The price of everything

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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