Money, banking & insurance

Bubble Trouble

A bubble can be many things,’ but in a financial context it is a ‘shared speculative hallucination’ (Eric Janszen). A bubble can also be described as ‘asset prices that exceed fundamental value because current owners believe they can resell the asset at an even higher figure’ (New Palgrave Dictionary of Economics).The most famous bubble of all time was probably the South Sea Bubble of 1720, which, after the banknotes had settled, resulted in the British Bubble Act forbidding the ‘raising or pretending to raise a transfererable stock’. Two hundred years later and bubbles were floating upwards again in the US stock market and this resulted in the famous crash of Tuesday 29 October 1929. Fast-forward to the early 2000s and it was bubble mania that created the dot-com crash and we are now fully in the midst of the US housing crash (another bubble if ever there was one) which has been caused by exotic credit derivatives and debt securitisation. The fact that the dot-com bubble and the US housing bubble happened within a decade of each other surely says something about collective memory being sidelined by optimism and greed. Indeed it looks as though a bubble cycle may have replaced the business cycle. How else can you explain rational men and women ignoring historical precedent and financial logic? What is interesting about these bubbles is that they often start with a new discovery or invention. The US housing market was hyper-inflated due to new innovations in lending (the idea that you didn’t actually need to have a job, income or assets to borrow money). As a result of cheap credit, the demand for housing went through the roof. So are there any candidates for the next bubble? There are a few potential candidates, such as healthcare, pharmaceuticals, nanotech, robotics, biotech and Web 2.0, but one industry does stand out as fitting all the criteria for a latent bubble – alternative energy. Energy security and energy independence are being touted as essential for the future and thus billions (between US$2-$4 trillion according to some experts) is flowing into technologies such as solar cells, biofuels, energy management software, energy infrastructure and so on. According to one estimate, this will create somewhere in the region of US$8-20 trillion in ‘fictitious value’.

Islamic Finance

Money is moving from West to East in the sense that liquidity is declining in countries like the US and growing in countries such as China and the Gulf region of the Middle East. Not only that, Islamic finance, that is, financial services provided in accordance with Islamic or Sharia law is booming too. 50% of banking assets in Saudi Arabia are now Sharia-compliant and 40% of finance in the Gulf region will be fairly soon. The total market for Sharia finance (assets managed under Sharia –compliant rules) is estimated to be US$750 billion according to Standard & Poor and this should grow even further as Muslim populations grow and assets move eastwards. But Islamic finance is not limited to Muslim markets. When a consortium bought the carmaker Aston Martin from Ford a while ago, the deal was developed using Sharia-compliant structures. Similarly Caribou Coffee, the second largest coffee shop chain in the US, is now owned and controlled by a private equity company that is Sharia-compliant. Around 300 financial institutions now provide Sharia-based finance and many of the world’s biggest banks, among them CitiGroup, HSBC, ABN AMRO, Deustche Bank and Standard Chartered, have developed Islamic finance groups or departments. What makes Sharia-compliant financial services and deals particularly interesting is that all parties are required to be open and honest about both risks and rewards and short-selling is essentially banned. Given the crisis of confidence and the lack of trust surrounding the financial services industry in other parts of the world this emphasis on openness, ethics and values could be the shape of things to come in more ways than one.

 

Sovereign Wealth Funds Backlash?

On Tuesday 15 January 2008, the governments of Singapore, Kuwait and South Korea effectively bailed out two of the largest banks in the world – CitiGroup and Merrill Lynch. Cash from Asia and several Gulf states has also been following into the US to support or acquire other companies and assets. According to The Economist magazine these newly-rich nations have about US$2.9 trillion available to invest and this sum is likely to increase given surging oil prices and expanding exports. So far so good. The West needs money and the East is supplying it. It is the capitalist system and global money markets working like they are supposed to. However, there are a few future concerns. To date these approaches have been reasonably friendly but they are still far from transparent. With the exception of Norway, sovereign wealth funds do not produce annual reports stating what they own or what their aims are. There is little if any accountability to regulators either. This is almost guaranteed to create nervousness and it is quite likely that there will be a considerable backlash and rising economic protectionism if this process continues. This has happened before with China trying to buy US oil companies and Arabs buying ports. A broader point concerns the implications when money is largely controlled by a handful of semi-authoritarian nations? Perhaps this won’t happen, but we should be thinking about it now in case it does.

 

Cyber Crime Trends

If you think that identity theft is a relatively trivial matter – more a case of hapless hackers than organised cyber criminals – think again. Last year, a couple of Russian crooks created a subscription-based identity theft service for criminally inclined minds.The idea was to break into secure data and then sell unlimited access to this data for a weekly fee. The business included customer service guarantees, a consultancy element and various add-on premium subscription services including reports itemising what data had been stolen and various data ‘cleaning’ services that allowed customers to filter out low-grade identity information. The idea of stealing things and then selling access is quite entrepreneurial and would probably form the basis of a Harvard Business School case study if the business was legitimate. According to some cyber crime experts, such criminal services are worth around $1.5 billion a year (2007) and are growing at an alarming rate. Other similar services include botnets that steal large amounts of data using automated processes and then rent out this data for people to distribute spam or perhaps steal intellectual property. Why the growth? The main reason is obviously the growth in online banking and
e-tail but it is also connected to the fact that you are less likely to get caught as a criminal in the B2B space than as someone working in the B2C space.

 

Worst Case Scenarios

In theory the worst is over. Despite the sub-prime fall-out, world markets have not collapsed and growth looks set for about 3-4% this year in most countries. Banks’ exposure to risk is currently around 1% of the theoretical value of contracts and there is somewhere in the order of US$7 trillion (US$7,500 billion) in cash (US$1.6 trillion in China alone) floating around the global economy to sort out any further hiccups.That’s the theory anyway. If another large institution were to get into serious trouble in the future there are only three real options. First, the institution could be allowed to go bankrupt (the free market solution). But if this were allowed to happen trust would evaporate (some would say it already has), the US dollar would collapse and that would be the end of the US economy for a while. The second option would be that the institution could be ‘saved’ by foreign money (eg, sovereign wealth funds) or third, the institution could be nationalised (the very opposite of perceived wisdom about government intervention in free markets). If option 2 happened and Chinese or Middle Eastern money moved in, this could signal the end of US independence and this could in theory trigger a domino effect across the whole US financial system. Then again, if option 3 went ahead it would require funding via additional taxation, which would put a further braking effect on the domestic economy. In almost all of these scenarios cash ‘aint safe (inflation reduces its value), artworks ‘aint safe (rapidly falling global market) and housing, of course, ‘aint safe. Ditto local consumption, jobs and so on and so on until the global financial system is dominated by a handful of undemocratic authoritarian regimes and the US and Europe turn into emerging markets. Yikes. Talk about a rock and a hard place.