Friday, 30 January 2009

Plus ca change, plus ca meme change?

"We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists, and in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step. "

So said James Callaghan when he was Labour prime minister around the time of the 1976 IMF crisis (when it bailed out the British economy before north sea oil could do the very same thing)

How things change give or take the hack back in spending plans from 2010/11 onwards set out in the November 2008 Pre Budget Report by the chancellor. And dear god was that predicated on optimistic economic assumptions.

crystal balls

A Minsky moment is the point in a credit or business cycle when investors have cash flow problems due to spiralling debt they have incurred in order to finance speculative investments. At this point, a major selloff begins due to the fact that no buyer can be found to bid at the high asking prices previously quoted, leading to a sudden and precipitous collapse in asset prices and a sharp drop in market liquidity.

So says Wikipedia. For me a Minsky Moment is an epiphany, a mass realisation that such and such a market is a speculative bubble about to burst. Herd behaviour being what it is the bubble does burst as investors panic sell en masse. If only we could spot them.

Well I think we can sort of. The old joke was when your dentist started giving you stock tips you knew it was time to sell. This was updated after the dotcom bubble – when people started talking about a “New paradigm” you knew it was the time to get out quick.

Except, the cynicism attached to the "New paradigm" comment was recognised as having more than a grain of truth to it, hence the boosters of the private equity mega-deals seen before the credit crunch avoided it in favour of dull arguments about the alignment of interests between senior managers and owners. Commercial property never quite attracted the brains private equity did so on occasion its boosters did refer to paradigm shifts if not new paradigms and then only in passing.

So if clich├ęs aren’t much of a guide what is? Unfortunately, it’s commonsense. You see speculative bubbles typically generate behaviour that’s so stupid, so over the top and so too good to be true even a modicum of common sense should let you step back and decide “Nah, I’m getting out of here”. Examples of this include the Japanese frenzy for investing in golf clubs (prior to the lost decade) that prompted the creation of a golf club investment index. During the dotcom bubble it was enterprise values that implied every customer of say generated an EBITDA of $200,000 a head. Closer to home it would be the Investment Property Databank organising a conference on alternative property assets that included the joys of investing in yachting marinas and tree plantations. Or it could be the root of the current crisis and selling mortgages to NINJAs (no income, no job or asset borrowers) who could barely afford the upfront teaser rates let alone what the mortgages cost when they reset to realistic levels.

The same three factors apply to each of these examples of fringe investments moving into the mainstream. One, you’re scraping the barrel to find something to invest in because the mainstream market just doesn’t work regardless of whatever financial innovation you throw at it. Two, you’re scraping the barrel because of bureaucratic reasons which in banking means you’ve sales/profit targets to meet to get your bonus. And three, if you do have second thoughts and question a superior about it ultimately, other than blind faith either in them or someone else (a ratings agency perhaps), the only justification they can give that makes any sense is “I am superior to you therefore you will do what I tell you”.

So there you go, that’s how to anticipate a Minsky Moment. Of course you won’t get it precisely right and might even pull out one, two or even three years early. But, given the magnitude of the collapse in bank equity values and losses we’ve seen and the extent to which these have cancelled out years of profits so feckin what?

P.S. This leaves the issue of leadership and who sets the stupid targets that drive businesses over the cliff in the first place.

Thursday, 29 January 2009

the luck of the irish

Am sure one day I’ll have something positive to say. In the meantime …… was reading a really dull report on European commercial property investment today from some US investment bank that reminded me of a really dull property investment conference I went to a coupla years back.

People managing billions of pounds of property investments where there, gosh they were impressive. One of the speakers from a major property consultancy touched upon the then novel development of Irish property investors investing in Britain. Now to get a sense of how important this new factor became I think in either 2006 or 2007 around half the shopping centres - by value - bought in Britain were bought by Irish investors and that’s without the kind of tax advantage the Spanish government handed to Spanish investors who bought overseas assets (the EU remains remarkably silent about that competitive advantage for some reason).

For the property analyst speaking at the conference, the professional paid to advise on market conditions and property transactions, this sudden interest reflected an Irish desire for “trophy assets”. The Irish, to her, were after a bit of British quality, some prime retail outlets sat on the green and dark blue bits of the monopoly board.

Bollocks. So hard-nosed investors who made themselves fortunes in Ireland turned so weak at the knees at a bit of British status and cache they chucked standard investment criteria out the window? The reality was more straightforward, Ireland led the property bubble and the kind of yields then on offer in Britain stacked up when compared with Dublin; these business transactions were about business not status and by buying into retail in the first instance they were simply following much the same strategy as everyone else did during the commercial property bubble.

So rather than analysis this “expert” trotted out jingoistic city-boy crap to fill the gaps left by the admittedly poorer data on the Irish property market, in the process reassuring a British audience that Britannia did indeed still rule the waves.

Which brings us back to the investment report I was reading today. Rather than gossip this simply lobbed graphs at the reader. Except they weren’t very good ones, they were simply what the Investment Property Databank sends out each month to whoever is on their cheapest subscription. This is a problem because they don't take geography into account, which matters because commercial property in Britain is essentially 2 markets. Now I know property consultants will disagree with this, but then they have to otherwise how could they justify their fees? So yeah, Britain has 2 markets. One is London offices the other is offices, retail, warehouses, factories and what not everywhere else.

London office capital and rental values are far more volatile and move in a different pattern to capital and rental values everywhere else. London offices are also absolutely stuffed at the moment and will be for years because of the restructuring i.e. hacking back, of the financial services sector that drives demand for them. Not that everywhere else is doing well or is going to, its just that by comparison they didn’t see quite the same increase in supply as London where developers knocked out as many buildings as possible to feed speculative oops sorry, tenant demand. Despite these rather obvious, glaring facts the investment bank report instead told me industrial property was my best bet at the moment i.e. it missed the dirty great financial disaster surrounding whoever wrote the report.

For me this combination of city boy chat and incompetent "technical" analysis highlights the arrogant stupidity that drove much of the credit crunch. To put this more formally Gossip times an unquestioning belief in financial models squared by financial instruments = an economic disaster for all of us.

Monday, 26 January 2009



So far the treasury’s rediscovery of Keynes and the use of counter-cyclical capital spending in response to a deep economic downturn has been the credit crunch’s only notable intellectual development. There’s just one problem you see in the run up to August 2007 government was so busy hardwiring as much of its capital spending as possible to the credit and property cycles it’s not clear how this rediscovery of Keynesian economic policy can be put into practice. Oops!

Some examples; PFI/PPP finance was used to pay for everything from new hospitals to military flight simulators. For deals over a certain size the financing would be via a bond “wrapped” by a monoline insurer. Unfortunately, because monoline insurers have been stuffed since 2007 bond issues simply aren’t an option. Instead even big PFI/PPP deals started looking to banks for debt. Except banks simply didn’t (and don’t) have the liquidity to finance major projects and keep them on their balance sheets.

This would be manageable if there was a secondary market at the moment for them to arrange a deal then sell it down too, but there isn’t. Well there is sort of, but the kind of terms and margins being demanded (a) keep changing and (b) are so steep its difficult to imagine the Value for Money test (can the government finance this deal cheaper itself?) applied to every PFI/PPP deal being passed, and anyway (c) banks are only willing to take on board smaller slices of debt, which means more banks are needed for each deal making the whole process more time consuming, convoluted and expensive (the phrase “herding cats” arguably applies to the kind of syndications now being seen).

The reason is straightforward; while PFI/PPP poses relatively little risk, this is reflected in historic pricing rates that simply aren’t regarded as tenable at the moment. The practical result is that while the chancellor last year announced his intention to bring forward capital projects to alleviate the effects of the downturn, the actual number of PFI/PPP deals signed off in 2008 was just 34 compared with an average of 60 per year over the previous decade. In other words there is a dirty great big logjam due to credit constraints.

It gets worse. While the assumption that PFI/PPP finance would remain available was built into all the major capital spending strategies announced by government, most notably the Building Schools for the Future programme, other quasi-government agencies were also expected to do their bit and borrow more to finance the capital expenditure needed to meet government targets. The most notable were the housing associations who, like local authorities wanting to renovate schools, received additional central government tied to their willingness to borrow more. Similarly, further education colleges, like housing associations, were also obliged to sell assets i.e. property, to finance their capex plans, another oops given the current state of the property market.

It gets even worser. You see the size of the social housing stock is intimately connected to private residential property development. Builders typically need to contribute to the provision of social housing to get planning permission as part of what are called section 106 agreements. Now this is something not a lot of people appear to know about including Kate Barker, variously described as Gordon brown’s favourite Housing economist who in her report to government a few years back recommended the introduction of a planning gain supplement i.e. a quid pro quo tax on property value appreciation following the granting of planning permission that was essentially already there. Regardless of that the point is during a boom forcing private developers to contribute to the social housing stock makes sense, but during a bust when new private residential construction orders fall around 60% in Q4 2008 on the 2007 level, the supply of new social housing will fall significantly because fewer people are applying for planning permission.

So there it is. Government capital spending plans were and arguably still are predicated on the assumption that private finance will always be available and that property values/developer activity will keep rising. Neither is the case right now and when private finance is available, it’s at a cost that by historic standards would be judged unacceptable. The various schemes announced by the Treasury in January to ease liquidity constraints are vague enough to accommodate PFI/PPP finance, but they don’t appear to have been written with that in mind. Rather, the explicit references are to commercial and residential property as well as leveraged loans i.e. the riskier businesses banks did to help themselves rather than the lending to government institutions that arguably helps us all.

Thankfully there are some signs this has been recognised most obviously the decision reached on January 26th for government to underwrite the widening of the M25. But, by definition the response so far has been both piecemeal and begrudging, highlighting the traditional criticism of Keynesian economics that by the time government actually responds to a downturn, its simply too late.

Wednesday, 21 January 2009

Taking us to the cleaners?

Financial booms and busts kick new words, concepts and forms of finance into the public arena. The dotcom bubble introduced the world to the venture capitalist. In the run up to the credit crunch we discovered Private Equity or what used to be called a leveraged buy-out. Private equity we were led to believe was brilliant. It aligned the interests of managers and owners to an extent that would have made Marx dizzy given he failed to anticpate the emergence of a managerial capitalism based on executives and institutional investors.

Private Equity also became a bogeyman in the run up to the start of the credit crunch in August 2007 because of its tendency to pay investment managers squillions at the same time (as the Work Foundation neatly documented) as people working in the companies being bought and sold tended to be subjected to what are called "aggressive HR policies" e.g. less job security, relatively lower pay rises, higher targets and so on. Oh and the private equity chaps benefitted from some wonderfully beneficial tax arrangements or as one Private Equity bod put it millionaire financiers were paying less tax in relative terms than their office cleaners.

Come the credit crunch and everyone started casting their envious glances elsewhere including the parliamentary Treasury Select Committee. But, 2 things suggest we should have another look. The first was a study published by the British Venture Capital Association this January that clearly stated the single most important contributor to private equity companies outperforming their publically listed peers was borrowing more money more cheaply. There, its not rocket science, or incentives or whatever, its simply the ability to arrange a deal and swap debt for equity to an extent that in the current environment increases the risk attached to a business.

Or does it? You see second thing is the Treasury statement on its new Asset Protection Scheme i.e. insurance policy for bank debt. This states

"The following categories of assets will be eligible for the Scheme, subject to assessment by the Treasury for inclusion on a case-by-case basis:
  • Portfolios of commercial and residential property loans most affected by current economic conditions;
  • structured credit assets, including certain asset-backed securities;
  • certain other corporate and leveraged loans;
  • and any closely related hedges, in each case, held by the participating institution or an affiliate as at 31st December 2008.

5.2 The Treasury may consider the inclusion of other asset classes in the Scheme, subject to appropriate investigation by the Treasury and its advisers and the determination of an appropriate fee."

In other words there is clear scope for government to land taxpayers with a dirty great contingent obligation that effectively bails out private equity investors who overpaid for assets using cheap credit in the run up to the credit crunch. Go figure. There again as I'm sure every cleaner currently hoovering under some private equity investment director's desk will confirm they do create jobs.

P.S. apologies for the pun in the title

getting started

I decided I’d start a blog for all the usual reasons – self-indulgence, vanity, ego, frustration at my mediocre lot in life, a selfish desire to spleen-vent and the deeply self-deluded belief I've something interesting to say. Even better I figured I’d focus, fixate even on the credit crunch because its so much a part of my actual day job. So in the spirit of all that I figured I’d start with my Anglo-centric reading list for keeping up to date with what’s happening.

So first off who do I read?

Willem Buiter: Very pithy, insightful and to the point, but can also be very, very technical for those of us without postgraduate degrees in financial economics. Nevertheless the argument he’s been developing in recent blogs, as I understand it, that the scale of the British problem is potentially too big for the economy to handle, is frighteningly pertinent.

Robert Peston: Compulsory reading really. Poor Evan Davies he really missed the boat focusing on becoming a presenter just as things changed. Poor Peston he really is getting ideas above his station writing that PDF on the economy of the future. Stick to the journalism I say or is the (self?) censorship being practised over the collapse in RBS and Lloyds share prices getting in the way allova sudden?

Samuel Brittain: There’s something wonderfully Yoda-like about his articles and I mean that in a good way. Gordon Brown scolds banks? Samuel scolds Bishops. The Treasury look to the Swedish bank bail-out? Samuel looks to the New Deal between the wars. Now that’s perspective!

Finally, an honourable mention for John Kay because when he does comment on actual events he usually has something very interesting to say and does it so eloquently. And like Samuel Brittain he has that certain Yoda quality.

Who to avoid?

Martin Wolf: Maintaining a dotty professor persona is all very well, endearing even, but when you’re constantly catching up with actual events who cares?

Roger Bootle: The man, the legend, the Bootle. In fact bootle is a new verb, it means to spraff on endlessly trotting out what sounds like insightful jargon to the uninitiated when your understanding of actual events is little better than a first year economics student. I’ve lost count of how many years he’s been consistently saying the housing market is doomed, but hey ho a stopped clock is right twice a day I suppose (unless its digital and on 24 hour mode).

Every bank, financial institution, hedge fund, mortgage association, etc., etc., head, president, director, vice-president, Tsar of global, country, universal whatchamacallit economic research. I do not consult the Catholic Church when I want an objective view of abortion so why the dickens should I listen to what people in the pay of the (were) great and good that caused this mess have to say about the credit crunch?

Pretty much every academic: The tragedy of the academics is that for all the wonderful impartiality they could potentially have brought to bear (if we ignore the debates between the neo-classical/neo-keynesian tribes and so on) they live for the most part in such splendid, mathematical isolation, they have nothing to say about the real world other than what they read in the Guardian last Tuesday (although I understand the THES is doing a supplement next month). There is that Freakconomics bloke or was his fixation with using odd real examples to prove how clever he was simply more of the same only quirkier?

Finally there is the Wall Street Journal. I’m not sure where to place this. The last piece I read on the money being thrown at a US bank by the government was so wonderfully anti-government/pro-bank it provided a fascinating insight into the Wall Street mentality. Have they no shame? Nope.

Right next time I'll try and say something wonderfully insightful.