1929 Depression VS 2007 Recession/Depression

By Andy Shaw | January 26, 2010

Originally posted 26th June 2009

Depression vs Recession

The jury is going to be out on this for some time yet although as I have stated if they don’t make significant changes and in the right direction then that’ll be where we end up. For those that don’t know the difference between a depression and a recession – it’s in the length and depth of it.

There have been some economists who have collectively put together a lot of comparison charts of the 1929 Great Depression and the 2007 Great Recession based on what happened over a period of 0 to 50 months, following the start of the troubles. I thought it made interesting reading and a good pictorial example of where my instincts are telling me we are at in the cycle

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Everyone’s Taxes In The UK Are Going To Have To Go Up Full Stop!

By Andy Shaw | January 26, 2010

Originally posted 22nd June 2009

An Unsustainable Trend in Debt

Basically, we have spent too much and we will be spending far, far more to get out of the current crisis. At some point this will need to be paid for and the only way to pay for it will be simply to create more revenue. So they can try scooping up air into the room and force up GDP which of course creates more revenue but in times like these the easiest and probably most palatable way they will create this required new revenue, given that whichever party is elected gets a full 5 years to get it right before we have another say very shortly, will of course be to increase tax. It is just a matter of time now until tax revenues have to start going up. If you think they won’t be raising taxes, then I hope you are good at handling disappointments.

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The US Housing Market Problem And How It Will Effect Us

By Andy Shaw | January 26, 2010

Originally posted 15th June 2009

The Coming Mortgage Crisis

The US housing market is still very much in a slump and when you start to dig deeper you start to see just how big the problem will become. When you look at the American market you see that as a portfolio they are 70 – 80% geared and at a quick ‘media’ glance things look to be ok but when you consider the simple fact that 33% of the market has no mortgages at all the problem starts to come into view.

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They Are Lying, Their Lips Are Moving

By Andy Shaw | January 26, 2010

Originally posted 27th May 2009

I noticed a few things among the barrage of noise in the papers recently that were actually important. The RPI (Retail Price Index), which measures inflation and the relevant pressures, fell to its lowest level in 60 years. This is an important figure because it is a more accurate ‘waypoint’ than is found in the majority of the info that comes out. However, the government does not like this figure as it includes too many things that make them look bad, so they don’t use it.

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The Unemployment Tsunami

By Andy Shaw | January 26, 2010

Originally posted 22nd May 2009

Following on from my last article, I thought I’d cover the unemployment issue in a little more detail. Now I’ve been banging on about how unemployment will take off around the end of this year for some time now, and even though the media and nearly all financial pundits seem to be saying it is looking like we are coming through it, I struggle to find ANY positive data that shows signs that the recession is nearing an end. The bear market rally that is happening now will prove to be just that within the next six months and this time next year the talk will be about the winter of discontent we will have just had and how everybody hopes the new conservative government can turn around the disastrous policies of Gordon Brown.

Well I was reading one of the many newsletters I receive and there was a good bit on unemployment in the US and how it has taken over from employment. They presented a site with an animated chart that shows through several years of monthly figures how these figures have changed. It starts with 2006 when there was great employment, then it rolls on to March this year and the representative change in colour is dramatic. I suggest you view the chart, it takes just over a minute:


Its been 50 years in the US since they have seen so fast a drop and given that there is now a much smaller percentage of manufacturing jobs there then the volatility is breathtaking.

What happens in the US is a fairly good indicator of what is likely to happen in the UK and even though we may not experience unemployment here as severely as they have, it will definitely follow a similar pattern. The US went into recession in Dec ‘07. In May ‘08 we followed suit – i.e., we are a minimum of six months behind them. Signs of the problem for them started to show in Jun to Aug (as you can see from the chart) and then things got really dangerous in Sep to Nov.

So 6 – 9 months after the recession started they were getting some bad signs and after 10 – 12 months the figures were dire. I think we will experience dire figures a little further delayed than they because of the yearly pattern and things will really start to look bad for us from September onwards. Just look how bad it got between Nov and March in the US. I expect to see some serious protest marches this year and there is a possibility that we could even see rioting in some areas.

To quote another analyst – “Normally, labour markets lag the economy because incremental spending transactions are financed via debt, stimulated by interest rate cuts. But as long as credit remains frozen, spending will require income, and income comes from jobs and debt service payments are made out of income. Therefore, in a deleveraging environment job growth becomes an important leading, causal indicator of demand and other economic conditions.

“… The bounce in the economy and the stabilisation in markets reflect government actions that are big enough to impact near-term growth rates, but are not sufficiently directed at the root problem of excessive indebtedness to produce permanent healing. The deterioration in employment markets will continue because companies’ profit margins are so deeply damaged that a little bounce in growth won’t do much to alter their need to cut costs. This deterioration in labour markets will undermine demand and continue to pressure loan losses, which will keep the pressure on the banks and elevate the cost of capital for tentative borrowers, inhibiting credit expansion.”

The problem at the moment is that the media and the economic prediction ‘experts’ are using data to draw their conclusions from, and that data is wrong. So they are using recent past performance to predict the immediate future. The problem is that no-one was really alive and at work the last time this sort of thing happened. So even though we continually hear from the experts that past performance is no guarantee of future results, they are failing to heed their own advice. You have to look at the underlying conditions in order to get a real comparison, and we have not seen a de-leveraging recession in the US or the UK for 80 years.

This will prove very harmful to people who look at their portfolio rebuilding and decide to hang in there. They think it will be over when they see something positive. Well, let’s not forget that 8 out of the last 11 recessions have had one quarter of positive growth, which of course then went on to have other quarters that were negative.

Ok, So What Does This Mean For Us Landlords?

People say I’m a bit of a doomonger at the moment and I just do not see it that way. I am looking at what is happening as a golden opportunity for those that are armed with knowledge and the ability to put themselves in the way of the tide of opportunities as they arise.

In business good news has to travel fast, but bad news has to travel faster. Whenever someone says, ‘I have good and bad news,’ the good news can always wait as I would rather enjoy that after I had taken action on the bad news.

Well here is how this bad news will work for us as landlords. If you are a landlord in an area that usually has a high rental demand then you will probably find that this demand has curbed a bit.  In some areas it will have mellowed and in others the demand will be weak. This is because of a number of factors and I could write a lot on this. However, I will keep it short.

We have gone from being borrowers & spenders to savers overnight, so people will be holding back from leaving the nest. Also, jobs are not being created so there is not as much demand and there have been a huge amount of property developers who have decided to rent rather than sell.

There are other reasons as well but you get the point, the demand has slipped. As unemployment rises then the demand for rental properties will increase again and so will the prices we can charge. As this drags on from the winter of discontent we will see more people using government handouts to rent property and we will have high demand again.

Don’t get me wrong this will not be good news for the country but it will be good news for our profits. Probably from next year on you will have to keep quiet at parties about being a landlord, as the media will most likely be vilifying us for taking a profit when providing a public service. This would not be a good time to have labour in government as they may look to introduce a new landlord tax, or maybe I’m just a cynic!

Anyway, I would expect rental demand to pick up next spring time and I would also expect my yields to increase.

Best wishes


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Humility Becomes The Bank Of England

By Andy Shaw | January 25, 2010

Originally posted 18th May 2009

The quarterly work of fiction has just come out from the Bank of England and as usual they have got some pretty big assumptions wrong. However, in this report as well as in the press conference, I saw a more reserved approach from Mervyn King.

I think he had been riding on a decade of success where whatever he said was pretty much ok and then after his TOTAL failure to recognise the recession/depression coming (the D word has not left my vocabulary, despite other commentators now believing we are actually through the storm and starting to recover) he now is less confident (wisely) of the accuracy of his predictions. As with anyone who has had life give them a smack in the mouth, he is treading much more cautiously now.

Well, here are the notes I made whilst reading and listening to the report:

King says it is worse in other countries than in the UK, and some of what he says is right. However, other countries are nowhere near as exposed as we are and that could and probably will prove very bad for us when the new money in the world actually figures out that the UK is one of the most over exposed of all the financial nations. Even though we will not end up like Iceland or Ireland, we are in a similar predicament only on a much bigger scale, but with big friends and big bargaining chips.

I think their GDP fan chart is wrong, as it shows on page 9 we in a ‘V’ shaped recession. We are not, we are in an ‘L’ shaped recession, so the assumptions for the remainder of this report will be wrong once again.

They said that they are favouring 2 years of stable bank rates to get inflation back on track. Now as their prediction of the economy GDP is wrong, this means we will see low rates for at least 2 years. In my opinion, as the GDP fails to deliver as I predict, then the 2 years won’t start for a fair while yet. If the ‘L’ shape happens as I predict, then we could see Japan style long term low rates. The first real signs of this will be in the November report and the February report will confirm it, although I expect they will try and dress it up somehow.

Again, he admitted that there has been more bad news than they foresaw in their February report. Well guess what, as I have said on every previous report I have commented on, he got this wrong then and he has done so again now. Is there any reason to believe his predictions after they have so got it so consistently wrong? The fact is his report now shows a ‘V’ shaped recession, yet when he speaks he is saying that this could be wrong. He knows damn full well that we are in an ‘L’ shaped recession/depression but he won’t say so…because the British people, the world and most importantly the markets can’t handle the truth.

He has said that the timing and the pace of recovery is very hard to judge. Finally, I agree with him and he is not joining the crowd of ‘goofballs’ that are saying we are coming out of the recession. Yet his report clearly shows that they think we are… why did none of the journalists push him on this point…talk about media control. However, over the next few months it may well be that I am wrong and the goofballs are right. As I have said before we will see over the next few months (exactly when I don’t know when) what looks to be an end to the recession. However, this will be driven by sentiment and not by real support, so of course it will fall back, but it will look like I am wrong.

The report is keen to show that the committee is voting unanimously. This is just marketing as they have got it wrong so often that when they all agree they have to shout about it.

Again King is keen to say we don’t know what is going to happen. Though as I have said, he thinks that this recovery is not real and is just a bear market rally.

King said that he has no idea of when the banks will feel comfortable enough to resume lending, as whilst they are private they will remain averse to risk for ‘quite a while’. I do not think we will see the cheaper deals returning to the market for at least the next 3 months and my prediction that ‘good’ish deals will re-appear in September is now be at risk of being incorrect. If this happens the way I think it will, then we will not see good rates until March 2010 at the earliest. Given that we will be going through a terrible winter and unemployment will be the key word on the news, then it could be much longer. In other words, the window of opportunity I spoke about a few months ago is not likely to open up.

He admitted elsewhere that it would take longer to restore bank lending than they had thought in February’s report.

According to King, there are 3 key factors why there ‘could be’ a recovery (more marketing – he’s trying to sell us snake oil):

1) Massive policy stimulus
2) A fall in the exchange rate
3) The turn around in stocks

…which when taken together, make a solid reason to expect a recovery.

Here is why this is wrong…firstly he is ‘talking’ it up as he thinks that could be enough, well not this time. The massive policy stimulus just won’t be placed selectively at pivotal points as we are seeing from the money spent with the banks. So what will happen is that the effectiveness of this will be massively reduced (it will of course cost us for the future). This is like giving a poor investor piles of cash, some of it will work but most of it they will lose.

The fall in the exchange rate will provide good results but they will not be as good as he thinks they will as the ‘new’ money will start to consider whether the UK could become a copycat Japan.

His last point is the turn around in stocks. This is a bear market rally, nothing more, and this bear market rally could look the same as the one in 1929 when the market rebounded 48% before crashing further still.

So his 3 main points are, in my opinion, just bravado. He is trying to sell us snake oil when he knows as I do that next winter we will start to feel the real pain of this recession, he is just talking it up!

King is now trying to say that he is just showing us where the risks lie and he is not saying that this will be the future. It is amazing the humility that can show in one who has gotten it so wrong. The question is, is there any reason to believe he has got it right now?

Averages of other forecasters see base rate at 0.7% in 2010 and 1.9% in 2011 and then rising to 3.4% in 2012. I am not in anyway convinced that these figures are correct. However, given the current climate, I can see them stupidly putting the rate up to 0.75% in Jun to August time next year. Then I can see them considering to reduce it again in October or November time when they start to see the cracks appearing.

The following year it is likely to rise to 1% at some point and maybe stupidly to 1.5%. However, 2012 will be the first year that we see any real growth in figures. So I broadly agree with these assessments. However, that does not mean I think they should do this. I think they will be completely wrong in raising rates until we have ‘normal’ bank lending and sustained economic growth. However, the likelihood of them thinking this way is nil, as it is in their interest to have higher rates than are here today.

I would say they will repeat the mistakes of the Great Depression again and raise rates too soon, which will lead to a few years of prolonged recession.

Ok, some of that makes for fairly depressing reading. However, forewarned is forearmed, there are going to be opportunities everywhere as the mass of investors will believe this work of fiction and we will be able to capitalise on their faulty assumptions. As different opportunities come up I will keep you informed of my thinking so that you can stay ahead of the herd. However, for the next few months I suggest you watch the media closely as they may well convince you that a recovery is going to happen. After all, some reports I have read recently nearly manage to convince me :-)

Best wishes


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No New Instructions Coming On

By Andy Shaw | January 25, 2010

Originally posted 5th May 2009

In our constant chatting with estate agents, we have noticed that without exception they are all saying that they are not getting any new instructions coming on. Obviously this is an exaggeration as they will be getting some, but they are not coming on at the rate they need to in order that they survive.

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Persistence Is The Answer

By Andy Shaw | January 25, 2010

Originally posted 22nd April 2009

I was chatting with Greg yesterday about how it is going finding properties for clients right now and he was explaining the problems that we are facing currently. The biggest problem we are having is the one that I mentioned would happen a few months ago.

That is, the first time buyers are swamping the market trying to pick up bargains and they are willing to pay more for them than we are. So what is happening is that the vendors are selling to them and of course we all know that the inevitable will happen and most FTB purchases will fall out of bed – especially in today’s market.

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The Real Reasons Behind The Crises Part II

By Andy Shaw | January 25, 2010

Originally posted 9th April 2009

What If We Were A Great Bank?

So let’s say we were a bank and we started out with say £2,000,000 of capital. So we started trading and we took in deposits and decided to loan out our deposits at a higher rate than the interest we were paying for the them. I’m not going to make this more complicated and discuss how as a bank we can create money against those deposits, so let’s just keep it simple and say that we loan out just the deposits that we take in. In which case we make our margin on the spread.

Let’s then say we take in £30,000,000 of deposits and we loan that money out. Our loan ratio is 15 (loans) to 1 (capital), which is apparently healthy. Now let’s say we go very conservative and we decide that we will only loan out at 70% ltv. We also decide that we want very low ratios of income and so we state that just 10% of someone’s income must cover the mortgage (ie very affordable) and we require a minimum credit score of 900 (max 999) – we are looking for only the best borrowers!

So now let’s look at us. We are in good shape, our loans are great and with no defaults we are making a good profit and our share price is going up. Life is easy! And, deservedly so, we are paying bonuses to the people who have generated this growth in our business (without the media spin it now looks different).

But then comes along mark to market – the property market is in decline and we have to re-evaluate our portfolio. Even though our loans are performing beautifully we have to re-evaluate them at today’s price. The property price has gone down in value by say 20%, so instead of us having loans on our balance sheet at 70% ltv, they are now at 90% ltv. So our company is now not as attractive as on paper our loans are higher risk. In reality they are not but on paper they look much more risky. So let’s say we have to mark the value down from £30,000,000 to £29,000,000. It’s bad but not too bad at first glance and it was the conservative thing to do, to avoid going to prison for not knowing something.

But where do we take this paper loss? Well against our £2,000,000 of capital, of course. So this transforms our 15 – 1 ratio (loans – capital) to 30 – 1, making us appear over-geared. This triggers off various alarms, the regulators are now very worried that we are way, way over exposed and are close to failure, so we are on the watch list.

We Have Now Become A Bad Bank, Yet We Have Done Nothing Wrong!

Our share price gets hit, we are now considered to be a bad credit risk, so we can’t borrow money anymore. Depositors see us as a bad risk so they do not want to deposit their money with us but worse still current creditors want to withdraw their money. Then the stock market shorters (people who bet on a stock price going down) come out to play and they drive our share price down because we look weak and on paper they are right, we are weak. In the real world of course we are fine but the real world has no place in mark to market – which is the very place it was supposed to be the most realistic.

So we are in real trouble. We are massively over-geared, but what went wrong? We have some great loans out there – none of them are late, none of them are even hinting towards repossession, we’ve been ultra careful. But because of the accounting rule of mark to market our world bears no resemblance to the real world.

Some of the world’s biggest financial institutions have gone through this and they have then had to try and sell their assets in a fire sale as very distressed sellers. Don’t forget they can’t lie about their value of course, because they could go to prison. So they are forced to de-lever at a time when everyone is wanting to sell and de-lever – which is the paradox of de-leveraging.

We Are Now Going To Have To Have A Fire Sale

There are two ways we can de-lever, we can increase capital – well who is going to lend to us right now, our stock price is down, the regulators have us on their watch list and we are in real trouble – or we can be forced to sell wonderfully performing assets at knock down unbelievable prices.

So we are a distressed seller in a market place where the only buyers want to buy at ridiculously low prices.First there were 15% discounts, then 35% and now all the way down to 88% discounts!

Side note: The land value of property is going to be worth an absolute minimum of 20 – 25%, so how the hell can the assets fall to 12%, if not done artificially? Which is why I said this was the second best money making scheme in history.

All of this happened when the bank has no bad loans, we have just lost our depositors money because of an accounting rule. What’s more, who else gets hurt when we sell at fire sale prices? Other banks of course, so not only are we dead but we are killing our peers off at the same time as they have to reduce their assets further because of mark to market, or go to prison. So give me all your money and assets or you can go to jail. As the Director of RBS said, this was a drive by shooting.

We Have Just Been The Victim Of A Robbery In Broad Daylight

So this brings us to the question of where all the money is going to and why I wrote the article about the second best money making scheme in history. Let’s say we were not a bank, but capital investors and I walked in and said how about this for a deal:

We can buy £1,000,000 of loans, none of which have ever been late. All the borrowers have credit scores above 900, their loan ratio is just 10% loan against income and the loan to value is just 50%! We can get a £1,000,000 basket of these loans for just £600,000!!! The deal of a lifetime!

So how much do we stand to make? Well, the average term for these loans will be at least seven years when we will get our £600,000 back. But we will not just get our money back, we will get the £400,000 discount as well, a nice little 66% return.

But wait – there is the interest on the money as well. Let’s say they were paying 6%, then that 6% was on £1,000,000, which on our £600,000 gives us a 10% return. So we are getting 10% a year plus a 66% bonus at the back end! This deal is too good to be true!

The Devil Is In The Detail

Well no, because of mark to market rules. Let’s say more banks are forced to sell this way then eventually even the assets we bought at a fire sale could be forced down further too and then we would be forced to sell. Which is why the credit markets are frozen! No-one wants to be left holding the bad asset. They all know the deals are unreal and hugely profitable but if they get caught because of mark to market then they will die just the same as Meryl Lynch did.

This is the real reason why Meryl Lynch went under – they bought billions of dollars worth of loans at 60 cents on the dollar, but the market value went down. So they then had to sell at 22 cents on the dollar for these terrific assets. What was worse for them, they only got 5 cents in cash and the other 17 cents was a loan!

So the buyer who bought those loans which will pay out £1,000,000 in 7 years, actually put down £50,000 cash and took a loan off Meryl Lynch for £170,000. What an outstanding return, does anyone think that the government are not profiting from this? This is why AIG had to be bought out, Lehman Brothers, Indymac bank – the list goes on and on.

The Knight In Shinning Armour

So in steps the Fed with a $700 billion loan, out of kindness, to buy assets at a dangerous 60 cents on the dollar. Ie, they are paying too much for them but in doing so they create a few things.

Firstly, a 66% return on their investment of borrowed money. Pretty cool by anyone’s standards, especially seeing as they do not have the problem the banks have of actually getting to the 7 year pay out in one piece (which is what every other financial institution has the problem of doing). Their problem is that they need the assets to be worth that much in 7 years. So they make 10% per annum when they are only paying 2 – 4% on their bonds. So the Fed make a nice spread as well.

As I have said before this is a great money making scheme for the Fed. But when I wrote that I wondered if the Fed had had nearly enough and history has proved my instincts right – they enjoyed this feast and didn’t want it to end for a while.

This was such a good deal for them they wanted to make more and more and just how long could they keep going before the world collapsed… Well now that the Fed have had a good fill, they are about to relax the mark to market rules and allow other players to enter the game.

So now they are finally trying to stimulate the game at the level of 60 cents on the dollar, that way they make enough and the world doesn’t come crashing down. Remember the $700 billion was passed in October last year? So they kept the feast going for 6 months and came up with various reasons why they couldn’t use this money to bail out the banks.

Shortly it will be down to when the other financiers around the world notice this wonderful worm dangling on the fishing line and whether or not they can resist it. Afterall, the Fed are offering non-recourse loans to tempt them back into this market. This removes the borrower’s risk and could unfreeze the market.

The trouble is that no-one trusts them and who is to say there will not be another round of musical chairs and the purchasers at 60 cents on the dollar will not end up the way of Meryl Lynch and now of course the Bank of America is suffering because of its purchase. However, the Fed has now said that they are a buyer at a reasonable price, so this means that they may be able to tempt the private market back in, as they will think we’ll, I may lose a little bit of money if I have to sell to the Fed, but the upside is now enormous and only a small downside. This is a very smart play for the Fed as I said several months ago, they have to create a market otherwise they will not realise their gains in the future.

Is $700 Billion Enough?

So is this new $700 billion going to be enough? Well that depends on how it is spent and what assets are grouped into the ‘distressed’ group. Afterall if this $700 billion was just to buy out sub-prime loans then there is only around $1 trillion in total, so they could just pay cash and be left with change of 60 cents on the dollar. So they are talking about a much bigger market.

What’s more let us look at those loans and group all the sub-prime, option arms and Alt-A loans together. Let’s go crazy and say 20% will default across the board (12 – 15% is expected). Well it’s almost impossible to lose money on this deal then buying at 60 cents on the dollar.

Possible Conclusions

So this could actually re-inflate the bubble for the US and the UK, or it could just put a floor on the market very quickly. I’m not saying it will, I’m just saying that it could right now as we need to see how things gradually unfold. However, right now I would say that the credit markets could potentially unfreeze and eventually that will trickle down into a need to lend to support the property market.

Why? Because just like the Fed the new buyers of the mortgage backed securities (MBS) need the markets to be worth at least what they are now so that they can collect on their 10% per annum and their 66% profit in 7 years. Now in that time the market value of MBS’s will recover and so they will not be able to make as many significant gains anymore. They know they will have to keep the market afloat, so it will be in their interests to keep it funded with new loans under the protection of the Fed and the Bank of England, who will step in if there is a problem and buy at reasonable prices – and of course each time they do buy one of these assets at knock down prices the world will thank them for it and they will rob from the rich and give it to the people who badly manage their country’s money.

All this means that instead of playing the game out and going down the deflationary spiral, there is a good chance that they may get to re-inflate the game and start playing it once more. Well, at least that is their plan.

As for me, I think their plan is a little suspect to say the least but then so is most government intervention when you get to finally unravel it. I think from our point of view a sweet spot will start to appear where we will be able to get some long term fixed rates to capitalise on the current low rates and I think that new products will become available as soon as the banks stop having to worry about their capital ratios. This could happen this year and we should start to see the banks return to the market within the next six months.

However, I still think we are in a depression and this will take several years to play out. The other problem is that if their plan does succeed then we will have probably put off today so that our children will pay later.

As always we will simply have to find the opportunities that are hidden within the rubble.

Best wishes


PS I had a realisation a little deeper the other day when I was discussing conspiracy theories with Alison. She said that her problem with them was that she didn’t want to believe that anyone could do something so horrible. It was at this point that I realised something – she was letting her own opinion affect her judgement as to whether something is likely or not. She had let her emotions guide her – what possible use would they be! The difference I have When looking at markets, property prices, currency movements and government conspiracies, is that I don’t care what I want to believe – that is totally irrelevant to me. All that matters to me is what is likely to be right and I ignore what my emotions would have me believe, as how do they help me when I evaluate something?

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The Real Reasons Behind The Crisis Part I

By Andy Shaw | January 25, 2010

Originally posted 8th April 2009

It has been said at the moment that if you are not confused then you are not thinking clearly.

The credit markets are frozen and despite the recent surge in the stock market, they remain so. So any recovery in stocks will turn out to be a false dawn until these are thawed out.

There is no shortage of information at the moment to confuse anyone, most of it mis-information which is of course from people in the know who do not understand what is going on or the people in the media who just want to report a story. The reasons for both these two producers of excessive mis-information is that these people still falsely believe this is a normal recession and the credit market bubble has burst and led to the house price bubble bursting, whereas the truth at the moment is quite different from the reporting of the mass media.

I wrote in the summer of 2007 that we should be able to escape a major downturn in prices as the British and American property markets were not the same and that the British one was inherently stronger. However, I then had to write how the American market could end up affecting the British market, yet there was nothing really wrong with it (despite what the media will have you believe).

However, the real issue that brought about this crisis was not the lax lending policies in the US, it was not the ‘new wave’ structured investment vehicles and it was not the house price bubble deflating. The real reason for this crisis was the reason I wrote about a long time ago, when I said that I did not know about a particular law that meant that the banks could be forced to sell that assets at today’s price (mark to market).

This single law has brought about the whole crisis and an accounting reason is all it is. The mortgage market in the US, however, was the catalyst that brought about the crisis.

You Only See Who’s Swimming Naked When The Tide Goes Out

As Warren Buffet says, ‘you only see who’s swimming naked when the tide goes out.‘ Well the tide went out on the property market and exposed the real problem, which was one of accounting. And it is this problem that I am going to try and explain today.

Indeed I did not even know until last March that this law even existed. Had I known that such a ridiculous law existed then personally I believe I would have been able to spot this whole thing coming from a long way off. But then hindsight is a wonderful thing and we all need a slap in the face from time to time.

Well I’ve looked into the origins of this stupid law and I found out that it came about following the stock market crisis of 2000 – 2002. What happened was that when people saw their pensions wiped out, they got very angry and things like Enron were going on, which allowed certain other things to be kept hidden from balance sheets. The lynch squad wanted blood; they wanted to know that this couldn’t be allowed to happen again.

So a few congressmen got together and passed a bill that meant greater transparency, which of course was the buzz at the time. This law meant that people could go to prison, not just for knowingly doing something wrong but for ‘should have known they were doing something wrong.’ Now can you imagine passing a law that meant people could go to prison for things that they did not know they were doing wrong? This brought in a very conservative mindset into the banks and hedge fund reporting practices (ie they valued their assets below what they thought they could get for them).

This bill was not thought through as it was obviously a ridiculous thing to pass, but the problem was the buzz at the time was towards lynching anyone who did not support full disclosure. This meant the bill was rushed through and not thought out. This reminds me of what is going on now – when something is broken and the world screams for justice, governments have a tendency to not just fix it, but to over fix it, which is what they did then and what I think we will see again now (and if you don’t believe me then just wait until after next year’s ‘Winter of Discontent II’).

So they rushed it and they went over the top on transparency, but the property market especially in the US had been covering up a lot of mistakes that the financial markets were making. As the asset values soared they hid their mistakes but then when the tide went out it exposed all of the weaknesses in the models, such as loans of 100% LTV’s to people with no income & no job. Now with an inflating property market people who couldn’t pay their loans simply just sold their home to cover it, but this stopped being possible when the property market in the US started to fall.

Here’s where the problem comes in with the stupid ‘mark to market’ rule. It means that you have to value your assets at today’s prices and of course, you have to take the conservative approach to valuing these as you don’t want to go to prison for the ‘should have known’ rule. As for a property investor, could you imagine ever being one if you were forced to sell should the market go down? Of course not, it is ridiculous.

Having To Sell When The Market Is At Its Weakest

So let’s relate this mark to market rule to property again to put it into our context as property investors.

Let’s say you have a property worth £300,000 and there are plenty of other properties in your neighbourhood worth £300,000 too. But let’s now say one of your neighbours had to sell their house in an emergency. They were a very distressed seller and they had to sell right now, so they took the reduced price of £200,000.

Does this mean that your property is now worth £200,000? Well, of course not, this was a distressed sale. Your home may be worth a bit less because of this new comparable evidence but no more than a couple of percent. Why – because you are not distressed and you are in no rush to sell. In fact, you could easily say it has had no ill effect on your property at all, as you do not have a lender looking to call in their loan – but if there was a chance you could go to prison for saying it was worth the same as the day before then you may automatically down value it by 5%.

However, if we had to play with the mark to market rules then you would now have to say your home was worth £200,000. This is the whole problem and the cause of the whole crisis.

Part II tomorrow,

Best wishes


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