Investing Through the Looking Glass

A rational guide to irrational financial markets

Tim Price

• Editore: Harriman House
• Anno: 2016
• ISBN:
  9780857195371
• Edizione: 1
• Argomento: Business
• Categoria: Business internazionale

The investment markets have never been more dangerous. Interest rates are at all-time lows; the sanctity of cash deposits is under threat; government bonds are expensive and offer ultra-low or negative yields; equity markets are largely detached from reality after years of loose monetary policy. Investors need to calibrate themselves to the realities of this extraordinary new environment so that they can protect their wealth and, ideally, prosper.In Investing Through the Looking Glass, longstanding portfolio manager and investment columnist Tim Price identifies and shatters a number of investment myths and misconceptions. He questions whether stock markets inevitably rise over the longer term, whether bonds continue to be relevant as a failsafe low-risk asset, whether professional fund managers represent "smart money", and much more besides.But this is not just a counsel of despair. Having identified the problems besetting today's investor, the focus then moves on to practical guidance to help investors preserve and grow their capital in this age of inflationary and deflationary uncertainty. Tim Price provides ideas on how to find attractive investments in distorted equity markets, on what might be the best-kept secret in finance, and how best to insure portfolios in an environment of heightened systemic risk. Investing Through the Looking Glass presents a route map for navigating one of the most challenging financial environments that anyone has ever seen. For the sake of your wealth, can you afford not to read it?

Part One – Problems

Chapter One – The Banks

“What you as the City of London have done for financial services, we as a government intend to do for the economy as a whole.”

Gordon Brown, Mansion House speech, June 2002

Erik Schatzker: “$1.6 billion in compensation [at Goldman Sachs] is still a lot of money.”

Nassim Taleb: “Anything above zero is too much money.”

Erik Schatzker: “Why zero?”

Nassim Taleb: “Because it is a utility. Anything you bail out, you should not be earning more than a civil servant of corresponding rank. Period.”

Nassim Taleb in an interview on Bloomberg News, 18 October 2011

“From Mr Thomas Janichen.

Sir, Why create another bad bank? We have enough already.”

Letter to the editor, Financial Times, 17 January 2009

“Banking may well be a career from which no man really recovers.”

John Kenneth Galbraith

The delusion

Commercial banks are an essential part of the modern economy. Their rescue during the Global Financial Crisis, at extraordinary cost to the taxpayer, was unavoidable.

The reality

For centuries, banks have portrayed themselves as prudent custodians of our capital, as shrewd and disciplined lenders. However, over generations, they have shown themselves systematically and cumulatively unworthy of such a positive reputation. As we will see, banking may be necessary, but banks, as we know them, no longer are. New financial technologies, and the advance guard of fintech pioneers, are already hammering at their gates.

The troubled history of banking

When it comes to either their behaviour or their capability to fulfil the traditional banking role, of prudently accepting deposits and extending loans, the historical record of banks is not reassuring. The British author John Lanchester, for example, tells of an extraordinary Scottish adventure:

“During the 17th century, Scottish investors had noticed with envy the gigantic profits being made in trade with Asia and Africa by the English charter companies, especially the East India Company. They decided they wanted a piece of the action and in 1694 set up the Company of Scotland, which in 1695 was granted a monopoly of Scottish trade with Africa, Asia and the Americas. The Company then bet its shirt on a new colony in Darien – that’s Panama to us – and lost. The resulting crash is estimated to have wiped out a quarter of the liquid assets in the country, and was a powerful force in impelling Scotland towards the 1707 Act of Union with its larger and better capitalised neighbour to the south. The Act of Union offered compensation to shareholders who had been cleaned out by the collapse of the Company; a body called the Equivalent Society was set up to look after their interests. It was the Equivalent Society, renamed the Equivalent Company, which a couple of decades later decided to move into banking, and was incorporated as the Royal Bank of Scotland. In other words, RBS had its origins in a failed speculation, a bail-out, and a financial crash so big it helped destroy Scotland’s status as a separate nation.”3

That a bank as big as RBS could crash spectacularly, twice, says something about the immutability of human nature. This is not to single out the Scots. Citibank, one of North America’s largest banking organisations, has also gone bankrupt at least twice.

Picking out another example, in the early 1980s the major US banks went on a lending spree in Latin America, determined to test the observation of Walter Wriston, a former head of Citibank, that “countries don’t go out of business”. But fairly soon afterwards, 27 countries did. In the summer of 1982, large American banks lost close to all their cumulative past earnings. The loss was equivalent to everything they had ever made in the history of American banking.4

Then, in the 1980s and 1990s, US Savings and Loan companies – the equivalent of Britain’s building societies, designed to take deposits from retail savers and convert them into mortgages and personal loans – under pressure from rising interest rates and after a period of lax regulatory oversight, indulged in an array of highly speculative ventures. The outcome was that one in three savings and loan associations failed – 1043 businesses out of a total of just over 3200. The estimated cost of the crisis came to $160 billion. In what would become a model for future crises, most of that cost was borne by the US taxpayer.

By the late 1990s, Wall Street and the City had discovered, and were cheerfully dealing not just with, but on behalf of, hedge funds. One of the higher profile hedge funds of the 1990s was the inaptly named Long-Term Capital Management (LTCM), whose sizeable population of Nobel Laureates would go on to ensure its spectacular demise. LTCM, whose risk aggregation model predicted that the fund was exposed to potential losses no greater than $35 million, managed to lose $553 million in a single day, using leverage at a ratio of 200:1.

Pretty much all of the major players on Wall Street and in the City were counterparties to LTCM, and many of them held precisely the same trades. As a result, as the parlous state of the fund’s finances became increasingly clear, the capital markets froze up. Pretty soon, there were no prices available in anything.

What fails to feature in most accounts of the failure of LTCM is the role of the regulator. During those febrile weeks of September 2008, the semi-mythical investor Warren Buffett put together a private sector rescue plan that by all accounts was made, rejected and withdrawn in short order while the Fed was assembling Wall Street’s finest and knocking their heads together. In the words of the financial analyst Rawdon Adams, the intervention of the Federal Reserve in the affairs of LTCM amounted to “a rejection of the idea that a global capital market valued in the trillions of dollars is well positioned to absorb crises, demonstrate swift powers of recovery, and rapidly reinstitute order from chaos.” In rejecting a free market solution, the Fed sowed the seeds of moral hazard that would find full flourish in the malign harvest of the sub-prime credit fiasco ten years later. This role, of a financial regulator disrupting the free market solution, is an important theme in this chapter.

As the capital markets calmed down after the excitement of LTCM’s explosive failure, its major players could go back to underwriting and mis-selling that era’s most popular legal hallucinogens – dotcom stocks. Many of those clever hopes would, of course, go on to expire – but at least they died a natural death. After the terrorist attacks of September 2001, however, the US Federal Reserve would go on to slash interest rates in a stimulative frenzy that took the Fed Funds rate down as low as 1% in 2004. Ultra-low interest rates would in turn ignite a new bubble.

In the first years of the 21st century, the way to grow suddenly rich was not just through dotcom speculations, but through real estate. Speculative property mania was not limited to the US, of course, but it was in North America that its gaudiest and most outrageous manifestations found their fullest expression. This was the period of no doc (no documentation) ninja loans (from applicants with no income, no job, and no assets). Between 1997 and 2007, US house prices, as measured by the Case–Shiller national index, rose by 120%.

Money was loaned out that simply never should have been. If there was concern in any quarter about a housing bubble, it was not shared by the man with the power to do something about it. In July 2005, Ben Bernanke, the chairman of the US Federal Reserve, commented, with confidence that would prove unwarranted, “We’ve never had a decline in house prices on a nationwide basis.”

For someone apparently well schooled in the history of the Great Depression, Ben Bernanke revealed in that one sentence a dismal lack of awareness about the potential for things economic to go badly awry when circumstances change. Despite Bernanke’s confidence in the market, US house prices would go on to decline precipitously, across the entire country.

While 1% of all American households were in some form of foreclosure during 2006, by early 2007, US national property prices and sales were experiencing their most dramatic fall since the 1989 Savings and Loan crisis. US Treasury Se...