Wednesday, September 28, 2011

Don't Sweat it Greece, Sovereign Default is Normal

Everyone knows* that the sovereign default of England's King Edward III bankrupted Florence's Bardi and Peruzzi banking dynasties in 1345. And everyone knows** that Argentina's default in 1890 brought Baring's bank to the brink of insolvency, staved off by the massive rescue operation organized by the Bank of England.

My question was how common are sovereign defaults?
I found a couple dozen answers in the bookcase and on the 'net but the most interesting came from Bedlam Asset Management.

First a short digression.
The first thing that strikes you is: These people named their firm after the most famous lunatic asylum in the world?
This must be a put on.
Then I read a couple of their market commentaries. They are good. It's not a put on.
I went to their website where the front page says it is for institutional investors only.
No problem.
I click the enter button and am greeted with:

 Welcome to Bedlam 
A website for institutional investors

This has got to be a put on. Welcome to Bedlam?
I go back and Google a couple more of their papers. They're erudite and comport with my understanding of markets, economics, finance etc.
So I click on the team page where I see this poor unfortunate:

 Richard Greenwood | Senior Research Analyst
  • 6 years industry experience
  • Joined Bedlam in 2007
  • Chartered Accountant
  • Lincoln College, Oxford
    - BA (Hons) in Classics
r greenwood Richard commenced work at Deloitte and Touche in 2003 where he specialized in tax cash flow modeling and due diligence reports for private equity M&A. His other experience includes academic instruction; from 1999-2003 Richard taught Classics, Latin and Greek at Wisbech Grammar School.

I swear to God he looks as troubled as SocGen's Albert Edwards trying to laugh.
Some of the other photos also appear just a bit off:

Robert Dann | Institutional Sales & Client Relationships
  • 5 years industry experience
  • Joined Bedlam in 2005
  • BBA (Hons) Business Administration, University of Kent at Canterbury
  • Fluent in Spanish and Portuguese
Robert Dann Rob first worked at Bedlam as an intern then joined full time after gaining his degree in Business Administration. Robert is also a Non-Exec Director of a London Wine Merchant.

I'm really thinking this is a put on.
But another part of me says "Hey if he is a director at, say, Berry Bros. & Rudd..."
All morning I've been quoting that line William Goldman put in Butch Cassidy's mouth as the posse tracked he and Sundance relentlessly:
"Who are these guys?"
Just a few minutes ago I was shown that they were vetted by FT Alphaville's Izabella Kaminska.
That's good enough for me.
Here goes. From Bedlam Capital Management PLC, March 14, 2009:

Sovereign default
“Dictum meum pactum?”

The world of high finance is full of charlatans; those who claim never to have been duped are
lying or unaware. When clinching a deal, these fraudsters seize your hand in a manly but
friendly grip, look you in the eye and utter the immortal phrase “my word is my bond”. In
olden times, the 1990s, the more professional crooks would often say “dictum meum
pactum”*. This means the same thing but being in Latin shows great erudition, thus adding
credibility. If a man (and usually it is a man) insists on telling you he is honest, something’s
seriously wrong. Today, more dubious people than ever are saying ‘trust me’, and investors
are doing just that. Having lost millions to one group of hustlers – be they funds of hedge
funds, SIVs or structured products - they are now fleeing by the billions of dollars to other
fraudsters: central bankers selling the perceived safety of government bonds. Moreover, so
great is the issuance of these IOUs that inevitably there is a giant crowding out effect on the
private sector borrower. This ensures that bankruptcies accelerate, thus bond issuance must
do so as well.

Although objectively (sic) we are the greatest living authority on bank valuations and cycles
(as the only firm in the world never to have held bank shares in the English speaking world),
we make no claims as bond experts. Despite this caveat, we do understand when supply and
demand are chronically out of balance. Such analysis on bonds suggests that financial
markets are in for the worst shock of all – a series of Sovereign Defaults. ‘Don’t know where,
don’t know when,’ as the Platters used to croon, but this time default will not just be a third
world problem but will include some industrial nations.

Mankind is a natural herd animal. Criticising the status quo is never popular. Only when it
has become blindingly obvious that the decision makers and leaders are unquestionably
idiotic and their policies disastrous does the herd tear them to pieces. This is often when
default occurs. Debt markets and politicians are not prepared for these events. Given the
atrocious supply/demand dynamics, trusting in government issued paper is now one of the
worst investments anyone can make.

What is a Government Bond?
Until recently, none of us had ever read in full what is written on an American or British
government bond or the offer documents. There are lots of words and caveats, not dissimilar
to Bank of England bank notes with their lingering promise from the days when these notes
could be redeemed in gold.

Government bonds are the standard benchmark for risk. Their yield sets the borrowing costs
for everyone else. There is logic to this, as in theory the obligation to pay at some future date
by issuing government paper in prudent quantities can always be met through changing tax
rates or curbing government expenditure to raise the necessary funds. The promises are more
explicit than bank notes and commit future governments to meet these liabilities even though
their leaders may not yet have been born.
*Also the motto of the London Stock Exchange. Enough said.

Default is normal
It is not widely realised that governments failing to meet their debt obligations are
astonishingly normal. Indeed, it is utterly abnormal for a country to have a track record longer
than three generations of paying back IOUs issued by dead people. The chart below shows the
number of countries in default of their sovereign obligations in each year since 1823.

This chart understates the true extent of default; for at the sub-national level many states or
cities - such as four American states in the 1830s (well before the civil war), or the City of
Cleveland (Ohio) in 1978 - defaulted on their bonds. China created havoc in the late 1990s
when several of its local state-owned investment companies defaulted. Beijing-based
politicians and the central bank had always suggested they were government backed. When
these investment companies gambled themselves into bankruptcy, bond holders hired
translators and discovered they were not even backed by the regional governments which had
issued them. Meanwhile the Politburo developed collective amnesia....MORE

If you meet BCM's requirements do read their Q3 Global Investment Review and the Monthly Bulletin for September.

*If you read our little blog:
"How Venice Rigged the First, and Worst, Global Financial Crash"