Investment Management Blog - Montague Capital

If the best measure of efforts to solve the global financial crisis were the TV coverage world leaders have been grabbing for themsleves in the last few days, by now we’d be well on the way to recovery.  Unfortunately, the best thing that could be said about Junior’s 0800hrs performance on Saturday, for which the visibly exhausted suits were required to present themselves at White House by 0645hrs if they wanted to clear the security checks in time for the photo shoot, was that the markets were shut at the time.  They couldn’t respond to an almost complete lack of content.  The world has come to a sorry state when it is almost better to wish that the leader of the biggest economic force should be at home in Texas chopping logs rather than opening his big yap.

But read between the lines and the glimmers of hope are starting to multiply.  This is not to guarantee that they will succeed, but it has to be better than having no glimmers at all, as was the case about a week ago.  There are media reports that finance ministers refused to sign up to official statements until they included some real content.  There are indications that even Hank Paulson, Wall Street’s friend, realises that the best chance of a fix is to nationalise Wall Street.  And the quality end of the media is ramping up its mission to inform increasingly anxious and betrayed electorates, the better to exert pressure on our political leaders.

One way or the other it is all over for the banks now.  If the latest initiatives fail, then the Great Depression is going to look like a walk in the park.  Modern society can no more do without a functioning banking system than it can without mains electricity.  If the initiatives are to succeed, then the banks have to cede control to those wishing the best for society at large rather than for banks’ executives and shareholders.  There is no excuse for not lending.  It is disgraceful that, in a week which has seen 0.5% taken off the base rates of the countries which matter, Sterling LIBOR ended the week up 0.76%.  Everything else – recapitalisations, liquidity injections, base rate cuts – is pointless if the banks don’t lend.

Sadly, for each set of positives steps that are taken, another batch of negatives is ready and waiting.  The weekend press makes much of the unimaginably large amount of credit default swaps which have reached maturity in the last few days.  One commentator estimates that the recovered value of Lehman’s CDSs has been perhaps as little as 8%, which leaves the system nursing a theoretical loss of – wait for it – US$414bn on this counterparty alone.  That is not covered by either the Paulson Plan or Prudence’s Package.

So where does it come from?  To a certain extent the banking industry sits on both sides of these deals.  For every loser there is a winner, and it is not impossible occasionally to find them under the same employer’s roof.  At times like these – when the bankruptcy of the loser could bring the whole system down – might it not be correct to tell the winners that they can’t collect?  It’s not as though they would be worse off as a result, just not better-off.

Here too the system has been at serious fault and needs a radical overhaul with far tighter regulation.  Ordinary people can’t take their house insurance policy along to a bank and use it as collateral to borrow a far bigger sum of money, which they then use to buy another house, which then needs a house insurance policy, which they take to a different bank, etc. etc.  Where is the sense in letting the banks do so themselves?  The columnist Will Hutton estimates that Barclays and RBS have each built up mad pyramids like this of CDSs to the value – and this is each mind you – of US$2.4tr, which is more than the UK’s GDP.  If we get through this, such lunacy can never be allowed to happen again.  Alan Greenspan has an awful, awful lot to answer for in encouraging the deregulated development of the derivatives market.

But a few brave bargain-hunters are now beginning to appear.  Sir Philip Green is sniffing around the twitching corpse that was Baugur’s UK retail empire.  Big oil companies have dividend yields nudging towards 10% as the wider market collapses and will need the oil price to fall an awful lot further not to be able to afford to maintain such a payout.  Share prices are, sadly, falling far faster than real underlying asset values in non-financial sectors.  But market sentiment has been criminally slow to come to terms with the fact that the global economy always had been heading for recession, let alone that the recession is now going to be much deeper and longer.  While it is darkest before dawn, it is so dark out there right now that we can’t see the watch to tell whether it’s 0600hrs or 0100hrs.  Time to try to borrow someone’s torch.

Prudence is not usually the motorist’s friend.  When he was Chancellor he hi-jacked the environmental element of the fuel duty escalator in a blatant revenue-generating exercise.  The odd penny on a litre of fuel every year was going to have to be repeated for a few decades before we were going to abandon our obsession with the motor car and take to public transport, but it was a lovely little earner for the Treasury.  Instead, US foreign policy, speculative “investors” and militant groups dotted around key oil-producing areas did the environmental trick for him in a far shorter period of time.  But the oil price has collapsed since the July spike and Prudence is now calling upon the oil industry to share the benefits.  Well he might, because for as long as we don’t drive our cars the Treasury isn’t getting enough fuel duty and VAT on fuel sales.  HMG needs the cash and consumers need any break they can get in these cash-strapped times.  Prudence has got a point.  Taking 10^th October 2005 as a starting point (because it’s exactly three years ago and makes the sums easy), the Sterling price of the short-dated gasoline futures contract is just 4.3% higher, but the price of a litre of unleaded is up 45.3%.  Doubtless the petrol companies will tell us that it’s all about smoothing prices, insulating us form the very peaks but not always sharing the troughs.  Nice try boys, but it won’t wash.  At its lowest point in the last three years (18^th January 2007), the gasoline future had fallen 34.0%, but at that date pump prices were 18.7% higher.  At the peak (11^th July 2008) virtually all of the futures price (up 72.4%) had been passed on at the pump (up 65.3%).  If the futures price is only 4.3% up over three years, would the oil companies like to explain why a litre of unleaded does not cost 2005’s 75p/litre plus 4.3% plus whatever duty might be expected to have been chucked on top?

This one is choice.  A survey conducted by the World Economic Forum puts the US in 40^th place in the list of strongest banking systems, behind economic powerhouses like Malta (10^th), Namibia (17^th), Estonia (25^th) and Senegal (33^rd).  The US is then followed by Lithuania, Peru, El Salvador and – wait for it – the UK.  How are the mighty fallen!