Hot Off the Web– May 4, 2010

Personal Finance and Investments

WSJ’s Brett Arends tablesFour lessons from the Goldman case” for the readers and reminds them that “for many big financial institutions on Wall Street (or Bay Street), we’re simply customers to be sold a product”. The four lessons are: (1) be skeptical/cautious when dealing with a bank (or other financial institution).” Typical Wall Street bankers have three priorities: their own bonuses for the year, their bosses’ bonuses and their own stockholders. Customers — you and me — come a very distant fourth. It’s a mistake to forget that.” (2) beware of complex financial products “because, even when they’re not being put together as a sucker’s bet, they’re often being put together to sock you with high fees”, (3) don’t buy it if you don’t understand it , and (4) when in doubt, ask broker/salesman how much of his money he is putting into the product.

In the Financial Post’s “If you’re still in debt, forget retirement”Jonathan Chevreau takes a (well earned) shot at an RBC retirement strategist who suggests that debt in retirement “is not necessarily a bad thing”. I guess there could be unusual circumstances where this may be the case, like having an indexed guaranteed government pension well in excess of your retirement burn-rate, otherwise your “retirement” will be spent working to pay off your debts.

In Barron’s “Numbers often lie”Steven Mauzy tells readers that “Math, a reliable tool in natural sciences such as physics, is much less reliable in the soft sciences, such as economics. And the branch of economics that deals with investing is as soft, as squishy, and as multivariate as science gets.” The article is a stark reminder that even if your models could be perfect (and good luck with that), the inputs you feed into the models “are influenced by forces that are impossible to measure or to predict”. Also, the effect of benchmarks is that managers trying to beat their benchmarks quarterly “will either go for broke, be broke or follow the benchmark very closely”. He concludes with “Mathematics is a tool, not an infallible guide to right thinking and moral behavior. When investors meet gurus who are armed with algorithms, they should be on guard as much as they would be if they met a used-car salesman in a loud plaid sports jacket.” (Ouch!)

Jonathan Chevreau in the Financial Post’s “Why ETFs are starting to scare one financial advisor” tables the concerns of Winnipeg advisor David Christianson about how many of the new ETFs had significantly drifted away from what good with the original ideas behind ETFs. “These new products stand in stark contrast to the traditional benefits of ETFs — low cost access to indices in which the risks are clear and understood — into fringe investments of the sort that have traditionally caused surprise and disappointment for investors who knew not what they had purchased.  I have seen many a marketer ruin a good basic product over the past three decades.

Real Estate

Canadian Teranet National Bank House Price Indexcovering February 2010 was up 9.9% YoY and 0.2% MoM. Vancouver (+0.6%/11.8%), Toronto (+0.4%/13.3%) and Halifax (+0.2%/5.4%) showed MoM/YoY increases, however Montreal (0.0%/6.5%), Ottawa (-1.0%/+7.2%) and Calgary (-0.4%/2.2%) were flat or down MoM while still showing YoY increases. The Toronto and Vancouver “rises were the smallest in those markets since they begun reflating. This development is consistent with a general loosening of market conditions across the country. For some months now, homes have been coming on the market faster than they have been selling.”

Jennifer Sorentine in the Palm Beach Post’s “Appraiser: Lake worth property values fall 23%; county average
down 12 percent”
reports that the Palm Beach property appraiser estimates a 12% drop in county’s taxable property values last year. This means that long time Florida homesteaded owners who continue to benefit from the unfair save-our-homes driven tax system can expect a 2.7% increase in the taxable value of their homes while a 12% drop in taxable countywide property values means some mix of cut in services and/or an increase in mil rates. With homesteaders (voters) affected, this will help rein in the potential mil rate increases. This is good news (unless you are looking to sell) for non-homesteaded property owners who might still see a tax reduction overall. (Thanks to Dory Kilburn of Boynton Intracoastal Group for bringing article to my attention.)

Maureen Nevin Duffy argues in Barron’s “The condo conundrum”that condo owners who are behind in their association dues are effectively slowing/delaying the already record high condo foreclosure rates, because banks are delaying taking ownership from delinquent owners to avoid the risk of having to get stuck not just with the property, but also with paying the association fees. There are numerous other reasons for mortgage lenders to delay foreclosure, but “we could be looking at the calm before the storm in foreclosures”.

The Globe and Mail’s Rob Carrick pointed out the blog “CMHC: Fannie Mae Canadian style?” doing a pretty good job describing how Canadian house prices were propped up with historically low mortgage rates, low minimum down payments and unusually long amortization periods. Many believe that Canada has or is near a house price bubble, and we just some triggers away from initiating a bursting of the bubble.

Related to a potential Canadian housing price bubble, Dan Richards’ Globe and Mail article “Housing affordability: the great quandary”suggests that (un)affordability, “perhaps the most important determinant of short-term-price movements” (usually measured relative to the “The traditional rule of thumb…that mortgage payments, property taxes and utilities shouldn’t exceed 32 per cent of a household’s income, assuming a 25 per cent down payment”), is now around 50% in Toronto and 70% in Vancouver, the latter approaching the all time high. (It is interesting that looking at the data presented, which you might also interpret that,  with the exception of Vancouver, the current affordability numbers are not wildly higher than the (much higher than 32%) “long-term average numbers” presented for the various cities. Not sure what to make of that.)


You might be interested to read my input to Canada’s Minister of Finance’s spring 2010 request for  Consultations on Retirement Income System: The recommendations are to enable adequate savings, enable access to low-cost large-scale professionally-managed investment vehicle and longevity insurance, and increased tax-deferred savings.

In the Financial Times’ “Australia mulls route to annuities” Elizabeth Fry looks at Australia’s evolving approach to pensions. Australia is a leader in trying to solve the inadequacy of pension system, by introduction of (not a perfectly executed national pension system as a result of the inefficient approach to investment vehicles) a “compulsory (9% of salary) defined contribution scheme”. This effectively is forcing its citizens to save for retirement, whether they like it or not. A new study now suggests that it is “difficult to see how the private sector could develop efficiently priced annuities”, which are another key component of a credible national pension system even without forced annuitization. (The problem with finding private sector low-cost annuities is not just insurance companies’ addiction to fat annuity margins, but their aversion to being exposed to the combination of inflation and longevity risk, as well a few available vehicle to hedge these risks. A government run annuity with some level of risk sharing with beneficiaries may be the least of all evils associated with the currently available options.

This past weekend I connected (thanks to Ken Kivenko) with Dan Braniff founder of the The Common Front for Retirement Security. Dan Braniff’s Common Front is an umbrella organization consisting of “21 organizations representing 2 million Canadians” whose members agree that there is urgent “need for pension reform” and believe that the solution includes a “universal plan”. I hope that Dan and Common Front will be as successful in persuading Canada’s federal/provincial governments and secure changes to the pension system (now in systemic failure), as they were with the pension splitting issue, a few years ago. (Dan was one of the key players leading the fight to get the pension split legislation through; this was one of the long-standing critical unfairness issues in our tax system.)

On the subject of Nortel pensioners, on the way to being devastated by the effects of CCAA process so far, just about all forks in the road ended up heading toward worst possible outcomes (e.g. Ontario Court accepting $2B IRS claim against Canadian estate and entire Settlement Agreement including acceptance of no priority as well as giving up the right to sue Nortel, the Board, etc). There is an opportunity to reduce further compounding of the damage as the CCAA process enters the next stage, the claims process. While it is impossible to see the details of the proceedings that are all taking place behind closed doors, but at least two issues are emerging  as items that may cause additional damage to pensioners’ already dismal outcomes: (1) pension claims will likely have to be submitted to the Court before annuity quotes are received from insurance companies, and insurance quotes can be expected to ultimately be 10-20% lower than those calculated by Nortel or NRPC actuaries due to more conservative actuarial assumptions and required profit margin by the companies, and (2) there appears to be some consideration being given to using the remaining health and life insurance trust fund assets combined with recoveries from claims related to loss of health and life insurance, in a new trust fund rather than a cash payout to the already devastated beneficiaries. This would again be a worst outcome, as it would lock beneficiaries into the ongoing financially and psychologically toxic relationship; cash payout is a superior outcome, as it would allow beneficiaries to pursue the most advantageous insurance available on the market as past members of a group, or even lower cost if medically eligible for other insurance or self-insure. Time will tell if worst outcome will prevail again, or the right thing will be done.

Things to Ponder

Pauline Skypala in the Financial Times’ “Hard lessons on conflict of interest” writes that last week’s U.S. Senate proceedings on Goldman “shows is the gulf between how most people think big banks with reputations to protect conduct their business and what Wall Street practitioners think is reasonable behaviour”. Ms. Skypala also says that “proper discussion about conflicts of interest in all areas of financial services is well overdue. How can anyone trust an organisation they think might sell them a dud? Again and again, financial companies have done just that to their customers.” Her conclusion is that “Bank ownership of asset managers is riddled with conflicts of interest. The financial crisis made this clearer than ever, and rather than try to manage them, it is time to end them by separation, enforced if necessary.” (By the way, you might ask, what’s the difference between how Goldman Sachs and the financial services industry operates in general? Some might say that Goldman made deals with other professionals i.e. with equals, whereas the financial services industry makes deals with the average retail customer with relatively low level of financial sophistication. Yet we spend a great deal of time on transaction between professionals because they almost brought the financial system to its knees in a matter of a couple years of “innovation”, whereas the financial services industry is steadily grinding away over decades at the assets of the average retail investor resulting in decimated retirement assets due to fees/costs imposed by the industry. You might recall the title of the article “Jeremy Grantham: We add nothing but costs”discussed in last week’s Hot Off the Web)

For a slightly different take, see the Financial Post’s “Islands join Greek party” in which Diane Francis suggests that “the details oozing out about Greece’s spendthrift ways, make it obvious that the real legacy of Goldman Sachs and Wall Street is that they democratized greed.” (Interesting perspective!)

In the Financial Times’ “Why cautious reform is the risky option”, Martin Wolf says that “The role of big institutions is obviously problematic: they are, at one and the same time, the house, the biggest players at the gambling tables, agents for the other players and, if all goes wrong, beneficiaries of limited liability and implicit and explicit government bail-outs. This is a guarantee of repeated catastrophe. Under the gold standard, the scale of bail-outs was constrained. In a fiat system, there is no such limit, until the value of money collapses.” His list of fixes includes: reduced leverage (to about 3:1), equity-like liabilities, counter-cyclical capital requirements, move to very-long-term incentives, higher capital requirements in derivative trades and information quality (specifically “change in payment of rating agencies”)

The WSJ’s Scott Patterson in Mr. Buffett goes to bat for Goldman, Moody’s”report’s from Mr. Buffett’s annual love fest with Berkshire Hathaway shareholders in Omaha. In it he gives 100% support to Goldman, indicating no wrongdoing (I guess, in the legal sense at least) but then he also appears to have endorsed Moody’s the rating agency (clearly a significant contributor to the financial crisis with its failed ratings, likely to have resulted from conflicts of interest.) You can read the article and judge for yourself but many might say that Mr. Buffett, who has significant holdings in both companies, might be speaking with forked tongue; was he the one who not long ago called derivatives “weapons of financial destruction”. Mr. Buffett is also lobbying Congress for certain modifications to proposed derivatives related legislation, which may require Berkshire Hathaway to post billions of dollars of extra collateral for some of his trades.

For those who are gluttons for punishment, and would care to read more Goldman perspectives, consider Peter Foster’s Financial Post article “Goldman Sachs’ crimeless victims” where “The (Senate) committee seemed singularly incapable of accepting that for a company to be both a market maker and a trader on its own account could be anything but the route to client deception.” and the WSJ’s  “Clients first at Goldman? where Brett Arends  writes that “Perhaps it’s unfair of me to point this out, but over the past 10 years you would have been much better off investing in the stock of Goldman Sachs Group, Inc., than in most of its mutual funds.” This was due not only to Goldman introducing “fashionable” funds at peak of the market, but “Many of the funds also hit investors with higher costs”. Another article that you might find of interest is Bloomberg’s “Goldman armed salespeople to dump bonds, e-mails show” While you might be able to accept that Goldman was just reducing risk (by rebalancing) when they suddenly realized that their cumulative mortgage exposure was higher than what their current overall risk view was, clients who bought those bonds would after their lost money on them, how is it Goldman’s profitability is still great. In fact emails sowed that “Peter Kraus, Goldman Sachs’s then co-head of investment management, told Blankfein that some clients were expressing concern that the firm was making money for itself but not its customers. Goldman Sachs had reported six days earlier that third- quarter net income rose 79 percent to $2.85 billion after the bank bet against mortgage bonds. Kraus told Blankfein he had met with more than 10 clients and “individual prospects” since the earnings announcement. “The institutions don’t and I wouldn’t expect them to, make any comments like ur good at making money for urself but not us”. In “The masters of the universe were forced down to earth on Tuesday” Goldman CEO Blankfein was quoted as saying “as a market maker, it was not Goldman’s responsibility to tell customers how to trade or invest” and clients “are not coming to us to represent what our views are, they probably wouldn’t care what our views are. They shouldn’t care.” Though he also said that “everything that’s been the subject of criticism will be tightened up,” (referred to from CFA Financial NewsBrief)

And finally in the WSJ’s “Senate’s Goldman probe shows toxic magnification” Mollenkamp and Ng describe how a single $38M risky subprime bond (a tranche of a CDO) became the basis of numerous pure casino-like bets by the by replicating this toxic tranche via CDS and synthetic CDO bets in many other deals(which didn’t require that one actually even hold the bond) resulting in over $280M of losses.


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