Cluster Family Office Blog

If only we could have a Waste Allocation Load Lifter – Earth-Class (WALL-E) to eliminate the financial junk and toxic waste generated by the credit abuses of the last decade. Someone kind-hearted who will set about making the world of investment a more liveable place. But unlike what happens in the memorable film Disney’s Wall-E, he ought to come and clean up the planet before every trace of our financial system disappears, rather than 700 years later. In his absence, the scavengers of our market-based civilisation must be allowed to do their work, free from negative interference or disparagement from others. Quite the contrary: with the help of public bodies that have never been so grateful for the work of the scavengers. Only they can prevent a Wall-E from wandering aimlessly through barren financial wastelands when none of us are left standing to need him.

These vultures are as diverse as they are necessary: from Middle Eastern sovereign wealth funds to simple speculators who buy gold knives at the height of the slump, including the usual suspects such as Buffett, JP Morgan, Bank of America, BSCH itself and Chinese sovereign wealth funds. What’s more, amidst mergers and bailouts (especially the one about Mac & Mae) this benefits the major holders of debt issued by institutions in a state of decline, who, in turn, act as retaining walls against financial devastation. Among these major holders are many central banks, and this gives an idea of just how vital it is that the ‘carcass’ is properly absorbed by scavengers and rescued by whoever is in a position to do so, whoever it may be.

A few voices are surprised that the debt holders of institutions distressed come out better off than their shareholders. Perhaps this is because they do not realise that Investing in shares and buying corporate debt are two different things, even though many people confuse them as soon as the stock market turns bearish or simply flat (Some idiots even confuse them during bull markets). Gentlemen: The fact that fixed-income returns are, under certain circumstances, comparable to or higher than those of equities does not mean that they should be regarded as similar investment vehicles. It is entirely logical that, in the face of a highly dubious bailout or takeover, an equity investor might lose 100% of their investment, whilst a debt holder might not only come out unscathed but even stand to benefit significantly. These are entirely different risks.

The scope for manoeuvre available to a debt purchaser when faced with a credit event, particularly in the event of a default, is zero. And its successful outcome depends not so much on the balance sheets as on the degree of uncertainty surrounding its future as a company, contrary to what usually happens with the share price. In the event of a takeover or a solid bailout, the debt is free from doubt, whilst the accounting fundamentals and, ultimately, the very essence of the corporate remains highly uncertain. Just as much as the value of its shares. In such a scenario, the only uncertainty that will have been dispelled is whether the share price might fall to zero; but beyond that, uncertainty for shareholders usually remains total following a merger or takeover. Furthermore, the circumstances of such a public or private bailout are likely to distort the company’s future components beyond recognition. Therefore, what certainty can we find in the price of its shares? Only its survival. However, the potential windfall It can trigger a 1000% at the pre-bailout purchase price in just a few days, and that is something that debt holders will never achieve, however much they may stand to gain from the process of absorption, intervention or bailout, as has been the case with Bear Stearns. I repeat, they are different animals. In fact, someone I know well bought shares in Lehman Brothers at the market open on 11 September (with two c… and losing more than 18% in a single day whilst waiting for that big payoff), whereas his corporate debt is following a different, albeit uncertain, path. However, as we will explain in a forthcoming article, the quality of an investment depends on three variables: return, risk and the Circumstances of the Investment, the latter being the most important of the three.

Stratospheric volatility aside, so far there have been plenty of public bailouts, takeovers and private bids to dispose of decaying financial entities. And let’s hope there are plenty more. It is true that the honesty or dishonesty of these offers is directly proportional to the degree of decay of the carcass, the severity of the global situation and the scarcity of the scavenger market, but so far, where the private scavenger fails to step in, the public sector has. And that instils confidence in the System, so that many are beginning to see historic opportunities rather than hysterical breakdowns, thereby encouraging the emergence of new vultures circling above our nightmarish financial landscape. Never have their shadows over our heads been so comforting.

Let’s hope our lovable Wall-E doesn’t end up like a lost soul, wandering amongst the lifeless rubble of what was once a market economy. Carrying out a clean-up task that has become both absurd and futile, clearing away the remnants of investment banks and mortgages that once dragged the rest of consumer credit down with them. A debt burden that died of its own success back in the early 21st century.

«The greater the wealth, the thicker the grime»

John Kenneth Galbraith

P.S. Official statement from Lehman Brothers 24 hours after this article was written:

For Immediate Release

LEHMAN BROTHERS HOLDINGS INC. ANNOUNCES THAT IT INTENDS TO FILE A CHAPTER 11 BANKRUPTCY PETITION;

The carrion from Merryl than that of Lehman. Game Over…