Tuesday, May 05, 2009
The not so unpredictable collapse
Telegraph: Hedge funds net £190m from Barclays share price rise
Lansdowne, spent three years gambling on the collapse of Northern Rock. We are often told that nobody could have predicted the collapse of the banking sector. Did these people have a crystal ball? The truth is, that it was obvious to almost everyone in the industry. A similar situation is arising today with the gilts market. The same outfit is now saying, "If equities are the buy of a generation at these prices then gilts are the sell of a generation." Will we soon be told that nobody could have predicted this?
Posted by flashman @ 08:26 AM (993 views) Add Comment
48 Comments
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1. Lenny said...
Maybe we couldn't predict the collapse but a big decline was certainly on the cards from Spring 2008. When I went over to the US for the second half of 2008, the talk over breakfast tables was all about the impending collapses of WaMu and Wachovia a month before they happened. I know Wachovia were taken over by Wells Fargo but boy did their share price plummet.
This is also not the first time I have heard about a gilts decline in the last couple of weeks, maybe a good bet flashman?
2. flashman said...
Lenny: It is a good bet but not one I'd care to take. You'll have noticed that Lansdowne's bet only came good after 4 years and therein lies the problem. Everyone knows these things will happen but the wait can be exasperating. How much money did Lansdowne lose before it came right? Quite apart from the trading losses, there would be hefty overhead and opportunity costs.
Even the banks knew it would end in tears but they could not realistically prevent themselves from acting like they did. I am convinced that history will regard banks as nothing more than a reflection of a greedy society, when apportioning blame. Any bank chairman who did not join the party would have been ridiculed and fired. They would not easily have found another job because they would be considered a dinosaur Luddite who turned their bank into a bit part player, while everyone else prospered. This is entirely down to the shareholders. They would simply not have tolerated a cautious management team. The bank chairmen must have had fleeting moments of dread and foreboding whenever they permitted themselves a quite moment but who wants to lose their job and be ridiculed?
3. shipbuilder said...
That's an interesting point about the shareholders, flashman. Will solving the problem of a greedy society stop shareholders from demanding the highest profits possible? Surely when we allow economic systems to reflect and indulge greed, that is part of the problem? Just interested to hear people's views on these things.
I wonder, with the internet and the accessibility to the markets that it gives, has there been a fundamental shift in shareholder's attitudes that actually undermines the shareholder system (where people can invest in a companies future)? Have shareholders adopted a much shorter term view of companies and hence forced the companies to take a much shorter term view of their balance sheets? I used to work for a company that was penalised by the market for being unduly conservative and unwilling to take on debt.
4. flashman said...
shipbuilder: There is a nuance to this - share price appreciation has often become more important than profits/dividends. I suspect that this is a hangover from the dot com boom where profits became secondary. The significance of this is that speculators have usurped the authority of investors. Speculators are far more likely to pressure a company board than traditional investors
5. stillthinking said...
If funds are putting money on gilt yields rising, they must believe borrowing costs will rise sooner than later.
6. bellwether said...
I've read Societe General who have been reliably bearish througout put a recent valuation on Barclays of about £0.46.
The share price has increased 6 fold in a couple of months (we got above £3.00 today) but the rise is based on speculation not analysis as indeed was the decimination earlier in the year - ie the market has no idea what the company is worth but will keep guessing and eventually get it right.
Also anyone thinking ,or worse betting, that this govt sponsored rally might stop soon is likely to be frustrated. If we get above 200 ma then there is plenty of money on the sidelines that could start to pile in - ie Barclays etc could go a lot higher yet.
7. shipbuilder said...
flashman, I think maybe that's what I was getting at, where traditional long-term investment in a company has been replaced by those not interested in the company itself, but rather the movement of its share price in order to make a killing in the short term. But is it temporary, or a fundamental change?
8. shipbuilder said...
I guess my main interest is in our economic (and to an extent political) systems and how they benefit society. I get the impression from reading this site that at some point in the last few decades there has been a fundamental change in purpose of our economic and political systems. Originally (and some may disagree and call me naive on this), all economic and political systems are conceived for the benefit of a country's citizens.
Depending on your view, we seem to have either lost track of this, been manipulated away from it, or (in my personal view) been convinced by the Randian view that individuals helping themselves will benefit society as a whole and hence an economic system that concentrates on individuals maximising their profits will benefit us all. I think that this has been shown to be a mistake.
I think that there is also an element of arrogance, that the systems we currently have cannot be improved on and therefore should not be changed - I think this is dangerous.
9. flashman said...
Bellwether: I think you are on the money with your idea that the Barclays share price is based purely on speculation and that nobody knows the true worth of Barclays. I don't think the market is guessing until it get it right, though. It's like a giant game of chicken. No one actually cares what the value is and 'getting it right' would reduce the swings and ruin the game
The sad thing is that there is no value in genuine fundamental analysis (for the purpose of market prediction). It came to me years ago, that the only thing worth analysing is the light-weight tittle tatle that emanates from a thousand sources these days. It is this tittle tatle that moves and reflects the market. Obviously the tittle tattle changes with he wind and so does the market. This is why taking bets based on rational assumptions is often a quick way to the poor house
10. flashman said...
shipbuilder: I have to reluctantly admit to subscribing to the Randian view, with the enormous caveat that Government should do its job properly. Surely a government and its laws ahould be able to protect us from the more feral traits of man? Greed is a terrible side effect of any Randian system but I think that it is hard to create an alternative way without limiting individuality, freedom and creativity. Our government was either asleep at the wheel or entirely complicit. I believe the latter
11. icarus said...
flashman @2 - You make a good 'markets can stay irrational for longer than you can stay solvent' point, but I can't go all the way with you on blaming greedy shareholders (except insofar as the execs at the core of the system were shareholders). This crisis came about because a cartel of five US investment banks got US politicians to allow them to transform the financial system in a way that produced maximum leverage and the mobilisation of massive funding that enabled them to move markets in ways that were immensely profitable to them. Greenspan et al probably thought that the way to deal with any bust was to start another bubble and make new profits (and fuel economic recovery) in that way.
I think that everyone else in this game were playing catch-up with this core group and that it was the former who were the people in the position you describe. Shareholders would have been happy to get their dividends etc., fund managers would have been pressured to go along with the investment banks' need for funds and for buyers of their assets, all pressures would have been to go for the high yields (sustainable or not) that bubble activity produced. Essentially everyone else was sucked in to the banks' schemes and played a game they knew had to end. And they didn't all dread the comeuppance because many strived to be rich and retired before that happened.
12. icarus said...
make that 'everyone else WAS playing catch-up'
13. flashman said...
Shipbuilder: I have suddenly been hit by an insight... I previously thought that you were an idealist to my pragmatist. However, I suddenly realised that you are still an idealist but that I might well be an apologist. Such is life
14. shipbuilder said...
flashman - my view is that Rand's individualism is an extreme, just as pure collectivism is an extreme. We seem destined to flip from one extreme to another without seeing the reality in between - we are individuals, yes, but we also work best as part of a community. Our systems should reflect this. I think that we should seek to maximise the benefits of both, but there must always be some compromise. People talk of perfect freedom, yet our actions show it to be a false ambition - you are willing to let the government have some responsibility, others (i'm thinking of classical republicans in the US) acknowledge it by engaging with their community to a much greater level than we do in this country. We sacrifice our individuality willingly every day and many people work better and are more creative as part of a team - what i'm saying is that we already naturally compromise our freedoms and individuality without external compulsion. Of course we can, as is currently happening, pass too much responsibility to the community, or state. Obviously the ideal is reaching the natural balance.
15. bellwether said...
And Icarus as you pointed out a few days ago the trade imbalances drove the consumption that gave the impression that there was something to base the leverage on and so on.
Flashman I actually at least like to think that I subscribe to the notion that the only way to make money in markets long term is via analysis and valaution as per Graham and Dodd and of course BRK/ Buffett - often unfairly maligned.
The problem is that even now with makets cut in half there are not that many companies that seem to be offering the sort of values you would expect given the problems we have - and those that are (eg oil co's) being ignored in this rally
16. shipbuilder said...
flashman - not so much an idealist - it's very much my personality to look at a system and figure out how it can be improved or work best. I think that the mistake frequently made is imagining that the ideal has been reached and improvements are pointless.
17. flashman said...
Icarus: there is very little of your post that I can disagree with, but I do think that even the most brutally oafish bank chairman must have felt some dread and foreboding. One thing I've noticed about the truly rich and powerful is that they suffer from the arrogance of pondering their 'legacy'. My rational for focusing on a greedy society rather than greedy bankers is that ever strata of society was 'at it'. Tradesmen started charging on the basis that playing golf in Florida was an essential component of their lives and the middle classes manufactured a lifestyle for themselves that required spending several multiples of their salary .
18. shipbuilder said...
It sounds like a chicken and egg situation - maybe the result of the banker's actions was to allow everyone else to indulge their own greed, or maybe the bankers simply followed the general mood of society. I don't know - but I think influence generally comes from the top down.
19. bellwether said...
SB , people who are fundementally content rarely wish for a better world and also wishing for a better world is unsually the worst way of getting what we want.
20. flashman said...
icarus: Regarding your point about everyone else playing catchup. I think that the mores of the day happen spontaneously and sybiotically. We are all collectively involved and drawn by the same forces. It's a bit like punk rock. Simultaneously, around the country, unconnected bands started playing punk rock long before the name punk rock was coined. It just happened because it was in the air. The Sex Pistols, like the bankers get the credit/blame but it's not really true
21. shipbuilder said...
bellwether - unfortunately the luxury of being fundamentally content is not afforded to many.
22. shipbuilder said...
bellwether - but I think I get what you're saying - if we all left each other alone and ditched the striving and ambition, the world might be a lot more pleasant, but maybe a lot less 'advanced'.
23. icarus said...
bellwether @ 15 I think leverage and balance sheet expansion is central to what happened but I'm sure I said exactly that. I'd argue that leverage came from a number of mechanisms that enabled asset bubbles and leverage to feed on each other: e.g. repo funding is predicated on an asset price boom; CDOs with AAA ratings require minimum equity back-up.i.e. max leverage; or consider this - your assets are £100 securities funded by £90 debt and £10 equity. Leverage = 10. If the asset goes up 1% to £101 your equity goes up to £11. Keeping the same leverage you can now control £110 assets (£11 equity, £99 debt = same leverage of 10).
flashman @ 17 - I'm trying to get away from the 'it happened because we all became greedy' explanation because that doesn't really tell us what kicked it all off. The 'five investment banks and their Washington buddies' explanation may tend towards the conspiraloon end of the spectrum but at least it offers mechanisms and structures in the explanation.
24. icarus said...
@23 - I meant to say on the first line 'I'm NOT sure I said exactly that'.
Also, with regard to the £110 assets eg. - I forgot to mention that that stuff works also in reverse - but I'm sure we are all aware of that.
25. shipbuilder said...
Or maybe pretending to wish for a better world for others is an excellent way of attaining the power to make a better world for oneself.
26. flashman said...
Icarus: If you want to find the pathology of the crisis, I think we’d have to look further back than the US investment banks. The Austrian school of economics and particularly the laissez-faire component is taught to everyone who opens an economic textbook. It lost favour with regulators for a while but never really went away with economists. Over the last few years its followers got a better hold of the policy wheel. This is partly where the light-touch regulation came from. There is a link below to an excerpt from Wilkipedia below which highlights their belief in the power of pricing mechanisms (they foolishly trust the market above all else) and of course their advocacy of abdicating responsibility for the enforcement of contractual agreements between economic agents (think CDO’s).
Anyone reading this excerpt from Wilki cannot fail to get a chill when they make the connection between the Austrian School and our current crisis
27. flashman said...
sorry forgot the link
http://en.wikipedia.org/wiki/Austrian_School
28. 51ck-6-51x said...
Successful systems in nature are autonomous and self-damping. The most successful systems in nature also evolve in a environmentally manipulated fashion, including the actions of random events, at a distributed level. I think we should learn from this and allow our system of capitalism to work in a similar vein.
29. 51ck-6-51x said...
^^ It would appear that a fundamental macro-economic catalyst to the credit bubble was the building of international reserves by emerging economies as a form of protection. (This is not finger pointing - this was natural for these economic agents).
30. flashman said...
51ck-6-51x: true, but who says 'our system of capitalism' is a successful system? Most systems in nature are flawed and therefore eventually die. Why should we make the assumption that our system is successful?
31. 51ck-6-51x said...
Flashman - I was not assuming capitalism is successful. I was suggesting that with a few tweaks it could well be. I believe we need to replace the central control (central banks, government implied backing, taxes, subsidies...) with more subtle and efficient feedback mechanisms than those which exist currently.
32. flashman said...
51ck-6-51x
I expressed myself badly. I should have used the word 'potential' i.e. "Why should we make the assumption that our system has the potential to be successful?
I understand that you are saying that if we replaced the flawed central control it might have a better chance but what if we are flogging a dead horse and our system turns out to be unviable.
33. 51ck-6-51x said...
flashman - then we regroup and rethink I suppose.
We can always run a multitude of scenarios given our proposed changes now, since we have the right kind of technology with which to do so (powerful computers and AI concepts).
34. shipbuilder said...
I think that the best we can hope for is a 'fair' system where we all at least start with an equal chance. My original point is that perhaps we have lost sight of the fact that the best system is one that benefits all, conflict being the result of inequality. One of the fundamental flaws of capitalism that has led us to where we are today is that one the ultimate sources of all our wealth - land and natural resources - are privately owned, or at least the wealth extracted from them stays in private hands. This is what Land Value Tax attempts to address.
If we attempt to define our systems by rigid terms such as capitalism or socialism, then natural and beneficial evolution of such a system is doomed to failure.
35. shipbuilder said...
I should say what I mean by 'fair' - where we start off with an equal chance in life and are rewarded according to our talents that contribute to improvement to society/advancement of the human race. Sounds idealistic, but our current system fulfills neither of these criteria - I think most people are happy when they feel they have been fairly treated.
36. icarus said...
flashman @ 26 - You could go further back and list a number of influences that came together to engender the crisis. De-regulation is a biggie - a sine qua non for leverage & balance sheet expansion, which in turn played a major part in causing the bubbles/crisis - but the question is how/why this came about. There is plenty of evidence that this was driven by interested parties rather than by ideology (and I think you pointed out the other day that trade imbalances made it necessary for the authorities to ignore regulatory violations - correct me if I'm wrong). Perhaps the biggest single move in this direction was by Paulson himself in 2004 when, as head of Gold-in Sacks, he led a Wall St. campaign to get the SEC to relax the 'net capital rule' that restricted leverage for investment banks. A rapid rise in leverage ratios ensued and this freed up a lot of equity to go into CDOs, another leverage ruse. (This relaxation was dressed up as greater regulation by the SEC but that was window-dressing, especially as the SEC had the usual one man and a dog to oversee the banks.)
37. flashman said...
shipbuilder: any sane person would agree with you that society should be fair and that ideally everyone should start off with an equal chance. I probably lack the ability to concentrate on the aesthetic but the only way I can see this being achieved is to impose a 100% inheritance tax and to outlaw nepotism and private schooling. The Labour government of the late 70's came close to this with a78% tax on earnings and 98% tax on super income (stock market profits). They also tried to ban private schools. (I'm not saying that these were the policies that ruined the UK - that was standard post Empire/post Industrial decline
38. Narcissus'echo said...
"the only way I can see this being achieved is to impose a 100% inheritance tax and to outlaw nepotism and private schooling"
Quite. Spoken like a true meritocrat sir.
39. flashman said...
Icarus: Don't get me wrong. The investment banks did lobby for less regulation and they did play a large part in creating the crisis. I did, indeed, also talk about the part played by trade imbalances but that was more from the angle that the Western governments needed to allow a free reign to the city/Wall St. They needed to do this, because they had destroyed our manufacturing capability and needed another tax base . This is why we had Thatchers "Big Bang” of financial deregulation in 1986. Thatcher was the ultimate destroyer of manufacturing capability and therefore the ultimate deregulator of the city. Paulson was a Johnny come lately. In fact long before Paulson, Clinton repealed the Glass-Steagall Act of 1933. Did he voluntarily do this because he wanted Wall Street to replace the deceased productive economy or was he coerced by Wall Street. A bit of both I'll bet
40. icarus said...
flashman @ 38 - bit of both is probably right. Wall St. couldn't just decide to create profitable bubbles unless a number of things came together. As I've said before, I think a major influence has been that the world's main economies have lost a lot of their dynamism (falling growth rates in profitability, investment, productivity, real wages, GDP) over the decades since WWII and that governments need bubbles to give these flagging economies a shot in the arm. (Instead of, or as well as, goverments borrowing to boost demand in a keynesian way, let joe public borrow and create asset price bubbles, wealth effect, spending - and boost aggregate demand that way). When the dotcom bubble burst Greenspan lowered IRs to avoid recession and gave birth to the housing bubble - an adreneline shot to an exhausted patient. And it worked - for a while.
41. shipbuilder said...
flashman - i'm not saying that my idea of whats fair can be achieved straight away, or even ever, but the current system does not even aim for it. Perfection will never be achieved in any system, but i agree with 51ck-6-51x in that small changes could make a huge difference. The problem with most measures such as the taxes you describe are that attempt a revolutionary change, and such changes never work. Inheritance will always be an issue, but large inheritances are a result of past inequality - in a system that aims for equality and fairness, inheritances would diminish naturally over time. Similarly, the gap between private and public education would diminish. Again in terms of the tax measures you highlight, I don't either inheritance tax or income tax are fair either and would be replaced by land value tax, which taxes 'unearned' wealth.
I think that most people are realistic and accept a system that has the spirit of fairness and equality, rather than one that protects inequality. Likewise, I don't think that anyone expects absolute equality, just that efforts are rewarded accordingly rather than the game being rigged by the few.
42. p. doff said...
''society should be fair and ideally everyone should start off with an equal chance''
Nice idea guys, but totally impossible. There can never be an equal chance because we are all different. In nature there will always be 'individuals' (be it animal, vegetable or 'people') that eke out an existence on the fringes of society. Consider a child born to a 'traveller', who may never have been sent to school and cannot read or write. Consider also the child born to a professional state scrounger who might spend all his benefit on beer and cigs. What chance have these kids got. If you wiped the economic slate clean, cancelled the debts of the poor and wealth of the rich, then gave everyone £5 million so everybody was 'equal', you would pretty soon end up with a new polarised society of 'haves' and 'have-nots', with various degrees in between.
Forget 'starting out from a level playing field' as a solution, and just accept that there will always be disadvantaged people that need a leg up and help from the better off in society. It's just the way it is.
43. shipbuilder said...
p. doff - please, if you read my posts, you'll realise that I was saying none of those things. Fairness and equality of opportunity as an aim do not imply that everyone will end up equal, that is illogical. But having them as the ultimate aim of our political and economic systems mean that the systems evolve to be as fair as is possible and therefore cause the minimum of resentment and conflict. Our current systems seek to preserve inequality and widen it beyond what is natural and do not reward in a fair way to anyone, not just the poor.
44. 51ck-6-51x said...
shipbuilder said, "I think most people are happy when they feel they have been fairly treated."
- I beg to differ. I think most people would be "happy" when they get an advantage over the majority. The problem here is that contentment should not be inferred from the material plane, as it, unfortunately, seems to be for the vast majority.
I put happy in quotes, because there is a further problem. This happiness will erode itself over time.
I agree with the ideal of a level playing field at birth (which implies 0 inheritance), although it would become extremely difficult to allow parents any freedom of choice in how they bring up their offspring whilst also blocking all (or even most) wealth transference (i.e. as Flashman says, 'no private schools' - but where does one stop?! The quality of the water the baby gets to drink? The amount of sunlight a child gets?..)
My gut tells me that even a pragmatic approach to this would cost more in terms of ongoing administration than it would produce in economic benefit.
Furthermore the decisions about where to draw the lines will be with politicians, and will therefore be far from optimal too (will get further and further away from optimal, until the system breaks- as with every other system they touch it would seem).
A 100% inheritance tax would be a start, but the loopholes are and would remain numerous and easy to take advantage of.
45. shipbuilder said...
51ck-6-51x, I don't agree at all. The majority of people take the trade-off between work and money, in that they will accept that they are not going to be rich(er) because they do not want to do the work required. These kind of compromises are made every day because people know and accept the rules. It is when people feel that someone else has an unfair disadvantage that conflict happens. People do the lottery without complaint because they are happy that they havce as much change to win as everyone else. What would happen if it was announced that people in London had double the chance for the same payout?
A level playing field at birth with zero inheritance is not fair because it attempts to redress a balance all at once. A tax such as LVT does not do this - the balance will be redressed over time, because the way it works is to redistribute land value - value which should belong to the community and not the individual, who has done nothing to earn it.
I'm surprised that you fall for the 'all or nothing' argument. The idea is that the system will not be perfect, just fairer than current and as long as it evolves toward the correct goal, it will become fairer over time. The free market could be such a system for certain things - I am not arguing for legislation.
46. shipbuilder said...
51ck-6-51x - a further comment on your examples - the quality of the water a baby gets - isn't that what our current water system does? Why would we seek to do anything different? The amount of sunlight - that is an extreme example. My point is that people are happy and feel they are treated fairly when they are free to pursue a fair opportunity - no one in their right mind would complain because their baby gets less sunlight than another.
47. 51ck-6-51x said...
shipbuilder - I think you have the wrong end of the stick I was bearing there... I was talking about happiness, not the playing field :)
I believe a level playing field is indeed fairer, and that people prefer a level playing field, just that one cannot ascribe a value to happiness from such a change.
In the extreme if no one got any more or less chance for anything throughout their entire lives, I believe happiness would generally be far lower, and you may not agree, but hear me out.
As an example consider the lottery again. People play this game because the bet is small and the potential (albeit improbable) reward is huge - this is in human nature. Those playing the game are actually seeking the unfair advantage to which you refer because they believe that is what will bring them happiness (which is incorrect, see my final statement, below).
In fact, if what you say were true no one would play the lottery, as the playing field is far from level - there are N players in that game, N-1 of whom expect to lose roughly half their stake - so far so level - and one player who expects to take all of this excess as income (The National Lottery itself is that other player).
Furthermore it has been shown time and time again that when one makes a big material gain the happiness one gains is far less than the unhappiness for an equal material loss - it's the way we're wired, ask any trader!
And lastly the happiness from material possession is fleeting, a far more constant happiness may be found.
48. shipbuilder said...
Ah, I get your point - my fault for not reading your post properly, although on the lottery point I don't believe people see the National Lottery as a player - they feel they are competing on equal terms with their peers, who have also paid, like all those who have paid for eduction in the same school will expect equal treatment.
Perhaps happiness was the wrong term, maybe more content and less inclined to conflict.
In terms of the level playing field, I meant equality of opportunity from an equal start. Beyond that, enforced equality between two differing talents would than be unfair and cause conflict.
Therefore I agree that people are happier to have an advantage, but others will only see that advantage as fair and accept it, if it is in proportion to the work put in, given a equal start.
The key is in the definition of fairness - fairness just for the 'poor' (as per 'socialism' that I assume people believe I am advocating) is not real fairness. For example redistribution of unearned land value I believe is fair, whereas redistribution of the proceeds of someone's work and creativity is clearly not.