The End of the World is Nigh ... Maybe

This week we are going to take a quick break from our continuing series on Portfolio Construction to address the current situation with the world’s stock markets:
Stock markets have been bouncing all over the place lately and even the most casual observer must be aware that this is at least partly related to the fact that too much money appears to have been leant out in mortgages in the US to too many people who stood little chance of being able to repay. The history of global financial catastrophes is that they tend to start with a few leaks in the dam which get plugged (cartoon style) fixing the immediate problem but not the underlying one, causing the problem to spread and spread and by the time that the extent of the damage is realized it’s too late to do too much about it.
For a long time Warren Buffet has issued financially apocalyptic (if such a concept exists) warnings about the dangers of derivatives. His fear was that in some financial sphere there would occur some unexpected event that would suddenly cause major counterparties (Wall Street banks, global financial institutions) to realize, way too late, that, despite the fact that they employed sophisticated risk management systems, they had inadvertently bet the farm on the status quo only to find out that a major shift had taken place and as a result they had lost the farm and some and were left as helpless as the spread-eagled cartoon character desperately plugging holes in the dam with all 4 limbs and as many other bodily parts as possible.
Long Term Capital Management’s risk modelling strategies calculated that it would take a 3 sigma event (something that happens once in 3 times the entire life span of the universe) for LTCM (who extensively used derivatives) to lose 50% of its invested capital or more - in fact they lost their entire capital within 4 years of launch. When this happened Buffett’s fears were taken by many ‘traditionalists’ as being an investment equivalent of The Book Of Revelations and the end of the financial world was generally regarded as being ‘nigh’. Everyone was extremely watchful of what type of investments should and could be made and sanity came back to the markets - briefly.
Since then complacency has returned and many investors have become more comfortable with the markets use of derivatives. After all, they now ask, what event could possibly occur that would expose such a major discrepancy between what Wall Street had understood to be the case and what was reality? If we’ve survived Peso/Asian/Russian crises what could there be that we can’t handle? Maybe in some small marginal markets valuing esoteric assets could be a problem but that wouldn’t have any large scale impact ... so best to just assume that Buffett’s got it wrong for once and carry on making money left, right and centre?
Actually no.
After all we’ve seen Barings, Sumitomo and now Bear Sterns - and that begs the question what market could be big enough to cause anything other than a localised problem?
Well it would have to be equities, currencies, debt or property in a substantial economy or (as the Latin and Asian crises showed) in a series of connected smaller economies.
And it would have to involve a situation where financial engineering had taken place on such a huge scale that the counterparties had been massively complacent about the risks.
And it would have to be a situation where the risks suddenly materialised and were significant.
Currency is a zero sum game - when one falls another rises - therefore any currency crisis per se is simply a redistribution of wealth - that in itself can be a significantly fraught experience for those on the losing side of the equation, but in itself it’s not so severe as the problems that tend to follow currency collapses, such as hyper-inflation, but even these scenarios, difficult as they are, have generally been seen before and have been survived.
You can probably largely rule out equities - there’s probably insufficient capital currently concentrated in exactly correlated leveraged derivatives in stocks and shares to create a collapse that the markets can’t handle - sure markets might fall 50-60% in value as shorts and swaps get covered and good assets have to be sold to repay the damage done by bad ones and the fall might well be so rapid that it feels like Armageddon and we might be living with the economic consequences for the next 5-10 years but afterwards the global financial landscape might be severely scarred but it would probably be just about recognisable.
Property is property - when it falls in value, its biggest impact is on the debt market - defaults may cause the value of property to slump but their greatest long term impact is on lenders and borrowers - counterparties to the mortgage contract. That could be significant but because of the nature of default, repossession and collateral realization that tends to be a drawn out process - property and property-related companies might be going out of business like there’s no tomorrow, but we’ve seen that before and survived.
Er, so what about debt then? Following the sub-prime crisis and following the much publicised recent problems with Bear Sterns hedge funds the entire debt market itself may be facing major systemic risk due to derivatives and fancy products based around debt. The conditions would be right:
* The ratings agencies convinced both parties that this was a win-win transaction and so both sides have bet hugely on this
* There exist assets which are probably seriously over-valued on a widespread rather than individual basis
* Conditions are conducive to exposing that systemic overvaluation very quickly indeed
Just to place this in context the USD37 billion shareholder equity in Goldman Sachs could be blown away almost overnight by the extent of their potential counterparty risk, as could the USD20 billion for Lehmans, as could the relevant figure for any major financial institution. Their risk systems have evaluated the risk of loss assuming that the credit worthiness of their exposure is what the rating agencies said it was on the label. Well it looks like they may have gotten it wrong.
Lots of times.
In a very big way.
We don’t know to what extent yet or which players will be the worst affected, but watch the debt markets closely. There could already be events in motion that may mean that the end of the (financial) world as we know it is nigh. This is unlikely but it is possible and it is very conceivable that there will be at least one major casualty.
This isn’t about recession or stock market crashes. This is about the entire financial system. At the moment it’s creaking under the strain which is why the central banks of some countries are already having to pump money into the system. I don’t know whether it will survive in its current form or not. But I do know that it’s in greater jeopardy now than at any other time. And I worry that if somehow it survives this crisis, instead of learning the lesson of “phew, that was a close one. Let’s not do that again” Wall Street will instead add the mantra “see, we survived that; we really are indestructible...” and next time will be even worse!

The above data and research was compiled from sources believed to be reliable. However, neither MBMG International Ltd nor its officers can accept any liability for any errors or omissions in the above article nor bear any responsibility for any losses achieved as a result of any actions taken or not taken as a consequence of reading the above article. For more information please contact Graham Macdonald on [email protected]@mbmg-international.com.com

Snap Shots: by Harry Flashman

Good photography made easier

Regular readers of this column will understand what I mean by ‘record shots’. These are simply photographs that anyone with any sort of camera, digital, film, SLR or throw-away compact, will get under certain circumstances. Take the picture of the Big Buddha in Pattaya, for example. A true case of f8 and be there, the photojournalist’s creed. Anyone who has ever walked up the steps to the top will get that photo. A ‘record shot’, recording what was there.
In an attempt to stop you making record shots and put something of yourself into your photography, I present this week’s column.
First off, try looking for a different viewpoint. Did you realize that the majority of photographs are taken in the landscape format from a point around 1.6 meters from the ground? That is because almost all cameras are designed to give you the landscape format, when held in the usual way; and the average photographer’s eyes are around 1.6 meters from the ground when standing up. So when you whip out the camera, stand there and shoot, you have just got the photograph of the Big Buddha that everyone else got as well. You can do better than that.
Before popping the shutter try sitting down on the ground and looking through the viewfinder. The proportions are changed, and so has the shot. Try walking round the side of the subject, in this case the Buddha statue, and look at the different shot you get there. By doing this, you are thinking about the final image you will get, and also you are putting part of yourself into your photography.
Again, when you look at the majority of photographs that people take, the sun is coming from over the right shoulder of the photographer, nicely illuminating the subject’s face (since most photographs are of people). Unfortunately, this makes the subject squint into the sun, not producing a nice look at all, especially not with the normal Asian eyes. The answer to all this is ‘contre jour’ photography, when you position the subject so that the sun is behind the subject, not in front. So why doesn’t the record photographer do this? Usually because he or she tried it before and got photographs where the face was so dark, the features could not be recognized. So here’s how to shoot contre jour, easily.
You have to give the camera some assistance, by working out the correct exposure for the face, and to do this, you do not need fancy equipment, hand-held light meters and the like. You just have to move in close, so that the subject’s face fills the frame and lock in the exposure settings. The vast majority of cameras have an ‘exposure lock’ facility, so use it. If it hasn’t, then turn your camera on to manual mode, note the settings and fix the shutter speed and aperture on them, and then go from there. Arrange your subject how you want and away you go. You will get contre jour shots, with halos around the hair and a correctly exposed face. Simple, and you have put some thought and effort into this shot too. And it will show in the final result.
By the way, you do not have to make contre jour just for people shots. It is an excellent technique for animals, as most have a ‘fuzz’ on their hides, which will show up very well. Try this at about 4 p.m., with the nice warm light before it begins to fade around sunset.
So this weekend, think about viewpoint - go high, low, side, and turn the camera into the portrait format as well as the standard landscape format. If you are shooting people, go for contre jour and practice that technique so that you can master it, and then use any time you want.
You will be taking better photographs, and doing it easily. Try it!

Modern Medicine: by Dr. Iain Corness, Consultant

The “ultimate” diet?

A few years ago I published a diet which apparently came from the Sacred Heart Memorial Hospital and is used in their cardiac care unit for overweight patients to lose weight prior to surgery. A friend brought it to my attention after he had lost 15 kg in two months!
He had done this by following the Sacred Heart diet - and this was one that had obviously worked! This is put forward as a seven day diet, and although I am not really in favor of ‘crash’ diets, this one does merit some study. Of course the big problem with crash diets is redundant skin hanging from the arms and the like, and the more than slight possibility that you put it all back on after the next two months!
However, here it is. It states the first no-no’s as being bread, alcohol, soft drinks, fried food or oil. Agree totally. Just by stopping alcohol, most people will immediately start to lose weight.
After that there is a concoction called Fat-Burning Soup (FBS) which you make up and keep in the fridge. You gobble FBS any time you feel hungry and have as much as you want. You are also advised to drink plenty of water – 6-8 glasses a day along with tea, coffee, skim milk, unsweetened juice or cranberry juice.
The physiology of hunger works that when the stomach is empty, messages are sent to the brain to send down food. Fill the belly with non-fattening food and the hunger pangs will be less, but the weight does not go on.
Here is the recipe for the Fat-Burning Soup:
4 cloves garlic
2 large cans crushed tomatoes (810gms)
2 large cans beef consommé
1 packet vegetable packet soup
1 bunch spring onions
1 bunch celery
2 cans French beans (or fresh)
2 green capsicum
1 kg carrots
10 cups water
Chop all veggies into small pieces. Boil rapidly for 10 minutes stirring well and then simmer until vegetables are tender. Add water if necessary to make a thinner soup.
Now the other downside to dieting if food boredom. A week of FBS, water and cranberry juice will sap the resolve of most overweight people, so what this diet does is allow you to add different items on a daily basis. Here are the suggestions.
Day 1, any fruit except bananas. Eat only soup and fruit today.
Day 2, all vegetables. Eat as much as you like of fresh, raw or canned vegetables. Try to eat green leafy vegetables. Stay away from dry beans, peas, and corn. Eat vegetables along with soup. At dinner reward yourself with a jacket potato and butter.
Day 3, eat all the soup, fruit and veggies you want today. Don’t have the jacket potato today. If you have not cheated you should have lost approx 3 kg.
Day 4, bananas and skim milk. Eat at least 3 large bananas and drink as much milk as you can today. Eat as much soup as you want. Bananas are high in calories and carbohydrates, as is the milk but you will need the potassium and carbohydrates today.
Day 5, beef and tomatoes. You may have 600 gm of beef or chicken (no skin) and as many as 6 tomatoes. Eat soup at least once.
Day 6, beef and vegetables. Eat to your hearts content of beef and veggies. You can even have 2-3 steaks (grilled) if you like with leafy green vegetables. No baked potato. Be sure to eat soup at least once.
Day 7, brown rice, vegetables, fruit juice. Be sure to eat well and eat as much soup as you can.
By the end of day 7, if you have not cheated, you should have lost 7 kg. The theory is good, but I caution against losing too much, too soon.
Let me know how you go!

Learn to Live to Learn: with Andrew Watson

More and More Talking Heads

For the last in this mini-series, I return to a favourite topic of mine; pragmatism or idealism? I found the responses of the five Heads fascinating. They digressed and diversified, answered some questions and asked many more.
Pragmatism or idealism?
Head 1 appreciated that it is impossible to “do everything at once”, but with a prioritisation plan, at least everybody would have an idea of when certain things were going to happen. He spoke of embracing a principle which he described as “dynamic stability”, which he felt was a nice paradox. He felt that people want both to feel that they’re moving forward, but also that they don’t want to feel that they are ‘rudderless’.
Head 2 said that one of his biggest challenges is not becoming a bureaucratic administrator (which he aligned with pragmatism) and to continue to focus his position on service to his teachers who provide the optimum education for students (which represented idealism). He recognised the need to have good process and procedures in place, the “things they need to do their job,” but he also suggested that it was important not to blindly follow polices. It is possible to decide what to do, he suggested, if you always focus on whether any decision is going to be beneficial to the students, which is to say, if you keep your idealism at the heart of what you do.
Acknowledging a close relationship between pragmatism and ideology, Head 2 suggested that it was not possible to achieve ideals unless they are pursued in a pragmatic fashion. For example, declaring to students that ‘We are going to have responsible global vision’ requires teaching students the steps that reach this point. Similarly, referring to the learner profile, he argued that it was not sufficient to simply say, “We want kids to be thinkers” and not teach them how to think. Head 2 spoke of the need to be proactive in providing actual mini summative assessments to students that explicitly teach them where they are “right” and where they are “wrong”. He reinforced this point by saying that he had to be able to see the evidence of learning, in whatever form that took.
Head 3 suggested that one of the reasons that the IB is so popular is because in his view, most educators are idealistic insofar as they want to see the world improve as a result of their efforts. Dealing with the matter of finance and the costs in implementing or managing an IBO programme, it was Head 3’s view that it was not simply a matter of finance but that there were hidden values to be taken into consideration. Nonetheless, without proper financing, in his view, an IB programme would not “take off” even if the school believes in the programme and the ideology. However, it depends on the type of school. If it is a privately owned school, then a proprietorial owner might decide to supply the funding because he considers that the programme is going to bring in the most students and provide him with the quickest possible return on his investment, inferring that a proprietorial owner of privately owned school necessarily considers education from a profit based market oriented paradigm. Alternatively, he suggested that if it is a foundation and parent-owned school, it could be that they decide that “IB” is the best way to guarantee that their sons and daughters can access universities without having to go through any other tests.
To a question related to whether parents share the school’s sense of mission, Head 1 responded that in his view, parents are not necessarily driven by the mission in the way that a leader might be. At the very least, he suggested, the mission has to be “acceptable” to them. He pointed out that in his experience, parents choose one school over another because they do not like the direction of a particular mission or the way in which a school operates. He pointed out possible detrimental consequences of disharmony when the school is pulling itself in different directions. When this happens, he said, children’s learning suffers and the parents quickly become aware that something is wrong, although their analysis, he suggested, is necessarily more amorphous than internal school analysis.
When pressed on whether he truly believed that teachers are idealistic, Head 3 replied that he did and that for him, this was certainly true. He made it clear that he believed in multiculturalism, although he did not define what this term meant. He described his home country, Australia, as a multicultural society. He equated “multiculturalism” with “internationalism” and identified the presence of both in schools by large numbers of different nationalities and cultures of children and staff. Head 3 considered that a necessary condition of being a leader or manager in an international school is to embrace the idea of multiculturalism and internationalism. He was happy to embrace idealism as the foundation of his teaching philosophy, saying that; “True internationalism and the more we know about one another and can understand about one another, the closer we will be to solving the world’s problems, whatever they might be, particularly the violent aspects.”
Head 3 agreed that his own idealism mirrored that of the IBO mission statement. However, it was put to him that many staff in school might not share his commitment to it. In which case, considering the ease with which ‘A’ levels (as an alternative to IB) could be taken up in a school, Head 3 was asked why a school should bother with IB at all? Head 3 maintained that there were several reasons and started by giving a very ideologically based response. Without defining his terms, it was Head 3’s view that “Terrorist leaders come from education”. Rather interestingly, in light of his apparent devotion to the IBO mission statement and the phrase therein that, “Other people with their differences can also be right” he expressed a clear view that “terrorists” are educated “in the wrong way”. He then made reference to how in his view, “terrorists” are educated “with blinkers” towards a particular interpretation of the Koran, inferring that all terrorists are Muslim. He returned to a more theoretical and idealistically based view when he suggested that, “If it [terrorism] results from education, then it’s a pretty good place to start in fighting it or tackling it.”
Andrew Watson is a Management consultant for Garden International Schools in Thailand. andreww@garden rayong.com
All proceeds from this column are donated to the Esther Benjamins Trust. www.ebtrust.org.uk email: [email protected]
Next week: The Esther Benjamins Trust