Category Archives: financial risk

Forget the US, Europe’s in a mess

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Several years ago, at the height of the thermonuclear phase of the Global Financial Crisis (compared to the slow radiation death we’re experiencing at the moment) a colleague of mine poured scorn on the US as an economy and looked towards the mighty powerhouse of Europe as an example of How To Do Things Right.

So it turns out he was wrong.

Some of the individual underlying economies are in good shape. There is much to be said for Germany’s productivity levels, technology, social safety nets, strong exports, apprenticeship system and more. The house market / debt problems of the south are less obviously good.

The real problem is with the Euro. A single currency in an area more inclusive than theory would suggest as ideal for a common monetary area AND without fiscal union is proving to be very unstable.

I’m not quite ready to make a prediction that the Euro won’t survive, but I’m looking to that as a real possibility. Just take a look at the Germany-Italy spreads to get an idea of how nervous the market is.

Book Review: This Time is Different

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This Time is Different is a fascinating look at 8 centuries of financial crises including banking, currency and sovereign default.

It’s chock-full of analysis, numbers, tables and charts showing how as much as things change, the scope for financial crises changes very little.  The comparison of Developed and Emerging Markets is particularly interesting in that the differences, while they do exist, are far smaller than stereotypical views.  Emerging Markets do tend to have more ongoing sovereign defaults, but the frequency of banking crises is little different. Weirdly, some aspects of Emerging Market crises (such as employment impacts) are less than average for the Developed World.

It isn’t really the book’s fault, but this was one of the few books that I struggled with on my kindle – the graphs and charts and captions to figures were particularly difficult to read. Perhaps they would look better on the Kindle DX (the larger model) or even an iPad or something.

Although the book doesn’t focus on the current (still-happening, if you weren’t paying attention) financial crisis, there are several chapters dedicated to it with an analysis of the economic indicators leading up to the crash. Now it’s incredibly easy to predict an event after it’s happened, but I’m still hopeful that the results can be useful in predicting future problems and potentially impacting economic policies and regulations for the better.

Some key conclusions from the book for predictors of financial crises:

  • markedly raising asset prices (yes, and in particular house prices given the likely co-factor of increases in debt levels)
  • slowing real economic activity
  • large current account deficits
  • sustained debt build-ups (public and/or private)
  • large and sustained capital inflows to a country
  • financial sector liberalisation or innovation Continue reading →

Have all the World Cup expenses been counted?

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Airports Company SA, “ACSA”  now has some of the highest fees  in the world. Apparently they need to fund the huge “investment expenditure” incurred  in upgrading on our airports recently for the World Cup.

This begs the questions:

  1. What business plans were used in determining investment on our airports?
  2. How did actual experience compare to those budgets?
  3. What can we and ACSA learn from the difference between expectations and actual?
  4. Did the marketing benefit of the World Cup more than offset the de-marketing impact of higher costs of travel to (and inside) South Africa?
  5. Have these “investment expenditures” been capitalised on ACSA’s balance sheet and has the resultant asset been impaired or not?
  6. Have these additional costs been added to the official costs for the World Cup (and why not?)

Who am I kidding -  huge sums of money were spent on the gut feel that it was a good idea and because spending other people’s money is easy and it’s self-glorifying to build grand airports.

Bitcoin mirth [UPDATED]

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@RichardWooding sent me a link to a Wired story about a new Bitcoin wallet app for Android. I think Richard has figured I’d enjoy taking a few pot shots at this based on my past posts on bitcoins.

The article is fairly balanced, indicating the recent (and trust me on this, ongoing) problems with BitCoins. The idea of the app is fairly neat, using camera, display and barcodes to effect transactions. Then I read:

“Right now, Bitcoin appeals mostly to the hacker types,” said Android developer Brandon Iles, the app’s creator. “Down the line, though, it could gain traction between friends. There’s an advantage over credit card companies because there’s no fees involved in the transaction.”

Now this is a quote so I can hardly blame the journo, but the utter blindness of those involved with Bitcoin continues to astound me. Continue reading →

SA Bond Market – antiquated or efficient?

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[Update: for some incomprehensible reason the embedded video clips below only work on YouTube. Click the image for a link to the YouTube page]

Andrew Canter (of Future Growth) makes some strong statements about the “phone and dealer” approach to the South African bond market. When one of the arguments against Andrew’s preferred centralised, electronic order book is “we like the information we get from deal flow” I have to say I agree with Andrew.

and part 2 (which also includes some discussion of Covered Bonds with the clear links to Basel and indirect links to Solvency II and SAM) Continue reading →

A good explanation of the perceived problems of annuities

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There is much to recommend in purchasing an annuity at retirement to manage the risks and uncertainty of longevity. It’s well known though that surprisingly few people who have the option to purchase an annuity do so.

Richard Thaler presents some of the common perception problems with annuities in this article in the NY Times. The basic message is still as it has been for decades. Individuals are reluctant to pay a large portion (often the majority) of their life savings to an insurer with the risk that they will die in a few years and “not have got their money back”. The peace of mind that should come to the policyholder turns into a matter of stress.

The bequeath motive is strong – and amplified by a lack of understanding of exactly how long we’re likely to live in retirement these days and how much money will be required. Those to whom many plan to bequeath may ultimately become the source of support when the income draw-down products are depleted with no longevity guarantee to boost the funds available.

It’s a good explanation although he doesn’t break much new ground. He also doesn’t talk about the concerns some potential policyholders have, in some countries at least, of whether the insurance company who sells the annuity will definitely be around over the next 40 years come what may.  This is more common in developing markets with weaker regulation (probably a good reason to have concerns) and less history of annuities (a cultural bias that will probably disappear over time).

Mr Thaler doesn’t propose any solutions for the insurers in boosting sales – a common “fix” is to combine a traditional pay-until-death annuity with a guaranteed minimum period or a death benefit (either for a limited term or at any point).  These adjustments reduce the “risk” of “making the wrong decision but purchasing an annuity but only living for a short period”.

There’s no free lunch.  In the same way that cash-back bonuses on short-term insurance products actually increase the average cost of insurance and reduce the risk-transfer from insured to insurer, these guarantee periods increase the cost of annuities.

Doesn’t have two Bitcoins to rub together

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Prediction:  Bitcoins will be irrelevant by 2013 and will never emerge from a very small niche market.

In fact, they are already irrelevant today. This is what happens when open source supporters, crypto experts and privacy nuts think an understanding of C++ and maths equates to knowledge of economics and monetary systems. Oh, and add in an unhealthy dose of paranoia and persecution complexes.

The technology and theory is interesting – bitcoins are effectively a peer-to-peer currency with various controls around their creation, existence, trading and (lack of) tracking.

From a monetary system perspective they are irrelevant. To show the extent of the problem, just read this nonsense article “explaining” why Bitcoins will always have value. The article includes how the “Federal Reserve rescued the dollar in 2008″. I must have missed that. Anytime supporters of a particular idea have completely incoherent arguments for it, that’s a pretty good sign there are no coherent arguments for it.

The author also states as a fact that a South African mobile operator is integrating Bitcoin support.

Prediction: None of MTN, Cell C or Vodacom will ever officially support Bitcoin.

I can’t begin to explain how many different ways this is a bad idea.  Good news is several people already have. Much of the hype about Bitcoins and other cryptocurrencies stems from a lack of appreciation for the devastating impact of deflation, misunderstanding of what the money supply really is and the role of the Federal Reserve in this crisis and the Great Depression.

Now I just need to find a way to short Bitcoins.

Fixed Interest is a viable asset class

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I heard someone talking on Classic Business tonight. Pity I didn’t catch his name so I can avoid his advice in future.

He was saying that he doesn’t see the point in investing in debt instruments.  He explained that the return is low and the risk high since if the company gets into trouble, you’ll likely only get a few cents on the dollar back.

Well, he’s wrong.

Risk and asset-liability matching

Fixed Interest investments are often the only investment that makes sense when you need to match or hedge fixed liabilities.  Naively consdering expected return only and not asset-liability risks  gives naive results.

Credit risk premia more than compensate for default experience over time

It’s worth exploring risk a little further. The caller stated that if the company gets into trouble, it’s likely the bondholders will also be hurt, and will likely only get a few cents on the dollar. Well he’s wrong here too.

The historical default frequency for investment great bonds (BBB and above) has been hardly more than a few single digit percent.  The Loss Given Default (how much an investor will typically lose if the bond issuer does default) is anywhere from 35% to 80%, depending on the seniority of the instrument, which estimate you trust, how it is measured and when the estimate was made. It’s because there are so few investment grade defaults that the data is so sparse and the estimates so wide. However, it’s clear that the likely return won’t be “a few cents on the dollar”.

I’m going to hunt round for some references here so you’re not just trusting my word.

Illiquidity premia = higher returns for some

Given the illiquidity of many corporate bonds, the expected returns are even higher if you as an investors are not considered with easy liquidation of your investment. This is a “pure risk premium” that you will earn over time without expected loss.  You could purchase extremely high quality, well-collateralised debt and earn a good return above risk-free as long as you have the patience and resources to hold it for long periods or until maturity.