22 June 2008

Bankers around the World go for it -Needham

Banker’s humour shines out with what is euphemistically referred to as “The Great Moderation”. Like most of these monikers it is another spin designed to put the mindless punters at ease while the bankers shuffle the cards. “Moderation” in the context of this expression refers to the unusually extended and smooth economic cycles over the past two decades but I recently saw NZ Reserve Bank boss Alan Bollard refer to the global deleveraging currently being espoused as part of the great moderation. Undoubtedly Governor Bollard like all other central bank rulers is aware of what is going on. The current round of deleveraging being miraculously reported by bankers and investment banks is just another sleigh-of-hand trick to make those dollars fly around to parts of the globe and others balance sheets where they will appear more palatable or at least avoid scrutiny.

Don’t you wonder when bankers report a $55 billion deleveraging in one quarter how they were clever enough to do it? The problem with deleveraging is that both sides of the balance sheet have to be skinned. There is no known way (yet) to get rid of the liability (loans) and hold onto the asset other than something very old fashioned like reducing liabilities through retained earnings and surplus cash flows, and that my friends is not the business these turkeys are in.

Theirs is the arcane world of leverage. Thimble and pea tricks where unpaid interest on mortgages is taken to account as profit, where highly leveraged assets are parked in SIVs from which banks collect fees whilst pretending that it is an arm’s length transaction for which they have no supportive funding liability. The acquiescence to this behaviour by central banks, regulators and governments is truly staggering. The almost universal acceptance now, of what I wrote four months ago-that taxpayers will finish up shouldering most of the bill for the bankers’ shenanigans- is profoundly interesting to me.

In the US, Congress is preparing to pass legislation to bail out over reaching banks and borrowers; US Fed without Congressional approval has acted to forestall the inevitable consequences of the great debt boom; in relatively conservative banking communities down under (no ARMs or negative amortization mortgages), the Australian Reserve Bank has been quietly accepting impaired mortgage backed paper from not only the four pillars (major national banks), but from the next tier of slime meisters as well, since last September. In New Zealand the Reserve will start allowing mortgaged backed bonds to be used as repo collateral starting next month.

Not content with sticking their snouts into the central banking system for relief, Australian banks have gone a step further and managed to offload some of those onerous assets to a strange beast called the Australian Future Fund as reported this week by the Sydney Morning Herald on June 12:

Cash-strapped banks are tapping Australia's sovereign wealth fund to raise new finance as traditional sources of funding dry up in the ongoing global credit crisis. ANZ Bank, the country's third-biggest lender by assets, has raised about $500 million in term funding from the Future Fund, an industry source said today. The Future Fund, Australia's largest single investment fund with $60 billion in assets, was set up by the government to cover public service pension liabilities. Its assets are set to grow to about $148 billion by 2020. "My understanding is that all Australian banks have done transactions with (the Future Fund). If you want debt in your portfolio, having some bank term debt is not a bad option, particularly given that you are getting more attractive spreads,'' said one industry source, who declined to be identified.

ANZ and Westpac spokesmen declined to comment, while NAB was not immediately available for comment. "It's smart move for the Future Fund and it's a smart move for the banks,'' said Martin North, managing consulting director of Fujitsu Australia and New Zealand. He said the risks attached to putting investment capital into a mortgage business are relatively low, as such businesses are backed by secured assets.

As a piece of uncritical reporting, this is a doozy. I thank my colleague Derek J in the far West for drawing it to my attention. To my knowledge these transactions have not been reported elsewhere and have drawn no flack from the usual columnists and scribes. Why the Herald is acting as a shill for the banks is unknown but why the rest of the financial community accepted this action so uncritically must have some meaning. To explain these strange transactions requires some knowledge of the Futures Fund.

It is not a sovereign wealth fund as reported by the Herald. Its funding comes from government surpluses which will disappear quickly as the economic cycle turns. It is a triumph of bureaucratic power in a country where one in four workers are public servants. After generations of accrual of public service pensions which are light years more generous than those in the private sector, the Howard government was forced by the certainty of the law of compounding numbers to deal with the inevitable consequences of these massive unfunded liabilities, so they established this fund to meet those liabilities. Many other countries including the US face similar problems as legislators happily appropriate not only immediate funding for their pet programs but continue to ignore the legacy costs that compounding numbers always create.

The government appointed trustees of the fund are charged with its maintenance and management so no doubt the spin from Mr North that “risks of putting investment capital into a mortgage business are relatively low and such businesses are backed by secured assets,” was most welcome. Indeed the only way for the trustees to have approved this arrangement was if they had also formed that view on advice.

To state the obvious that mortgage backed securities have hardly proved to be a safe, secure investment elsewhere in the world highlights the very real disconnect between the hemispheres. That the new Australian Labour government has acquiesced in this charade shows what is churning under the surface. With the Australian stock market already under pressure, the prospect of the big four banks coming clean and facing up to their losses with a public issue is obviously not a prospect that can be willingly contemplated. In the scheme of things the amounts mentioned are pin pricks but we simply don’t know what these transactions have been, nor do we know the extent of Reserve bank and quasi government funding extended. In a country where sporting figures make headlines while politics and finance are largely ignored, there is no clamor for disclosure. How this all complies with the Australian Stock Exchange’s rules on continuous disclosure to shareholders is a mystery to me. Australian company directors are required to sign statements that their annual accounts give a “true and fair” view of the company’s position. Banks creating off balance sheet SIVs and other non reportable entities, then taking them back on their books when the SIVs are unable to fund themselves makes a mockery of the process.

Neither shareholders or regulators seem concerned so the joke goes on.

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