Tuesday, 30 December 2008


I spent a number of years tracking the build-up of debt in Russia. Now, the party's over and the high cost of producing oil and gas in Russia is becoming a significant factor in its economic downturn.

The NYT here produces a rough overview of the issues. Great final quote:

“Everybody was thinking Russia had succeeded, and they were wondering, how do you keep water in a sieve?” Ms. Latynina said. “When the input of water is greater than the output, the sieve is full. Everybody was thinking it was a miracle. The sieve is full! But when there is a drop in the water supply, the sieve is again empty very quickly.”

Wednesday, 17 December 2008

No more news?

Here’s a curiosity. The Financial Times’ blog Alphaville went down for a day, annoying a number of people. The outtage provoked Yves Smith at Naked Capitalism to have a whinge about the Financial Times. She complains about the "sensationalistic" headlines, minor errors of detail and "way-too-frequent tech issues".

Well, if these make for a failing newspaper, then most journalists should worry. And the discussion beneath Yves’ post is full of bloggers and blog-readers complaining about the poor quality of mainstream financial journalists.

As one myself, it is interesting to read others’ views on the industry. However, I’m not sure if Yves or those making the comments add much to the debate.

Financial journalists are always swimming against the tide of facts, events and trends. Basically, there is far more out there than we journalists can ever track, log and explain. Much of our business is educated guesswork and a reliance on simple narratives.

So should we embrace trends and hope that blogs and other free internet sources will do a better job than newspapers? It seems a little unlikely. The only blogs that regularly break news stories are Alphaville, which is published by a newspaper and is run by two senior newspaper-trained hacks, and Robert Peston's blog at the BBC, and he is also an ex-newspaper man.

Most of the other blogs add analysis and views but do little in the way of systematic news coverage. In fact, many of the facts they use as the basis of their analysis come from newspapers and agencies.

One danger is that the newspapers will accept the ultra-modern thesis suggested by hyped up bloggers and so duck their ('boring') responsibility of reporting news and instead drift further to being newsy lifestyle guides. The Guardian has already marched a fair way down this murky track, as has the Telegraph. Any further along and newspapers will amount to little than this nonsensical fluff. If so, then the newspaper industry is really in trouble.

"Don't expect any presents, because the banks have closed."

Time have published a wonderful set of interviews with old-timers who can remember the Great Depression of the early 1930s.

"We just knew that we couldn't have things, and that was it."

"Don't expect any presents, because the banks have closed."

"These kids today are so bright and so smart, but they just don't have any sense of responsibility. If this little downturn can wake them up, they'll be magnificent."

"Nobody in my era splurged. No one traveled."

"The Depression is really hardest on those who can least afford it — the people who are not in great health, the people who are not educated, the people who are not gifted or blessed with good fortune."

Compare that with 2006. When some people spent just for the sake of spending money.

"Paul Levine, Signature’s owner, will 'offer you a glass of Courvoisier while you discuss your cycling habits.'"

Friday, 12 December 2008

From news to views

Just how much does the financial press know? Nils Pratley thinks it an "outrageous" slur the belief that the newspapers are the last to know anything.

City professionals have a withering line to describe the wisdom found in newspapers. "If it's in the press, it's in the price," they say, meaning that, by the time hacks have latched on to a trend, the peak can't be far away.

However, he admits that while the slur might be outrageous, "the trading strategy can be rewarding".

Looking at headcount gives a good illustration why. Excepting the Financial Times, the national newspapers, combined, probably have – at a guess – around 50 people working full-time as financial journalists. This may sound like a lot, but then there is a huge amount of duplication (and herd behaviour) and the word 'financial' covers not only companies and share prices, but personal finance too.

The majority of the editors of these newspapers have been focused on shares and share prices throughout their working lives. As such, the credit crunch came out of nowhere for them, and many have struggled to catch up. But still, there remains little credit or technical expertise on the desks of these newspapers, though some – again notably the FT (which is itself hamstrung by spending constraints) – are trying to make up for this lack.

But these attempts seem rather pitiful when compared with the scale of the task at hand. London's financial industry is probably the most complex and innovative in the world, as well as one of the leakiest. Without experience, and in the face of the challenge of the internet, many of the newspapers have given up providing comprehensive news coverage, leaving much of the hard news provision to the better-staffed agencies.

I wonder if this trend will change. Will newspapers like the Telegraph, Times, Guardian and Independent ever employ another two or three people to inform and entertain with stories of credit, structured finance and emerging market debt? Will they try to get across to people how the global capital markets work? How London sits at its centre, drawing in money and talent from around the world?

It seems unlikely. Instead, these reporters will too often feel they are the country cousins of their more glamorous political colleagues, perennially looked down upon in the office, and treated with a certain distain at parties.

Something will change this. The demand is there for high quality financial news and information. At the moment, I suspect this will be supplied by the internet, away from the established newspapers.

Wednesday, 10 December 2008

An end to CDS?

A while ago I stood outside a City pub having an argument with a friend about the capital markets. He said that the majority of the financial structures in the capital markets are parasitic and the industry as a whole was a busted flush without much value to society.

I disagreed: I thought that private capital markets need a variety of structures to work efficiently, and some of these would not always appear useful (like shorting) in the short-term. The alternative to the present system was not an efficient, smaller capital market, but either an inefficient smaller capital market or purely state-based provision of capital.

The conversation stays with me because it was the first time in a while I had thought hard about what the capital market is for. From my personal perspective, a big, rich capital market, full of complexity, is good for my career prospects. And as a Londoner, born and raised here, it is generally a good thing, bringing the city money, ideas and prestige.

However, these should be secondary issues. A capital market's primary function is the efficient allocation of capital, hopefully to those areas of the economy most deserving of it. The latter is clearly something we can debate forever – how to define where best for capital to go? In our present system, the private sector is left largely to its own devices while the state decides where investment should go for the half (roughly) of the economy it controls.

Over the last decade, the financial sector earned increasingly large sums from financial transactions, many of which were useful for companies, some of which were not, and were instead purely speculative. The financial industry is now looking carefully at which financial transactions are necessary and useful, and which are irrelevant, and possibly toxic.

Collateralised debt obligations (CDOs) are now seen to be in the latter category and the whole of securitisation is in doubt. Now, the credit default swap (CDS) is under scrutiny. CDS is a type of financial instrument that allows investors to buy insurance against companies going bust.

If CDS did just that, it would not be so controversial. However, CDS has become entangled in much larger systems where industry players used it to create financial monsters such as synthetic CDOs and wrote huge amounts of insurance for purely speculative purposes. A longer list of criticisms can be found here, including calls for the entire market to be shut down.

Felix Salmon, the prolific blogger at Portfolio.com, has posted a defence of CDS. His post is interesting largely for what he doesn't say – he does not make a strong case for why CDS in particular, and derivatives in general, are good for the capital markets. Instead he appears to be saying that CDS is good for its limited purpose of credit insurance but is no good at anything wider such as being built into speculative financial structures or being used to predict default rates (note how the correlation has broken down in the graph, most likely because the tool has broken). (BTW the comments underneath Salmon's piece are probably as interesting as his original post.)

Certainly there is something wrong with CDS when gullible hacks write stories like this, saying that 'McDonalds is a better credit risk than the UK'. The story should actually be: CDS market broken: produces ludicrous results.

Monday, 8 December 2008

Private equity – a smaller role in future

Private equity is in real difficulty. A claim very likely to bring tears to the eye, I know. In the newspapers, we find out that Permira is returning some cash to investors. One investor in particular, a subsidiary, was heading for trouble without such a move.

But ultimately private equity's problems lie not with investors' change appetite, but lenders' drastically reduced demand for debt. And without debt funding, private equity's dominant business model in recent years has been made impossible. What is the point of having a mega fund if this money cannot be used to leverage billions out of lenders?

Funds are now going to back to the drawing board, trying to work out new investment strategies. They are likely to find profitable schemes in the future but maybe never quite so profitable (and significant) as taking many large public companies private and then using cheap debt to take out massive dividends. That was frothy, top of the market behaviour if I have ever seen it.

And you knew the scene was dead when the Gulf Sheikhs tried (and failed) to get a piece of the action.

Changin' times

Sometimes it is difficult to believe, but things change. The weather, friends, relationships, workplaces, market conditions, business opportunities – they all change. What works one day does not work another. Going out in a pair of shorts and T-shirt might have been a good idea yesterday but might not be today. Tomorrow, meanwhile, could be an umbrella and raincoat day, however much we might hope not.

It is a natural human tendency to assume that certain things do stay the time. Not just because it might suit us, but because we must plan and build. If everything always changed then it would be very difficult to do anything complex, such as develop civilisation. Hence our society's focus on property rights and stability.

It is ironic therefore that the result of giving greater significance to the wisdom of the markets, compared with the knowledge of planners in government, or the aristocracy (as in previous times), has been to not just to create much greater wealth but also greater instability. Market society has flattened class barriers and opened up society but has also created new inequalities and uncertainties (cf New Labour). Placing great store in the meaning of the market price meant good times when prices rose but huge uncertainties when prices dropped sharply. Massive volatility in the indexes our society has given great significance means uncertainty spreading throughout the economic system.

Today's recession is a significant turning point in western capitalism. It sees the demise (for now) of debt-led financial capitalism and the return of government dominance of the markets. How long the recession lasts will be significant. If it is short but sharp then it seems likely that the make up of our societies will remain largely unchanged. The power dynamics between the public and private sectors will be rebalanced slightly, but not greatly. This means evolution rather than revolution; a continuation of recent years' unexciting but quite fruitful technocratic rule (in the domestic sphere).

However, if the recession leads to real economic (and then social) strife, we may see real change. And while real change may be the demand of campaigners across the political spectrum, recreating the institutional frameworks to allow all to gain from such a transformation is likely to take many years, and may never be achieved. In short: expect a 'lost decade' of real economic and social pain if a recession lasts longer than two or three years.

Friday, 5 December 2008

Debtor nation

Casting an eye over the Atlantic I see that chipmaker Freescale Semiconductor intends not to make a payment on part of its debt next year, and will instead take out more debt. (This is what Payment in Kind (PIK) loans do - you can opt to make an interest payment by taking out more debt.)

This is all above board – no-one is doing anything wrong. In fact, not paying debt is the new taking out debt. Everyone's doing it. No less an institution than the UK government is putting together a scheme where those with the most debt can opt not pay debt for a couple of years so as to get into shape to take out some more debt.

Nils Pratley in the Guardian says that this government scheme to bailout mortgage holders looks like it fails the moral hazard test – ie it encourages bad behaviour.

But which politician cares? The country's rulers are running scared of debt-laden householders. Like weak-willed parents confronted with a very determined and stroppy child, they will make almost any decision, however wrong, just to achieve the quiet life.

Thursday, 4 December 2008

The sound of inevitability

John Foley of BreakingViews says that this year's key financial phrase has been 'bail out'. He predicts that next year's will be 'refinancing'. He has a point, because there's a lot of debt maturing in the next 18 months (USD 4 trillion he claims, USD 2 trillion in Europe to 2011 S&P claims) and almost all of it will need to be replaced or repaid.

Already, analysts and rating agencies are looking at companies' repayment schedules and identifying maturing debts as key credit risks. If banks choose not to replace maturing credit lines, the companies affected are left with a stark choice: repay, merge or shut down. And for many companies, particularly leveraged firms, the repayment option is simply not possible given the size of the debt involved.

This means that many companies will not survive the next year or so. And already we have seen a wave of firms going bust. While I feel intensely sorry for the staff that have and will lose their jobs, I am not particularly surprised. For one thing, there are a number of firms that have only been keeping going because the economic conditions were so good and credit conditions so relaxed. As soon as anything went wrong, these companies were liable to collapse or hit difficulties.

Tasteless comparison: this is a bit like seasonal death rates. If there is a mild winter then all those people that would have died during a normal cold winter are still going to die, just not yet. The better weather just delayed the inevitable and the next summer and winter see higher death rates than normal.

Woolworths was like this. A frail, confused 99-year-old maintained by the artificial life support of cheap debt (from new entrants to the UK market seeking market share) and profligate shoppers. Without this life support (falling sales, recalcitrant lenders) the patient died.

And so the next few months are likely to see many more companies go under. Unlike John Redwood, I do not see this as a good thing. It is not worth sacrificing people's livelihoods simply to prove an economic theory. However, there is a certain sense of inevitability about bad companies going bust during difficult times. It is something that, unfortunately, we are going to have to get used to in the next few months.

The golden age is now

We live in a time of cultural pessimism - in other words, many people want to believe that today is worse than yesterday, that our world is in decline.

I don't agree, and like to find evidence that suggests otherwise.

The chart to the left shows that death rates amongst the poor in the world have declined sharply in the last fifty years.

It's from UN figures and is part of larger, and interesting piece published earlier this year, on food prices and their impact on death rates.

Tuesday, 2 December 2008

Everyone fails equally

At the start of the year, my gauge as to whether someone was a headbanger socialist was to ask the following question: do you believe in public or private allocation of capital? Now, at the end of the year, it looks as though this was the right question though everything else has changed.

Those that still believe in private allocation of capital are the headbangers while the moderates are those that believe in state allocation of capital. How times change.

Now that we’re fully versed in the annals of market failure, when it is time to lift the equally large tome marked ‘government failure’?

Pimco’s Bill Gross has been looking into these issues too.

“More regulation, lower leverage, higher taxes, and a lack of entrepreneurial testosterone are what we must get used to — that and a government checkbook that allows for healing, but crowds the private sector into an awkward and less productive corner.”

“We are now morphing towards a world where the government fist is being substituted for the invisible hand, where regulation trumps Wild West capitalism, and where corporate profits are no longer a function of leverage, cheap financing and the rather mindless ability to make a deal with other people’s money.”

Elsewhere ...

Lots around today. Am interested in Islamic finance. Here’s a primer on some recent issues.

Am also fascinated by the retail market. Lots of them are worried about going bust, so they are getting in their sales early. Debenhams is having another. Back by popular demand it cries ... what a joke!

Also this FT story on the Magal Group is worth a read. The bank in the dock is RBS, the state-owned bank.

And yet more on super senior CDOs.

"Where oh where do we put our money?"

The quote in the title comes from the BBC's Robert Peston, who tells us that even professional investors don't know where to put their money (and why would they when they learn that analysts don't tell them the truth?).

Well, the numbers tell us one place they are putting it - the British equivalent of under the mattress: gilts (UK government bonds), where yields have plunged to less than 4%. (Bond yields move down when demand goes up.)

Monday, 1 December 2008


Sense would suggest that now is a good time to be free of debt and have a load of cash in the bank. Think again.

Democratically-induced politicians across the western world are looking at their electoral chances and weighing up options. The easiest solution to the impending downturn is a fiscal stimulus paid for by tomorrow’s people. And in an ideal world, this will prevent a slump by maintaining employment levels as excess credit/liquidity/money drains away.

The second option is to focus help out all those indebted householders. Firstly, by making sure that there is a mortgage market even as the securitisation market collapses. And then by pressuring central banks to cut interest rates sharply, allowing banks to re-invent their old pre-securitisation business model, while keeping people’s mortgage payments low, and allowing back in a bit of inflation. Deflation, they say, is now the main enemy. A little inflation, on the other hand, is benign because it will reduce debts.

(Those that argue that deflation is looming are not wrong. However, the jury's still out on whether it will actually occur. But what is certain is that policymakers do not mind if there is more inflation in the system than they would have accepted previously.)

Savers and retail investors, meanwhile, are stuffed. Equity prices are through the floor (with little sign of a recovery for at least six to nine months) while banks are not willing to pay for savings.

There was a moment, around the summer, when banks’ wholesale funding costs rose so high they started to
pay savers a healthy rate of return for deposits. This has now ended, and rising inflation means that savers have to work hard to make any money at all from their funds. The savings rate for a good bank is around 4-5%, and only if you look around. The retail price index is also around 4-5%. Therefore saving money in an average bad savings account will actually lose you money. (That is, if you can open one!)

The phrase moral hazard keeps springing to mind. Or in normal English: why are people being punished for making the right choices while others rewarded for making bad decisions? Debtors are being bailed out while savers are being stymied.

There are those that say we should simply save more and spend less. But this would be likely to worsen the downturn in the short- to medium-term. The ideal ('goldilocks') solution for the economy would be for the savings rate to steadily increase whilst offsetting the troubles in the economy through sensible long-term fiscal boosts.

Restoring banks' profits by stuffing savers with sub-inflation rates and poor investment options whilst reinflating asset bubbles aint gonna help any. And dumping cash into a bank aint gonna do much. The only option is to invest it somewhere (be brave!) or to spend it. Tough times.

Synthetic CDOs - again!

Here's a super explanation of synthetic CDOs.