Friday, April 13, 2012

Bird flu

It seemed like a bad joke. Earlier this year, a Dutch biologist had developed a strain of bird flu that is both deadly and very contagious. We are not sure if this danger was being hyped, as so many flu stories are; but reports were saying this virus could kill half the earth’s population. The concern is that it could find its way into Jihad terrorists’ hands and become a biological murder-suicide weapon. Doesn’t this seem crazy? And – the U.S. government provided financing for the research to develop it! Sit and ponder this for a while: how did this super virus come into existence?
It was intentional. Some person or group of people intended to develop a virus capable of killing half the world’s population. I am certain the American government officials who financed the research and the genius biologists who developed the virus had concocted an excellent-sounding reason to work on such a project. It must be akin to the intention of Albert Einstein when he worked on his nuclear physics project: his discoveries led to the development of the atomic bomb… another case of good intentions gone wrong.
What’s needed here is a committee of Irish philosophers headed by the notorious Mr. Murphy, namesake of that famous law. Their job would be to look at these projects with an eye to Murphy’s Law: if something can go wrong, it will go wrong. Surely these great scientists can envision the impact of their own discoveries on the war-like tribes that currently inhabit this earth! It seems like a bad joke where nobody’s laughing.
But the scientific community isn’t the only one to indulge in extreme naiveté. The financial community has taken us to the edge. In the greed-inspired mortgage fiasco in the first few years of this century, American mortgage lenders blew the brains out of the mortgage and real estate markets in the USA. To make matters worse, greed-inspired investment dealers sold that mortgage paper to banks all over the world. The consequence of this wild irresponsible action was the mortgage crisis of 2007-2008. And the consequence of that mortgage crisis was that many Canadians saw the value of their RRSPs drop by 30 to 40%.
2011 revealed yet another example of financial craziness. This time it was whole nations who went crazy. They call them the Euro pigs: Portugal, Ireland, Italy, Greece and Spain. Their governments borrowed so much money that now they're unable to pay it back. And the European banks who own these nations’ debt instruments are in deep trouble. We've got another banking crisis on our hands. It seems like another bad joke; but once again, no one's laughing.
Do we live in the age of naiveté? Do people not realize the consequence of their own actions?
Our government tells us that Canadians are seriously in debt. Mortgage debt, credit card debt, personal loans: Canadians are in over their heads. On average ordinary Canadians have borrowed way more than they can afford to pay back. My friends in the consumer banking business tell me that the worst offenders are lining up to get even more in debt. Apparently they just don't get it. Apparently the concept of paying back your debts is not a part of their repertoire.
The underlying theme of this financial naiveté is that, when they borrow money, people aren't thinking about paying back their debts. Whether it's American homebuyers, European countries, or Canadian consumers, they all seem to have forgotten that debt has to be repaid. And in doing so they've created a financial super virus.
In my investment book, Beyond the Bull, I talk about having personal investment techniques. An investment technique has two parts: buying and selling. It's just like a loan: the two parts of a loan are borrowing and paying back. In the same way that borrowers sometimes forget about paying back, investors can sometimes forget about selling out.
Selling out is the investment equivalent of a flu shot. You can’t lose money in a stock market decline after you’ve sold your stocks. You become immune. If your investment technique has a provision for selling, there's no need to lose money if the stock market goes down. In the same way, there is no need to miss out on making money when the stock market goes up if your investment technique has a provision for buying. Good investors plan the buying AND the selling.
Good consumers plan the borrowing AND the paying back.
I wonder what good biologists do. Do they plan the sickness AND the cure? It's obviously wiser for them to plan the cure first, then the sickness. That would be like a good investor planning to sell his investments before he buys them. Such wisdom is rare.

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Tuesday, March 13, 2012

Things are not as they appear: your champagne glass is full of beer.

Last week I drove past a bright neon sign that read: Gentlemen's Club. But it's really a strip joint. The words gentlemen's club allowed the patrons to imagine they were something they were not, as they indulged their basic cravings. It was all about appearances and feelings.

Today's banking crisis is all about appearances too. Modern banking is based on faith. When I borrow money from the bank, the bank has faith that I will pay it back. They also have legal remedies to make sure I pay it back. That's why modern banking works. It appears that honourable gentle people are borrowing money from honourable banks. It's all about appearances and feelings.

But now that the banking system is in trouble, the mask is coming off. We're beginning to see there may not be as much honour there as we had thought. Perhaps the gentlemen of the banking industry are not gentlemen at all.

First there were the robo- signatures in the US mortgage business. In the greed-inspired feeding frenzy that preceded U.S. sub prime mortgage blow-up, it got so crazy that many bank executives didn't even sign the mortgage papers. They used mechanical signature machines to sign for them. A few years later when foreclosure actions were in full force, some lawyer challenged the actual mortgage document. He argued it was not valid because the signatures were not valid. And the judge ruled in his favor. The mechanical robotic signatures did not hold up in court. The registered contract that protects the bank from borrowers who can't afford to pay them back had failed. And all those so called gentlemen who borrowed all that money and could no longer afford to pay it back, receive a huge free benefit.

Then there was the Iceland melt down. Iceland's government guaranteed the repayment of certain bail out loans received by Icelandic banks. The lenders who bailed out those Icelandic banks were assured that the Icelandic government stood behind those bail out loans. But when the Icelandic banks went broke again, and it was time for the people of Iceland to make good on their guarantee, the people rebelled. In the referendum of March 2010 the Icelandic people decided to renege on their guarantee. Iceland’s elected government were gentlemen when they needed the money, but turned out not to be so gentlemanly when they had to pay it back.

Apparently ordinary borrowers are not the only ones who stop being gentlemen when circumstances permit. Whole countries can stop being gentlemen too. Consider the Greek sovereign debt fiasco. Last week the Greek government “negotiated” a deal where about 90 billion Euros of Greek debt disappeared. That’s right; the Greek people now owe 90 billion Euros less than they owed the week before. And, they claimed the banks accepted the golden fleece “voluntarily.”

It appears that the gentlemen of the banking profession are neither gentlemen nor professionals. American bankers loaned money to thousands of people who couldn't afford to repay their mortgages. Icelandic banks set up lending portfolios on such thin ice that they went broke twice. And now the Greek people have decided they no longer have to pay back as much money as they borrowed.

In my investment book, Beyond the Bull, I suggest that deceit is an important part of the stock market.
As we strip away the grey suits and the distinguished looking gentlemanly faces, we see that banking, too, is not what it appears to be. Bankers have consistently loaned money to people who could not pay it back. The Gentleman’s Banking Club is just another neon sign.