Bernard Whimp is NOT a leech -

Investors are being warned of a fresh round of "shocker" low-ball share offers from companies linked to trader Bernard Whimp.

TrustPower and DNZ Property Fund are warning shareholders off yesterday's unsolicited offers, which are being investigated by the Securities Commission.

In two-page letters, TrustPower and DNZ shareholders are being offered above-market prices for their shares but in the fine print are told they will be paid off over 10 years. They miss out on dividends that would be paid out over that time.

...

Carrington Securities LP - which bought 2.2 million shares off DNZ shareholders below market price last August, is targeting TrustPower shareholders this time. Energy Securities LP targeted seven large companies shortly after Christmas and is now writing to DNZ shareholders.

TrustPower spokesman Graeme Purches said the offer was a "shocker".

"The worst case scenario is he purchases shares worth $7.17 for $9.40, pays the first instalment of 92c, and then Carrington gets wound up leaving the sellers with the loss of $6.25 per share and no future income from those shares," he said.

I will be blunt.

Bernard Whimp is NOT a leech.

Bernard Whimp is a lamprey eel.

How the banking system works... 2

Courtesy of todays Sunday Star Times we have yet another example of the BSC (Banking System Crisis, or is it really BS Crisis?) and the kind of operation being run by many of the banking institutions.

AN ELDERLY grandmother with no known assets or income was lent $4 million by a mortgage fund company chaired by former prime minister Jim Bolger a transaction now under investigation by the Serious Fraud Office.

Mortgage documents obtained by the Sunday Star-Times show that Trustees Executors, a trust company chaired by Bolger, advanced $4m to Maria de Magalhaes, a 73-year-old Portuguese speaker originally from Mozambique, who was only in the country on a visitor's visa.

After explaining that the $4M loan is part of a total of $33M lent to a “property developer”, SST comes up with this very brief paragraph.

Sources dealing with the fallout of the saga say it raises serious questions about the lending practices of Trustee Executors. The money was part of the $242m Tower MortgagePlus fund, administered by Trustees Executors and frozen last April. More than 5000 investors had savings tied up in the "low-risk" fund, of which about 40% has been returned.

For more on the Tower saga, you can read up here, but the primary statements are –

Tower said the NZ$242 million TOWER Mortgage Plus fund, which is owned and issued by Trustees Executors, will shut after a surge in redemption requests and a jump in the proportion of mortgages in arrears to 9.1 per cent.

The Trustees Executors-owned 1st Mortgage Fund, branded TOWER Mortgage Plus, was being wound up, Tower Investments Chief Executive Sam Stubbs said. The fund lent on a diversified portfolio of residential and commercial first mortgages and was no longer relevant given heavy competition from banks, Stubbs said.

“Given heavy competition from banks”? Given that it seems over 13% of their total assets have gone down just one drain, I would hold little hope for a good part of the remainder.

But that is not the major point...

The bulk of the investments in the Fund (in TMP) were in the “low risk fund”. Let’s just think about that for a moment.

I have my super (401k equivalent) in a “cash and low risk” category. From that I expect to earn no more than about 3% nett of tax in a good year. On the other side of the ledger, I don’t expect to earn less than 1% nett of tax in a bad year.

It seems that if the same expectations apply to TMP, we can start with a mortgage interest rate of (say) 7%. Take out “expenses and administration” at 0.5% (not unreasonable for keeping a computer account straight). Take out tax at 35% and we get 4.5% ROI. So the bank is paying me 3% for their “good year”. Who is getting the other 1.5%??

The same calculation from a savings bank interest rate of 5% (not too high for a good year) we get a ROI of 3.2%; very much in line with the actual return.

So, there is a matter of Trust involved here.

Personally, I do not think that the investment policies of TMP and many of the other superannuation and unit investment funds have ever been any different. What is going to emerge from the ashes of TMP will be some very questionable investment decisions by all manner of people from Board on downward. Investment decisions that are all driven by the pursuit of personal wealth, rather than the benefit of the investors for whom they are purportedly supposed to be acting. High returns for the Company, means high bonuses at the end of the year....

And, I most sincerely hope, there will be some very high heads in many of the other "investment funds" who will losing significant amounts of sleep over the next few months until they are sure that their own patchs are cleaned and seemingly kosher. The shredders will be running...

A little deja vu

Drifting around the 'Net on a lazy Sunday... the good guys at ALDaily drop this one in my lap.

Funds worth trillions of dollars start to plummet in value. Political pressure to be “socially responsible” distorts the market decisions of government-related enterprises, leading to risky investments. Investors who once considered their retirements safely protectedwake up to a sinking feeling of uncertainty and gloom.

Sound like the great mortgage-fueled financial crisis of 2008? Sure. But it also describes a calamity likely to hit as soon as 2009. State, local, and private pension plans covering millions of government employees and union workers with “defined benefit” accounts are teetering on the brink of implosion, victims of both a sinking stock market and investment strategies influenced by political considerations.

Now it doesn't matter how hard I try, I can feel some sympathy for the "beneficiaries" of this.

In the early '80's I had been contributing to a defined benefit plan superannuation scheme for some 20 years. The tri-ennial audit* certification was about 5 years overdue. (There is a different name here that I can not for the life of me put a neurone to). Then - revelation!!! It was announced by the Government that the fund was not technically but literally broke.

It turned out the the last released tri-ennial audit had shown an adverse trend in contribution account values and current pension values. That trend had not been reported by the auditors.

It had reached the point where the fund was paying current pensions from current contributions and had been doing so for some while.

Overnight, I lost in excess of 1/3 of the total value of my personal account plus the right to the guaranteed benefits.

Currently, my super funds are all specified as "Cash and Savings only" for investment. Yes the returns have been crap - less than 2 1/2% per annum for the past five years. But if they show a loss for last and this year there is going to be several different kinds of hell being raised.

*The missing word was "actuarial". Silly me.

Deja vue?

Listed at ALD...

With those who yearn for "the old days" and the freedom of open markets is this little piece of history.

Fueled by easy credit, the real-estate market had been rising swiftly for some years. Members of Congress were determined to assure the continuation of that easy credit. Suddenly, the party came to a devastating halt. Defaults multiplied, banks began to fail. Soon the economic troubles spread beyond real estate. Depression stalked the land.

The year was 1836.

The nexus of excess speculation, political mischief, and financial disaster—the same tangle that led to our present economic crisis—has been long and deep. Its nature has changed over the years as Americans have endeavored, with varying success, to learn from the mistakes of the past. But it has always been there, and the commonalities from era to era are stark and stunning. Given the recurrence of these themes over the course of three centuries, there is every reason to believe that similar calamities will beset the system as long as human nature and human action play a role in the workings of markets.

Yes, Al, much of the cause can be sheeted home to "government interference". That as much as anything is my point.

The result was a credit crunch. Interest rates that had been at 7 percent a year rose to 2 and even 3 percent a month. Weaker, overextended banks began to fail. Bankruptcies spread. Even several state governments found they could not roll over their debts, forcing them into default. By April 1837, a month after Jackson left the presidency, the great New York diarist Philip Hone noted that “the immense fortunes which we heard so much about in the days of speculation have melted like the snows before an April sun.”

The longest depression in American history had set in. Recovery would not begin until 1843. In Charles Dickens’s A Christmas Carol, published that same year, Ebenezer Scrooge worries that a note payable to him in three days might be as worthless as “a mere United States security.”

All manner of good quotes -

Many people, especially liberal politicians, have blamed the disaster on the deregulation of the last 30 years. But they do so in order to avoid the blame’s falling where it should—squarely on their own shoulders. For the same politicians now loudly proclaiming that deregulation caused the problem are the ones who fought tooth and nail to prevent increased regulation of Fannie and Freddie—the source of so much political money, their mother’s milk.

and

Herbert Hoover famously remarked that “the trouble with capitalism is capitalists. They’re too greedy.” That is true. But another and equal trouble with capitalism is politicians. Like the rest of us, they are made of all-too-human clay and can be easily blinded to reality by naked self-interest, at a cost we are only now beginning to fathom.

The "Global Financial Meltdown" explained...

Full credit to yesterday's Business section of the Herald. They have given one of the most cogent, and hence rational, explanations of the liquidity crisis within the global (not just American) banking systems.

Included in the main article was this graphic which I have had to scan as it does not seem to appear anywhere on the digital version of the articles...


To fully understand, and to make it clear -

75% of global liquidity is made up of "Derivatives". The value of this portion of the pyramid is over 8 times the global GDP. The importance of this "top of the pyramid" will become apparent when we look at what it is made from.

13% is "Securitised Debt". The value of these "securitised debts" is just under 1.5 times the global GDP.

11% is made up of "Broad Money". The value of this part is just short of 1.25 times global GDP.

1% is in the form of "Power Money" - what you and I carry in our pockets.

So we can say, with a little simple addition, that the total global liquidity is somewhere in the vicinity of 10.8 times the total world income. How much of a worry should that be? At this stage I am far more worried about the top end of the pyramid.

What is that "top end"? The Herald graphic defines it was "Futures, options, swaps etc". Putting into my own words, this is the world of "financial products"; of units and risk and literally gambling with other people's (read thine and mine) money. I quoted Liam Dann at some length a whiles back here and concluded (my words) -

we are seeing what happens when the economy is run by snake-oil medicine men and itinerant side-show freaks.

So, 8 times the global income has been sunk into what is little more than betting slips that are owned and traded between the snake-oil medicine men. They end up back in the open market in forms such as the "Unit Share" of a superannuation fund. They are funded (as far as it is deemed neccessary) from the term deposits and savings accounts of the simple minded people who believe (in their naivete) that bank money is secure.

Read through Brian Gaynor's analysis in full. I want to quote just this piece -

Forty years ago there were almost no investment banks, securitised debt or derivatives. The huge increase in global liquidity and credit since the early 1980s has been almost exclusively driven by investment banks through the creation of securitised debt and derivatives, which now represent nearly 90 per cent of total liquidity.

At the beginning of the year there were five major US investment banks - Goldman Sachs, with assets of US$1061 billion (or US$1.06 trillion), Morgan Stanley US$1045 billion, Merrill Lynch US$1020 billion, Lehman Brothers US$689 billion and Bear Stearns US$424 billion.

Bear Stearns and Lehman Brothers have disappeared and Merrill Lynch is being taken over by Bank of America. These companies created a huge amount of toxic securitised debt and derivatives that have plunged in value.

The conversion of the two remaining investment banks, Goldman Sachs and Morgan Stanley, into bank holding companies is significant for a number of reasons:

* As commercial banks they will be subject to regulation whereas they were almost totally unregulated as investment banks

* Their lending capabilities will be severely restricted because commercial banks have strict capital adequacy requirements. Morgan Stanley's debt to equity ratio is 30:1 and Goldman Sachs 22:1 whereas banks are generally restricted to no more than 15:1.

Now that kind of difference is the stuff that makes my blood run cold. Morgan Stanley (to take that example) has borrowed 30 times its owner equity to fund financial market operations that are no more than betting slips that they hope to validate by winning the battle to influence the value of currencies, the value of future contracts.

This is not Capitalism 101, nor is it Capitalism 201.

This is Master Degree stuff; the kind of Capitalism that was never dreamed of by the likes of Friedman, or the early designers of the principles. It is Capitalism as was never dreamed of by the politicians of the US, or any other country.

___________________________________________________

In another article, the Herald records the demise of WaMu - Washigton Mutual - in "the largest failure ever of an American bank".

The Government measures bank failures by an institution's assets; Seattle-based WaMu has roughly US$310 billion in assets.

The previous record was the failure of Continental Illinois National Bank in 1984, with US$40 billion in assets when it closed. IndyMac, seized in July, had US$32 billion.

WaMu was searching for a lifeline after piling up billions of dollars in losses because of failed mortgages. WaMu has seen its stock price plummet by 87 per cent this year, and it suffered a ratings downgrade by Standard & Poor's earlier this week that put it in danger of collapse.

The Bush Administration's proposal for a US$700 billion bailout for distressed financial institutions was believed to have given fresh impetus to a buyout and new allure to Washington Mutual. Besides JPMorgan Chase, Wells Fargo, Citigroup, HSBC, Spain's Banco Santander and Toronto-Dominion Bank of Canada were all mentioned as possible suitors. WaMu was also believed to be talking to private equity firms.

The FDIC was seeking a buyer willing to bear a large burden of WaMu's losses, to lessen the impact on the insurance fund.

In a statement, JPMorgan Chase said it was not acquiring any senior unsecured debt, subordinated debt, and preferred stock of Washington Mutual's banks, or any assets or liabilities of the holding company, Washington Mutual Inc.

JPMorgan Chase's chief executive, Jamie Dimon said in a conference call, the "only negative" related to the deal was "how to handle some of these bad assets". He did not elaborate.

WaMu had "$310 billion in assets". Right. What kind of "assets"? The article says "billions of dollars in losses because of failed mortgages". Well there goes some of the assets. How much was "owned" and recorded as "assets" in derivatives? My guess somewhat more than the thus far "failed mortgages". If I were a betting man, I would accept even odds that WaMu has 6 times the value of its total mortgage portfolio in the form of derivatives. If 50% of the mortgages failed, that means that likely 16 times that value is held in derivatives.

Little wonder that JP Morgan Chase is quoted as saying -

In a statement, JPMorgan Chase said it was not acquiring any senior unsecured debt, subordinated debt, and preferred stock of Washington Mutual's banks, or any assets or liabilities of the holding company, Washington Mutual Inc.

JPMorgan Chase's chief executive, Jamie Dimon said in a conference call, the "only negative" related to the deal was "how to handle some of these bad assets". He did not elaborate.

A weekend roundup...

The weekend started with Herald running a series of articles on the probablility of a "dirty election". Not that the election might be won fraudulently (in the direct sense) but the emergence of the "dirty trick brigades". Think, if you are American, of the SWIFT boat saga in the last elections or Richard Nixon and Watergate for extreme parallels.

Rochelle Rees' background with the Labour Party was revealed by bloggers yesterday after news stories she was behind a ploy to ensure Mr Key's website link was the first to appear when people searched for "clueless" on Google.

Yesterday, National leader John Key said it was another example of petty attacks on him by Labour.

Link to the Labour Party or not is not the issue here. The real issue is the denigration of the electoral process.

The second theme was run by the business pages of Sunday Star Times. The headline "Gluttons Table Set by Central Banks" was a good hook to a Gareth Morgan analysis of the weeks' crises in the international finance markets.

If you think that global financial "crises" seem to be happening with increasing frequency, congratulations - you're right.
...
It was back in 1996 that Fed chairman Alan Greenspan, who was really at the centre of the liquidity flood, declared the sharemarket was suffering from "irrational exuberance".

The market ignored his warning and it wasn't till two years later, in 1998, that it suffered its first setback. When hedge fund manager Long Term Capital made some wrong bets and was staring down the barrel at bankruptcy, the US central bank decided this institution was too big to fail and organised a consortium of investment banks to absorb its assets.

The Long Term Capital episode was the first big indication that the financial system was getting sick. If a single institution that was only four years old was too big to fail without bringing the US financial system down, then something was wrong with the system. But it would get worse.

Nice to have the 20/20 now, but let's follow a bit further...

Oh oh! Here's the problem. Central banks, and the Fed in particular, have become so addicted to the need for economic growth each year that they have sacrificed a tenet of sound central banking. It seems they no longer care whether lending by banking is within prudential bounds.

Indeed, it is their effective prudential supervision that they have sacrificed at the altar of this newfound, but ultimately false, belief - that you can have continual economic growth and low inflation. This shows a surreal confidence in the private sector's ability to constantly deliver sufficient productivity gains so that inflation isn't an issue, plus deliver more income to everyone in the economy year after year.

Not covered here, but a strong echo of the 1929 crash - which was fuelled in part by the fervor for stock - any stock - as long as it earned more than the money borrowed to buy it.
Also in the same section this morning was this news item.

Now I spoke of "derivative trading" in my last bit on the subject.

In the past two weeks billions of dollars have vanished as the shares in Australia's Macquarie Group have fallen 45 percent, America's Morgan Stanley 47%, Goldman Sachs, 35 percent.

Their plummeting stocks appear to be following other financial giants into the abyss, as Bear Stearns, Lehman Brothers, Merrill Lynch and HBOS suffered such meltdowns they were forced to sell to rivals.

Bear, which hit trouble in March, was acquired by JP Morgan Chase in May. Lehman filed for bankruptcy protection on Monday and its core businesses were acquired by British bank Barclays the following day. Merrill Lynch is now owned by Bank of America after watching its shares dive 38% in less than a week. HBOS went to fellow British bank Lloyds TSB on Thursday after its shares fell 40% in a matter of days.

The screaming headlines say these institutions were victims of a financial meltdown as their dangerous punts on speculative debts turned septic.

There's another story and it's not pretty either.

Sydney-based Macquarie Group believes it is the victim of a concerted campaign to manipulate its share price and Australia's market regulator has started an inquiry into allegations that short-sellers who profit from falling shares are spreading false rumours.

Now hang on a sec!! What's this? Spreading false rumours to create loss in value on specific stocks?

An inquiry immediately announced by the Australian Securities & Investments Commission was echoed by New York attorney-general Mario Cuomo, who announced on Thursday a probe into possible illegal short selling in financial stocks.

"This investigation will not only encompass short-selling of Lehman Brothers and AIG but also short-selling in other companies that may be occurring, like Morgan Stanley and Goldman Sachs," he said.

In Australia, short-sellers are required to report their positions to the stock exchange daily. "Clearly some haven't been doing that," said one market source.

OK, so what is "short selling"?

TO "short sell" you first borrow someone else's stock. You sell it on the open market. You then wait for the value of that stock to fall. Then you buy back the same stock - at hopefully a considerable gain. The apparent risk is that the stock does not fall - which is where the dirty tricks brigade come in to play.

But, it gets worse -

In practice, in Australia only "naked" short sales are being reported to the exchange - these are deals where the short seller has not yet borrowed stock. A legal ambiguity means "covered" shorting, where the seller has borrowed shares, is not reported to the ASX. As a result, no one knows how big those positions are.

Say WHAT? Selling stock you don't own, or haven't even borrowed yet?

Executives at Bear Stearns believe they were the victims of just such a calculated attack by short sellers. In a detailed exploration of the fall of Bear published last month, Vanity Fair journalist Bryan Burrough uncovered signs of deliberate efforts to undermine confidence in the firm.

He quotes a senior executive at a rival firm: "If I had to pick the biggest financial crime ever perpetuated, I would say, Bear Stearns."

Proving someone was behind the Bear collapse, or any other share price death spiral, is tough. The firms that are targeted are vulnerable precisely because they are highly leveraged and it may be easy for a short seller to point to evidence supporting their negative view of a stock.

You betcha it would be. Super tough.

The article concludes -

CRACKDOWN

UNITED STATES: September 18 - New York attorney-general Mario Cuomo announces probe into alleged illegal short selling of shares in giant investment banks Lehman Brothers, Goldman Sachs, Morgan Stanley and insurer AIG. Short selling is a share trading strategy where a trader borrows shares and sells them on market in the hope they can be bought back more cheaply later. September 17 - Securities & Exchange Commission bans "naked" short selling, in which traders sell stock without first arranging to borrow it.

UNITED KINGDOM: September 18 - The Financial Services Authority bans all short selling in financial companies until January 16. It said anyone creating a net short position in a financial sector company is "engaging in behaviour that is market abuse [misleading behaviour]."

AUSTRALIA: September 17 - Australian Securities & Investments Commission announces extension of inquiry into market manipulation and false rumours, citing specific alleged false rumours against Macquarie Group.

Anyone hearing stable doors being slammed on empty stalls?

And Roundup? Very popular here in the agricultural community for some years. There was a bit I caught during the the week on the use of glyphosphate on roses imported from India to stop their propagation in this country, and just how easy it was to do just that.

Inflating thoughts on economy...

I posted this on Dave Justus' thoughts on McCain and the economy -

… and as yet not one commentator (that I have heard or read) has pointed out the long term effect of these multi-billion bail-outs.

Not that anyone wants to know, but until those funds are retrieved the rate of inflation is going to increase. How do I define inflation? It is the decline in the buying power of the dollar; my dollar, US dollar, Aus dollar, British pound whatever.

How can the handouts be retrieved? Well economically it is quite simple, but politically it is very difficult.

You can regain the hand-outs from the direct beneficiaries in exactly the same way as any other loan. The difficulty is that this will impact directly the amount of money available for lending - ostensibly to businesses to make new business but just as likely to the worker down the road so that he can buy that $5000 flat screen tv… The effect is a slow burn on the fuse that the handouts tried to extinguish.

You can regain repayment of the handouts (let’s be honest, that is what they are) by balancing the government’s fiscal budget. To achieve that requires two very bitter political pills - either a cut in government expenditure, or an increase in taxes.

Now, where do Mr McCain and Mr Obama stand on those two matters? I doubt that either will ever say the truth - it would be political suicide.

I have repeated it here because there are thoughts in that which do not apply solely to the McCain (or Obama for that matter) political approach.

Dave and I had a good discussion on the line of thought here with Dave concluding that I was "talking of micro-economic effects".

I did, and still, disagree with him on that point.

In any capitalist (no, make that ANY) economy, the fundamental drivers are the people; he tangata, he tangata, he tangata! Without people to buy goods, what would the economy comprise? Robot driven factories producing very cheap widgets with no one to buy them?

The point is, anything that impacts upon the disposable income of the ordinary Joe has an immediate effect on the economy. That, for one reason, should give great favour to tax cuts from the political wing. There are other counter-vailing impacts from that direction which are not politically acceptable - and so it goes.

What makes me so hot about the likes of these political bailouts is not the use of tax-payers money, or the cause of the bailout.

Effectively, there has been some $180 billion (globally, so I am not nit-picking America here) injected into the money markets. We could rattle off all of the immediate impacts that justify the move. We could prattle all of the political rationale from here to the bank and back.

I have already lived through a period where the international monetary system got itself out of whack. It led to the agreement to drop the gold standard. Most importantly it created an international climate of inflation that ran for some eight or ten years from about 1972. In NZ, we had inflation then "stagflation" (which had nothing to do with the genesis of the deer farming industry) of up to 18% p.a., averaging about 10.5% over the period as I recall the numbers.

What did that mean to me?

Well, my income increase by about 300%. Prices for everything increased by 300%. I was no worse off, right?

WRONG!!!

The $1,000 I had in savings is now worth something like $300 in "old money".

That is the effect of these "rescue packages" that the politicans are not going to tell you.

Someone is going to pay.

That someone is you and me.

On the principles of greed...

The first rumbles were back in May 2005, prompting the probligo to put this out.

Now at that time, and the reason for selecting “Four Prominent Bastards”, the big fear back then was the impact of Freddie Mac (yes I mis-typed “Mae” at the end) on the investment community, and the likelihood of the collapse of both Freddie and Fannie.

Then in December last it was raised again, following the Bush “rescue plan”.

Now as I understand it, the idea of the rescue plan was to “support” those who were in danger of default on their loan, with the intent of protecting the investments made to Freddie Mac and Fannie Mae.

But in fact, the malaise runs much deeper, as can be seen in this country.

In the increasing “investment products” of recent times come the “Portfolio Investment Entity” (PIE). Now these little sweeties for the hopeful rich are the product of a tax law change effective 1 October last year. Essentially they differ from the more traditional Unit Investment Funds in that the capital gain in a PIE is not taxed, whereas the capital gain is a fundamental of the UIF and hence is taxable as “income”. From Herald –

What is PIE?
A PIE (Portfolio Investment Entity) is a tax effective managed fund. They range from "on-call" cash management accounts to funds that invest in assets such as fixed interest, property and shares. PIEs do not tax capital gains on New Zealand and most Australian shares (as is the case with conventional managed funds), and tax on income from New Zealand dividends and cash investments is capped at 33 per cent (falling to 30 per cent on 1 April), or 19.5 per cent if that is your marginal tax rate.
This means that by investing in a PIE, effectively investors receive more interest. If a return of 10 per cent is taxed at 39 per cent, the tax-paid return is 6.1 per cent. If that same return is taxed at 33 per cent, the tax paid return is 6.7 per cent.

So, what is the connect between Freddie, Fannie and PIE? In very large part it is the nature of the backing investment for the deposit to the fund. I invest $100k in a PIE at 9% interest. The PIE invests my money in suitable securities that will cover the 9% interest plus a suitable “administrative income” (which I would pay as part of the cost of belonging to the UIF). So, it has led to promotions like the following –

What is it called and what sort of savings product is it?
UDC Finance's Term Maximiser Fund is a managed fund under the new portfolio investment entity (PIE) tax rules.

What is the company behind it?
UDC is a subsidiary of the ANZ National Bank. It is New Zealand's largest finance company, and lends solely on plant and machinery.

Who is the target market?
UDC says it suits people in retirement, nearing retirement or saving for a particular goal.

What return does it offer?
Its opening rate is 9 per cent annually, with interest paid quarterly. For investors on a 39 per cent marginal tax rate, this is the equivalent of 10.68 per cent under the PIE regime.

...and so on

How strong a stomach do you need for it?
Mild. This term fund doesn't have a Standard & Poor's rating. However it invests in UDC's debentures, which have an investment grade AA rating from Standard & Poor's.

OK!! Now that really is interesting; for this reason. I found this Mary Holm column dating from 2003 while looking for (confirmation bias warning) the line of connection between the various elements that need to be covered.

Q. Re borrowing at 6.1 per cent and investing at 8.28 per cent - interesting opinion from you in last week's column, in that you seem to be advising us to pay scant attention to 23 of the Herald's 24 investment adverts!

However, Mary, please don't resign on principle, as we always enjoy your words of wisdom.

On a more serious note, we would appreciate your comments on our approach to offerings with G6 ratings.

We're in our late 70s, with well over half a million in savings etc.

About 50 per cent is in Kiwi Bonds, 40 per cent is in the main banks, and 10 per cent is in G6-type investments.

Those include $50,000 in capital secured deposits with Capital & Merchant, covered by Lloyds of London Mortgage Indemnity and Mortgage Impairment Insurance Policies.

We two antiques hope you will advise us. Stay young!


A. I'm trying to. But then I get letters like yours that seem to imply that I should write with half an eye on the advertisers. That's enough to age any journo! Seriously, though - and not because of any pressure from anyone - I'm not dismissing investment in higher-interest products.

But they are considerably riskier than banks. Go in with eyes open.

For the benefit of those who don't know what a G6 rating is, Bondwatch is a service which rates finance company investments - from G1, safest, to G8, riskiest.

Of a G6 rating, Bondwatch says: "Ability to meet current obligations dependent upon favourable economic and/or business conditions. Concerns about security over the longer term."

I should add, though, that your Capital & Merchant capital secured deposits pay lower interest than the "investment deposits" discussed last week. So they are almost certainly somewhat safer.
...

As I said last week, I know little about the company. But I wouldn't put that much in any single company of that type.

Sure, the wording about Lloyds, insurance and so on sounds comforting. But I don't know what it means. Do you?

Too often, when things have gone wrong with similar investments in the past, words like that - along with "secured" and "guaranteed" - didn't amount to much.

Sage advice, especially when lined up against the findings of the various Receivers and Liquidators appointed to the failures in the “investment industry”.

But the link I wanted is proving elusive. At least one of the failed investment companies was in fact fronting for another, parent company, and the investments of the funds received were almost exclusively in that parent company. The specific example I was seeking was a company seeking investments in NZ, offering interest at 8% interest plus. The investments were passed to the parent, an Australian property development company which had several times (as I hear it) been running very close to the wind with marginal developments in Queensland and NSW. The Receiver, appointed during last year, has announced that investors will get back only 40% of their investments and likely less than that.

Now the link between Mary Holm’s article, failed investment companies, through to Freddie Mac and Fanny Mae, and finally to PIEs is the nature of the backing investment to my money. Go back to the Herald article that defines PIE and you will see that they are “funds that invest in assets such as fixed interest, property and shares.” And the question has to be asked “What fixed interest, property and shares?” In the case of Freddie Mac and Fannie Mae it is becoming clear that they were being regarded as lenders of last resort; they picked up loans which no one else was prepared to take on board, but which had in some way (second, third and fourth mortgages perhaps?) been secured against property.

At this point one has to wonder just what manner of need or desire would have prompted a person to take out secured borrowing against their property. Was it for the initial property purchase? Or was taken out subequently as security for the purchase of a car, or boat, or holiday? Even worse, was the secured borrowing taken as a margin investment in an opportunity that offered a higher rate of return; borrow at 8% and invest at 10%.

So, a bank holds a “fixed interest” paper with the property as security in the form of a second or third mortgage. The true property value might cover 105% of the first mortgage. What a risk if the second mortgage defaults! Particularly if the second mortgage is for 20% of the property value! The borrower might well be able to cover the repayment at present but come two or three years’ time things can change dramatically. So the bank hedges its risk by selling the mortgage paper to one of its personal investment arms – the PIE system – or Freddie or Fanny.

Without belabouring that any further, there is another solution. Perhaps the loss from the failed “investment” should head in the other direction; not to the mum and dad investor at the bottom of the PIE, but to the originator of the investment paper, the ones who (please pardon the pun here) are holding the crust.

If a bank, or finance house, has made a bad investment that is where the risk should return. It should not (as has been the case thus far) be the mum and dad investors who have been (quite unknowingly) sold a PIEce of worthless paper.

If a retailer has sold a $5000 plasma screen to a family with an annual income of $30,000 then it is that retailer who accepts the loss when the HP falls over. That gives the retailer some specific rights, and he also takes the very specific risk of the failure. If the HP is factored to a finance house, that is done most oftenly “with recourse”.

I will leave that thought hanging. It gives good indication of the failings I see in Freddie and Fannie. It gives a good lead to what I see as the solution for their failing. From Forbes –

NEW YORK (Thomson Financial) - U.S. stocks fell further Friday after U.S. Treasury Secretary Henry Paulson indicated that a bailout of troubled mortgage giants Fannie Mae and Freddie Mac was not on the horizon.

...

'Today, our primary focus is supporting Fannie Mae and Freddie Mac in their current form as they carry out their important mission,' Paulson said in a written statement. 'We appreciate Congress' important efforts to complete legislation that will help promote confidence in these companies.'

Fannie Mae was last down 43% at $7.55 and Freddie Mac was shedding 47% at $4.27, paring earlier losses to $6.68 and to $3.89, respectively.

And in the matter of "greed", Al the Old Whig I think it was put out the idea some while back that "greed is good". Al, I agree. But at some point one has to accept the inevitable bout of indigestion.

Oh DEAR!! How sad...

...never mind.

Amongst all of the bad news stories over the past few months for local investors comes this little piece –

The country's top 1000 property speculators are being targeted in an Inland Revenue crackdown on unpaid taxes.
As part of the campaign, IRD staff are visiting real estate agents with warnings that sales and purchase information would have to be disclosed if requested.

In this year's budget, the IRD got an extra $14.6 million to target tax evasion in the property market.

A Wellington real estate firm, which declined to be named, said it was dismayed that a recent IRD visit warned of possible sales and purchase auditing.

"At the end of the day it shows they can come in here and do anything," an agent said.
IRD assurance group manager Martin Scott said its visits to real estate offices included a presentation on the obligations involved in property transactions.

The 1000 people identified with extremely high numbers of property transactions would be contacted to see if they would make "voluntary disclosures" about their tax returns.

"Some people have a belief you don't have to pay taxes on housing profits but depending on the purchaser's intent it could be taxable."

He declined to say how IRD identified property profiteers but said it used audit powers that required "third parties" such as real estate agents to disclose information about their clients.

"Yes, we do have powers to request information but at this stage these visits [to agents] are more about where we are going and what to expect from us. We would give them [agents] scenarios on what we would consider taxable and what we wouldn't."

By making voluntary disclosures people could limit or avoid penalties, Scott said.
"We are not trying to trap people. We are working to ensure that people have the information they need to do the right thing."

It is not as if the action was being taken without warning. The start came from the last Budget, with some $14 million being set aside for the purpose. It is not as if there has been any retrospective law change; the tax law being used has been largely unchanged since I did the tax law part of my professional qualifications in 1980.

Interesting too that the real estate boys are crying “Foul!”. I suspect that a good number of them will be among the people who will be getting “please explain” letters from IRD. The “invasion of privacy” argument is a total crock. All of the property transactions are a matter of public record through LINZ. It would not be difficult (or expensive) for IRD to tap into that source of information.

Essentially, the tax law distinguishes between trading as a business (which is subject to the tax laws) and the level of “trading” that a person might undertake in the normal course of living. There have been similar “attacks” from time to time in the past. First to come to mind is the people who were trading in motor vehicles; the guys who might buy a car from the local car fair in Paeroa and then sell at a profit the following weekend in Auckland. Good business, but that is what it is. It is not a hobby.

What the IRD is saying, what the law has always said, is that trading through perhaps four or five properties in a year and living in none of them is not necessarily a hobby or incidental transactions. There might even be no “intent” (as Rodney describes it). The fact that there has been both volume of trading and profit made is sufficient for IRD to get interested.

So Rodney Hide is quite wrong when he says, "The IRD has come up with new and novel ideas that have just tipped people over.” Rodney, there are a lot of people out there who have made assumptions, listened to advice with their confirmation bias at full volume, or in the saddest cases been given plain wrong advice. Some of those people might even be the mates who are getting in your ear.

UPDATE -

And just to add to their woes...

A mini-boom is about to hit the property market, giving buyers a chance to bag bargains and make money as the market corrects.

That's the advice from Martin Evans, president of the New Zealand Property Investors Federation.

And, according to test-cricketer-turned-mortgage-broker Adam Parore, more deals are likely to come on to the market as homeowners, who have enjoyed low fixed rates for years, have to contend with the current high interest rates.

The Herald on Sunday's search of Trade Me's property website found dozens of properties already going below valuation.

Evans said: "The values have dropped and people are becoming more realistic. The cycle has gone over the top and is on its way back down again."

Interpretation -

Now that the market has topped, I want out and I want to sell to you so that you cop the loss instead of me.