Thursday, 8 January 2009

A journo's take on the crisis

Following on from Nick Drew's Q&A, I thought I'd ask a financial journalist for their views on the current crisis. Hugh Wheelan runs the rather ace Responsible Investor website, here's his take on things.

How bad do you think the crisis is/will get?

I think this crisis is certainly the biggest of the last 30-40 years, both financially and psychologically (it’s unreasonable, I think, to compare its effects to that of the Wall Street Crash post 1929, which had such a serious social impact on incomes/job losses and poverty, even if it bears many of the same financial hallmarks: bank solvency issues, etc). It could (and I say this with no little sceptical caution) start to re-define the way financial markets operate. One reason is that I think that society at large has become much more aware (and distrustful) of the operations of financial markets and the potential impact on their daily lives. I believe, and hope, that will create an onus for a back-to-basics, honest broker approach from financial providers with much more intense external scrutiny. Large parts of the financial markets had become too large, complex and unwieldy (not to say potentially fraudulent), to the extent even that many of the biggest financial players on the planet were brought to the abyss. That can’t be allowed to happen again, both for moral and financial hazard reasons. The opacity of the $8.5 TARP bailout in the US, as well as the terms of taxpayer funded bailouts in Europe and the UK are breathtaking to my mind, as is government reluctance to stipulate favourable terms/influence for the taxpayer for its cash injections (which is what the markets would do). I can’t help thinking that if this is not resolved then taxpayers will ultimately have been taken for a very big ride, even if part of the blame for the credit crisis lies in the public desire for cheap lending and government desire for lax regulation and short-term wealth creation. These latter points merit a great deal of self-reflection on the kinds of societies we wish to live in.

I also feel that we are only really at the beginning of the long-term knock on effects of the crisis on the real economy, which will be felt increasingly on several fronts: restricted lending, falls in real estate and other asset values, lack of consumer confidence. Instinctively, I think global interest rate cuts are the right move to ease the burden, but they must be short-term. Banks that have been bailed out must not toughen lending criteria on companies, and non-bailed out banks should be leant on not to do so either. Governments can and should be patient in waiting for their investments to be realised; repayment should not be at the expense of the real economy.

Finally, the long-term impact of the crisis on the future of the US economy ($1.2 trillion in debt and counting) will be fascinating/frightening to behold under Barack Obama. How long can the US economy go on bucking its indebted status (bond downgrades anyone?) and the dollar continue to be the global fiat currency when the country’s books are so seriously in the red? Both could raise serious questions about the future shape of the global economy and the shift/rebalancing of capital/financial markets to the east, notably China. Obama’s New Green Deal is certainly wise in terms of climate change realities, but is it enough of an R&D boost to reinvigorate the US economy?

We’ve seen a big growth in socially responsible investment (SRI) in the UK since 2000. Can the SRI world claim any sort of insight into the crisis?

It can’t claim much insight into the credit crisis, although one SRI research agency did ring early alarm bells about ‘sub-prime’ or predatory lending as it used to be known and the potential hazard of foreclosures on mortgage backed securities. But, in reality the SRI movement has done little yet to raise systemic issues/problems as part of its social responsibility. I think SRI investors could and should be better placed to do this than mainstream investors, who tend to follow the trend while it’s in the money. They’ll have to be bold and prove themselves though. It’s no mean feat to cry wolf over systemic issues (nor is it easy to know what to then do about it), but as we’ve seen, investors lose a lot of money when markets blow up and the recent tendency has been for these to occur rather regularly (Enron, LTCM, Russia, tech)…boom and bust is not good for long-term investors, particularly for personal pension plan holders!

You’ve reported that several institutions have cut their research into environmental, social and governance (ESG) issues in recent weeks. What’s the significance, and do you think it’s a mistake?

It’s a sign, I think, that some banks didn’t believe that much in it. SRI research teams were amongst the first to go when cuts were being made at investment banks. It’s difficult because SRI research doesn’t generate huge commissions for banks. Personally I think it’s a mistake because I think investors will start demanding much broader equity and bond research, including environmental, social and governance factors, which I believe have much to inform stock selection decisions, albeit only if investors are really serious about demanding longer-term buy and hold strategies from their fund managers, which I think they should, and increasingly will be. It's worked for Warren Buffet!

I think research in areas such as environmental risk/value creation, human capital, staff training, pay ratios, corporate ethos, brand reputation, internal governance, management controls, etc, is seriously under valued in today’s investment decisions.

What impact (if any) do you think the crisis will have on the way pension funds invest in the future?

As per above really, back to basics focus on long-term equity/bond/property returns with more focus on duration than short-term risk/return plays. There will also undoubtedly be more private equity money, hopefully in venture capital in the environmental space…with the necessary risk caveats, and in transparent long/short hedge strategies.

I think ESG (environmental, social and governance issues) will be a play a much bigger part in stock selection (in all these areas), although I would say that as editor of a magazine called Responsible Investor.

Shorting and stock-lending have both come in for criticism, is this justified?

It’s a long and complex debate. I have nothing against the principle of shorting (in fact I think the idea of the value of a company being inherent in the share price has almost become laughable these days). I do, however, have serious concerns about the increasing tendency for the market to be able to almost short companies out of existence in a kind of rapid, self-fulfilling prophesy (short stock, share price bombs, ratings downgrade leads to further share price drop and more expensive debt, etc) and to spook the market en masse, particularly in the nervous crisis period we are living through now.

Institutional investors tell me they make good money from stock lending, but in what context? I think there needs to be a serious discussion about the impact/breadth of market shorting, the amount of stock now on loan, the effects of shorting on overall market values. There is far too much discussion about shorting these days rather than the creation of good, long-term responsible businesses, which is what we should be encouraging. A world in which hedge fund managers are feted more than entrepreneurs is not good.

Do shareholders, as the notional owners of businesses, bear any responsibility for what has happened?

Yes, I think so, notably in the financial sector. Shareholders (notably asset managers) in financial services companies should have been much stricter about the way the companies they invested in made their money/business models (off balance sheet vehicles, for example) /risks/incentive structures, etc. However, for the large part it’s the old debate about getting the police to police themselves – there’s too much aligned self-interest. Fund managers operate largely under the same parameters (and often in the same groups) as the banks and insurers whose stock they hold (bonus structures, etc). It’s the same reason why the issue of tax is rarely brought up in the context of socially responsible investment, despite tax evasion being one of the most socially irresponsible practices globally.

As a result, the real shareholders (pension funds/insurers) who delegate to fund manages, need to be much clearer in the instructions they give their fund managers about the way their money should be managed. They need to be much clearer about what investment principles they believe in and justify them.

What actually needs fixing, and are there any legislative or regulatory changes you would like to see?

It’s difficult to be specific here (partly because there is much that needs legislating in my opinion.) However, there are principles I think need to be applied. Regulation must be more protective for investors and transparency for financial markets should be absolute when decided upon, not exist in pockets. Philosophically, I think we need to apply overall market health criteria to the approval of financial products. The idea that regulation stifles market innovation doesn’t wash with me. I see little real healthy innovation in financial markets in reality. I’d like to see more innovation in the real economy, notably in environmental sectors, backed by long-term patient capital and less large-scale trading.

1 comment:

Andreas Paterson said...

That's a really good interview, I agree with a huge amount what he's written there.