Apologies for another posting on short selling, but it has become a bit of a preoccupation for the media, regardless of whether they understand it or not. These are just a few things I've picked up on in the last few days.
* The publicly-traded hedge fund manager MAN Group has asked to be added to the FSA's list of financial sector companies whose stock can't be sold short. You can dish it out but you can't take it, eh guys? You'd think they'd know how to cope with hard times anyway -- MAN's predecesssor company, ED & F Man, was founded in the eighteenth century as a commodities trading house. They've seen a few crises come and go in that time.
* Hedgies on both sides of the Atlantic are crying foul over the short selling ban, and they've got an advocate on the editorial pages of the Times. Oliver Kamm, one of the paper's leader writers, is an ex-hedgie himself, and he broke cover this week to explain why short selling is a good thing.
I have to say, some of his arguments were a bit short of compelling. Kamm claims that short selling draws market attention to badly-run companies, and thus allows capital to be moved into more productive uses. This "whistleblowing" argument in favour of short selling makes me pretty queasy. It seems as if the short sellers are claiming to be like the kid at school who constantly gets his classmates into trouble by ratting them out to the teacher. Nobody likes that kid, and nobody much likes the short sellers either. In any case, I can't see much current evidence that short selling is abetting the efficient allocation of capital. Lending has dried up regardless of how productive the use for the funds might be.
Kamm also said that more short selling might have prevented Northern Rock's unstable business model from falling apart to the point where the bank needed a massive public sector bailout. Hang on though: there were no restrictions on short selling when the Rock was getting into trouble, so the only lesson I can draw from this example is that short selling doesn't work in the way that Kamm claims it does.
* Lastly, a nod to good old Anatole Kaletsky, who has written two intemperate rants this week blaming the whole mess on Hank Paulson! What an imbecile! (Kaletsky, not Paulson, though I guess the jury's still out on poor old Hank). Suppose a guy goes out and gets drunk, then crashes his car into a lamp-post on the way home. If he then dies in the ambulance on the way to hospital, I guess Kaletsky will want to charge the paramedics with murder.
By the way, I have sent so many comments on Kaletsky's drivel to the Times website that they seem to have set their mail filter to prevent my comments from ever seeing the light of day. Bit of a badge of honour, that.
Thursday, 25 September 2008
Monday, 22 September 2008
The worst sentence ever written?
Sports reporters are rarely good writers. The older ones seem to be the worst, and the more senior ones who can insist that their stuff be published without editing are the worst of all.
James Lawton of the Independent is one of these. His prose is often excruciating. Even by his standards, though, this sentence from today's column on the Ryder Cup is a doozy:
"Also, and you could see it plainly enough when Faldo embraced him after he had won his fourth straight point in the cause that had looked to be lost the moment Garcia could not disguise the fact he had no answer to the power and the authority of young Anthony Kim in the opening singles match, that here was, for the foreseeable future, probably the most dynamic candidate to lead a European drive to regain some of their old competitive edge in South Wales in two years' time."
Words fail me, but not nearly as much as they seem to fail James Lawton.
James Lawton of the Independent is one of these. His prose is often excruciating. Even by his standards, though, this sentence from today's column on the Ryder Cup is a doozy:
"Also, and you could see it plainly enough when Faldo embraced him after he had won his fourth straight point in the cause that had looked to be lost the moment Garcia could not disguise the fact he had no answer to the power and the authority of young Anthony Kim in the opening singles match, that here was, for the foreseeable future, probably the most dynamic candidate to lead a European drive to regain some of their old competitive edge in South Wales in two years' time."
Words fail me, but not nearly as much as they seem to fail James Lawton.
Friday, 19 September 2008
OK Sarah, tell me about short selling
Sarah Vine has a column in today's Times suggesting that the financial sector would be a lot more stable if there were more women in senior positions in the City. To illustrate her point, she talks about going to a mortgage broker (with her husband, Michael Gove, who is a member of the Tory shadow cabinet) to arrange a mortgage. The broker recommended a deal with HBOS, and according to Sarah, she was the only one who thought to ask what would happen if HBOS got into trouble. Seemingly the broker poured scorn on the very suggestion.
That broker may not seem so smart now, although I don't suppose there are many people out there who can say that they saw the demise of HBOS coming. But more to the point, how exactly does this story show that Sarah Vine is smart? She wasn't planning on putting money into the bank, she was trying to arrange a loan. Does she think that all those people lined up outside Northern Rock branches this time last year were distraught borrowers looking to repay their loans?
If I knew for sure that a bank was getting into trouble, and if I were that sort of person -- which thank the Lord I'm not, sir, and I'm sure Sarah Vine isn't either -- I'd try to hit it up for the biggest loan I could wangle. After all, once the crisis hit, it might take the bank a good long time to come after me for the money. Judging by the soaring delinquency rates at Northern Rock, quite a few people are thinking in those terms.
So Sarah, you may well have a point about women in the City, but I'm not sure your own experience goes very far to prove it. Still, never mind, maybe you can help me to understand something about short selling that still puzzles me, even after all my years in the financial sector.
Short sellers are being widely blamed for the demise of HBOS and Lehman and for the pressure that Morgan Stanley finds itself facing. Short selling has been around for a long time and its defenders claim that it adds to market efficiency and liquidity. I'm not sure about that, but I do know that it's always blamed when financial crises hit, and regulators regularly ban it, only to relent and allow it again once markets stabilise.
You can't just go into the market and sell a stock that you don't own. You have to go out and borrow it first, from a pension fund or some other long-term investor. You pay them a small fee for the shares and hope that by the time the borrowed stock has to be returned, the price has gone down and you can repurchase it ("cover your short") at a lower price, allowing you to pocket a nice profit.
Here's the part that puzzles me. Why would a long-term investor lend stock to a short seller? You'd know the only reason they're borrowing it is to drive down the price of your asset, so why on earth would you help them out? If I came to you and offered you £100 to borrow your car for a day, but told you I was planning to write it off, you wouldn't lend it to me, would you? I'm sure Sarah Vine would agree with me on that one.
That broker may not seem so smart now, although I don't suppose there are many people out there who can say that they saw the demise of HBOS coming. But more to the point, how exactly does this story show that Sarah Vine is smart? She wasn't planning on putting money into the bank, she was trying to arrange a loan. Does she think that all those people lined up outside Northern Rock branches this time last year were distraught borrowers looking to repay their loans?
If I knew for sure that a bank was getting into trouble, and if I were that sort of person -- which thank the Lord I'm not, sir, and I'm sure Sarah Vine isn't either -- I'd try to hit it up for the biggest loan I could wangle. After all, once the crisis hit, it might take the bank a good long time to come after me for the money. Judging by the soaring delinquency rates at Northern Rock, quite a few people are thinking in those terms.
So Sarah, you may well have a point about women in the City, but I'm not sure your own experience goes very far to prove it. Still, never mind, maybe you can help me to understand something about short selling that still puzzles me, even after all my years in the financial sector.
Short sellers are being widely blamed for the demise of HBOS and Lehman and for the pressure that Morgan Stanley finds itself facing. Short selling has been around for a long time and its defenders claim that it adds to market efficiency and liquidity. I'm not sure about that, but I do know that it's always blamed when financial crises hit, and regulators regularly ban it, only to relent and allow it again once markets stabilise.
You can't just go into the market and sell a stock that you don't own. You have to go out and borrow it first, from a pension fund or some other long-term investor. You pay them a small fee for the shares and hope that by the time the borrowed stock has to be returned, the price has gone down and you can repurchase it ("cover your short") at a lower price, allowing you to pocket a nice profit.
Here's the part that puzzles me. Why would a long-term investor lend stock to a short seller? You'd know the only reason they're borrowing it is to drive down the price of your asset, so why on earth would you help them out? If I came to you and offered you £100 to borrow your car for a day, but told you I was planning to write it off, you wouldn't lend it to me, would you? I'm sure Sarah Vine would agree with me on that one.
Wednesday, 17 September 2008
In Lehman's terms
Most people have reacted to the collapse of Lehman brothers, demise of Merrill Lynch, nationalisation of AIG and so on in predictable ways. George Bush and John Paulson say the US financial system is sound and flexible; in an editorial today, the Times says it all proves that markets are working; the head of the TUC is calling for the Government to do something to help the "ordinary" victims. And Sir Simon Jenkins has produced the most thoughtful piece I've come across so far, in the Guardian.
Just about everyone is blaming the crisis on the decline in the US housing market. That's true as far as it goes, but it doesn't go nearly far enough. The US housing market has fallen apart because it was wildly overinflated in the first place, and that's largely down to an abject failure of US monetary policy during the Greenspan years. I've written enough (or more than that) about this in the past, but in essence Greenspan presided over a period of exceptionally low interest rates and rapid money supply growth. Thanks to the entirely coincidental expansion in the supply of cheap goods from China and elsewhere, this did not trigger the rise in consumer prices that would normally have been expected. Greenspan appears genuinely to have believed that the credit for the low inflation era belonged to him, so instead of being cautious, he just kept pumpimg up the volume.
All this cheap and abundant money had to go somewhere, and it went into assets. So stock prices and house prices began to rise, not just in the US but all around the world. Greenspan never seemed to see this as a problem. Although he once spooked the markets by talking about "irrational exuberance", he never actually did anything about it. In fact, he repeatedly denied that central banks could predict or forestall market excesses. Worse, each time the market seemed about to correct itself (the Russian debt crisis, the tech stock collapse, 9/11) he simply opened the money spigot even further, creating the "Greenspan put".
So far, so irresponsible. However, at the same time as the flood of cheap money began to distort the markets, there were major changes underway in the financial system itself. Regulation became generally lighter, in the US and around the world, and large parts of the financial system quietly went off the radar screen. The rise of LBOs and private capital reduced the role of the stock markets, while the largely unregulated hedge funds eroded the influence of more traditional investors. Many of these newer players were much less adequately capitalised than the more tightly regulated banks.
And everyone had access to much more powerful trading tools than ever before, thanks to the explosive rise in computing power. Options may have been around for a long time, but computing allowed them to mutate into new forms at a staggering pace. The first swap transactions took place only in the early 1980s, but that market quickly mushroomed into ever more complex forms. And the computer allowed trades to take place faster than ever before, sometimes without any human intervention. (It's worth recalling that Nick Leeson put Barings under by arbing microsecnd differences between the updating of Japanese stock prices on two separate exchanges).
There's nothing wrong with these developments in themselves, but in a world where the monetary authorities and the regulators seemed to agree that inflation and crises were a thing of the past, they were a recipe for trouble. It became all too easy for the math PhDs on the derivatives desks to persuade senior management to get into these new markets. The profits were good (or at least, they looked good when the deals were booked) and since nothing had gone wrong yet, it was easy to believe that nothing ever would go wrong, especially with the Greenspan put lurking helpfully in the background.
The very nature of the banks themselves allowed this almost piratical culture to take hold. It used to be a standing joke in the industry that the Japanese banks moved like a herd, but the truth is, almost all banks are guilty of this. If the chairman of bank A plays golf with the chairman of bank B and brags about how much money his firm is making out of credit default swaps, it's dollars to donuts that bank B will try to hire a CDS boffin within the week. Very few banks are immune to this. In addition, the traders are almost always rewarded on the basis of the expected profits at the time the deal is booked. In fact, if they don't get rewarded that way, they go somewhere else. But when deals have very long "tails" and there is no real precedent for how they are going to perform, this is absolutely the wrong way to compensate people.
So: the housing crisis is the result of insane monetary policy; light regulation; changes in the structure of the financial sector; massively increased computing power; the culture of banks themselves; and a flawed compensation system. These are not problems that can be solved simply by easing monetary policy, as the events of the past year, and especially the past week, have made abundantly clear.
Where do we go from here? There is talk on both sides of the Atlantic about a need for a thorough overhaul of the regulatory system, but that's going to take years. Banks themselves are changing their behaviour -- just try getting a mortgage in the UK -- but is anyone going to dare to take on the hedge funds? This is a genuine "crisis of capitalism", certainly the most serious since the great depression. In some ways it may be worse than that, because the underlying values of bank assets are almost impossible to calculate.
There are two things I like to keep in mind about the Great Depression. Whenever a financial advisor tells me that stocks always outperform in the long run, I ask him/her when US stock prices recovered to the level they had been before the 1929 crash. They never know the answer, which is 1954. That's a bit too long for someone of my age to wait! The second is that US policymakers never did find a way to end the Depression. As the Norwegian economist Axel Leijonhufvud wrote many years ago "sad to say, Schicklgruber did it". Let's hope we're luckier this time.
Just about everyone is blaming the crisis on the decline in the US housing market. That's true as far as it goes, but it doesn't go nearly far enough. The US housing market has fallen apart because it was wildly overinflated in the first place, and that's largely down to an abject failure of US monetary policy during the Greenspan years. I've written enough (or more than that) about this in the past, but in essence Greenspan presided over a period of exceptionally low interest rates and rapid money supply growth. Thanks to the entirely coincidental expansion in the supply of cheap goods from China and elsewhere, this did not trigger the rise in consumer prices that would normally have been expected. Greenspan appears genuinely to have believed that the credit for the low inflation era belonged to him, so instead of being cautious, he just kept pumpimg up the volume.
All this cheap and abundant money had to go somewhere, and it went into assets. So stock prices and house prices began to rise, not just in the US but all around the world. Greenspan never seemed to see this as a problem. Although he once spooked the markets by talking about "irrational exuberance", he never actually did anything about it. In fact, he repeatedly denied that central banks could predict or forestall market excesses. Worse, each time the market seemed about to correct itself (the Russian debt crisis, the tech stock collapse, 9/11) he simply opened the money spigot even further, creating the "Greenspan put".
So far, so irresponsible. However, at the same time as the flood of cheap money began to distort the markets, there were major changes underway in the financial system itself. Regulation became generally lighter, in the US and around the world, and large parts of the financial system quietly went off the radar screen. The rise of LBOs and private capital reduced the role of the stock markets, while the largely unregulated hedge funds eroded the influence of more traditional investors. Many of these newer players were much less adequately capitalised than the more tightly regulated banks.
And everyone had access to much more powerful trading tools than ever before, thanks to the explosive rise in computing power. Options may have been around for a long time, but computing allowed them to mutate into new forms at a staggering pace. The first swap transactions took place only in the early 1980s, but that market quickly mushroomed into ever more complex forms. And the computer allowed trades to take place faster than ever before, sometimes without any human intervention. (It's worth recalling that Nick Leeson put Barings under by arbing microsecnd differences between the updating of Japanese stock prices on two separate exchanges).
There's nothing wrong with these developments in themselves, but in a world where the monetary authorities and the regulators seemed to agree that inflation and crises were a thing of the past, they were a recipe for trouble. It became all too easy for the math PhDs on the derivatives desks to persuade senior management to get into these new markets. The profits were good (or at least, they looked good when the deals were booked) and since nothing had gone wrong yet, it was easy to believe that nothing ever would go wrong, especially with the Greenspan put lurking helpfully in the background.
The very nature of the banks themselves allowed this almost piratical culture to take hold. It used to be a standing joke in the industry that the Japanese banks moved like a herd, but the truth is, almost all banks are guilty of this. If the chairman of bank A plays golf with the chairman of bank B and brags about how much money his firm is making out of credit default swaps, it's dollars to donuts that bank B will try to hire a CDS boffin within the week. Very few banks are immune to this. In addition, the traders are almost always rewarded on the basis of the expected profits at the time the deal is booked. In fact, if they don't get rewarded that way, they go somewhere else. But when deals have very long "tails" and there is no real precedent for how they are going to perform, this is absolutely the wrong way to compensate people.
So: the housing crisis is the result of insane monetary policy; light regulation; changes in the structure of the financial sector; massively increased computing power; the culture of banks themselves; and a flawed compensation system. These are not problems that can be solved simply by easing monetary policy, as the events of the past year, and especially the past week, have made abundantly clear.
Where do we go from here? There is talk on both sides of the Atlantic about a need for a thorough overhaul of the regulatory system, but that's going to take years. Banks themselves are changing their behaviour -- just try getting a mortgage in the UK -- but is anyone going to dare to take on the hedge funds? This is a genuine "crisis of capitalism", certainly the most serious since the great depression. In some ways it may be worse than that, because the underlying values of bank assets are almost impossible to calculate.
There are two things I like to keep in mind about the Great Depression. Whenever a financial advisor tells me that stocks always outperform in the long run, I ask him/her when US stock prices recovered to the level they had been before the 1929 crash. They never know the answer, which is 1954. That's a bit too long for someone of my age to wait! The second is that US policymakers never did find a way to end the Depression. As the Norwegian economist Axel Leijonhufvud wrote many years ago "sad to say, Schicklgruber did it". Let's hope we're luckier this time.
Monday, 8 September 2008
A healthy correction? Not for everyone, it isn't
The editorial pages of the "quality press" are virtually unanimous in the view that the current credit crunch/economic slowdown is an inevitable consequence of the excesses in borrowing and consumption that defined the past decade. No argument from this quarter, though I don't remember too many warnings of impending doom from the same wise men before the crisis hit, which would have been nice.
Many of the columnists in the same papers are going further, saying that the crunch is actually a salutary and welcome development. Here, for example, is a paean to the slowdown by India Knight.
I have a problem with this born-again asceticism. It's all very well to see things this way this if you're a comfortably middle-class scribbler, and your idea of a tough adjustment is to delay your next purchase from Hermes for a month or two, or to eat at Gordon Ramsay only once a month instead of every two weeks. It's a different matter if you're a young couple wondering if you'll be able to renew the mortgage when it comes due, or a back-office worker in the City about to lose your job, or a public servant getting only a 2% pay rise, or a senior citizen worrying about how to pay for the heating this winter. I haven't seen many people from these groups saying how welcome the economic downturn is, but then again, not many of them get to expound their views in the media.
Many of the columnists in the same papers are going further, saying that the crunch is actually a salutary and welcome development. Here, for example, is a paean to the slowdown by India Knight.
I have a problem with this born-again asceticism. It's all very well to see things this way this if you're a comfortably middle-class scribbler, and your idea of a tough adjustment is to delay your next purchase from Hermes for a month or two, or to eat at Gordon Ramsay only once a month instead of every two weeks. It's a different matter if you're a young couple wondering if you'll be able to renew the mortgage when it comes due, or a back-office worker in the City about to lose your job, or a public servant getting only a 2% pay rise, or a senior citizen worrying about how to pay for the heating this winter. I haven't seen many people from these groups saying how welcome the economic downturn is, but then again, not many of them get to expound their views in the media.
Do they know it's not Christmas?
Yesterday was September 7. I was in our local Matalan store, which had a big display of Christmas ornaments and decorations! A dispirited young mother was trying to convince her agitated six-year-old that it really wasn't Christmas just yet, but the little boy kept dragging her back to the display, saying "you're lying to me, look at all these Christmas things".
Shame on you Matalan! And if you can't shift all this Christmas tat, where are you going to put the plastic pumpkins for Halloween? Unless, of course, I missed those when they were on sale back in July.
Shame on you Matalan! And if you can't shift all this Christmas tat, where are you going to put the plastic pumpkins for Halloween? Unless, of course, I missed those when they were on sale back in July.
Tuesday, 2 September 2008
They've gone and done it anyway
When rumours first emerged in early August that the UK Government was considering a stamp duty "holiday" to boost the housing industry, I blogged that it was a dumb idea (see "They've lost the plot", 6 August). Nobody in the mainstream media or the blogosphere seemed to think much of the idea, but today the Government has announced that it's going ahead and doing it anyway. It's still a dumb idea and it isn't going to work.
It's only a partial "holiday". Homes changing hands for less than £125,000 were already free of stamp duty; that exemption is now being raised to £175,000. Above that level, the 1% stamp duty rate remains intact, and the thresholds at which higher levels of the tax kick in remain unchanged. Apparently as many as 50% of all home sales take place below the new limit, and of course a very high proportion of those will be first time buyers, whom the Government is especially anxious to be seen to help.
So why won't it work? Well, first of all, it's pretty trivial in scope: the most any purchaser is going to save is £1,750. But with prices reportedly falling at a 10% rate (according to the Nationwide), any prospective buyer can save that much by waiting for about six weeks! As there is no sign of the price declines easing any time soon, the stamp duty cut may not even provide any short-term stimulus. Any smart buyer will wait until just before the stamp duty holiday ends, in order to benefit both from the tax cut and the seemingly inevitable further falls in house prices. So the market might see a big jump in transactions in about August of next year -- and who can say whether the stimulus will still be needed by that time?
The second reason the holiday won't work is that it's not addressing the real problem. In fact, it's not addressing a problem at all: there's nothing wrong with house prices falling, especially after the astounding increase we've seen in recent years. The problem for first time buyers is that they can no longer get financing on the silly terms that were available until the credit crunch began (or as we should be saying, until sanity returned to the market). Unless lenders believe that the stamp duty cut will stop prices falling further -- and they won't believe that for a second -- they'll be no more willing to lend to marginal borrowers tomorrow than they were yesterday.
You need more reasons? Well, if the stamp duty cut persuades some vendors to hold on to irrationally high asking prices, it will delay the needed correction the the market. And all experience suggests that measures like this don't change the number of transactions over a sustained period. They just alter the timing. So any boost in sales in August 2009 will be offset by a fresh slump later in the year -- at which point, no doubt, calls for another set of stimulus measures will immediately be heard.
As I've said before, stamp duty is badly structured and should be reformed. Reformed, not tinkered with.
It's only a partial "holiday". Homes changing hands for less than £125,000 were already free of stamp duty; that exemption is now being raised to £175,000. Above that level, the 1% stamp duty rate remains intact, and the thresholds at which higher levels of the tax kick in remain unchanged. Apparently as many as 50% of all home sales take place below the new limit, and of course a very high proportion of those will be first time buyers, whom the Government is especially anxious to be seen to help.
So why won't it work? Well, first of all, it's pretty trivial in scope: the most any purchaser is going to save is £1,750. But with prices reportedly falling at a 10% rate (according to the Nationwide), any prospective buyer can save that much by waiting for about six weeks! As there is no sign of the price declines easing any time soon, the stamp duty cut may not even provide any short-term stimulus. Any smart buyer will wait until just before the stamp duty holiday ends, in order to benefit both from the tax cut and the seemingly inevitable further falls in house prices. So the market might see a big jump in transactions in about August of next year -- and who can say whether the stimulus will still be needed by that time?
The second reason the holiday won't work is that it's not addressing the real problem. In fact, it's not addressing a problem at all: there's nothing wrong with house prices falling, especially after the astounding increase we've seen in recent years. The problem for first time buyers is that they can no longer get financing on the silly terms that were available until the credit crunch began (or as we should be saying, until sanity returned to the market). Unless lenders believe that the stamp duty cut will stop prices falling further -- and they won't believe that for a second -- they'll be no more willing to lend to marginal borrowers tomorrow than they were yesterday.
You need more reasons? Well, if the stamp duty cut persuades some vendors to hold on to irrationally high asking prices, it will delay the needed correction the the market. And all experience suggests that measures like this don't change the number of transactions over a sustained period. They just alter the timing. So any boost in sales in August 2009 will be offset by a fresh slump later in the year -- at which point, no doubt, calls for another set of stimulus measures will immediately be heard.
As I've said before, stamp duty is badly structured and should be reformed. Reformed, not tinkered with.
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