Irish Mortgage Brokers Blog

I have maintained for some time that new world orders don’t occur overnight, and that even trends that may appear to be secular don’t necessarily work out if you extrapolate them into the future. Let me explain, in the 70’s everybody said Brazil was going to rule the world by the late 1980’s, they came up with all of the reasons for this, demographic, growth, the education and markets in place etc. then it just didn’t happen.

By the end of the 80’s when Brazil was meant to be the new world power they had been usurped, this time by Japan, now it was the turn of the Japanese to be ruling the world within the next 20 years, then far from taking over Japan imploded and they have struggled ever since.

Today we are told that it will instead be China who rule the world by 2020, and frankly, I don’t believe that this can happen without massive painful adjustment that would set them back years, and it also doesn’t accommodate for the fact that the USA views the world as having only one power, theirs, and they will find ways to dethrone any who stand to pass them by.

In this video there is some commentary you may or may not agree with, in terms of the bet on China, time will tell who is right or wrong, but it is important to remember that for every reason ‘for’ there is an ‘against’ and conversations on the Chinese economy are often lacking in the latter.

In the first clip, James Galbraith (son of the famous JK), economics professor at University of Texas, discusses whether a new tax on big banks is justified. Ken Bentsen, of the Securities Industry & Financial Markets Association, and Mark Calabria, of the Cato Institute, share their insight as well.

In the second clip Mark Walsh, of ‘Left Jab,’ and Dan Mitchell, of the Cato Institute, discuss taxing banks based on their risk to the system.

Financial innovation has meant you can make money from many things which may or may not be considered morally correct, there are ’short sellers’ who make money when the price of a stock drops, some people consider that a bad thing, others feel that it is proof of an efficient market working correctly. Then you have the likes of ‘vice funds’ which invest only in things considered immoral such as weapons manufacturers, liquor distilleries, beer brewers and gambling. Then there are those that literally make money from death and today we will consider that group of investors, the SLS traders [naturally there are other non-market groups such as those dealing in blood diamonds but they are not tradable and fall outside of the remit of our description].

There is a thing called a ’secondary life settlement’ (SLS), and it is a financial trade where an investor buys a persons life insurance policy from them and continues to pay the premiums on it, then when the seller dies the buyer gets the money from it. Naturally this sounds pretty grim, especially when you see some of the buy side criteria - such as looking for ‘medically impaired’ policies, translation: the seller has cancer and is unlikely to survive for long.

SLS’s are therefore portrayed as a fairly macabre way of making money, even more so than the companies that sell insurance for death, and that is an odd thing, because a SLS investor is really only seeing out the duration of an assurance policy to its natural end of contract (and payout) that may have occurred anyway and in the meantime the seller makes some money from it.

Secondary settlements are actually a good idea for several reasons, first of all is that it infers certain property rights onto the owner of a policy, currently an insurance policy isn’t considered property that you can sell and that undermines the value of even paying for it in the first place, it is after all a type of asset albeit one that most of us never want to cash in!

It would be a good thing if people who were old were able to realise a cash settlement in life from a utility point of view, so rather than look at the example of paying off a granny with 6 kids who is dying of cancer, consider it another way - what if getting a cash payment for selling her life insurance gets that granny the best palliative care available that the kids (who may not have the money to pay for it) can’t afford, and this means that despite the inevitable conclusion, that this person passes away in the best and most comfortable surroundings possible.

Some might say - well… this isn’t really any different to ‘reversionary loans’ [which I jokingly call 'revulsionary loan' because people are so put off by them] where a person sells a stake in their home that they never pay back and then when they die the reversionary lender sells the property (offering it to next of kin first) and gets their money plus interest back.

The key difference is the asset, and in particular the validity of the asset, you see, a house can be used long after a person is dead, it can be rented out if they are in long term care and passed on as an asset that may eventually appreciate etc. A life insurance policy on the other hand stands several serious risks that may prevent it from realising a meaningful end, mainly that of premium cessation, where the person gets ill or in old age can’t afford the indexing premiums (many SLS are on policies where they get more expensive as you get older) and if they stop paying it becomes void and invalid.

In that example the policy now becomes worthless, you could argue that an old sick person might miss mortgage payments and get repo’d but experience tells us that the majority of people don’t have a mortgage after age 65 so while one asset becomes increasingly expensive to service (life policy) the other becomes less, and then negligible (house).

Take this example a bit further, imagine the person who is old and sick wants to give children a gift of money while alive but they only survive on a pension, a secondary settlement can do that, it can also help to cover the gap left by financial storms such as our 2008/09 crash which have left many who held dividend paying equities or other investments with catastrophic capital and cash flow losses.

When you consider every facet of a secondary settlement you can start to see that far from being a mercenary thing, it is in fact the market finding a way of offering people what they want. A person may have many perfectly good and rational reasons for wanting to take the money now rather than leaving it as a benefit to others after they die, most simplistic of all: what if they have no beneficiaries?

The secondary settlement market may be a partial solution to our pending pensions crisis, if the funding for this is not available in the public purse perhaps there is a market solution to providing income for the aged and this could be a part of that. Obviously, not everybody will ever continue to pay premiums or hold a policy large enough to provide a meaningful payout in the future and there are some restrictions that will weed out some participants, but SLS’s are not ‘bad’ by nature, they merely reflect a transaction between a willing seller and buyer, each have their motivations and each take from the transaction what they can but it is not inherently ‘wrong’ or ‘right’, if it is wrong then explain that to the buyer and see if they change their mind?

There are some important controls in place such as an auction system which ensures that people are not underpaid for their policies, and the buyers are regulated heavily as well. The one thing that could cause big problems in what is a totally uncorrelated investment market (to markets, there is obviously correlation to actuarial longevity tables) would be something like a cure to cancer, but frankly, I think even the losers in that example would be pleased with that because it would serve them in the future better perhaps than their profits would.

Roger Bootle notes that markets do quite well at the end of a recession and at the start of a recovery by drawing the benefits of the future down into the present. Roger has a lot to say on the topic of banks, in particular that of banker bonuses - he states (and we agree) that when banks become ‘too big to fail’ they essentially are oligopolies and hence they are able to pay so well. From an Irish perspective the domination of AIB and BOI put some stock in this theory.

Sometimes when I’m having a rough day I decide to reach out to some of the people that I see on TV or read about in the press and talk to them, it’s part of a greater ideal in which I believe people should have as many mentors as possible, spending time around the people whom they hope to emulate, if you can’t meet them in person then call them on the phone. It works (in my opinion!).

Anyway, today I was reading something Dan Mitchell from the Cato Institute wrote and decided that it would be best to give him a call, his receptionist obviously mistook me for somebody important (pigeon American/Irish accent works wonders!) and put me through and all I can say is that in person Dan Mitchell is a joy to talk to, while somehow managing to make a lot of sense in an easy to digest manner. That particular talent is a rarity.

I wanted to talk about taxation, the Commission on Taxation Report that came out this week has been playing in my mind, the idea that it is ‘revenue neutral’ is a myth in my opinion, simply because 1. it is state run and that means it will either be run badly (and not take in money) or run as most of the bureaucracy is run here meaning it will cost much more than expected.

Dan had an interesting point on this, his research has suggested that it is virtually impossible to have a positive and healthy tax system when a government gets too large, specifically, if they are responsible for spending any more than (when we mention ’spending’ you can replace it with ‘borrowing’ because the money they are spending recently is essentially coming from elsewhere) 20% of GDP, at which point it actually slows down an economy. We are (in Ireland) well above that mark unfortunately.

In considering a taxation system he said that there was a ranking of the ‘general approach’ and it is broadly as follows:

1. Consumption taxes (best).
2. Property taxes (middle ground).
3. Income taxes (worst).

While some commentators such as Fred Harrison are advocates of (essentially) a property only/asset only taxation system, it has yet to be tried in real life or in any country so the jury is out although it is definitely considered a better option than taxing incomes.

The Singaporeans try to avoid ‘tax and transfer’ and instead put much of the responsibility on the individual rather than using it to fund entitlement schemes. However, they also manage the money and that is why (according to Mitchell) the Australians have it right: mandatory participation in an individual pre-funding scheme.

This is currently only used for retirement, but similar schemes could equally be set up for health or unemployment, the obvious obstacle is that of trying to convince people to take responsibility for their own future, while that may seem cruel, it is equally cruel to sub-contract this out to the state who have a deplorable record (internationally) of getting things right individually.

There is a rare opportunity at the moment in Ireland to radically re-think the way we have been doing things and sadly, I believe that opportunity will be largely missed and the tenet of a ’simplified tax system’ (as suggested in the report) will not become a reality, nor will the horizontal equity it purports to bring about.

Dan is a well known commentator on CNBC, Bloomberg, and every other business channel of note, I was really delighted he took my call and some time out of his day to talk to me (so if you ever read this: thanks!). We hope to bring you more on Dan’s thoughts in the near future, for now, here is one of the snippets from the past.

This is a video on the fall of Bear Stearns, it is based upon the book ‘House of Cards’ by William Cohan, it is a six part interview so rather than post them all on our blog, if you want to watch the rest go here. Minyanville is also a site worth bookmarking!

The most popular question I am asked as of late is whether or not we are at the bottom of the housing market, and the answer is ‘no…. but perhaps closer than we think’. Today we will consider a few of the things we will need to see in order for ‘recovery’ to occur.

First of all we need to see a reduction in the massive overhang of housing stock, even if the number reduces, they all need to be sold and a degree of scarcity will need to develop in order to make prices go up again, currently supply is swamping demand and that dynamic will leave uncertainty in its wake.

However (and here is part of the ‘perhaps closer’ bit), NAMA will likely take a lot of housing off the market, in particular it will take it off the market and drip feed it back in, if this happens then it will avoid devastating fire sales, it might also lead to stagnation however if people believe that there is still more price drops to come and they are not arriving due to NAMA holding them back. In any case, it is fair to say that NAMA will change the market landscape in the near future.

Currently the market is in a position where buyers think the prices are too high and sellers can’t afford to drop their prices (unless they realise a loss in the process), so the two sides of the equation are at odds.

Jobs will need to recover as well, I can’t think of a single property market that went into an upswing during a period of rising unemployment. Housing also needs to recover its confidence, as well as job market growth we’ll also need to see wealth grow too.  Unfortunately the precipitous drop in the jobs and housing markets have been accompanied by an equal erosion in wealth.

There are four key pillars we will need to see improvements in before widespread recovery comes along:- employment, production, personal income, and sales. At the moment it doesn’t seem there are any indications that any of these factors are improving.

Of course, that doesn’t mean the property market is totally dead any more than the stock market is, there are profitable ventures out there, the trick however, is to find them and to make the right choices from the outset of the project, if you want to call and talk to us about what those decisions are feel free to call on 01 679 0990.

This is an insightful look into the financial crisis, looking at it from the view of how mass borrowing for residential real estate lead to a bubble, the political input into the causes as well as the packaging of these loans and how it ultimately lead to the closure of Bear Stearns and Lehman Brothers.

This is a great video set, surprisingly the Wall Street Journal are the makers of it, you don’t see that kind of departure from vested interests very often.

I was really disappointed to hear that Jack O’Connor of SIPTU and Sean Sherlock of the Labour party had brought the idea of ‘removing the state guarantee’ into the public arena regarding PTsb in retaliation to their 0.5% hike in the variable rate they are charging their customers. The outcome from a removal of a state guarantee could be catastrophic and in this post we hope to demonstrate this.

Before that though, it is vital to remember that there is no ‘price promise’ with a variable rate, the margin is not tied to the ECB - a mistake many borrowers made when expecting rate cuts as the ECB lowered the base. The margin on a standard variable rate is determined by the lender so this is case of the bank doing what it is entitled to do, they didn’t break tracker agreements or any loans that didn’t implicitly allow it, so on one hand the bank is acting within its rights.

The other thing to remember is the contradiction we see (mainly from politicians and union reps it seems) to the credit system, several weeks ago they were lobbying to allow people on fixed rates (who have a price promise in their fixed rate) to break out of it with no penalty, now several weeks later they want to see people on variable rates get ‘fixed’ style benefits, the utopian situation in credit simply doesn’t exist and it’s likely a case that many people are getting no advice in relation to their mortgage decisions on an ongoing basis which is why these situations occur.

Even with the 0.5% hike factored in the interest rate is still incredibly low and it is right that the people who borrowed from a bank should have to pay whatever the bank charges to remain profitable rather than every taxpayer via recapitalisation or nationalisation.

The basis of my frustration is that you can’t and should never consider, the removal of a state sponsored guarantee/covenant in the midst of its duration or it would send a clear message to credit markets that the Irish government ‘didn’t really mean it’, and in particular it would be a mistake to do it in retaliation to a rise in interest rates because doing so would politicise banking and put the power of credit into the wrong hands, rewarding those who shout loudest rather than those who might be making the right decisions.

That banks have made grave errors is a given, that the tax payer is saving their hide is as well, however, if the choice comes down to doing this in an effort to save and retain credit institutions then it must be recognised that banks are ultimately good for society and that to remain profitable they need to charge higher margins.

The IMF remarked on how low our mortgage rates were in their recent report on Ireland, banks are telling us via their upward move in rates (I say ‘banks’ plural because others will follow eventually) that this is what’s required in order for them to make money and not be bailed out.

Make no mistake about it the flow of events would be something similar to what I describe if you were to remove the guarantee from a bank prior to its expiration:

Share prices would tumble first as concern is raised in the markets about the viability of a company when its capital is now unprotected, PTsb’s reliance on money markets would mean they would instantly have issues rolling over that debt at whatever the next due date is, if it was overnight money then it would be instant disaster.

The fact that the state removed a guarantee would mean that bond holders in other guaranteed institutions as well as institutional depositors and investors would instantly lose any faith in the credibility of the state guarantee, seeing it removed for political reasons means no institution is safe, capital would flee the country, bond prices would nose-dive, capital reserves for every covered institution would dissolve in a matter of days, there would be runs on every guarantee covered bank and we would then have to nationalise the entire banking system at a cost to the taxpayer so impressive that literally three generations would have to pay for it, the IMF would come in, austerity measures would be put in place the whole system would collapse.

There is an interview on the Tom McGurk show on 4fm on the right hand side of this blog in which Sean Sherlock of the Labour party talks about the idea of removing the guarantee, my instant answer is that it is a lunatic idea, not because I like banks, but because I like a non-IMF controlled Ireland. We don’t need instant systemic risk thank you.

The fact that the idea of ‘removing the guarantee’ is even mentioned in national press concerns me, I can’t think of a single thing that would break the country faster and more effectively, it is just a sincere pity that union leaders don’t spend some time trying to understand the markets, time after time they demonstrate an inability to understand markets beyond populism or rhetoric, their appeal to the lowest common denominator often makes me wonder if their members see through such a plain ruse.  Most importantly, they should never try to gain public support for measures that would literally implode our whole financial system, it is careless, wreckless, and downright ignorant.

Here is a simple question: ‘how do you protect or even augment your portfolio returns when markets are crashing or where there is systemic risk?’ if you have an answer then you can be a little smug because the majority of fund managers, the best and brightest the world of finance has to offer, for the most part didn’t have an answer during the last two years and if they did they didn’t (by and large) act upon it.

The classic definition of a hedgefund is not the ponzi-schemes run by the likes of Bernie Madoff, rather it was a fund that strategically goes long and short to produce positive gains regardless of whether the market goes up or down, that was what Winslow Jones was doing when he started the first hedge fund in 1949, while managed fund managers are happy to post a 20% loss when the averaage is -30% (for instance), hedgefund managers are meant to be able to outperform bull markets but also post positive returns in bear markets, sadly, many hedgefunds in the last few years weren’t even hedged! They were basically long only equity funds that liked to charge high commissions based on returns which were largely posted due to excessive leverage!

How did that work? Well, a fund starts off with €100 and then they go and borrow €900 so now they have €1000. If the market goes up 3% they make €30 which looks like a 30% return on funds invested if they pay back the leverage (borrowings) but this is false economy because if prices don’t go up funds get margin calls and then they are often coupled with problems of not being able to ‘roll-over’ their borrowings, repo markets [to a degree] have the ability to stand over any fund once in a 24hr period but in many cases this mechanism failed as credit providers lost confidence in repo-borrowers.

It is worth taking a moment to understand the ‘repo’ market, it doesn’t mean ‘repossessed’ rather it means ‘repurchase’ because what happens is that collateral is given up overnight in order to obtain operating funds, if this doesn’t happen, for instance if your counter-party doesn’t trust your collateral or thinks you might not be able to repay tomorrow then you can literally be shut out in an instant and you close down rapidly, this is what happened to Lehman and Bear Stearns.

Back on topic, the way to ‘hedge’ is to include investments that have an inverse correlation to the broad stock market or to particular shares held in the fund. The Japanese Yen is an example of a currency that does this, when markets crash the Yen strengthens, since around August 2007 - where the first hit of the current crisis started to play into the market. Every time the market took a dive the Yen has risen.

Often when stocks crash institutional investors rush to cash out of their stocks and repay their Yen denominated loans (Yen was used due to its low interest rate), that is called the ‘unwinding of the carry trade’ which we have covered before - the ‘carry’ trade occurred where people borrowed in yen to leverage up because a ZIRP (zero interest rate policy) meant it was a good currency to borrow to the hilt with.

Gold is another hedging tool, the deeper the crisis got in the early days the faster gold rose, going over the $1,000 mark in 2008, since then it fell back to the low 700’s and is trading again in the 900’s, the part to remember is that gold has

There are beneficiaries of systemic risk and systemic collapse, the downside is that many investors are nowhere near a life raft when the ship is sinking. I like the analogy of the Titanic, you see, for all the history of tragedy associated with the Titanic, it must be remembered, there were also a lot of survivors, they were the ones who got onto the available life rafts.

Dollar hegemony or dollar supremacy is likely going to change significantly in the next decade, the transition will be difficult and will feed through to commodity prices and equities. So being ready for volatility is vital.

Publicly I said at the end of November that I saw real value showing in Irish banks, they were trading well below the €1 mark, they fell right down but came back with a vengeance, hence I followed up with a sell call in June 09′when the major bank shares in Ireland were trading closer to €2. It is important to have an exit plan whenever you get into anything (again, make sure you have access to that life raft!).

the thing to understand is that there is always a bull market somewhere, you just have to find it, sometimes that means using inverse ETF’s or shorting strategies (which can be done via options as well), or just going long in the right places, we hope you don’t lose sight of the desitination because of the current scenery on the journey! Wealth is built in small steps, one day at a time.