SoftBank & Lehmans

Following on from my previous post about the age of loose money comes this article from Capitalist Exploits with some of the same concerns, namely that we’re partying like it’s 1999 again.

There are only two ways VC can get liquid: a buyout or an IPO.

And given that so many of the famous “unicorns” are valued at multiples that make my eyes shoot blood, there are now an ever decreasing number of companies that make suitable suitors.

So we’re down to flogging this stinking pile to the folks who always get roasted, especially at the tail end of a boom: retail investors… which is why we’re seeing tech unicorns IPO-ing.

This is a good strategy for VC, so long as those retail investors buy what is being sold.

The trouble now is that there are early signs that the appetite for these “growth” stocks is collapsing like a teenager after a bottle of Absolut on spring break.

The Instagramization of Finance

Interesting article at The Reformed Broker looking at the current state of finance markets where money is essentially free and a company’s style is more important than its substance - image is valued more than assets.

There are no asset managers who represent their strategy to clients as “We buy the most expensive assets, and add to them as they rise in price and valuation.” That’s unfortunate, because this is the only strategy that could have possibly enabled an asset manager to outperform in the modern era. It’s one of those things you could never advertise, but had you done it, you’d have beaten everyone over the ten-year period since the market’s generational low.

But almost every investment professional says that they do the opposite of this. Even the explicitly growth-oriented managers use terms like “at a reasonable price,” to communicate their place on the spectrum of speculative chastity. There are no textbooks lauding an investment approach where it makes more sense to buy PayPal at 4 times book on its way to 9 times book while forsaking Goldman Sachs at less than 1 times book.

Some of this is no doubt down to network effects - AirBNB’s product can be rolled out in a new market for a negligible cost compared to a major hotel chain moving in to a new territory - but you still wonder if this is some sort of repeat of the Dot Com boom where most tech companies were massively overvalued based on hype.

I’ve had a similar discussion with a friend of mine regarding buying property. We both took the rational approach of not buying for a long time as the market was severely overpriced, and, in my case, when I did buy I bought something I could afford to repay even if rates went up a few percent. In this age of free money, that was completely the wrong strategy. The correct one was to borrow as much money as the bank would give me, get an interest only mortgage to lower repayments and just get rich off the capital appreciation without repaying any of the principal. Is this a temporary aberration, or the new normal?

Uber: Unicorn or Ponzi Scheme

Interesting read from American Affairs, delving into Uber’s pre-IPO financials and making the case that it’s not the great revolution in transport it claims to be admin a way resembles a Ponzi scheme with earlier investors making massive profits from the suckers lured in later.

Uber’s investors, however, never expected that their returns would come from superior efficiency in competitive markets. Uber pursued a “growth at all costs” strategy financed by a staggering $20 billion in investor funding. This funding subsidized fares and service levels that could not be matched by incumbents who had to cover costs out of actual passenger fares. Uber’s massive subsidies were explicitly anticompetitive—and are ultimately unsustainable—but they made the company enormously popular with passengers who enjoyed not having to pay the full cost of their service.

Uber’s financials don’t tell a great story…

Uber’s GAAP profit margin was –135 percent in 2015. It appeared to improve to –51 percent in 2017 and (adjusting for the divestiture and noncash equity gains discussed above) –35 percent in 2018. Yet these subsequent “improvements” were not driven by efficiency gains, but by the ability to force driver take-home pay down to minimum wage levels. If Uber drivers still received their 2015 share of each passenger dollar, Uber’s negative margins would still be in the triple digits.

I wonder how many of today’s unicorns are where they are today due to the essentially zero cost of money since the GFC supporting otherwise insupportable business models, or at least permitting those unprofitable business models to persist for far longer than would otherwise be the case. Tesla’s another candidate. Great cars by all accounts, and Musk is a great entrepreneur, but making the transition to established, profitable car maker seems perpetually out of reach.

Housing Shortage

Myself and Jacqui are doing the responsible thing and saving for a house deposit, so we’ve started paying a bit of attention to the goings on in the property market. Property crashes in the US, UK, Ireland and throughout the world gave a glimmer of hope that Australia’s over-priced property market would also deflate a little, but it hasn’t happened.

To ease their entry into the market, the Federal Government started offering between $7000 and $14000 to first home buyers, on top of the $7000 plus stamp duty concessions which have been offered by the State Governments for years. Most people think this is a great idea, but a moment’s thought shows that it’s completely stupid, as all it does is push up house prices by the amount of the handout. Sure enough, first home buyers now make up almost 30% of the market and prices in the cheaper suburbs have increased by up to $40000, so there are quite a few idiots out there paying $40000 more for a house in order to ensure they get a free $14000 from the Government!

Interest rates have been at historic lows, further encouraging first home buyers, and now that the economy looks to be on the mend, we’re being told that now is a great time to buy a house and that the main reason Australian property will never fall in price is that there’s a huge housing shortage. This adage has been repeated so often over the last few years that it’s accepted as gospel, but no-one ever provides any evidence for the claim. A financial site that I keep an eye on finally had enough, and in their daily mailout on Monday asked anyone for evidence supporting the property shortage claim.

The responses were forthcoming, and it appears that the evidence for the claim originates in the National Housing Supply Council’s State of Supply Report 2008, which claims a shortage of 85,000 houses in 2008. The funny part is when you delve into the report to find out how they came to that figure and learn that it’s based on the numbers of homeless!! They’ve added up the numbers of homeless sleeping rough, homeless sleeping with relatives or friends and unemployed people living in caravans. Then they’ve decided that the rental vacancy rate should be 3%, so have increased the ‘shortage’ to allow for it.

So there you have it. The reason Australian property prices won’t fall is because there are homeless people. Priceless!

The GFC Breakdown

Rolling Stone has an excellent article covering the disaster that is the global finanical crisis (GFC), detailing both how it derailed AIG and also how the bailout procedures are also little more than a Wall Street power grab.

This cozy arrangement [TARP] created yet another opportunity for big banks to devour market share at the expense of smaller regional lenders. While all the bigwigs at Citi and Goldman and Bank of America who had Paulson on speed-dial got bailed out right away — remember that TARP was originally passed because money had to be lent right now, that day, that minute, to stave off emergency — many small banks are still waiting for help. Five months into the TARP program, some not only haven’t received any funds, they haven’t even gotten a call back about their applications.

“There’s definitely a feeling among community bankers that no one up there cares much if they make it or not,” says Tanya Wheeless, president of the Arizona Bankers Association.

Which, of course, is exactly the opposite of what should be happening, since small, regional banks are far less guilty of the kinds of predatory lending that sank the economy. “They’re not giving out subprime loans or easy credit,” says Wheeless. “At the community level, it’s much more bread-and-butter banking.”

Nonetheless, the lion’s share of the bailout money has gone to the larger, so-called “systemically important” banks. “It’s like Treasury is picking winners and losers,” says one state banking official who asked not to be identified.

This itself is a hugely important political development. In essence, the bailout accelerated the decline of regional community lenders by boosting the political power of their giant national competitors.

Which, when you think about it, is insane: What had brought us to the brink of collapse in the first place was this relentless instinct for building ever-larger megacompanies, passing deregulatory measures to gradually feed all the little fish in the sea to an ever-shrinking pool of Bigger Fish. To fix this problem, the government should have slowly liquidated these monster, too-big-to-fail firms and broken them down to smaller, more manageable companies. Instead, federal regulators closed ranks and used an almost completely secret bailout process to double down on the same faulty, merger-happy thinking that got us here in the first place, creating a constellation of megafirms under government control that are even bigger, more unwieldy and more crammed to the gills with systemic risk.

The more I read the more gob-smacked I am that no-one bothered to put a stop to it before things got out of hand. You can bet all the bankers at the heart of the dealings knew that they were selling rubbish, but since they were making billions they were never going to stop, and it appears that the regulators just weren’t interested in regulating.

The most galling thing about this financial crisis is that so many Wall Street types think they actually deserve not only their huge bonuses and lavish lifestyles but the awesome political power their own mistakes have left them in possession of. When challenged, they talk about how hard they work, the 90-hour weeks, the stress, the failed marriages, the hemorrhoids and gallstones they all get before they hit 40.

“But wait a minute,” you say to them. “No one ever asked you to stay up all night eight days a week trying to get filthy rich shorting what’s left of the American auto industry or selling $600 billion in toxic, irredeemable mortgages to ex-strippers on work release and Taco Bell clerks. Actually, come to think of it, why are we even giving taxpayer money to you people? Why are we not throwing your ass in jail instead?”

But before you even finish saying that, they’re rolling their eyes, because You Don’t Get It. These people were never about anything except turning money into money, in order to get more money; valueswise they’re on par with crack addicts, or obsessive sexual deviants who burgle homes to steal panties. Yet these are the people in whose hands our entire political future now rests.

That sums it up about right. These idiots should be committing harikari, not being rewarded with multi-million dollar bonuses.

Shit Hits Fan

Well it looks like the global economy is finally going in to meltdown. It’s been a long time coming, but yesterday seems to be the final realisation that the house of cards is on shaky foundations. The Aussie sharemarket dropped 7% yesterday, along with significant drops around the world, and it’s now down 24% since its high of November.

I moved my superannuation out of shares and into diversified fixed-interest back in September, only to watch the share market go up by 10%, leaving me worrying that I’d made the wrong decision. Now however, with the market down 17% from when I got out of it, things are looking a bit more rosy. For once I’ve made a financial decision which hasn’t cost me money!

The Financial Times has an article on why the American recession will be hard to shift, explaining that reserve banks’ dropping of interest rates isn’t an instant fix to credit worries.

Interest rate cuts work their way through to the real economy by a number of transmission channels. During the 2001 recession in the US, the most important was housing credit. The rate cuts came at a time when the housing market was already booming. They turned the boom into a super-boom. Inflationary expectations were low. People expected interest rates to remain low. It was a great moment to take on extra debt, and this was precisely what Americans did.

The current US downturn could not be more different. House prices are falling, and have further to fall before reaching a more sustainable level (in terms of the price-to-rent ratios as well as several other measures). Core inflation has been above the Federal Reserve’s comfort zone for some years now. There is no way that either the Fed, the Bank of England or the European Central Bank could, at this stage, create another housing boom even if they wanted to. Housing downturns have a strong dynamism, which is not easy to break. This is not a great time to take on debts, but to pay them off.

What about the other channels?

The corporate credit channel works more slowly. A company faced with an acute downturn in demand for its products is not going to start investing immediately when interest rates fall. At the very least, it would only do so if it expects variable interest rates to remain low for some time.

For that to happen, inflationary pressures have to be well contained, which they clearly are not.