Saturday, August 06, 2011

International Money Issues and Other People's Property

The past week's  global financial  mayhem culminating with the news that the USA's credit rating has been notched down from AAA to AA+ by Standard & Poors is so far at least,  largely  passing ordinary people by. Wise sounding pundits on TV and radio warn darkly of the effects of collapse in share prices  on pension benefits in the years to come or on the banks' capacity for lending yet we have heard all this before eg after the Lehman Brothers' collapse and life still goes on. The down grading of the American financial status is in my view sad though possibly not too detrimental at this stage not least because  an effect might be that  politicians on all sides there might begin to roll up their sleeves with a view to securing reinstatement of the USA's accustomed AAA status.

A factor in the first chapter of the financial mayhem which started in about 2007 was the absurd arrangement made by some banks for labeling large numbers of their rights to be repaid by borrowers, with opaque financial terminology then selling  off bundles of such rights   at generous looking discounts, to other banks and financial institutions, which  in turn  repackaged them and sold off some again hoping to pick up a profit. Many such buyers of these  debt bundles  undertook only superficial checks into the likelihood of the borrowers being able to repay so when  borrowers began to struggle with their unrealistically high personal debt burdens, the whole pile or pyramid   is better word, of bank investments in such debts began to collapse which in England at least  came to be reflected in the TV images of Northern Rock customers queuing around the block to withdraw their own cash. Governments' answers to this at the time were initially to guarantee bank deposits in the UK's case up to a specified cap although the Irish government went further than most and gave an open ended guarantee. Ultimately many banks were nationalised in part or whole to save the system from complete collapse.

Chapter two of the global book of financial mayhem is still being played out. The Eurozone approach appears to be to try to settle European  problems through committees but with so many  different Eurozone nations having opposing interests, their committees give the impression of dithering  thus adding to the existing uncertainty. Thankfully the UK is neither part of the Eurozone nor of the group of nations which dither by committee although the jury is still out on whether the UK is dithering by coalition. So far   we seem at least  to be  trying to rein in national spending and if the complaints about the hurts being caused by so doing are any fair yardstick, the attampts are having a measure of success.

The very sharp falls in share prices I do find interesting. Take a company like  Encore Oil. In past months it has made by my reckoning at least four significant oil finds in the North Sea yet the graph below shows what has happened to its share price in recent weeks:

Before commenting further I should add that I invested in a few Encore Oil shares towards the end of last week so as they say on PI bulletin boards: "Do your own research".

Encore Oil ("EO.") is so far as I know fully funded and might even be attractive take over target for a larger oil company to consider so why the huge fall in its share price especially over the last few days? The answer may be partially caused by the  creation by the same kind of financial whizz kids who dreamt up the packaging in unfathomable language of groups of questionable debts  for sale  between banks leading to the banks' crises a few years back, of  financial products to which unfathomable names like  spread betting or shorting  are applied,  for ordinary people to use as well as institutions.

For example if an ordinary person (private investor or "PI") wanted to gamble on EO. share price falling the PI could as a consequence of the financial whizz kids' scheme, use EO. shares belonging to someone else and agree to sell them now at today's price for delivery back to the true owner  in say 2 weeks time. The shares would have to be be bought back usually through an intermediary) in two weeks and the expected  lower share price then would give the shorter an handsome profit. As it can be so much cheaper to short shares  than to buy and own them, often the sheer  weight of shorting can give the share price a downward momentum even where the company's financial fundamentals are healthy, to the serious disadvantage of those who invest in rather than bet on shares .

 Added to this is the possibility that financial wizardry makes it possible for such practices to be financed purely by borrowing, thus making it far cheaper to deal in  shares you don't own than to buy with real money and own the shares personally. The true owner of the shares whose best interests obviously lie in  in the share price going up, would thereby unwittingly and unknowingly have his shares used to  enable  a stranger to  bet that that their price would fall. The outcome then would be that the stranger has made his profit by using the owner's shares after which the owner (usually none the wiser as to why) holds an asset worth less than before the stranger became involved.

A difficulty is that when the financial climate becomes tough, the intermediaries who make  loans to facilitate  gambling in this way, call in their loans resulting  in many people trying to cash in their positions at the same time. The eventual outcome is the plummeting share prices witnessed on TV screens worldwide, based not on the underlying value of the companies like Encore Oil but simply upon betting on shares suddenly being made more difficult/expensive and everyone rushing for the exits simultaneously.

Years ago in the UK there used to be restrictions on how much could borrow on what used to be called hire purchase to buy cars TVs etc. The objects of such restrictions included those of protecting consumers from their/our own lack of financial  self discipline. Hansard the Parliamentary records a debate about this in July 1967  rather well at::

Perhaps I may remind your Lordships of what has happened so far as hire-purchase on these products is concerned. First of all, before June, 1965, a down payment of 10 per cent. was required and there was a repayment period of 36 months, together with a purchase tax of 25 per cent. Over successive stages this has changed to a down payment of, not 10 per cent. but 33⅓ per cent., a repayment period of 24 months in place of 36 months, and a purchase tax of 27½ per cent. The result of all this, since July, 1966, in particular, when the 33⅓ per cent. came into force, is that all electrical appliances subject to these restraints—except, I believe, toasters and percolators—have declined in sales. Cookers and storage refrigerators which are less severely treated, have been doing reasonably well.
 I'm not suggesting that we should go back to having restrictions placed on the the way one might wish to borrow to buy a domestic cooking stove. However the free for all that successive governments internationally since the 1960s, have facilitated to enable huge and opaque gambling with other people's shares and money to be  available to anyone who wishes, is in my view a significant cause of the latest financial turmoil affecting many parts of the world and likely to affect many ordinary people.

Some of the financial restrictions deemed necessary to protect society from borrowing too much for equipping kitchens etc  in the 1960s should surely now  be considered for protecting society's ability to fund pension and similar stock exchange investing in the C21?

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