Sunday, December 09, 2007

The perils of investment -

One of the pebbles I tossed into the pool the other day was the latest economic directive from GBW to give some relief to those affected by the sub-prime mortgage financing debacle in the US.

Well, it has been little different here in NZ. As far back as March, commentators were pointing to direct impact on the investment markets and the “supermarket variety” finance houses that were soliciting investments at that time.
A private equity failure is inevitable and one bad deal could be enough to wipe significant value off New Zealand markets, says leading investment manager Arcus.
Arcus - which manages $5 billion in New Zealanders' savings - says the local sharemarket's record highs were substantially driven by the prospect of merger and acquisition activity. If such a merger was to fail, this would create uncertainty and sharemarket volatility.
"It is inevitable that at some stage, a private equity company will encounter difficulties," the company said in its quarterly investment strategy update yesterday.

In the broader definition of “private equity company” – as investor of funds “on behalf of” – must be the finance company. These range from the company that provides mortgage funds to home-buyers to the kind of persistent advertisers on tv who will lend anyone money irrespective of financial status or ability to repay. As a point of comparison this is NZ’s version of the sub-prime market that has been somewhat shaky in the US of recent times starting with the Federal bailout of Freddie Mac and Fannie Mae.

Investors should be heartened by the performance of major finance companies over the past year, and the string of 13 failures in the sector over the last 18 months is a "purging in the process of a return to health," says KPMG.
The failures have to date, put close to $1.5 billion in New Zealanders' savings at risk, with the latest - Capital + Merchant Finance - placed in receivership last Thursday, after KPMG finished its report.
Boyce said while the aggregate results were solid the overall picture was one of "a continued slowdown in asset and earnings growth with the deterioration in credit quality measures suggesting the favourable credit environment enjoyed by the sector since 2000 has ended".
(Empahsis mine)

Now I think that $1.5 billion of private individuals’ savings is a fair amount in any books. It doesn’t quite rank with Enron, agreed, and there are 13 different and unrelated companies involved. But when you factor in that a government guarantee for that amount would cost $333 per person then the value starts to be significant.

As I have said in the item on IRD taking a gander into property trading as a taxable activity, all of those who lost money in these companies have made assumptions, listened to advice with their confirmation bias at full volume, or in the saddest cases been given plain wrong advice.

It is that last group that the regulators are rightfully concentrating on. The “financial adviser” who has a lucrative commission agreement with a finance house MUST be prepared to back his advice with a good share of the risk.

But the mere fact that someone might lose money from taking an investment risk does not in any way mean that the government should step in and guarantee that investment.
PRESIDENT George W. Bush has rolled out multiple measures aimed at preventing borrowers with sub-prime adjustable-rate mortgages from entering foreclosure, but he also blasted Congress for not doing more to help.

"There is no perfect solution," he said. "The home owners deserve our help. The steps I've outlined today are a sensible response to a serious challenge."

The plan seeks to combat a rising tide of foreclosures by making it easier for lenders to freeze the "starter" interest rate for certain borrowers for five years. The initiative includes an agreement, brokered by Bush administration officials, between the loan servicers who would administer a rate freeze and the investors to whom the mortgage debt has been sold.

The agreement sets conditions under which rates on certain loans could be temporarily frozen. It isn't binding, but because it hasthe support of major investors, it is expected to give loan servicers much more flexibility to quickly rework some loans and direct other borrowers toward refinancings.

Now let's just think for a moment what that means. The government is providing controls "...aimed at preventing borrowers with sub-prime adjustable-rate mortgages from entering foreclosure...". In other words, those making the investments are protected from the failure of the borrowers. So, it must be asked, who really benefits?

I submit that it is those who own and invest in the lenders.
Mr Bush said a rise in foreclosures would have a "negative" impact on the economy.

"Yet one reason for confidence is that the downturn in housing comes against the backdrop of solid fundamentals in other areas, including low inflation, a healthy job market, record-high exports," he said. But with close to 2 million sub-prime ARMs scheduled to reset higher by the end of 2009, Mr Bush said initiatives were needed to address such a broad potential problem.

and again -
The big sticking point in the negotiations was getting investors who had purchased the mortgages after they were bundled into securities to agree to accept lower interest payments. Critics have said that even with a deal, there are likely to be lawsuits. But officials representing major players in the mortgage industry said they believed the plan would withstand any legal challenges and would help at-risk home owners avoid defaulting on their mortgages.

...and crying all the way to the bank.

There is little difference here in NZ.

ONE of the major economic growth drivers of the past ten years started with the "get rich quick" seminars that were all the rage (and still are too judging by my mail) back then. "Protect your future by investing in the property market". Highly geared property purchases became all the rage. In the past three years or so 100% mortgages have become commonplace. My daughter and s-i-l have a house in Paraparaumu that they would not otherwise be able to afford.

There has been much talk in the past couple years of the "property market bubble", and when it was likely to "burst". Don't look now, folks but at the moment I think I would prefer to have my money in the bank. That raises the question of "Which one?"
CITIGROUP faces a crisis of investor confidence as one of the world's top ratings agencies warns that up to $US65 billion ($A73 billion) in debt issued by the world's biggest bank is at threat from the US subprime crisis.

Moody's Investors Service said at the weekend that it had either cut or was reviewing its evaluation on debt issued by structured investment vehicles (SIVs) controlled by Citigroup.

Essentially, SIV's are exactly the same as the investment vehicles used by the likes of Capital+Merchant Finance. I suspect that the PIE's being offered by the likes of Rabobank in NZ are little different.
Moody's said in a statement that it had observed "material declines in market value" across SIV holdings during a broad review of dozens of SIVs run by a number of banks.

Since November 7, Moody's has reviewed 20 SIVs worth about $US130 billion associated with various lenders. It has cut its rating on $US14 billion worth of debt, placed $US105 billion of debt on review for a downgrade, and confirmed the ratings on $US11 billion.

And are those scary numbers or what...

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