Friday, 31 October 2008

Up or across

I'm stuck on a thought at the moment: was it wrong for the financial industry to believe that diversification reduced risk? Now, it is thought that diversification actually stacked up risks on top of each other, until it all came crashing down. But was diversification a mistake in concept or in practice?


That election next week, you know the one in the US. Well, my friend Jonn Elledge pointed me towards FiveThirtyEight, an extremely comprehensive polling and election commentary site. Almost incredibly, it stands head and shoulders above the output of mainstream media outlets.

Jonn's also been hard at work, blogging America. He's a great writer, well worth a read.

Edited to add: Here's an extremely thorough New Yorker recommendation of Obama. If you know you wanted to vote for him, but didn't know why (which is how most people vote), it's worth a read.

Wednesday, 29 October 2008


Sometimes when I read John Kay's columns in the FT I wish people like him ruled the world. And maybe they do and we just don't know about it.

Often I come across people that I'm glad do not run the world. And no, I'm not talking about John McCain, though that prospect appears to be dwindling (though no counting of chickens just yet!).

One person on the list of those I would wish to have less power include Larry Elliott, Economics Editor of the Guardian. While he may feel his life's opposition to the world of finance has finally been vindicated, I can't find myself agreeing with a word he says. I feel that along the way his strident political beliefs have blinded him to other realities.

The fact that London has built up the world's leading knowledge-based economy, in information, IT, banking and creativity, is nothing to him, only something to denigrated and insulted. This is a difficult one to accept, particularly as many of these insults come from someone whose employer has
directly benefited from the 'fake' economy. Hypocrisy is an over-used word but surely the fact that the Guardian is employing the same techniques would give Elliott a moment to think through his prejudices?

Friday, 24 October 2008

Why debt aint all bad

From The Economist.

"Ultimately, debt is a way that people bet on their own futures, placing a wager on their own ability, cleverness, diligence and luck. When those bets fail, the consequences for the loser can be sad. But the world is a better place, on the whole, if people have the right to make such wagers in the first place."

Thursday, 23 October 2008

Rating agencies, a gentle defence

I have sometimes been a little obsessed by ratings agencies. I have worked for one, almost launched a news service covering them and they now form a large part of my grand unified theory of disintermediated markets (pt1), which one day I might share if I lock myself away and do something proper crazy like a Phd.

Anyway, the US Congress has decided (once again) to give the ratings agencies a kick, looking to make political capital out of their misery and mistakes. It's easy to see why, the agencies have not only been sloppy in their procedures and policies, but have allowed themselves to become inveigled into the global financial markets' regulatory system while taking little or no responsibility.

Because they have become involved in regulatory systems - sometimes one wonders against their own wishes - this gives journalists, aspiring politicians and prosecutors an easy opportunity to gain during these difficult times. Certainly some of the behaviour revealed recently does not look good.

However, I still believe that the agencies are more sad than mad. During the peak of the credit boom they were staffed by junior analysts (particularly in structured finance, where all the party-types worked) were poorly paid (by industry standards) and teams were regularly poached en masse by investment banks, which seemed to believe that agencies were perfect training grounds for up-and-coming deal structurers.

Overall, the problem, as Frank Partnoy argues, was often not the credit rating agencies, but those that decided to believe their ratings. Those in the market knew that rating agencies were not much use, unless you needed a rating to help sell your deal. Rating agencies give opinions on credit, not objective true assessments. Just as journalists on many newspapers give share tips, rating agencies gave their view on debt. The agencies' problem came when their ratings ('tips') became entrenched into the regulatory mechanisms of the emerging disintermediated economy. Agencies profited from this but failed to increase their standards sufficiently in case a time came when they came under intense scrutiny. To an extent they sowed what they will now reap.

However, the blame for the credit crunch does not really lie with the relatively small rating agencies, though they were clearly not perfect, it lies within humans failing to see risks for what they are, and being unprepared for how sudden change might come. Ultimately, the cause of the credit crunch is not criminal, however tempting that conclusion might be.

Cov-lite deals, a gentle attack

Notes about covenant light (or cov-lite) deals, following the entry below, and in response to the article by Tony James, head of private equity company Blackstone. Firstly, these loans barely exist in Europe, the vast majority of them were in the US. So Tony James's argument that the leveraged world is unaffected by covenant tests, those nasty, horrible hair-triggers, doesn't apply in Europe. However PIK loans, which he does also address, did become relatively common in Europe.

Secondly, there is a counter argument in favour of covenants, which James must know and does not even address. Covenant tests allow lenders both to know that a company is in trouble and begin a process where lenders and borrow can work together to resolve a borrower's problems, forcing companies to make difficult decisions which they might not do otherwise. They do not just suddenly go bust as he suggests.

Thirdly, there was an interesting note from Moody's yesterday about PIK loans. These loans allow borrower to opt not pay interest at maturity but extend the debt's maturity. The rating agency distinguished between different times when PIK loans are 'toggled' in this way. It might be that the company is in serious difficulty or is just using its cash wisely, and these different uses tells us different things about the company doing the toggling.

Edited to add: Jon Moulton seems to agree that covenant-lite deals aren't a sign of strength with the following delightfully brief reposte.

Sir, I read with interest the Insight column "In praise of covenant light loans, your flexible friend" (October 23) by Tony James, president of Blackstone.

He is right - covenant light loans do extend the life of businesses with over-adventurous capital structures. A respirator maintains life in a seriously ill person too.

I cannot but observe that avoiding disease is generally better than providing for surviving it. Certainly "commending" survivable over-leverage as a capital structure for real businesses is a remarkable view.

Saved by cov-lite loans

No time to comment on this piece, but it's a great one. Talk about self-serving!

Wednesday, 22 October 2008

Our bloated economy

"Who's to blame for the credit crunch?" is a question I am often asked. My answer – "pretty much all of us" – doesn't usually satisfy so I have started thinking of new analogies for how the culture of debt formed and why we were unable to cope with it.

On a Mediterranean holiday this summer, it was hard to avoid the fact that Europeans are just as flabby as our American counterparts. From all corners of the continent, great heaving lumps of flesh would waddle past. Stomachs on stilts. The reasons for excess weight are complex, as any women's magazine will tell you, but also simple.

The simple reason is that calories are extremely cheap, so cheap that almost everyone in western societies can feed themselves to excess, if they wish. The complex reason is that because price does not constrain, to avoid eating to excess requires self-control. This is because our societies, and brains, are likely constructed and programmed to operate in an environment of food scarcity, because that is all most people have ever known. But it means that to limit weight, people must apply self-control, which is a difficult, and often learned, skill.

This reminds me of people's attitudes towards credit. For almost all of human existence, credit has either not been available or incredibly difficult to receive. This fact permeates all cultures and has shaped economies for centuries. Very occasionally, access to credit has seeped down beyond the incredibly wealthy, as it has done so over the last decade.

And just as with food, many people have been unable to cope with this excess of debt. Our personal and institutional structures were not designed to withstand a culture of cheap debt just as our brains and bodies are not accustomed to living in a world of cheap calories


John Kay: "Banks would normally be wary of lending to someone whose liabilities were 50 times their net assets, but they happily lent to each other on that basis – until, one day, they stopped. If you want a one sentence explanation of the present crisis, that is it."

Sunday, 19 October 2008

Something must be done

It is beyond the wit of any man to work out the morality of the Daily Mail. Just when you think you have it, they do something that surprises you completely. However, one over-riding theme is for a sense of moral outrage to emerge whenever something bad happens, and this outrage is often blamed upon the government. The implicit message is "something must be done", or maybe "something else should have been done", but the paper often lacks the courage of its strong convictions and would not support a government that actually did any of the things it might recommend.

An example: today's Mail has found us a couple of millionaires to take pity on. While they drive a Porsche and live in a big house, these are people like us Dear Reader. They sold up their caravan park for a massive profit but then placed their money in a corporate offshore account run by an Icelandic bank. The chances of them seeing all their money again appear rather slim.

"There are hundreds if not thousands thousands of people in our position," the couple claim, before blaming their predicament on the government and asking for a bail-out. It's Gordon Brown's fault these people lacked the financial acumen to know where to safely deposit their money, apparently. I struggle with this one, but partly because there is an element of truth to it.

It is not true that wealthy people should sue the government for their own stupidity and greed. If people bury their head in the sand, understand as little as possible about finances and pass all responsibility for it onto someone else, then it is difficult to believe their claims that the government is at fault for their predicament. If I refused to take any driving lessons and then crashed my car, few would agree that Gordon Brown was to blame for the smoking wreck that I had created.

However, I would like to start playing the blame game. But it is not the government I would point the finger at, but at financial advisors. I have yet to find a financial advisor who has come through the recent crisis well. Examples of such poor advice are legion, I split with my financial advisor after a succession of illiterate advice, which included recommending investing in commercial property just as the sector crashed, investing my pension in shares just as the credit crunch hit, and then arguing with me ferociously when I decided to sell my equity holdings at the top of the market.

But normal people aren't to know better than their advisor, are they? People are told to 'speak to their advisor' before making financial decisions, but what if their advisor talks rubbish? Sue them? Possibly, but the number of disclaimers now makes this very difficult. And you can't sue someone for stupidity. The only real insurance is to know a fair amount about finance, to actually engage in it and think about what it is about.

Finances are boring until the point you lose your life savings. And is this something that the government could help with? Providing financial education and advice, and advising people to be much better informed about their financial choices? Maybe so.

‘The ultimate result of shielding man from the effects of folly is to people the world with fools.’ Herbert Spencer

Thursday, 16 October 2008

Equity market people are funny

I used to work with a former equity analyst, a man who believed truly, deeply in the share markets, and so regularly lost huge amounts of money backing his hunches.

He would trade on anything. On rumours that a war might break out (they usually didn't), on talk that a company would fail to pay its debts (they usually did), or just on any old piece of analysis that seemed to make some sort of sense. In short, he was a normal short-termist trader, trying to profit from being just in front of the news curve. Unfortunately for my former colleague, he was rarely ahead of the market, nor near the truth, just a consistent loser, the type of bloke that keeps many others in the market (and many bookies in business).

The trick to making cash on short-term trading is not evaluate whether a piece of news is true or not, but whether it will move the market. But truth isn't profitable, it is only something for pedants and historians to argue over.

However, in the long-run everything tends to work out, and reality is hard to escape. I don't mean this in a general equilibrium sense but in a more prosaic commonsensical way.

For example: the credit boom had to end; and so the share markets were going to fall at some point. I sold my shares in November last year because of the credit crunch; it amazed me that the equity markets held up for so long. Apart from anything else, without the potential for a private equity bid many companies needed to be revalued. Look at

So now we have the fallout from the credit crunch hitting the equity markets all at once. Whatever the fundamentals of a company, there is little they can do to fight bigger market trends, the biggest of all being the unwind of the hedge funds, deleveraging the entire market (credit and equity) with an almighty sucking sound. It has taken several weeks and multiple bailouts for the banking sector to work out how to move forward without massive flows of fund money, now it is the turn of the equity markets to wake up to the new reality of limited bids from slimmed-down funds. As such, expect more volatility in the weeks to come, and no sustained rally for some time. New 'regimes' take a while to settle in.

I haven't stayed in touch with my former colleague but I hope he has successfully navigated the last few weeks. Given the massive upswings, there has been much potential to profit, but only by timing moves very precisely, or being very, very lucky. Overall, I wonder whether retail (normal) investors will return to the equity markets any time soon, given that many will have lost a lot in recent weeks.

Elsewhere, a worrying quote: "there are signs that LEEBOR is stabilising", Stephen Timms, Financial Secretary of the Treasury, speaking last night on the BBC. The guy's weird pronunciation of a market standard phrase worries me.

Reasons to be cheerful, 1, 2, 3.

Wednesday, 15 October 2008

Winning prizes

Official recognition is always nice. Prizes, medals and the like might ultimately be rather shallow, but it can serve a purpose. Many more people are likely to read a literary novel such as White Tiger because it won the Booker prize.

And this week I’ve been looking more closely at the academic work of Paul Krugman, following his win this year of the Nobel Memorial Prize in Economic Sciences (not a Nobel Prize!). Though I’ve read his columns frequently, and like his mix of policy wonkery and partisan attacks on right-wing myths, I’ve never really encountered his academic work. It’s not bad.

Here’s a good piece about the man, putting him in context. Krugman, it says, is "the first of the 1970s/1980s MIT/Harvard crowd--a group that includes such familiar-to-noneconomists names as Larry Summers, Ben Bernanke, Frederic Mishkin, Greg Mankiw and Glenn Hubbard--to win a Nobel."

It goes on to say that these economists are characterised by their non-ideological stances, while Krugman is well known for his little models, rejecting the grander theories of some of his predecessors. It reminds me of my ideas about how economics and politics can be explained best by using a toolbox of theories and models, rather than a grand masterplan that links up everything. However, and as Krugman has found out, having lots of little stories makes a grand narrative difficult, as well as specific policy proposals.

Krugman is undoubtedly a clever guy. Here’s a readable essay by him about economics. Specifically, it’s about why even smart people makes basic mistakes about economics, often preferring complex and difficult models so as to ‘disprove’ simple and provable ones. It rings very true and might explain some of the popularity of anti-economics industry writers such as Taleb.


Mark to market accounting eased

A strong defence of hedge funds and the issue discussed by Peston.

The road to hell is paved with good intentions. Melanie Phillips started out on the Left, grew disaffected, grew to hate the Left to the point of mania, and now writes pitiful slime like this.

Tuesday, 14 October 2008

Brown a Red?

By a curious coincidence, in the week that the UK state took over a huge swathe of our economy, by taking major stakes in the country’s banks, it also backed down on its attempt to extend the period of time prisoners could be held without charge.

With one hand it gives, the other it takes away, it seems. At least that is what it might seem from those that are highly sensitive to the size of the state. And certainly the Gordon Brown of the 1970s would have loved the idea of taking control of the commanding heights of the UK economy. And the Labour Party has rarely been a friend of liberty, except for a short (and significant) burst of liberalism in the late 1960s under Roy Jenkins.

However, Brown today is not the Red of yesteryear. He is taking control of banks to save the banking system as a whole, because without it the country's economy would quickly grind to a halt. Even the FT, hardly a fan of state-controlled banking, accepts this, as a thoughtful leader today reflects.

But Brown, and the Labour Party, are not instinctively liberal – they do not see the necessary linkage between state control and transparency. Brown in particular does not seem keen to explain his actions, nor even to ask the population to trust him. His is a very anonymous form of leadership. But the state now takes a very large stake in the condition of the economy, and this is only likely to grow in the years to come, as recession squeezes the private sector.

In this climate, the government needs to be much clearer about its actions and thinking. This is in the interest of good decision-making; the world of finance desperately needs some cleansing light to pour into it. Moreover, if such clarity does not emerge, it seems likely that Brown's government will quickly be replaced by someone better able to connect with the public.

Saturday, 11 October 2008

Democracy as a spectacle

I am quite a fan of US presidential elections. While they might be trashy, money-obsessed and personality-orientated, at least they get people involved. I'm watching this one closely, and have been greatly enjoying all the various commentary on the process, and the characters involved.

Here's a great flow chart on how Sarah Palin might approach debates. It might be a little mean but it seems scarily accurate! While the Rolling Stone rolls out this broadside against McCain. It makes Bush seem almost presidential by comparison with his potential replacement.


Mr Doom and Gloom does not change his spots but this time goes political.

Quote from a Citi analyst: “The great leverage wind-up (20-30 years in the making) has become the accelerated leverage unwind (12-18 months and counting).”

Thursday, 9 October 2008

Battling for a frame

Throughout the last two decades, policymakers responded to most problems by cutting regulations and easing passage for capital to flow between countries. The end of ideology they called it, and that statement reflects the acceptance of a new hegemonic regime, a new form of normality.

The Right had won the debate about the appropriate relationship between the state and government, and the Left – most notably Tony Blair and Bill Clinton – adopted the Right’s frame of reference and promised only to make the deregulated economy work in the interest of everyone (whether this worked or not is a different point). But the credit crunch is changing things. It seems increasingly likely that deregulation will end up being one of the main ideas to get the blame for the credit crunch. This is something that John McCain is struggling with, having to make a case for greater state activity after years of advocating deregulation and arguing against the state. In today’s Mail, Peter Oborne laments this situation but his analysis seems weak given that the roots of the credit crunch are to be found almost entirely within the private sector.

But if one hegemonic regime is falling away, there is room for a new one to form making this a fascinating time, one where left-wing writers, for so long on the wrong side of events, are jostling for intellectual superiority amidst much harrumphing about how correct they were all along. The battle now is between different frames – which analysis of present events will be accepted? Here are some frames being thrown around:

- Smash the rich
- Earnest social democrats
- Depressed right-wingers
- Head in the sand muppets

None of them really rock my world, in case you were wondering. More on that one day, I'm sure.

- Apax chief slams own industry ... “it’s not balanced and people will give us more debt than we ought to take”.
- Weapons of financial destruction exploding tomorrow?
- Glimmers of light? Unsure, but a great article about reality of the debt market.
- I declare it to be the end of breakfast (thanks Matt!)
- An explanation that even Joe Six Pack would understand: I’ll have a McFear to go
- Alphaville publish an epic explanation of the US government’s debt position.

Comment on Alphaville:
"No diversification in most cases because hedge funds started out as alpha producers but couldn't generate the absolute returns on a fully hedged basis and so are now all beta and leverage. So correlation with long-only in the good times is now very strong and in the bad times is close to 1. So why pay 2/20 for that?"

Tuesday, 7 October 2008


The repeated leaking of insider stories to the BBC's Robert Peston has been a key characteristic of the credit crunch, from a UK perspective. His government sources told him about Northern Rock and Lloyds/HBOS ahead of time, meaning that the market began to view his reports as near-gospel.

However, his most recent story about UK banks going cap in hand to the government for funding might have been a big scoop, but has backfired spectacularly, triggering a run on RBS bank shares today. It is difficult to know the intentions of those leaking these stories, but the effect of this leak has been disastrous. Instead, of giving the impression that the government is strong and willing to work closely with the country's leading banks, the banks look feeble and the government appears confused and unwilling to clarify its position. In Alphaville's opinion, the mistake was giving the markets a heads-up ahead of time, which allowed them to pre-emptively react. Maybe so.

Given the government's apparent incompetence, and the inability of the European Union to do anything at all, the time is approaching when the authorities might have to do something rather dramatic. I really hope it does not come to that.

Edited to add: it's worth having a think about what these share price falls really mean. What they mean, technically, is only that the value of these banks' shares is in doubt. And that, farcically, is because of a government leak to the BBC. It doesn't say much about the economy as a whole, nor even the bank itself - only the value of the equity given there's a possibility the government might dilute existing shareholders.

This might sound like I'm splitting hairs and trying to deny the reality of what's happening, but no, what I am saying is that financial journalists are dramatising events and partly obscuring reality. "The world is coming to an end," noted a colleague a second ago to a market source, "scary stuff" she added. But the world is not literally coming to an end, or more precisely one world is coming to an end, but others are likely to grow soon.

Here is a hearty denunciation of the doomsayers (thanks Matt). And it is worth remembering that almost the entire cadre of financial journalists got it wrong on the upswing of the credit cycle so why should we think they are telling the truth now?

Read em and weep

A very painful list.

Credit as utility

Populist attacks against the financial industry, both from the Right and from the Left, often portray the dispersal of credit as an innately fraudulent activity. But it seems important to remember that credit provides a useful, dare I say it, essential function in complex societies.

So useful is credit that it is helpful to regard credit as a utility, just like other essentials, such as water and electricity. And the consequence of seeing credit as a utility is to then understand why the credit business is different from other businesses, and the level of regulation that it needs.

Here's an article that discusses this a bit.

Monday, 6 October 2008

Looking past the mess

Here's an attempt by one finance writer to look beyond the current crisis and have a think about what the world will look like in a few months' time. Here's what John Willman of the FT thinks will happen:

- A deep scepticism of finance (hence a locked-in contraction of the financial sector).
- A surge of recruits into the safer worlds of the public sector, such as teaching.
- Much reduced levels of leverage.
- People becoming more financially savvy.
- Kinder attitudes towards society's failures but also less tolerance towards public spending.

Confidence and information

It's hardly surprising that savers are pulling their money out of banks. People on the street don't know very much - though they are now scrambling to catch up - and very little information coming out is very clear. Here's a fun article. The headline sounds reassuring but by the time you get to the end, only a fool wouldn't be clearing their account of any Icelandic money.

Friday, 3 October 2008


The financial crisis is so big there’s plenty of blame to share around. My new financial guru Sarah Palin identified 'predator lenders' last night, and I can’t see a reason why she aint right doggone it. There are however, some many others to blame, and so little understanding. It worries me, how these two facts might meet.

Also yesterday, sprawled on my sofa watching Question Time, listening to the worried wealthy in the audience wonder where their money should be deposited. In Ireland maybe? Well, don’t ask me, my money’s currently with an Icelandic bank, and if I lose that then I’m going knocking on Martin Lewis’s door, and then that of the government, looking to dish out some blame of my own.

For what it’s worth, here are my views on the UK government’s position regarding savers: I think the government – as ever – has a very clear position but is failing to clearly tell the story, which in the present climate is probably a bigger mistake than having a bad policy (cf TARP). Reading between the lines, the government seems to be saying it will not let any saver lose money but it will not put that guarantee on its balance sheet. It’s like PFI all over again.

So, back to blame. All those people on Question Time were asking reasonable questions, but incredibly ignorant ones. Supposedly well informed folk are making the most basic of errors. As I put it elsewhere, many people are still at the ‘information discovery’ phase of this crisis. The ‘informed conclusion’ moment appears a long way off, given the weakness of some of the commentary I’ve read.

An example from Question Time. A woman asked whether the bailouts from govenments to the banks might encourage further risky behaviour. A reasonable question you might think, but this could have been easily batted away by the point that six significant-sized banks have gone bust this week alone which will mean management of these banks will go, shareholders have lost millions, if not billions, and thousands of jobs will be lost. Hardly the types of events likely to encourage further risk taking! One of the panellists made half a stab at making this point, but not half way near enough to present to the public the reality of what is happening in this country's financial sector at present.

I fear we are close to a situation where homeowners are told their massively over-priced houses are losing a little bit of their worth because of evil spiv bankers. Despite the fact that it was the action of these evil spiv bankers that brought about the massive increase in house prices.

This isn’t snobbery but an accusation. I think there is a real problem about information. Journalists are not good at informing, and readers are not good at learning. Most of the time this isn’t a big problem, but it does almost inevitably lead to booms and busts, panics and mistakes.

If you don’t believe me, and think that people really are interested in finance, then try introducing yourself to people at a party as a banker or a financial journalist. You get the same reaction every time: a blank look and a rapid change of subject. Admittedly, this has changed in the last couple of weeks, but only because people have belatedly realised something might be happening.

In my optimistic moments, I think one positive thing to come out of this crisis is that people will finally realise that finance is important, and pay much greater attention to the subject. We will learn that there is such a thing as good debt and bad debt, and that an appropriately regulated finance industry is a necessary part of economic development.

However, in less optimistic moments, I wonder how smooth the transition from here to there will be, and whether we will get there at all. Populism may prove to be an overwhelming temptation for weakened leaders, in the face of economic downturn and a population with little financial education. Where will this take us? My fear is a rerun of the 1930s, with a financial form of mercantilism leading to greater and greater international stresses. For lots of reasons this cannot be allowed. So the need to inform, to educate and to debate, calmly and openly, has never been greater.

Thursday, 2 October 2008

Credit where it's due

"You have been told repeatedly by George Bush and Henry Paulson that this bill is about a "rescue" of Main Street, not Wall Street.

You have been lied to repeatedly.

The bill The Senate intends to try to ramrod down your throat is neither about Main Street or really even about Wall Street.

You are going to get VERY angry. Sit down before you read further.

""Hundreds of billions of dollars are going to bail out FOREIGN INVESTORS. They know it, they demanded it, and the bill has been carefully written to make sure that can happen." - Brad Sherman , D-California"

That's right folks. You are going to have $700 billion - about 25% of the total federal budget - put on your personal credit card (via taxes forever) in order to bail out foreign investors."

Xenophobic Link