Every week our guest blogger, David Oakes of Mosaic Money Management (aka The Financial Ironmonger), shares with us his take on some of the major UK and overseas macro and political events that shaped the previous week.
Please be reminded the value of investments, and the income from them, may fall or rise. The views expressed in this article are those of the author at the date of publication and not necessarily those of Chelverton Asset Management Limited or Mosaic Money Management. The contents of this article are not intended as investment or tax advice and will not be updated after publication unless otherwise stated.
–THE FINANCIAL IRONMONGER BLOG NO 32/2017–
Wednesday marked the 10th anniversary of the Global Financial Crisis kicking off, when BNP Paribas announced that they could no longer price three funds that had invested in sub-prime American debt, pretty much because there was nobody left on the other side of the transaction. Bear Sterns had a similar problem the previous March, when a hedge fund they had raised $3bn for fell over.
For me, that was the clue that things were not going to turn out happy, in any way at all, as readers of this blog, in a previous incarnation will recall. Nevertheless, equity markets were firm between these two events, and many clients withdrew their funds, thinking that I had lost the plot. Hindsight, that most valuable commodity; certainly worth more than gold, or those mythical virgins that seem to be an alternative to Bitcoin.
Very few people understood the implications of what was happening, even as it unfolded before them. It was, after all, the end of a long bull run; a lot of people had made an awful lot of money, and could see no reason why it could not continue. The origins of the disaster went way back, when President Clinton forced the banks to lend to the underprivileged, under threat of being removed from government mandates. The loans were then packaged up, and sold off, often with complex gearing attached to them.
A few miles from here, there is a highly successful skip hire business, first generation wealth. A standard skip costs £185, or $230 for a dumpster as our American friends know it. But here is the clever bit. 86% of what comes in to the processing plant is recycled. Bricks are crushed in to hard-core, for instance, and then resold as such. So you are paying for his raw materials, and paying again for his output. Furthermore, he will not collect the skip from your yard unless he has been paid. It is a brilliant model.
And that is much what the guys in the City were doing, repackaging loans that on their own were dubious, and delivering a product that was given the highest credit rating. Some of our more conservative followers might consider this as fraudulent, which it cannot be, since no one has ever been prosecuted for it.
Ten years on, and in the middle of a news free summer, bar North Korea trying to kebab itself, these old stories are raked over again, in search of column inches. As to whether it could happen again, the answer is obviously yes, probably in a different format, and not just yet. The not just yet bit is because there are still plenty of people around who were senior players in 2008, and maybe still are, so memories run deep. Call it experience.
And, of course, whilst it will be called something totally different from sub-prime loans, it will be exactly the same theory as before. The extension of credit to people that cannot afford it. Here, in the UK, the worry is with PCPs. A Personal Contact Purchase plan enables you to put down a small deposit on a car, and then pay a monthly rental for it, before handing it back three or four years later. There are penalties for any dents, or excess mileage, sometimes as low as 6,000 miles a year.
Thus, people can have a car which retails for vastly in excess of their annual salary, providing the conditions are met, but as net incomes stagnate, and house values therefore stutter, the second-hand values of these nearly new cars is starting to crumble. Depending on the contract, that loss on expected resale value either falls to the contract holder, or the finance company. No one cares much about the former, who will be found either fully clothed, or naked, when the tide goes out.
But the cause of concern is where the finance is coming from; who takes the hit when the residual values fall. The credit arm of most car manufacturers vastly exceed the net worth of the company, much as British Airways used to be described as a pension fund that happened to own an airline. But the Germans have been clever, here. With interest rates at zero, locals have been encouraged to buy bonds, yielding say 1%, to provide the finance for the PCPs, of which I am sure they believe to be risk free.
The numbers involved are nowhere near those that went south in 2007, but you can see, if I have explained this properly, how these things start as a couple of wasps getting together, and turn in to a very angry nest.
Next week’s blog should be posted from Croatia, if the person I rented the apartment from ever answers an e mail, providing, of course, that a British Passport still carries the authority it used to.
–MORE ABOUT OUR GUEST BLOGGER, DAVID OAKES–
David joined Manchester stockbroker Henry Cooke, Lumsden in 1977 and after becoming a member of the London Stock Exchange in 1984 held a number of senior positions within the firm including Managing Director of the in-house fund management company and member of the Executive Committee.
After senior appointments at Cazenove Fund Management and latterly Mercater Capital Management, David joined Mosaic Money Management in 2013. He has successfully managed private client and fund portfolios for over thirty years and has particular expertise in providing a multi manager service to his loyal client base.
The Financial Ironmonger is a hat-tip to Ironmonger Lane, the location of Chelverton’s London office.