| Global Volatility & Opportunities |
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In our last newsletter edition we remarked about "Changing Times - The Year of Living Dangerously'. Roll forward a few months and our worst fears have been realized as we have witnessed unprecedented global volatility and turmoil the likes most of us have not experienced. Even though most of us have lived through it and for the most part been reasonably well read and so on, sometimes it takes a quick history lesson to understand why the latest global financial turmoil happened. Who were the authors and why there will be a new world order. Two well known Australian figures have assisted with the memory loss. One, a recently retired, high profile, federal (foreign) minister and the other a left wing socialist, national media and news columnist. The seeds of this global financial meltdown started way back with US Democratic President Jimmy Carter playing with markets for political purposes. Carter was apparently very concerned about the need to extend home ownership to poorer communities. So was Bill Clinton. Great objective, as long as you find a way of doing it without stuffing up the economy in the process. As we now know, a long way down the track, they failed to find one! Carter first introduced, and Clinton extended, the Community Reinvestment Act in 1995 whereby banks were required to extend home loans not just to rich neighbourhoods but the whole community, that is, extend home loans to the poor who had previously been unable to get a loan because they didn't have other assets. In addition, these people didn't have much income to service the loans. Two major US institutions, Fannie May and Freddie Mac, were also forced to lend more generously to the poor and Clinton reduced their capital adequacy ratio from 10% to 2.5%. That is, they had only enough capital to back 2.5% of their loans. As history recalls, financial institutions went on a wild lending spree to the politically and morally potent poor (ie many from the poor minority groups like African Americans and Hispanics - majority of whom vote Democrat!). So Bill got what he wanted and history might look kindly on him. He had extended home ownership to the poorest in society and the housing and construction industry boomed. In theory brilliant! As we know now, this was a really dumb way of expanding home ownership. So when property prices declined and interest rates go up, these high risk borrowers couldn't keep up their repayments - so they packed up and walked out and gave the keys back to the bank - their problem! The poor had no liability, but now the banks did! The banks knew when the property market collapsed they would be in dire trouble so they bundled up (securitised) these loans and on-sold them to other financial institutions (for the profit) who were prepared to take on the risk. This happened over and over again, on-selling, at a margin, to other global banks, thereby spreading the practice worldwide. George (Dubya), having inherited these disastrous policies, and seen interest rates decline via Alan Greenspan in response to the Tech Crash which helped fuel property growth to unprecedented levels did nothing. Bush was asleep at the wheel - he let credit expand too fast and didn't set up a proper framework to monitor the market. So there you go. Dumb, populist politics set up a pretty dumb scheme and then it was compounded by forcing banks to lend to people who can't service the loans. However, the Feds allowed this sort of system to continue unabated without regulation and allow the smart (and greedy) Wall Street bankers to develop some very clever by half financial instruments (derivative products) which ensured those on-selling product such as collateralized debt obligations (CDOs) lined their pockets with obscene amount of cash (fuelled by ridiculous remuneration incentive schemes). In reality, derivatives simply shift risk elsewhere - in this case, onto the whole financial system. The figures talked about are simply amazing and to most of us, incomprehensible. Figures quoted are $400 trillion, compared with reported global capital stock of about $160 trillion according to McKinsey & Co. Whilst all this turmoil was happening, iconic institutional names like Lehman Bros, Bear Sterns, Merrill Lynch and AIG are either going to the wall or being propped up by government bailouts. The government was deciding who would survive and who would go to the wall on the basis of main street national interests. The 700 billion dollar lifeline hasn't seemed to have helped as the crisis in now a drought on confident in the global financial economy. Perhaps instead of trying to pick winners and losers, the US should have let more 'names' go to the wall (like any other business would have) and then used taxpayer monies to guarantee deposits and shore up essentially healthier banks (not bad banks/debt). That is, use the UK bailout approach with the emphasis of an injection of capital into banks to boost the balance sheets as well as guaranteeing their loans. In this way, governments become part of the world's largest bankers. In the US there has been a history of iconic firm bailouts in the 'national interest' front. In 1970, Penn Central (railroad company); Lockheed aircraft manufacturers; Chrysler Corporation in 1979; New York City in 1975 and the Continental Illinois National Bank. My socialist author mate says all this political action resulted in privatising the profits and socialising the losses. The US politicians and financial gurus have learnt nothing from the past it seems. Money spent repairing a broken finance market is better than the alternative. Australia's finance industry, we are told, is in pretty good shape and the government finances in great shape. The business sector is sound so it's only the household debt which appears too high (although manageable). Meanwhile it is worth noting, climate change/warming is continuing. In the short term, it's not all doom and gloom. Well that's the view of many and certainly the view of the worlds most successful investor, Warren Buffet. He abides by a simple rule which dictates his buying of equities: be fearful when others are greedy and be greedy when others are fearful. He says history records that hapless investors bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy. His advice is therefore very simple: for those who are cashed up, there are some great buying opportunities around now - so buy now. For others, even though these recent events will undoubtedly affect us all (in some way), with good leadership and management, Australia should be in a better position than most to ride through the storm. Here's hoping. Tony Martin - Strategic Financial Coach - Director |
+ 61 8 8333 1944
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