Still waiting

“This suspense is terrible. I hope it will last.”
– The Hon. Gwendolen Fairfax in ‘The Importance of Being Earnest’ by Oscar Wilde.

The failure of Lehman Brothers in September 2008 will forever be regarded by capital markets professionals as a JFK assassination-style moment, an occasion now set in amber that marked the moment when everything changed – or at least should have done. With the benefit of hindsight, it’s somewhat remarkable that the bankruptcy of a second tier investment bank better known for credit trading than for any facility with stock underwriting, for example, could trigger a global credit crunch. But it did. Andrew Ross Sorkin’s ‘Too Big To Fail’ – still probably the best example of financial crisis porn – masterfully explains why:

It was just past 7:00 a.m. on the morning of Saturday, September 13, 2008. Jamie Dimon, CEO of JP Morgan, went into his home library and dialled into a conference call with two dozen members of his management team.

“You are about to experience the most unbelievable week in America ever, and we have to prepare for the absolutely worst case,” Dimon told his staff.

“..Here’s the drill,” he continued. “We need to prepare right now for Lehman Brothers filing [for bankruptcy]. Then he paused. “And for Merrill Lynch filing.” He paused again. “And for AIG filing.” Another pause. “And for Morgan Stanley filing.” And after a final, even longer pause, he added: “And potentially for Goldman Sachs filing.”

There was a collective gasp on the phone.

As we now know, Lehman Brothers remained the only lamb to be sacrificed at the altar of the financial markets. The US administration quickly capitulated in the face of those markets. The other institutions were therefore rapidly forced into shotgun marriages, emergency capital- raisings, or bailed out by taxpayers, or mysteriously allowed to convert into commercial banks (a privilege never granted to Lehman Brothers, but somehow deemed appropriate for fellow brokerage firm Goldman Sachs). But in a parallel universe, with less supine taxpayers and altogether less biddable regulators, there would have been a domino-style failure by, and concomitant run on, the financial system.
A revisionist British political perspective now blames everything on pesky North American speculators. The chart below, for example, courtesy of Grant Williams, shows the extent to which a culture philosophically committed to living beyond its means has infected its host:

This conveniently ignores the run on Northern Rock from the previous year, or the bail-outs of the likes of Lloyds and RBS. That Barclays Bank, which only avoided taking the taxpayer’s shilling by resorting to capital-raising from the Middle East that is now subject to a criminal probe by the Serious Fraud Office, has been wrestling with a £12.8 billion capital “hole” and seemingly been less than transparent in its own capital reporting, would suggest that the UK banking system is not exactly as healthily restructured as it really should be, five years after the Lehman bankruptcy. James Ferguson of the MacroStrategy Partnership asks,

How many other banks, concerned that their leverage looks borderline, are similarly fudging their capital numbers? With so many banks only just on the right side of the regulatory minimum hurdle and incentivised to stay there, this is of paramount importance. Banks that are hiding the fact that they are below the regulatory minimum capital requirement are not merely technically insolvent but are unlikely, indeed unable, to address other balance sheet issues like forbearance on NPLs [non-performing loans] and hidden losses.

And it is not just Britain’s banks that are “wrestling” to right-size their capital and leverage ratios five years after the Lehman bankruptcy. The chart below, via Grant Williams and Zero Hedge, shows the problem of bank lending is just as serious in the beleaguered euro zone:

Deutsche Bank, for example, has just said that it intends to shrink its balance sheet by another €250 billion over the next two years to comply with stricter leverage rules. So here’s the bottom line. As far as we’re concerned, whether or not the western banking system is insolvent, it makes sense to behave, as an investor, as if it is – especially after the Bank of Cyprus confirmed that depositors with savings over the €100,000 “guaranteed” threshold will lose 47.5% of their money.

This commentary will deliberately not include any charts relating to market performance – because they would be meaningless, given the extent to which the financial markets have become mesmerised by promises, hopes or fears of further monetary largesse from their respective central banks. Instead, we restrict chart use to economic statistics (for better or worse). As the chart below shows, we can to all intents and purposes ignore what the FTSE 100 is saying about UK economic prospects (and we acknowledge that the FTSE is a poor barometer for purely domestic UK economic health given its international composition). Rather, we can simply acknowledge that this “recession” would appear to be more severe than the 1920s or 1930s Depressions, on the basis of duration to date and the lack of any obvious recovery (as opposed to QE-driven stock market string-pulling). If it is a recovery, it is one that economist Liam Halligan calls “the most feeble in our history”.

In summary, we do not inhabit a remotely “normal” economy. We inhabit a recessionary slump that our monetary authorities seem determined to perpetuate by any means possible. Now that they have driven monetary policy rates to zero, conventional policy no longer works, so we are faced with the prospect of further quantitative easing until the system collapses on itself. Given the inherent unattractiveness of bank deposits and pretty much any form of fiat currency in a world beset by competitive currency devaluation, we would much rather hold gold. Yes, its “value” in inconstant and ever-depreciating dollars is volatile, but as fund manager Tony Deden points out,

In ten years’ time, our gold bars will still be gold bars. In fifty years too. And in one hundred. In fact, our gold bars will still be gold bars in a thousand years from now, and will have roughly the same purchasing power. Therefore, gold has a property which is unique in comparison with everything else we know: the risk of a permanent loss of purchasing power is close to zero. This is worth reflecting on. It is a most powerful property and implies that the loss of purchasing power such as that [which gold holders have experienced] in the last quarter can only be temporary.

Once again, we do not inhabit a “normal” economy. We live in a financialised world in which our banks cannot be trusted, our politicians cannot be trusted, our money cannot be trusted, and – not least thanks to ongoing spasms of QE and expectations of much more of the same – our markets cannot be trusted. But we have to play the hand we’re dealt. So in addition to holding the monetary metals as a long term insurance against the loss of purchasing power consistent with holding paper money in a money-printing orgy, we also hold the highest quality bonds we can identify, and market neutral trend-following funds, alongside ultra-defensive equities with genuine secular growth potential (not least the Halley Asian Prosperity Fund, a classic Graham-and-Dodd deep value fund which focuses on Asian domestic consumption without the taint of exposure to western economies that have gone conclusively ex-growth).

At some point (though the timing is impossible to predict), asset markets that cannot be pumped artificially higher will start moving, under the forces of inevitable gravitation, lower. The possibility of a secular dual bear market in equities and bonds does not seem unrealistic. In such an environment, conventionally positioned portfolios (that are long stocks in line with an index, and long bonds in line with an index) will incur massive losses. Yes, the suspense is terrible, and as fiduciaries we are obligated to survive through it as best we can, by diversifying our clients’ capital as prudently as present conditions allow. But unlike for Wilde’s Gwendolen, for us the reckoning cannot come soon enough.

This article was previously published at The price of everything.

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8 replies on “Still waiting”
  1. says: George Thompson

    Really? The UK has a “Serious Fraud Office”? We Yanks could truly use one ourselves except we could never afford its overtime even with Chinese assistance, even with Bernanke busy digitizing the fortunes of our posterity unto the 5,000th generation. Our National Anthem should no longer be ‘The Star Spangled Banner’ which after all memorializes an inspiring moment in Our War of 1812 at the expense of our friends across the pond (; it should be “Brother Can You Spare a Dime?”

  2. says: Paul Marks

    Governments (and the bank and other such that work with them) have learned nothing. The present gold scam (selling gold that DOES NOT EXIST) proves that.

    And when this scam (and all the others) fall apart, will the real big players go to prison?

    Not a chance – some flashy traders will be thrown to the wolves instead (no mention that the government Central Banks backed this scam every step of the way).

  3. Tim Price has fallen for a delusion of a type pointed out long ago by Edmund Burke: “Custom reconciles us to everything”. In other words Tim assumes that because central banks have done something unusual, i.e. converted large chunks of debt to cash (under QE) that therefor QE is distortionary.

    In fact the opposite could be argued. That is one could argue that the fact of governments incurring large amounts of debt raises interest rates and depresses asset prices, and that disposing of that debt returns us to a non-distortionary scenario.

    Of course governments would not be able to simply print money and buy back the ENTIRE national debt without serious inflationary consequences. But those consequences could easily be disposed of simply by raising taxes by the necessary amount and “unprinting” the money collected.

    That would return us to the situation that would have obtained if government had never incurred ANY DEBT: i.e. simply funded all its spending out of tax. And its not clear to me what the effect of that on interest rates or asset prices would be.

    Incidentally there are several high powered advocates of the idea that governments should borrow nothing: i.e. that all spending should be funded out of tax. Milton Friedman was one and Warren Mosler is another.

    Also, and contrary to common perception, the idea that governments should borrow to fund capital spending is an argument that can be demolished.

    1. says: Gary

      The govt giveth and the govt taketh away. There is no market. Mmt policy in a nutshell.

  4. says: Paul Marks

    Ralph Musgrove, it often comes as a surprise to people who have not read the work (who think it is mostly about the Queen of France), but the largest bit of Edmund Burke’s “Reflections….” is an attack on fiat money – the something-for-nothing philosophy of the Revolutionary regime in France (their lie that the fiat money is “backed” by land stolen from the Catholic Church and others – and other lies).

    There is no such as a free lunch – if governments want to spend money (or give money to other people to spend) then they should openly take this money by TAXATION.

    Better – governments should spend less money.

    There is no reason for governments to spend money on “Capital Projects” (“infrastructure”), indeed even when these projects are well built and the projects are honestly run (and the projects are normally badly built and corruptly run) they are economically MALINVESTMENTS, as the projects in the Highlands of Scotland (starting in Edmund Burke’s own time show).

    The government undertook what would now be called “public-private” partnerships to “improve” the Highlands with various infrastructure projects. These projects were entrusted to Thomas Telford (an honest man delivered well built schemes, on budget), but they were an economic flop.

    The government did NOT get its money back in higher tax revenues (as had been hoped) and the landowners who went into business with the government ended up bankrupted – in desperation they turned on their own tenants (the “Highland Clearances” – ever heard of them?) forcing them out in the hope that sheep (now that they had new roads and bridges and ports for transport for trade) would be their saviour from bankruptcy.

    The sheep trade failed also – and the landowners went bankrupt anyway (in spite of what they had done to their tenants – and in spite of all the new “infrastructure”).

    By the way…..

    Infrastructure projects are a TINY percentage of modern government spending.

    The vast majority of government spending (even in Japan – where government spending has increased from about 20% of GDP at the start of the 1970s to 43% today) is on the “public services” (health, education and welfare) i.e. the WELFARE STATE.

    The idea that the Welfare State can be financed by “borrowing” OR by the government printing press is absurd – utterly absurd.

    Of course it can not, in the end, be financed by taxation either.

    1. says: George Thompson

      Your mention of the Highland Clearances opened a nerve pathway in my noggin about an experience I had years ago at a local Highland Games here in America’s Midwest. The guest of honor was the Duke of Argyll (may have been the 12th), the chief of Clan Campbell. He gave a speech. It was not much of a speech as its major purpose was to beg all of us who descend from those folks his ancestors transported to the Carolinas after the ’45 when his clan took the Hanoverian side, and later because they valued sheep and cattle more than their own kin to come back to Inveraray and please bring all your tourist dollars with you. Of course, he neglected to mention that history, which includes the Glencoe Massacre. To date, and it’s been almost 30 years, I have resisted that invite. However, in researching this reply I learned that the 12th Duke sits on the board of 3 distilleries. Might have to reconsider.

  5. says: Paul Marks

    The Campbells are a big family – and there have always been good ones and bad ones.

    As for idea of mass raising of sheep in the Highlands of Scotland – it was never going to work.

    One can not argue with nature (well one can argue – but one can not win). Sheep raising in Southern England (say down the road from where I am typing this) was always going to be better.

    Better soil – and longer growing season (more sun).

    One might as well try and grow cotton in Maine and compete with Miss.

    By the way – the old tenure system was based (as you know) not on “rent” (in the Highlands money was hard to come by) but on military service. Fight for the Clan Chief in return for the land.

    After 1745 military tenure (in Scotland) was abolished – and it was easy to kick people out after that, for they had not paid the rent (subsistence farmers had no money to pay rent).

    But guess where military tenure remained?


    Yes late 18th century and early 19th century Canada maintained military tenure – you swore an oath to fight (if called) and you got the land (for no money).

    Most people thought the system would not work if put to the test – but it did work, it worked in the War of 1812.

    The Crown called and (rather to the surprise of everyone) the farmers (even farmers who had been born and brought up in the United States) rose up to fight for the Crown – they kept their oaths.

    If the Crown keeps faith – so will the people, it was the complaint in the Carolinas in 1776 that the Crown had not kept their side of the Feudal compact.

    This was the argument both of the “Swamp Fox” in South Carolina and the Patriots at the Battle of King’s Mountain in North Carolina.

    “If you had kept your side of the oath we would have died for you – but you broke faith, so we are prepared to die fighting against you”.

    Although it should be noted that George III himself (as an individual) had very little to do with any of this – before illness took him he was actually a decent man (as he was during lucid periods even during his decades of utter torment – personal Hell).

    The incident of Mr Harrison’s clock shows what sort of man George actually was (free of the hangers-on of “the Crown” that crushed him).

  6. says: Paul Marks

    With hidesight (or with basic character) the Scottish lords should have been content to be “proud but poor”.

    The nature of the land (and the weather) meant it was simply impossible for them to match the wealth of English lords.

    No clever “development schemes” were going to change that.

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