Saturday, March 20, 2010

The South African Financial Media: Too Old, Tired or Scared.

Herewith an example of the thinking of main stream financial media in South Africa on how they perceive the financial crisis:
"a little accident, but oops, just invest in the trusted financial products
we recommend (and from which we get commissions) and everything will be all right. You see, the financial crisis is THERE, and you are HERE, so not to worry".

Not a word and no opinion at all on the risk pension funds are running as they invested HEAVILY in (commercial) real estate and complicated financial products which nobody understands.

The problem with the South African financial media is that they are co-owned or at least heavily dependent on advertising streams from banks and other financial institutions.

Not a word about the world wide housing - and the upcoming Commercial Real Estate bubble, silence on the fact that the financial world is still busy scamming the last pennies out of the pocket of the middle class through paper promises from which they bloody well know they will only work in good times and not in good times.
"You see, the article you will be reading just now are the words of "boffins", and you know how stupid boffins can be, that's why they are called boffins."
The writer knows, but cannot utter the words that the ultimate product in protecting yourself is physical gold.

After all, gold has been used as protection by smart people against financial meltdowns for hundreds of years. It should not be different now. Our financial system is based on quicksand, boffins know and a few hundred critical economists and bloggers know.

But the media cheerleaders of the Financial Criminals, the people who ought to know and should critically follow and report and inform on the financial meltdown, are too old, tired or scared to be honest.

The outcome though, should be the same: they are going to punish the savers and save the spenders.

Unless you have physical gold. In your pocket.

With the meltdown, the bankers, politicians and financial media call girls will be running for the hills. But I wonder if they will be make it to the hills this time.
"But hey, until such time, not to worry: the financial crisis is THERE and you are HERE."

Boffins advise you to plan ahead for next crunch

Things went horribly wrong to cause the credit crisis, delegates at this week's actuarial congress reminded us, and they'll go wrong again. All you can do is be prepared.

If you want to survive the next financial crisis, start preparing now. Another crisis and yet another will come. The only problem is no one can predict when it will happen, what will cause it and how extensive it will be.

This was the message from a meeting of 1 500 of the brainiest people in the world from 100 countries, who were in Cape Town this week for the International Congress of Actuaries.

The global financial crisis and what can be done to prevent or reduce the destructive force of future financial crises was a major focus of the congress.

One thing that was clear from the presentations is that crises such as the "perfect storm" of 2008 are caused by small groups of people working in major institutions.

But there is virtually nothing the larger population as individual victims can do to prevent a repeat of the biggest credit crunch the world has ever witnessed, which resulted in worldwide recessions and the loss of millions of jobs.

All you can do is be proactive in safeguarding yourself against the consequences.

Garth Griffin, the immediate past president of the Actuarial Society of South Africa and a participant in one of the debates at the conference, says that you must build up financial buffers.

They include things such as keeping debt to a minimum, building up your savings, having emergency funds, being careful about the institutions to which you entrust your savings, and not chasing unrealistic investment returns through high-risk investments.

Griffin warns that you need to start today. The longer you postpone getting your personal finances in order, the greater the risk at which you will place yourself.

The biggest risk is losing your job and having no resources to keep you going. As millions of people around the world have found, they lost their jobs and then their assets, including their homes, when they could not keep up debt repayments.

While South African financial institutions escaped the worst of the financial meltdown, ordinary citizens were not so lucky, with almost one million people losing their jobs. As a consequence, many South Africans have lost assets and are still seeing their assets, including their homes, being repossessed.

In the debate, Griffin warned that financial institutions should stay away from investment structures where they do not fully understand the risk.

Banking, he says, is boring and should remain boring. The actuarial profession must also get back to basics and build a capacity to react to future crises.

"The reality is we are custodians of other people's money. We must meet reasonable expectations of investors," Griffin says.

Faulty risk models
The conference opened with Finance Minister Pravin Gordhan saying millions are out of work, the poor are suffering more, the achievement of the Millennium Development Goals (to end extreme poverty by 2015) has been placed in doubt and recent economic gains have been lost.

"Economic models have been fundamentally destabilised, risk management is in crisis, and the world is searching for new frameworks and conceptual models for a more equitable and sustainable economic model," Gordhan says.

One of the world's most eminent mathematicians, Paul Embrechts, professor of mathematics at the renowned Swiss Federal Institute of Technology, says one of the causes of the meltdown was the faulty risk models of financial institutions.

He says, with the crisis still far from over, the music is starting to play and people, driven by greed, are starting to dance again.

Embrechts and other speakers expressed particular concern about a financial instrument called a credit default swap (CDS).

Simply put, these instruments allow the trading of debt often between un- or under-regulated parties without an actual security changing hands.

Embrechts says the CDS market has grown from zero in 1995 to a massive $50 trillion. This is three times the United States economy and bigger than all the US credit markets put together. The world gross domestic product is $66 trillion.

CDSs have been "a huge source of financial engineering profits, both for Wall Street and the hedge fund community over the last few years", he says.

The growth in CDS trading has come from the banks selling off risk through securitisations.

Speakers also warned about the dangers of large, complex financial institutions that operate across financial markets and national boundaries, escaping the attention of regulators.

In doing so, these institutions take risks - often unknown or not properly assessed - because they consider themselves to be too big to be allowed to fail.

Yoshihiro Kawai, the secretary general of the International Association of Insurance Supervisors and a member of a special G20 committee appointed to properly assess and reduce the potential for another global meltdown, says that the international regulatory system must be revised.

This includes the need for co-ordinated regulation across international boundaries, as well as across financial sectors such as banking, securities and insurance, to reduce systemic risk.

Embrechts says the warning signs of another crisis are:

When people start talking about "new" paradigms. He says: "Always leave when the word 'new' appears." He says "new" usually means that the tried and trusted measures of the past are being ignored, increasing risk.

When leverage goes too high. In simple terms, leverage means borrowing to invest to multiply returns, but it can also multiply losses. Embrechts says leveraging should be strictly regulated. Part of the cause of the meltdown was the removal of the capping of leveraging by banks in the US.

When institutions become too big to be allowed to fail.

When valuations on assets become exceptionally high.

A failure to control complex, opaque and high-risk over-the-counter deals involving trillions of dollars.

The 900 000 South Africans who lost their jobs in the financial market meltdown and consequent global recession can blame David X Li's Gaussian copula function published in 2000. It was this formula for disaster that, initially, made Li the most influential actuary in history and now the villain of the piece.

Online encyclopaedia Wikipedia starts its definition of a copula: "In statistics, a copula is used as a general way of formulating a multivariate distribution in such a way that various general types of dependence can be represented ..."

Confused? Well you have just entered the world of extreme mathematics used to measure, among other things, the risk of investments, in particular the riskiness of things such as securitisations of mortgage loans.

Li and his copula came under the spotlight this week in a presentation by mathematician Paul Embrechts, at the International Congress of Actuaries.

Embrechts asked the question: "Why did no one notice the formula's Achilles heel?" He answered it saying: "We did, but nobody listened."

In fact, he and two colleagues warned about the dangers of Gaussian copulas two years before Li arrived in Canada from China with his copula. In their modelling they found that extreme events occurred a lot more often than predicted by Li and others.

And the warning was repeated in 2001 in response to the Basel II document that provides for the reduction of banking risk. What they did not predict was the scale of the disaster and how soon it would happen.

What made it worse was that no one was listening anywhere in those heady days of over-heated markets and big bank profits. Embrechts says no one listened when Harry Markopolos repeatedly warned, with plenty of analytical evidence, that convicted fraudster Bernard Madoff, with his hedge funds, was running the biggest Ponzi scam in history.

In 2001 a billionaire Texan banker walked into the Bellagio casino in Las Vegas to take on the world's top poker players, who saw people like him as "patsies" (tourist gamblers) from whom they could make money.

Andy Beal had lots of money and the pros thought they could not lose. As Beal lost he continued to raise the stakes until they reached about $200 000 a game. Then Beal started to win. By December 2001 all the top professionals had lost their liquid assets and had to sell investments and property. Then they were forced to borrow $1.5 million to make one last effort to beat Beal. Fortunately for them, they won.

If they had not won, they would have been forced to go back and start with low-stake games. Beal tried again and over a few years was the net loser of more than $30 million.

This story was related by Andrew Fleming of Lloyds Banking Group at the International Congress of Actuaries in Cape Town this week in comparing high-stakes poker with what has and is happening in the global financial community and what was behind the 2008 meltdown.

Fleming says the first mistake made by both the top poker players and the banks was that they did not diversify their risk and, worse, they got together as a group and effectively invested in one asset. And then to cap it off they borrowed from everyone else until, in the case of the banks, "the whole of the economy was invested in one asset".

Mistake two was that both the banks and gamblers thought they held AAA-rated investments. The gamblers did not realise that Beal was a genius and was determined. The mid-level professionals who lent money to the superstars also believed they were buying AAA-rated investments. In the real world, investors bought very risky stocks, compounded by rating agencies not rating them correctly.

Mistake three was that neither the gamblers nor the bankers held sufficient capital to cover the losses they never expected to suffer.

Fleming says the poker players have learned their lesson. They stopped playing with Beal on his terms, they imposed a reduction in the maximum stakes and they diversified their income to include television and internet sponsorship, and internet poker room ownership.

The banks face more stringent capital and liquidity requirements, and there is an attempt to combat the excessive bonus culture driving the excessive risk-taking at banks.

Will a credit crunch occur again? Fleming answers his question, saying "possibly, but not in poker!"

Published on the web by Personal Finance on March 14, 2010.
© Personal Finance 2010. All rights reserved.

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