry Ford once said,

 

“It is well enough that people or the nation do not understand our banking and monetary system for if they did, I believe that there would be a revolution before morning.”

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Hitting it out of the park

 

“If you can’t beat them, arrange to have them beaten.”

 

-       George Carlin.

 

 

What does professional baseball have in common with the stock market ? More than you might think. Research Affiliates’ Rob Arnott, writing in last week’s FTfm supplement, points out the tendency of the stock market to routinely overprice prospects for ‘growth’ stocks at the expense of their ‘value’ peers:

 

“In the past, did the market overpay for growth and over-punish struggling companies ? Yes. While premium or discount valuation multiples are correlated with future growth or future disappointment, the premium paid for the winners and the discount assigned to the losers is too great.. the market pays an average of about 100% premium for [companies with lofty growth expectations], relative to [companies with poor growth expectations]. The market overpays for future growth – relative to its ability to correctly anticipate that growth – by about two to one.. The market discerns which companies are likely to do best and then overpays for those future prospects..”

 

As Arnott says, this forms the basis of the so-called value effect, the apparent anomaly whereby the stocks of companies with low price / book and similar ratios tend to outperform the stocks of companies with metrics pointing to high confidence in dramatic future growth. But Arnott also points out the extreme valuations now present in the market. Growth stocks are no longer priced at “just” twice the valuation multiples of value stocks; they are now priced at a 2 ½ times multiple;

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Dancing near the door

 

“Banking may well be a career from which no man really recovers.”

 

-       John Kenneth Galbraith.

 

 

How much of the bailout money is actually supporting companies that provide jobs ? That was the question asked by entrepreneur Luke Johnson in his regular and typically outspoken column for the Financial Times last week. He answered it anecdotally, with reference to a “chilling conversation” with a senior banker, in which it emerged that almost three-quarters of the taxpayer lifeline provided to support British banks has gone to property lending. As Johnson sharply observes,

 

“A distorting addiction to real estate is part of why it all went wrong in the first place.”

 

You can give a banker money, but you cannot make him lend. Or at least, not to those causes most worthy of the aim. Gillian Tett, writing for the FT on Friday, pointed out that when Japanese bankers, mired in their own credit crisis, were ordered to lend to small businesses, they ended up directing loans to subsidiaries of Toyota – not exactly what their governmental overlords intended. If both bankers and politicians were constrained by appropriately powerful oversight, perhaps financial crises would be less infrequent. That suggests that there may be a fundamental problem with the democratic process itself.

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Bonderdämmerung

 

“You don’t take a very responsible job at a time like this and jump after eight months to make money in the private sector.”

 

-       Anonymous ‘Senior City banker’ quoted in The Financial Times after John Kingman of UK Financial Investments said he was stepping down. This response would seem to indicate that a) banking itself is irresponsible; b) the anonymous banker explicitly acknowledges he himself is in it for the money; c) bankers still dominate the field in the hypocritical delivery of advice to others; d) the coinage ‘banker’ has now completely replaced its assonant rival as a term of abuse to describe the hopelessly objectionable and contemptible.

 

 

The great Austrian economist Ludwig von Mises had the final word about a terminal credit crunch:

 

“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.” (Mises, ‘Human Action’, 1949.)

 

But there is an almost insurmountable problem in viewing the investment markets through the rigid and unforgiving prism of the so-called Austrian school. Mises wrote of the world as it should be. We live in the world as it is. Our own investment markets, or at least those of the supposedly developed west, are now government-directed parodies of free markets – having theoretically been at economic war with socialism and communism, and having seemingly triumphed as the Berlin Wall fell, the governments of the west have now adopted much of the socialist-driven command economy model that they had ostensibly vanquished as recently as 1989.

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Too many c(r)ooks

 

“You’re not only wrong. You’re wrong at the top of your voice.”

 

-       John J. Macreedy (Spencer Tracy), ‘Bad Day at Black Rock’.

 

 

The seemingly vampiric permanence of the investment banking survivors versus their peers in hedge funds, property or private equity suggests, as one correspondent posits, that “the end result is going to be very messy”. While Lehman was Wall Street’s singular blood offering, what will it take to put a stake through the heart of rejuvenated risk-mongering ? The Financial Times last week carried a refreshingly outspoken interview with Paul Purcell (brother of Morgan Stanley’s Philip) who laid the blame for the financial crisis on “the greed of fixed-income people”: “Go back and look at the history of Wall Street – Drexel Burnham, Salomon Brothers, Kidder Peabody, Bear Stearns, Long-Term Capital Management, Lehman Brothers, Merrill Lynch – the fixed-income guys blow up every firm.” On first sight this seems perverse, given the tendency of bonds as a whole to be largely mundane investments, seemingly offering little by way of either return or risk. But once you add leverage to the mix, in order to generate those super-sized profits (and bonuses), all becomes clear. Mr. Purcell continues to take Wall Street to task: “We [investment bank RW Baird] didn’t do the bad things that the rest of Wall Street did. The difference is we actually take care of our clients. We want to make money for people. The big firms created proprietary product they put through their own distribution systems to make them more money, whether the clients needed the product or not. Our business is to sell people the right product at the right time for the right price.” Which sounds fair enough; the problem being, says Mr. Purcell, in the “75% of the people in our business [who] are not honest.”

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Bank impertinence

 

“Except for con men borrowing money they shouldn’t get and widows visiting handsome young men in the trust department, no sane person ever enjoys visiting a bank.”

 

-       Martin Mayer.

 

 

Lewis Carroll would have been proud. “Leading” London bankers are reported to be critical of relatively modest proposals to rein in their executive privileges and to make more transparent the earnings of their best paid employees. One naturally unnamed banker reportedly told the Financial Times,

 

“Risk should be managed by executives hour by hour, not by non-executives month to month.”

 

Banks’ risk should be managed, we can all agree on that. But it wasn’t. Not by senior bankers at any rate, many of whom are only enjoying the fruits of employment now thanks to the involuntary appropriation of taxpayer assets. If “leading” bankers want to avoid being kicked to death in the street by a mob they are doing their damnedest to outrage, they would do well to keep a lower, humbler, more discriminating and less obviously self-interested public profile. Some hope. More evidence of the ‘Alice Through The Looking Glass’ world we now inhabit comes from Matt Taibbi’s much feted critique of Goldman Sachs. After the biggest banking bust in world history, the most trenchant criticism of investment banking (Rolling Stone’s “The Great American Bubble Machine” – warning: replete with some colourful expletives) has appeared in a rock magazine. Mr. Taibbi has also given us perhaps the most memorable description of an investment bank yet coined:

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Only in the land of the fee..

 

“Insanity: doing the same thing over and over again and expecting different results.”

 

-       Albert Einstein.

 

“There’s an old saying in Tennessee – I know it’s in Texas, probably in Tennessee – that says, fool me once, .. shame on.. you. Fool me.. you can’t get fooled again.”

 

-       President George W. Bush, Nashville, Tennessee, September 17, 2002.

 

 

Murkyweather Said To Shut F-U Hedge Fund After Losses (Update 2)

 

July 13^th (Greenwich, Connecticut) – John F Murkyweather, who mildly dislocated global markets when his Ultra Conservative Long Run Defensive Cautious Fund blew up in 1998 two hours after launch, plans to shut his latest “relative value” hedge fund, F-U Capital Management Opportunity XVII, according to a person who has been approached to fund F-U Capital Management Opportunity XVIII. The fund is believed to be so-called because the manager has had a tendency to use relatives to value it.

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Triumph of the realists

“Genius is only a greater aptitude for patience.”

 

-       George-Louise Leclerc de Buffon.

 

If it was Wednesday, then it had to be The Dorchester, where Citywire held their latest wealth management forum. Keynote speaker was Elroy Dimson, Professor of Investment Management and a Faculty Governor at the London Business School. Students of the markets will also know Dimson as a co-author of the magisterially weighty ‘Triumph of the Optimists: 101 years of global investment returns’ (Princeton University Press, 2002) alongside LBS colleagues Paul Marsh and Mike Staunton. You can read the 2009 updated commentary here.

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What colour are your spectacles ?

“Bank failures are caused by depositors who don’t deposit enough money to cover losses due to mismanagement.”

 

-       Dan Quayle.

 

What a mess. Still only part way through one of the biggest banking crises in history, yet having suffered grievous losses across multiple asset classes, we don’t appear to have learned very much. Relations between the UK’s tripartite oversight authorities seem to be deteriorating into acrimony and turf warfare even as the regulatory pendulum gains in weight and momentum. The banking and financial services sector is fast becoming a political football. Taxpayers deserve better. Maybe they will get mildly less incompetent treatment from the next government. Meanwhile, Wall Street firms that are only in existence due to the unconsulted largesse of US taxpayers are planning to boost executive pay. Citigroup (current share price: circa $3, which makes it the equivalent of a penny stock), having received $45 billion in “government” bail-out funds, now wants to increase some of its banking salaries by up to 50%. Did the events of 2008, during which the taxpayer rescued Wall Street and the City, never actually happen ?

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