Bronte Capital

January 21st, 2009 by Potato

I’ve started reading a blog with a horrendous eye-puking colour scheme called Bronte Capital, by John Hempton. Why do I subject myself to 4.5″ of column lost in a 12″ sea of green? (actually, these days I just read the RSS feed in Thunderbird) Because he writes about a lot of interesting (to me) macro-economic issues, in particular bank failures. To paraphrase a number of his posts, the banking crisis was started with some bad bets, some opaque financial instruments, and a poor sense of risk management and risk correlation (the odds of improbable losses all occurring together). But this was a fixable problem. What has happened is the bad bets, the subprime loans etc., have spiraled out into a crisis of confidence in the banking sector. Nobody knows who is and isn’t solvent, and lending between banks dried up. As runs on banks happen, governments are forced to step in with bailouts before the house of cards comes crashing down even further.

So it was a recent post of his that made a point that stuck in my mind: “[In many cases,] the processes are as important as the outcome. Indeed, they are more important. Markets work because we have a legal process.” When it’s not clear whether or not a bank is actually insolvent, yet the government decides to step in, unasked, and nationalize it on a Sunday afternoon, wiping out the bondholders (as well as the equity holders, where that risk is more explicit), and then next week acts completely differently for the next bank, it makes things very unclear. The markets (both stock and debt) can price in risks and defaults and bad loans, but the random acts of government are chaos. If investors can’t even begin to guess at how much something might be worth and whether the government will wipe them out, they’ll stay away.

Indeed, it was this exact problem that really raised my ire when Harper and Flaherty decided to make a 180 degree turn, breaking their election promise to tax income trusts. If it’s necessary, then you’ve got to hammer the market with data showing that’s the case. A phone book sized report full of evidence should have landed on the desk of every trust investor in the country explaining why it was absolutely critical to flip-flop and tax trusts, and explaining the process of that decision, and how it was absolutely justified, and followed a process of due consideration and laying the groundwork for people to anticipate any further moves so that investors never feel blindsided. Now the clowns in blue are at it again, trying to speed up the auto bailout. As though the bailouts and mortgage buy-backs weren’t ad-hoc enough, it’s very strange and troubling to read that the government is the one lighting a fire under the auto companies to take government money. WTF?

So far Canada’s banks seem to have avoided the worst mis-steps of the rest of the world. Indeed, I own some shares of them, so I’m hopeful things will pull through all right. But it’s time for someone at the government to sit down and draft some rules — hopefully ones that will never be needed — guiding a potential nationalization so that we don’t follow in the footsteps of the US. Heck, draft some rules for bailouts, nationalizations, and infrastructure boosts for other sectors as well so that people can know what to expect.

…and just as I was writing this up, along comes an article that says the Canadian government is taking steps to change the rules to allow it to own shares in banks. I find this a little troubling, actually. First off, Flaherty has shown no foresight in anything he’s ever done, which makes me worry that Canadian banks are closer to needing a handout than they’ve previously let on. Indeed, they all just did a fairly expensive round of fund-raising, ostensibly to boost capital levels well above the minimums to give investors some peace of mind, but now I’m starting to wonder if desperate times are nigh. Also, no mention is made of due process or deciding when or how the government will take a stake, which was the biggest point John Hempton had to make. I am invested in the Canadian banks, with rather huge paper losses, but I’m hanging in on the hopes that they will avoid the worst of this banking “thing”, and my investment will turn around. I’ve had some heartburn over the last year, and had to re-check the dividend yields a few times to stay the course, but now I’m having serious thoughts about bailing. After all, I have been far too optimistic all along. I was wrong about other banks: this time last year I was looking at Citi (I didn’t buy), and I figured that they got ahead of the credit troubles by raising cash early, even though the initial stock sale at $25 seemed like a steep discount at the time. Now they’re floundering. I was wrong about the extent of the troubles (and pessimism about said troubles) for the Canadian banks: I’m down 35% on those, and that was after waiting until I felt most of the bad news was “priced in” to buy…

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