JULY closed as it opened, with the European Central Bank promising to pour further billions into the totally bankrupt European banks, and I include the UK.
The Investment Club must not grumble though, because this helped its unit price climb 5p to £3.29. However, we have to be alive to where this extravagance with taxpayers’ money is leading. Due to the profligate policies of governments in every recession, the seeds of the next financial crisis are sown.
Far-fetched? Judge for yourself. In response to the 1930s Great Depression, Franklin D Roosevelt had a brilliant idea to promote growth, in the form of the New Deal. He pumped taxpayers’ money into the US housing market by guaranteeing depositors in Savings and Loans building societies their money via a federal deposit insurance scheme.
This meant depositors could safely deposit their money with Savings and Loans or thrifts, and thrifts could offer mortgages without fear of repercussions – moral hazard – from the mortgages going sour. The seed of the Savings and Loan crisis had been sown.
By the early 1970s, through US government-sponsored bodies, affectionately known as Ginnie Mae, Fannie Mae and Freddie Mac, bonds were issued that could then be used to provide further mortgages to less creditworthy borrowers via thrifts.
With the US housing market now effectively underwritten by the US government, the Savings and Loans mutual association lenders had a license to print money. So successful were they that by the early 1980s the mismatch between the assets and liabilities of most Savings and Loans had become disastrous.
By 1986, the US government’s Federal Savings and Loan Insurance Corporation was itself insolvent. The final cost to the taxpayer was £153 billion, 3 per cent of US GDP. The seed of the credit crunch had been sown.
But prior to 1986, while the state-funded money was still flooding into the thrifts, they could afford to sell their mortgages at fire sale prices to bring some cash in to stave off insolvency. A certain Lewis Ranieri, of Salomon Brothers, had the bucks to buy them up at rock-bottom prices.
By bundling thousands of mortgages together as “collateralized mortgage obligations” they could be sold as alternatives to traditional government and corporate bonds. This product was first issued in June 1983. The process was called securitization. It culminated in the credit crunch of 2007/8.
In each case it has been free money from the state that has nurtured the seed of the next financial crisis. Knowing this, how should the club remain solvent?
From the evidence of history, it does seem that while free money leads to the next financial crisis, it can take some time. In the intervening period, free money can promote rampant bull markets.
In July, the Bundestag, Germany’s parliament, voted to amend its Grundgesetz (constitution) to sanction euro bonds and a £500bn European fund. The only impediment to free this free money, are the eight constitutional German judges sitting at court in Karlsruhe.
They have to decide if German democracy is compromised by the Bundestag vote, which implies closer European integration and rule by Brussels. If the verdict due on 12 September is against, the euro and eurobonds are dead, and the Investment Club should pile into government bonds regardless.
Any other verdict, and the bull market is on, and we need to buy equities. In the month ahead we will have to ponder the question of which way to jump.
