Bond Revolution in Singapore : Remembering 2008 Part 3
And this is the final piece I wrote in Sep 2008. I think there are a couple for Oct that I will endeavour to publish tomorrow if readers are keen.
I had a good laugh reading this one for all my dramatics then, but also for the fact that the I was dead wrong about the new investment paradigm of pain because we are back to rolling good times now and no one would bother with what happened back then.
Happy reading.
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Tuesday, September 30, 2008
Pain and the Birth of a New Investment Paradigm
For a few days I was beseiged by random thoughts and radical ideas. Too tired to put it all down on paper. Too drained physically and emotionally and most of all, too scared to sleep for fear of another financial paradox happening in the next moment.
Systems are not made to withstand shocks. And a prolonged shock like this one is going to spawn hundreds of books over the next decade that will redefine all of our paradigms and assumptions on every single aspect of finance.
In the past week, more banks have fallen. Fortis, Bradford and Bingley, Glitnir, Wamu, Wachovia, Hypo Real Estate and even the mighty Dexia. I cannot even name them all now. What was unimaginable last week is happening now. What was unimaginable for the past century happened last week. Nothing is too big to fail. Our stalwart assumption we all make in investment is not true. Markets can, and do, remain illogical much longer than we can remain solvent. Keynesian theory.
Punishment
3 ways to bring down a bank, simply put.
Assets = Liabilities + Equity
Depositor run, Creditor run and Equity run.
Most of the cases we saw last week where central banks had to step in with equity involved the last scenario. Share prices just collapsed to the point where capital was insufficient to continue business even when cash flows remain stable. Poor Fortis bank, shored up cash defenses against deposit withdrawals, had a baffling collapse in its stock value. Investors just do not understand why the bank stock just buckled. Capital is not something you can raise overnight. And banks are prevented from share buy backs like other corporations, on the account of the capital adequacy ratios they have to maintain.
Some commentaries suggest that the rejection of the TARP package was due to revenge on Paulson’s arrogance. People out to punish the profiteers of the banking boom. I would imagine so.
Markets all standing still. All projects kept on hold. Virtually no interbank lending. The scale of damage is unprecedented. Perhaps only those who witnessed the 1939 Depression times could vaguely empathise.
Central banks are the borrowers and lenders of last resort. Which is why the ECB has taken in 44 billion worth of deposits daily at 3.25% and lending only 13 billion out at 11% . What a spread !! But look closely, there is no squeeze in the market. Just cessation of market lending. What do we need to do to get it started again ?
Central banks will have to play clearing house for starters. Why does my colleague disagree with me ? We are living in “last resort” times. Roles are being defined everyday. New roles and old ones. We did not come to these times living old rules. We created new ones. And the new rule, even if temporary, will need to encompass the central bank into the market place.
If I were a CEO.
If I were a CEO and I was staring at my crumbling stock value. I would do something drastic about it. Yet we all know that we have become too complacent in good times. Few good men can withstand the pressures and stresses of crisises. Highly paid men cave in. We have witnessed that in the past month. Lehman could have sold themselves to KDB at 7 bucks instead of their market price of 0.25 cts now. Why didn’t they ?
They are not superman ! Reading HedgeHogging by Barton Biggs now and about all those hedge fund chaps who break under strain. It is not surprising.
Because I have experienced those strains myself on a smaller scale. I have felt like just wrapping myself in my blanket instead of waking up to work, dreading the music I will have to face.
Yet, if I were a CEO, of say, Fortis Bank. I will do the radical. I will offer to each and everyone of my employees, the opportunity to take their salaries for the month in stock, in whatever proportion they would like. Because I would believe that the company I am running is worth as much as its people and not let the people in the street run my value to the ground. More importantly, I would like to let my people save the company that they had worked so hard to build.
It is not textbook though.
Price for Everything
Digressing a little. We watched the first Formula 1 night race in the world last weekend. We had to take a taxi to the shuttle bus stand. Conversing with the driver, he casually asked me the cost of my tickets which I calmly told him was listed as over a thousand dollars. His exclamation at the exorbitance of the price rattled me and had me examine my entire value system for a minute.
Over 10 years ago, that amount would be riches to me. Struggling as I was then, an emerging trader. Now I would not blink to spend that on a new Marc Jacobs skirt. (Incidentally I paid much more for that skirt sitting in my closet which I have not worn since I bought it in June).
Prices have indeed risen rather rapidly in the past 10 years. Times were good. Jobs aplenty. All riding on the economic boom of the world. Starting pays of young bankers now are way higher than what I was earning just 6 years ago.
Wasn’t it so easy to trade a bull market ? Everyone had the Midas touch. And many mistook it for genuine talent.
Where will prices go ?
Prices have gone down so much for all asset classes, what will happen next ?
In other words, wealth has evaporated. It has been slowly dissipating since last year and the advent of the crisis which was just the tip of a gigantic iceberg. Now its been wiped off.
Evaporation of wealth at the individual level is simply a loss of money. But money is so much bigger now. For the sum that RBS, Fortis and Santander paid for ABN last year, they could have bought over Barclays, Northern Rock, Bradford and Bingley, Lloyds and Marks & Spencers. That is the amount their shareholders lost and the shareholders of the forenamed lost too.
This is a huge loss of wealth.
Assets are cheap so why are my tickets still so expensive ? Why is the cost of my Japanese dinner still more ?
It certainly has not translated into the daily expenditure yet but I am sure I will be eating less Japanese in the days ahead until that meal becomes cheaper.
I concluded after some thought this afternoon that the only thing that will be expensive will be money. It is the only asset that is short in supply now.
Central banks may print more money to circulate the system but it is not going to end up in our pockets.
The truism behind the phrase “your dollar will be bigger” will strike us like it never did. For we are going into deflation.
This does not mean hoarding cash in the banks or buying treasury bills. Cost of treasury bills should go up as the government prints more money. Keeping cash in the bank is worse as central banks keep rates easy and there is no need to pay you more.
The pain of not knowing what to invest in, in a deflationary cycle torments everyone who is not worried about losing their jobs.
Haunted
Face it. Now we are a bunch of haunted investors and will remain haunted for the next decade. Like the Great Depression that left a heavy toll on the hearts and minds of the USA, this credit crunch will leave everyone in the financial world, if it has not already, a nervous wreckage.
Fear will hang around in the marketplace for a while and be ingrained in the new paradigm of the future.
The markets area clearly dictated by it now as I write and the Dow swings to and fro like a pendulum. Its fate hinging between the rescue package and some reality check articles on inevitable recession.
End of a Golden Era
I am painfully aware that my job will never be as glamorous as it was, if it ever was.
Trading will now be sandwiched between risk and compliance.
Fortunately I am a vanilla trader which means I do none of the complex derivative structuring that will be dying out. Like Buffet said, anything that he cannot compute without a calculator is investment no go.
The New Investment Paradigm will be built on pain. For it is painful now and we have not even hit rock bottom yet. For more jobs will be lost and more value will be lost.
But all is not lost yet. At least, hopefully, the crunch will be over. Once banks start operating and the heart starts pumping after a transplant, the rest of the body will be weak and shed excess weight. Then the renewal process can begin.
The new mindset will no longer be the quick buck but value based investing. Do your own homework. No more herds for us. And if I may add, I never liked herds (read my old posting Tribute to Herds). Ala Buffet style.
How do I know all this ?
Because last Sunday, my son told me to get him a Renault ING shirt (for his whimsical reason that he liked the ING advert) which I told him was for losers (because I had bought him 2 Mclaren ones already). I did buy him that shirt in the end, and ironically, Alonso (Renault) won.
I decided to ask him where were markets headed (because all traders are superstitious in some way). And he told me, looking at the sea of red on my flashing screen and said, in his childish way, that everything was going to turn green. Because, like the F1, once a race was over, the cars can start over again in the next race.
I will prepare myself for the next race then and buy that Buffet book.