I have tackled a different subject this month because of it’s dominance in the media and because I have been asked by a number of clients as to my thoughts on its significance.

The financial world has experienced its most tumultuous month in living memory. The failure of WaMu (Washington Mutual) is not only the latest US financial institution to topple but the single biggest failure in American history with assets totalling over $300 billion. Its demise caused Hank Paulson, the U.S. Treasury Secretary, and Ben Bernanke, chairman of the Federal Reserve, to try and piece together a government-backed rescue package referred to as TARP (Troubled Asset Relief Programme) to avoid what they said could otherwise precipitate a catastrophic nightmare. This morning’s announcement that Congress has rejected the deal caused further trauma throughout the financial world but none more so than on Wall St which saw losses totalling more than the cost of the rescue package itself (the largest failure prior to Seattle-based WaMu last week was that of Continental Illinois National Bank in 1984 which had assets totalling $40 billion).

Whilst it is deeply worrying for all involved, or at the very least exposed to the US financial situation, it is made considerably more so due to the fact that as human beings we have the extraordinary ability to turn unenviable situations into a crisis. One of the major implications that have morphed out of the state of the U.S. sub-prime housing market is that the ‘market’ has lost so much confidence in the ‘market’, that virtually all previously available cash has been pulled out of the system thus intensifying the pressures on liquidity.

Financial experts in New Zealand have provided some fascinating commentary during this period however it surprises me that they continue to focus on the ‘market’ when in actual fact, people determine the eventualities and catastrophes within a market. I accept it is not wrong to talk about ‘market’ confidence plummeting but nor is it entirely true. Markets don’t ‘lose’ confidence, people do. Nor do markets ‘gain’ confidence and drive growth, speculators, and investors do. If people, particularly in the U.S., were more prudent in their investments, it is possible we could have avoided the mayhem the world is currently experiencing.

To illustrate this point, during a conversation I had recently with a respected broker, it became apparent the cause of at least part of the meltdown we have witnessed amongst our own financial investment companies in NZ was caused by too many investors ‘losing’ confidence and pulling their money out at a time when liquidity was tight. Had they stayed ‘in’, it is possible some of our financial institutions that went belly-up may not have. Possibly of greater interest however, is that if the collective investment pool had greater staying power they may not have lost the significant value they did. In saying that, there were obviously a number of seriously leveraged companies trying to capitalise on speculative developments with insufficient cash to fund them, along with a grimmer picture emerging of shoddy practice being somewhat more commonplace than what we were led to believe when trouble first appeared on the horizon. My concern is the US crisis has in many ways taken the focus away from local practice at a time when it needs to be explored more rigorously to prevent such scenarios reoccurring.

 

What can we learn?

As you know, one of the reasons so many US politicians were against bailing out Wall St was because they believe many players responsible for fuelling the crisis in the first place would once again put themselves in a position to milk the system at the taxpayer’s expense. Profiteering out of others’ naivety or misfortune is bad enough, but causing the market to crash through foolish lending and then being rewarded outlandishly to fix it, is they say, an entirely different thing. The other reason of course is the fact that many were of the view the market needs to ‘find its own feet’ rather than being ‘pulled’ out by a package that may not deliver a speedier recovery. So while we can all but hope Wall St learns something useful to mitigate the chances of us experiencing another long and deep global depression similar to that of the 1930s (namely a deeper sense of morality, sensibility, and discipline), what can we as individuals learn to lessen the chances of further financial pain or prolonged misfortune?

 

There are two questions that I believe are worth considering;

1. If we are looking to invest a sum of money, at what point should we consider the promise of premium returns to be ‘speculating’ rather than simply ‘investing’? i.e. at what point do you believe this crossover occurs?
2. What risk are you as an individual investor prepared to take?

 

It seems to me too many people expect high returns from their so-called investments but do not have the stomach to accept that it must come at greater risk. If there was no greater risk or cost, wouldn’t the major financial institutions be offering a similar deal? If they are not offering a similar deal, what are the smaller investment companies doing that enables them to offer a better deal? What risks are they taking to be able to afford to pay investors more and if they are paying more, wouldn’t that suggest they need ‘our’ money more than we do? If this is the case, what are they doing that requires our cash when surely, if it was a ‘safe’ bet as they say, they could borrow more cheaply? Needless to say, such questions in my opinion point more toward speculative lending than actual investing.

Sadly the financial news dominating the media suggests greed has once again compromised the value of capitalism thus providing additional ammo for those who oppose it, however, it must also be said that it is possible to imagine a world where we could have one without the other. In other words, a capitalistic society doesn’t need to deteriorate into a dishonest and fractured society – the two needn’t go hand in hand.

 

Confidence

As I have mentioned before, confidence is an interesting phenomenon that affects people in very profound ways. To increase it in such circumstances, I suggest we each take a more proactive approach. There should be no surprise that the ‘fear’ of losing money precipitated an entire industry that will retain its position for as long as the fear remains. If people were more active and responsible in their research of the markets, or more precisely, the businesses or ventures they were investing in, maybe we could have avoided some of the dramas that have recently occurred.

In the meantime, we will continue to invest in both the business and the industry we know best - being that of Steel Performance Consultants and the performance improvement industry. How often have you considered the potential benefits of investing in the business or industry you know best? Maybe the ‘best’ place for you to invest is in the company or industry you are currently involved in. A business or industry you know intimately - one where you are aware of the opportunities as well as the pitfalls rather than buying the hype featured in glossy marketing publications. After all, many of our well-intentioned investment advisors acting on ‘our’ behalf know little more than what can be gleaned from published material. Do they really know the state of the businesses or investments they are recommending? Or do they, like the rest of us, have the tendency to seek safety in numbers and therefore recommend purchasing shares or committing to particular investments because other seemingly intelligent people in their industry are doing the same? And, whilst this may seem a completely understandable approach, isn’t this what also initiates imbalanced investments or balloon-shaped membranes that have a tendency to burst just when they are starting to look their best?

 

Summary:

If we want to generate a return on our money, I believe we need to weigh up how prepared we are to lose it. If we are in a stage of our lives where we have years to ‘earn’ through traditional business or employment, it is likely we could tolerate greater risk. If however we are nearing the end of our working days or have recently retired, it would seem extremely unwise to take such a risk. And whilst I do not consider myself qualified to make comment on financial matters, a bit of common sense and a weighing up of the two previously mentioned questions may not be a bad place to start.

 

 

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