Irish Mortgage Brokers Blog

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.

This is an interesting animated film on the origins of the crisis, it holds with the view that banks were only ever a part of the problem and not necessarily the sole cause. Central banks have a lot to answer for, as does all of society because when you stop saving and instead spend somebody else’s savings it means that eventually, when it comes time to repay your loans that not only is the money not there, but the productivity has likely suffered as well - income based on lending gives the artificial appearance of wealth but it is a mirage.

part 2

Joe Saluzzi of Themis Trading (I mistakenly read the link initially as ‘the mistrading’!) have recently published a paper which accuses traders of intentionally trading huge volumes where they buy and sell for the same price and in the process make a half a cent per share. The volume of trading is fictitious ‘high frequency traders’, what they do is buy and sell and collect liquidity rebates from the exchange (note: 50 milliseconds is a huge amount of time) in this game. Do it 8 billion times and it really starts to add up.

This is just depressing, actual investors don’t get to join in because the firms engaged in this are doing it within the actual exchanges using the fastest computer technology available. They also have an unfair advantage in how they trade because they use rules intended to match buyers and sellers to their advantage, they find hidden liquidity and in essence remove it from the market as profit.

The most powerful deterrent would be to make a rule whereby trades have to be in good standing for a full second, that’s right, 1 second would do away with almost all of this.

The clip below on Bloomberg is supplimentary to the 5 page report which is a fascinating insight into the inner workings of an exchange.

Now I understand why the likes of Goldman Sachs went after the person who stole their computer code with such vehemence, the issue with ‘algo’ trading is that the volume is not truly there, it is instead ‘presented’ as being there but not actually executing and the algorithm trader makes money on that basis.

Todd Harrison of Minyanvill.com talks to Yahoo!’s tech-ticker team about the five signals he sees as being those that fundamentally move the market.

1.Treasury yields: The 10-year yield settled at 3.50% on Friday, down from its recent rise to 3.78% on June 19, but still well above the January lows around 2.7%. Whether traders view this rise as a sign of “normalization” or incipient inflation will help determine the market’s fate, Harrison says.

2.Inflation vs. Deflation: Even Alan Greenspan knows the Fed faces a major challenge of needing to rein in excess liquidity before inflation takes hold, but not too soon as to risk choking off the recovery. Inflation is clearly a long-term threat, but Harrison says there’s 75% odds deflation persists for the near-term. (great piece on this by Morgan Stanley here)

3. New Supply of Stock: UBS’s $3.5 billion stock sale Friday is just the latest in a series of secondary offerings from banks. Some are worried about the pure supply and demand issues, but Harrison is more focused on a view the rally from the March lows was “synthetic” and “manufactured” by the U.S. government for the express purpose of facilitating these dilutive stock sales.

4.Technical Indicators: As detailed here, Harrison believes S&P 950 is the “most important level of the year” and believes the bulls have a window to make a run at that mark in the next week to 10 days.

5.Valuations: For all the talk of how “cheap” the market got in March, P/E ratios never got as low as at major market bottoms in 1990 or 1987. Furthermore, the market’s forward P/E is now close to levels that existed near the October 2007 highs, Harrison notes.