Monthly Archives: August 2009

28th August What will September bring

In the last couple of weeks the sense of growing euphoria in markets and the media almost defies belief. While there has been some sobering coverage to commemorate the run-up to the collapse of Lehman Brothers, it seems the rest of the World has forgotten what caused this economic crisis in the first place.

Rampant borrowing, disreputable selling practices of financial institutions and too complex “financial innovation” all contributed to the root causes of the Credit Crisis. Unless I have missed something, the policy responses of Governments and Central Banks have almost exclusively focused on hosing the system with money to try and solve the problems. Of course the fundamental contradiction of solving a debt-driven crisis with more debt has been overlooked, but worse than this little to no effort or attention has been made to restructure our economy.

There has been an obsession with returning to the way things were. But the problem is that the way things were was clearly unsustainable and undesirable. A large proportion of “economic growth” was little more than a credit driven boom.

I just cannot believe that the underlying issues have been fixed. Our society is engulfed by debt. Economic data is not yet positive, but is in fact less bad. More importantly the stimuli packages are yet to end. We will only be able to get a true view of the health of our economy once this latter support is pulled.

One thought struck me this morning. I cannot recall seeing or hearing a senior politician declare that the worst is over. Now it is perfectly possible I missed this over the summer, but I think the absence of such a declaration has to be an indicator that the establishment does not yet believe the bottom has been reached.

So how can I apply this view?

My Sterling trade worked very nicely a couple of weeks ago. I actually went long again versus the Dollar, when the price hit the 100 day moving average. This is only a short-term trade and I have not risked very much at all.

However it is in equities that I am most interested.

Equity indices have continued to stagger forward. However volume has been very light, apart from on the odd occasion in the last 6 weeks. This is not too surprising, given that it is the summer.

I am now looking to short the market. I would not be at all surprised to hear in the next month that more fiscal stimulus measures are required here and in the US. Remember that the US stimulus measures are due to end in September and the Bank of England has already used an additional £25billion of Quantitative Easing than originally budgeted for.

I am going to sell the FTSE100 and DJI this evening. Prices are at levels that should either see a reversal or provide support to the next stage of the rally. With this in mind I am going to apply quite tight stops.

13th August The FSA sounds its own death knell

I had a clear choice of two topics to choose from today. I could either have written about the latest comments from the Bank of England about the likely duration of the recession or alternatively I could have written about the laughable report from the FSA on bankers’ remuneration. As you can probably guess, dear reader, I am going to stick with the latter for today. The Bank of England can wait until tomorrow.

Yesterday the FSA announced their long awaited plans for reforming bankers’ remuneration.

The front page of today’s Times gave a damning verdict of the proposals. I couldn’t agree with this view more. Frankly the FSA have shirked their responsibility to us all and the sooner they are abolished the better. A sad, but all too common, feature of this Government’s policies has been the formation of toothless, expensive QUANGOs. In the case of the FSA their absolute failure is going to cost us a decade.

In an interview on Radio 4 Hector Sants, chief executive of the FSA, tried to argue the case that it is not the job of the country’s regulator to limit bankers’ pay, but was rather up to politicians. Apart from being total nonsense, this argument raises the question just what is the point of the FSA?

I don’t know why I thought this, but prior to the announcement I really hoped (expected?) that the new rules on City bonuses would bring an end to the culture of greed, which infected the financial system. This was foolishly naive.

Yet again the argument that the City will collapse and UK banking will become uncompetitive if bonuses are in any way limited has won the day. When we really think about this argument it is ridiculous. I can think of only one other industry (if I can even call it that) where it is claimed that to compete requires a hugely increased cost structure. I am talking about Premiership Football of course and let’s face it I don’t think that is a model for us to base our economy on.

Even a basic understanding of business and economics will tell you that to be competitive requires costs to be kept under control. Given that wages tend to account for the vast majority of a company’s costs it follows that wage control is an important aspect of running a successful, efficient business.

But not in the City apparently. City executives will maintain that this is because they would lose their talented staff to other companies in a so-called “flight of quality”. Again this is total rubbish. It was these same people who caused the greatest financial crash of the modern age. Had they not been bailed out, the majority would have lost their jobs. As events have unfolded they survived and went on to start paying huge salaries again with 9 months.

The myth that investment banking is the engine of economic growth is the Great Con of the last 100 years. The system has become so warped by greed that it now bears little relation to the true economy.

These bonuses will only be possible going forward thanks to the huge tax subsidies. While other strategically important industries go to the wall in our Country, City executives will continue to enjoy the high life at our expense. I just wish more people understood what is happening at the moment as this issue is at the heart of the troubles facing us and is something to get extremely angry about. It is such a shame that the absence of genuine widespread anger is creating the permissive environment where this Great Con is allowed to persist.

This is not just a problem in this country. You will remember I covered America’s plans for regulatory overhaul about two months ago. Under their proposed new system there will be seven regulators overseeing financial markets. Given that we only had three and they have not only made a total pig’s ear of regulatory enforcement but have also passed the buck to one another, do we really believe the US system will be that much better? I think not.

I have made this point before, but the future of banking surely will have to be based on more simplicity. The financial system has become so complex, unwieldy and disfigured that to try and solve the clear structural problems, which caused the Credit Crisis (and other crises before that), the answer is not to add to the complexity. Without clear boundaries of responsibility and, more importantly, accountability the next financial crisis is going to be so much worse.

7th August So what exactly is plan B?!

No sooner had I published yesterday’s blog, then I read an article that the Bank of England had voted to extend the Quantitative Easing programme from £150bn to £175bn.

I simply could not believe what I was reading. This is madness of the highest order.

After last month’s Monetary Policy Committee meeting the word was that the Bank was going to halt QE at £125bn. Now, four weeks later, we discover that they not only need to use the full allocation, but have actually extended it.

There can be know doubt that the people responsible for resolving this crisis have lost even the semblance of control. There clearly isn’t a plan for resolving the long-term structural issues our economy faces. The only response has been a series of knee jerk reactions, which it now looks like have compounded the underlying problems. By saddling us with this level of debt it is going to take an agenda of exceptionally radical reform to get us out of this mess.

Given the paucity of debate amongst the political parties on this issue, it doesn’t look like we are going to receive the leadership we desperately need from that quarter.

My fear is that things are going to get so bad as a result of what is happening now, that change is going to be forced on us in the most painful manner. This will not just be an issue of public sector spending cuts, but will also involve massive tax rises, reduced consumer spending, less innovation, decline in the national wealth and even the viability of Sterling will be called into question. The likelihood of an IMF bailout has to have increased as a result of yesterday.

While the sums involved might appear not to be that great, it is highly unlikely that the BoE is going to call a halt to QE at this level. How much more money they invent at the press of a button is anyone’s guess, but historical precedent is clear as to what happens when Central Banks magic money from thin air. Inflation, value destruction and substantial decline in living standards follow.

It will be interesting to read the minutes from this month’s MPC meeting. With Interest Rates at 0.5% there isn’t really any option to reduce them. Such an action would cause immediate comparisons with Japan in the early 1990′s and the “lost decade” which followed. This would also be tantamount to an official admission that QE hasn’t worked. While it is true that in requiring the extra £25bn they are effectively admitting the same, this point will be lost on the majority of people.

Unsurprisingly Sterling took a short-term hit yesterday. I should have been writing about US unemployment today, given the Payrolls number comes out in half an hour, but I will save this for the weekend, once the number is known.

I haven’t traded for a while, but I am going to short Sterling after the announcement.

6th August Our Phoney Economy

You really would be forgiven for thinking that the worst is behind us. Sterling has been powering ahead, the stock market is on the rise, buyers are apparently coming back into the property market and even beleaguered retailers have reported rising sales. If only the weather weren’t so awful this could be a summer to remember.

Or perhaps we are reliving our own version of the Phoney War. Between September 1939 and April 1940 things seemed fine in this country. OK so there was a scrape on the Continent, but the Navy was standing strong, the Graf Spee had been sunk and life on the home front had barely changed. The threat from Germany, while ever-present, had not manifested itself into anything tangible. Then in May 1940 the maelstrom was unleashed.

While it is true that we are not facing anything as cataclysmic now (i.e. the threat of bombers raining death from above), there are stark parallels between the level of denial this country seems prepared to immerse itself in, both then and now.

We simply cannot afford to wait until after a May/June 2010 election to start enacting the radical overhaul our economy desperately needs.

The encouragement markets are allegedly meant to be providing us with is starkly contradicted by the newsflow from other areas of the economy.

Apart from resolving the deficit and the reform ationof public sector spending, there are three main questions, which need to be answered;

  • What will happen when the fiscal stimulus comes to an end?
  • What will happen when interest rates go up?
  • What will happen as unemployment continues to increase?

Northern Rock’s results yesterday provide food for thought in respect to all three of the above.

I had a conversation recently, in which I was told that Northern Rock’s balance sheet was not as bad as had been claimed. Tuesday’s results belie this view. The 3.92% of its mortgages being 3 months in arrears versus the national average of 2.39% was particularly worrying, as this announcement came with no calming statement that this situation was showing any signs of improving.

It is no surprise that Northern Rock made a loss, while other banks have been making obscene profits. HSBC, Barclays and their American Investment Bank counterparts have been able to offset losses in their traditional income streams, through their speculative activity in money markets.

Northern Rock, however, remains a one-way bet on the housing market. This gives us something of an insight into the trouble still facing us and further reveals how little faith we should have in the profits of other banks. As I wrote recently, modern investment banking seems to have become completely divorced from the true economy. The longer this situation is allowed to remain, then the more severe the ultimate reckoning will be, but more of this another day….

Moving back to Northern Rock we should remember that a large proportion of this company’s business model pre-2007 was supplying the British equivalent of sub-prime loans. The fact that so many of these are already underwater is an indicator of more serious trouble in 2010 for the housing market. If unemployment continues to rise, as it surely must, then how long can it be before higher grade mortgage holders also start to suffer.

At the moment low interest rates and fiscal stimulus measures are preventing this from happening. However neither policy can go on indefinitely. There clearly isn’t a plan at senior levels as to what to do after these policies stop.

It increasingly looks like denial isn’t just a river running through Egypt, it also flows through the corridors of Westminster and Whitehall.