The End Of Certainty

If you work in finance, financial services or deal with people who are in the process of saving or investing – then in the past six months your world has changed fundamentally and probably permanently.

It’s not just the size of the recent capital losses which are the issue - according to Bloomberg data these losses already total more than US$335 billion.

Putting it another way that’s a US$55 loss for every one of the planet’s six billion odd residents, although considering only a tiny percentage of these people would have had any direct exposure to equity markets means some people will be sitting on quite significant losses.

While the losses are bad, the biggest change it’s likely to cause is that trust in the system may be gone and the golden decade of the financiers, the people who can manipulate money and work their magic over balance sheets, may be over.

Some of the big retail and business banks, which Western economies have come to rely on as the bell weather of economic security, are starting to show signs of fallibility, especially those that binged on a diet of cheap debt from the unlocking of wealth stored in houses as their strategies for fast growth over the past five years.

In the UK, the Brown Labour Government was forced to effectively nationalise Northern Rock.

In the US, Bear Stearns – the 85 year old investment bank which had been the watch word of significance and solidity in New York for generations – was sold for a knock-down price to JP Morgan.

While in Australia the Federal Government – in a move reminiscent of the economic management of the Wiemar republic – bought mortgage debt from the banks, in effect propping them up.

The best example of the outcome of this fast growth strategy may be St George, Australia’s fifth largest bank, now effectively so constrained by the credit crunch that it is under offer by Australia’s third largest bank, Westpac – led by the seemingly-permanently smiling Gail Kelly.

In a twist that the proves that the economic Gods at least have a sense of humour, the fast growth strategy, which brought St George to the point of sale was architected by, among others, the perpetually smiling Kelly.

It’s curious that the risk models employed by banks are very good at creating a picture of the past but oddly weak in creating a picture of the future, modelling forward risk, the inputs always appear to assume that the prevailing economic wind will never change direction, just intensity.

There are two significant outcomes of the current crisis – the first is that we are now sailing into a time when financial regulators around the world are going to enter a tightening phase -regulation after all seems to be a ceaseless cycle of tightening and loosening.

It’s always struck us as odd that regulators only effectively become involved after bubble’s burst, they have observed the change in the way that capital is used, the sub-prime industry emerge and been essentially silent on the matter, only stepping in when the custard has hit the floor.

It’s as if they are a caring, but lazy parent, who sit and watch their children plunging down a dangerous slope on a billy-cart only to provide advice and comfort after the inevitable crash.

The second thing that is coming under scrutiny is the ability and value of the executive pay, which in financial services has ballooned to Pharaoh like proportions over the past decade.

In fact according to Alpha Magazine, the highest paid hedge fund manager received a pay packet of nearly $4 billion Australian last year, all of that without producing a house, a computer or a product of any sort.

In a speech last week the German president referred to them as the monsters of the system and encouraged all of the world’s markets to examine their worth.

Some argue that reward is due for the risk taken, others argue that banks exist not to serve customers, or enrich shareholders, but more grimly to enrich the bankers themselves – who indeed seem to share very handsomely in their success.

Others still imply that there is in effect no risk – that if everything goes pear shaped, the Government will, Northern Rock Style, simply step in and bail them out, so the banks themselves in effect risk nothing.

It’s curious the subtle signs of change.

Last week a CoreData-brandmanagement staffer was jammed onto a 7pm flight from Edinburgh to London and was seated between two large Chinese gentleman sporting the Bank of China logo on their lapels.

The staffer noted the logo and struck up a conversation with them about their trip to Scotland, had they enjoyed it, did they play golf and talked about life and business in China.

Towards the end of the trip, he asked them why they had been in Scotland.

The representative replied blithely, “we are visiting a number of English Banks, it seems they have spent all their capital and are looking for more, capital is something that we are not short of in China”.

So when interbank lending re-emerges, when the flow of mortgage debt starts again in the UK, it’s possible that the money backing may not be local savings, or even European savings, but the bundled savings of 1.3 billion Chinese.