Finan­cial Hocus-Pocus? From man­aged fund to bank?

Flattr this!

The sug­ges­tion that the Fed­eral Gov­ern­ment might extend its guar­an­tee to man­aged funds in return for the funds becom­ing banks is, as Glenn Dyer has observed for Crikey, sheer bunkum.

On the lender side, this sec­tor of the finance indus­try largely arose to make money out of lend­ing prac­tices or finan­cial prod­ucts that were too adven­tur­ous for banks them­selves.

On the “depos­i­tor” side, investors in these com­pa­nies knew full well that they weren’t mak­ing deposits that can be with­drawn at call—as with a bank—but invest­ments.

One con­se­quence of this non-bank behav­iour was that man­aged funds weren’t required to keep on hand the idle funds that banks must to meet the pos­si­bil­ity of depos­i­tors with­draw­ing their funds at will. This of course increased the poten­tial upside—less idle funds, there­fore higher poten­tial returns. When the econ­omy was boom­ing, this free­dom from the pru­den­tial lim­its of a bank was a win­ner for both the com­pa­nies and their investors—the sac­ri­fice of liq­uid­ity was rewarded with higher returns.

But now, in the midst of this finan­cial cri­sis, investors are will­ing to sac­ri­fice returns to get liquidity—only whoops, man­aged funds aren’t liq­uid because…

You get the drift.

If times were nor­mal, then the gov­ern­ment could hap­pily stand by when the odd man­aged fund suf­fered a run, and had to freeze redemp­tions. But now that eight major fund man­agers have frozen $12 bil­lion in funds, stand­ing by doesn’t seem an option.

How­ever, it may be a more sen­si­ble strat­egy that the offer to con­vert man­aged funds to banks. After all, it takes more than the wave of a magic wand to make this tran­si­tion.

Becom­ing banks might require the funds to give up the invest­ment strate­gies that have defined them to date. There is lit­tle chance that any of these funds would imme­di­ately meet Basel II risk cap­i­tal require­ments, for exam­ple. What should they then do? Call in the loans that are out­side the pale allowed to banks? This would surely pre­cip­i­tate what the funds and the gov­ern­ment are try­ing to avoid: the funds call­ing in their loans to meet redemp­tion demands, and thus bring­ing many com­mer­cial con­struc­tion projects to a halt (not to men­tion stuff­ing up insur­ance con­tracts a la HIH, given AXA’s insur­ance busi­ness).

Nor are the funds likely to have on hand the hun­dreds of mil­lions of dol­lars of cash needed to con­vert investor funds to at call deposits. They’d likely have to bor­row these from the RBA—dramatically increas­ing their idle bal­ances and cost of funds at a time their busi­ness model was sud­denly dri­ven from adven­tur­ous to con­ser­v­a­tive.

The gov­ern­ment has been mak­ing pol­icy on the run dur­ing this cri­sis, which is the only way it can behave when the sit­u­a­tion itself is unprece­dented: there is no “how to” man­ual for cop­ing with any finan­cial cri­sis, let alone one of this mag­ni­tude.

Often those poli­cies have seemed sen­si­ble, and may well prove to be so with the ben­e­fit of a far dis­tant hind­sight. The guar­an­tee of bank deposits surely fits that bill, because the very last thing we want is a run on the banks.

 But this pol­icy sug­ges­tion may be one that is best retracted. After all, the man­aged funds haven’t col­lapsed: they are still pay­ing div­i­dends to investors—all they’re not able to do is to return investors cap­i­tal to them imme­di­ately.

The funds are also in a legit­i­mate posi­tion to freeze redemp­tions, while still meet­ing their div­i­dend pay­ment oblig­a­tions. These “mar­ket-based funds” dif­fer from shares, in that most of those who invested in them did so for the income stream rather than cap­i­tal gain. A case-by-case approach to assess­ing alleged spe­cial needs to  with­draw cap­i­tal is fea­si­ble.

That may not always be pos­si­ble, of course—if the econ­omy turns sharply for the worse, many of the invest­ments made by man­aged funds will sour and investors will actu­ally lose their money, rather than sim­ply hav­ing to tol­er­ate their illiq­uid­ity. Losses  then will be unavoid­able.

Stand­ing by would then still be the best option. Greenspan’s pro­cliv­ity to res­cue investors from every last mar­ket col­lapse is part of the rea­son why we’re now in the biggest col­lapse since The Really Big One. The real pain inflicted back then caused a fun­da­men­tal shift people’s atti­tudes to finance—which we have since for­got­ten. Re-learn­ing that les­son may once again require some pain.

About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
Bookmark the permalink.
  • pru­dentsaver

    Let me add that sugar have been the lead com­mod­ity
    the last weeks. It’s going to explode to the upside’ I can feel it in my bones.

  • Bull­turned­bear


    How do you know the fear of 2008 will not be repeated in 2009, but with even greater wealth destruc­tion. I feel that in my bones.

    Major bot­tom could be quite a long way off. My guess for equi­ties, Temp bot­tom in Novem­ber (below the cur­rent low) cor­rec­tive rally into Feb or March. Then new waves of sell­ing will begin to find new bot­toms in ’09.

    I think you are prob right though that money will flow out of trea­suries at some point. The yields are crazy low for a coun­try with mas­sive debt.

  • pru­dentsaver

    This could be a 1929 sce­nario. But except that bear mar­ket, the norm is around 30–50 %, and we are already at 45 %. Many stocks look tech­ni­cally now as they have looked in other bear mar­ket bot­toms.

    I think Obama will be like Roo­sevelt, or jimmy carter. Some­one who spend a ton of money. And he have the abil­ity to really move con­sumer con­fi­dence in the right direc­tion. I think house­prices will land and turn around on soft com­mod­ity price increases, together with gold.

    You have the CPI. and keens dou­ble bub­ble, and the possibility’s for dow at 3000 IF the cpi is cor­rect. I think the CPI is flawed, and that the dow already is trad­ing at a very low level. When infla­tion is taken into account, I think the dow is trad­ing at around 4500 (in com­par­i­son to the 8000 in 2003)
    Look at the nas­daq, it went to 4500, then down to 800, down 80 %, now it’s trad­ing at around 1600. Despite that, I don’t think the nas­daq is more expen­sive now than it was trad­ing at 800 because of infla­tion. The num­bers also sug­gest that it’s just as cheap now.

    I see no signs the dow jones is a bub­ble. The bub­bles was the emerg­ing mar­kets. Like the sen­sex in india , the indexes in pak­istan, China…When they was trad­ing at around P/E of 30–40. To be 1929, the dow should had been around that level ear­lier this year, with sim­i­lar enthu­si­asm to those coun­tries. The dow is more in a trav­el­ing phase, where it can go flat for a long time.

    Like other stock exchanges, like Oslo were trad­ing at a price/book ratio of 0,9 ear­lier this month. It could drop to half of that, but I think it is unlikely. Like the dow jones, have only been that low a few times in it’s his­tory.
    Another sim­i­lar­ity is the baltic dry ship­ping index, what’s hap­pened in China, with bulk car­ri­ers, and every­thing is iden­ti­cal to the early sev­en­ties.

    I rather think it is that the CPI is deeply flawed, and peo­ple are think­ing their cash is worth more than it really is, not fully real­iz­ing that it’s lost half of it’s value the last 5 years.

  • pru­dentsaver

    Another thing, very few seems to think of is that China will avoid the 0 % prob­lem. China can com­fort­ably take inter­est rates to 2–4 % and lift reserve require­ments, and have the econ­omy heat up again. When the China econ­omy heats up, with more focuses on the domes­tic side, so will infla­tion in our coun­tries.

  • pru­dentsaver

    The rea­son for this, is that a move from China to heat up their own econ­omy, will push our economies towards stagfla­tion, because of the reval­u­a­tion of the ren­minbi

  • pru­dentsaver

    If there is a bub­ble, it’s in our liv­ing stan­dards, and how cheap we can fill up our shop­ping wag­ons at the food store. That cheap­ness is really a mir­a­cle that can’t last, that’s why I see, long term yields on bonds going higher.

    Sugar, not adjusted for infla­tion, is only dou­ble the price in 1950. You can’t say that about the stock mar­ket. Com­modi­ties are still very cheap, at least the soft com­modi­ties. Oil is 30 % lower than in 1974, com­pared to the US GDP.

  • pru­dentsaver

    One thing about the “Com­modi­ties bub­ble”, that is inter­est­ing, is that com­modi­ties, that were at 100 in 1971, now are at 370, that is a 3,7 times increase, how­ever the CPI have increased 5,4 times

    So in real terms, using the very flawed CPI, com­mod­ity prices are at 68, rel­a­tive to 100 in 1970. So, that means the “huge bub­ble”, in com­modi­ties really is no bub­ble at all. I think the bub­ble is in trea­sury bonds, and is cre­at­ing ratio­nal spec­u­la­tion in com­modi­ties.

  • pru­dentsaver

    Just one pic­ture, to prove the ratio­nal spec­u­la­tion.

    Com­modi­ties at a 200 year low in 2000. And they are still cheap. I think the bub­ble is our gov­ern­ment bonds, and ser­vice economies that don’t pro­duce any­thing at all.

    With com­mod­ity prices at a 200 year low, I really cant see defla­tion com­ing, I rather think
    the ser­vice economy/debt/phony/bond bub­ble will burst in a way that will cre­ate higher infla­tion, to cush­ion the stock mar­ket. But at least, find­ing stocks that are a play on com­modi­ties, or the com­modi­ties them­selves. Sugar was 5 cent in 1950, now it’s 12 cent, try to find a stock you can say that about. I think the key is that cer­tain stocks, will track com­modi­ties, and that they might go on to be good invest­ments, like they was for a few years now.

  • Emil


    I believe there is an eco­nomic rea­son why sugar was 5 cents in 1950 and a mere 12c now — effi­ciency.

    Think of how much labor went into pro­duc­ing sugar back in the 50’s — a lot more than there is now — and effi­cien­cies are only going to improve. 

    Granted, if the debt bub­ble bursts and sugar pro­duc­ers go out of busi­ness, we could see legit­i­mate sup­ply side induced rises, so I don’t dis­count that it could go up. It could also go up sig­nif­i­cantly as we hit peak oil (increased fer­til­izer costs, greater demand for bio fuels), but as a com­mod­ity itself, I think its upward move­ment of price is more depen­dent on exter­nal influ­ences and gov­ern­ment inter­ven­tion than its fun­da­men­tal value. 

    I would be inter­ested to under­stand your ratio­nale behind why you think its value will rise?

  • pru­dentsaver

    My ratio­nale is, high prices, a fer­til­izer bub­ble (not really a bub­ble com­pared to fun­da­men­tals over the long term 15 years, why else is George Soros this month octo­ber the 30, buy­ing fer­til­izer stocks in Aus­tralia at rock bot­tom prices?) You should read his book.

    Any­way as you say, those prices means less sugar pro­duced. World­wide reces­sion (infla­tion­ary reces­sion of course) ( 6 month ago krug­man was all into this infla­tion stuff, now sud­denly he is back to his Japan sce­nario, these guys don’t look at the fun­da­men­tals) world­wide reces­sion mens a increase in demand for sugar of 20–30 % at least. Sev­eral ana­lysts have pre­dicted a lack of sugar in 2009, more demand than sup­ply, but these ana­lysts don’t know how much demand for sugar increased in 1981–1982, and in late 1974- early 1975. They just think a nor­mal year is going to hit, with less demand than the last year, they don’t under­stand that demand will go through the roof as it always does in those hor­ri­ble reces­sions. You could not get sugar any­where, not at restau­rants, it was not the spec­u­la­tion, it was an actual lack of sugar. The sugar was sim­ply not there. Why you think war­ren buf­fet is buy­ing choco­late pro­duc­ers and chew­ing gum pro­duc­ers. He is look­ing for strong brands to pass on the cost explo­sion com­ing, of course sugar will not have a last­ing increase, from next year, but one hell of a peak. Of course that is also why he invest in rail­road. Rail­road track oil, a very cheap com­mod­ity, that means it does not mat­ter that com­pared to the CPI, the dow jones look like it’s in the sky, under­stand?

    When dow jones was expen­sive in 1965, you could buy com­mod­ity related stocks (at the peak of the dow), and make tons of money from 1965–1980), it’s the same now, it’s just a cor­rec­tion in the trend going on.

    Ok, pro­fes­sors don’t get this, but they don’t have com­mon sense.

  • pru­dentsaver

    One more thing. In march tips yielded 0,5 %, now it’s 7–8 %, the mar­ket is so much smarter now than 6 months ago?

    How about Pimco and Bill Gross that are to bonds what War­ren Buf­fet are to stocks. Why are they hav­ing most of their port­fo­lio in TIPS. They know some­thing we don’t?

    BRIC will lower rates, and their economies, at least China will respond like crazy, with all their sav­ings, bank reserves, and room for expan­sion of credit (com­pared to the west), the Chi­nese econ­omy will respond like crazy, add some reval­u­a­tion to the mix, and we have stagfla­tion before we know it. It’s the the panic of 1907 in China. Remem­ber, we are in the up wave for com­mod­ity prices. Still lower than in 1932. 

    I think you need to under­stand that this is the bot­tom for stocks.

  • pru­dentsaver

    It’s not so much before stocks are cheap, but because gov­ern­ment bonds are com­pletely “over priced”.

  • icon­o­clast

    i don’t believe we will be see­ing any infla­tion­ary signs for quite a while, it is defla­tion that is the main game. As i said before the govt. will try to min­imise the pain by ensur­ing that aggre­gate demand does not com­pletely col­lapse, but there is no doubt that it will cer­tainly shrink dra­mat­i­cally. The RBA can pro­vide liq­uid­ity, that is all, but it can not force lenders/borrowers to trans­act. Lower inter­est rates won’t mat­ter when peo­ple are star­ing down the eyes of unem­ploy­ment. The pur­chas­ing power of indi­vid­u­als will also col­lapse espe­cially here in Aus­tralia, given we are so credit depen­dent, when credit stream are being restricted.
    It is already hap­pen­ing with the non-bank mort­gage lend­ing mar­ket hav­ing col­lapsed, the car lend­ing mar­ket with GMAC and GE flee­ing the Aus­tralian mar­ket hav­ing col­lapsed, the credit card mar­ket tight­en­ing due to higher defaults and ensur­ing that this mar­ket does not become the next sub-prime bub­ble. This is shreak­ing out defla­tion. The govt. is stick­ing its fin­gers in so many dikes, whilst the levy is col­laps­ing all around them.

    Govt. bonds are cur­rently per­ceived as a safe haven and thus sig­nif­i­cant demand. The US govt. will ensure they will be a buyer of last resort to ensure yields remain low, just think if the yields on bonds of long term matu­rity started to move up, this would cer­tainly feed into the hous­ing mar­ket with float­ing rate mort­gages also forced upwards. This would merely exac­er­bate house price defla­tion and crash the mar­ket even more.

    China has so many mal-invest­ments, over­ca­pac­ity its not funny, hous­ing and equity bub­bles, in fact bub­bles galore. 

    With the new US admin­is­tra­tion sound­ing like they will take pro­tec­tion­ist mea­sures this will not bode well for China, since what they don’t want to here is restric­tions placed on them with respect to access to mar­kets. I see China head­ing for a hard land­ing as well.