Posts Tagged ‘NAB’

How well informed is NAB’s CEO, John Stewart?

Monday, July 28th, 2008

On Sunday’s Inside Business interview with NAB’s CEO, John Stewart (regarding the recent write-down of $1.2 billion US home loans securities), there were some things he said that made us wonder how much he understands:

Taking those one at a time, I mean the rating agencies clearly are under pressure but in their defence, they couldn’t have foreseen the meltdown that’s gone on in the United States housing market.

Well, “couldn’t have foreseen” is a very common excuse. As we said before in An example of how the sub-prime contagion may spread, economists from the Austrian School already had strong reservations about the Housing Economy as early as 2004! Very long time readers of this publication would already know that we first voiced out our reservations in October 2006 in The Bubble Economy.

Next, John Steward said:

Well the answer to that really is that the only error NAB made was investing in Triple-A securities which have a one in 10,000 chance of defaulting…

Basically, what he is saying is that NAB was extremely unlucky, which it implies that it is none of their fault that this should happen. But as we said in How the folks in the finance/economics industry became turkeys?Part 2: The Bell curve, that great intellectual fraud,

The problem with mainstream thinking in today?s finance and economics industry is that the Bell curve is their cornerstone assumption. In other words, the Bell curve assumption is used extensively to model reality and derive conclusions and forecasts.

Unfortunately, the model of reality is completely incorrect. As such, nonsense such as the ones said by John Stewart get repeatedly perpetuated on TV. As we quoted Nassim Nicholas Taleb in How the folks in the finance/economics industry became turkeys?Part 2: The Bell curve, that great intellectual fraud,

If the world of finance were Gaussian [Bell curve], an episode such as the [1987] crash (more than twenty standard deviations) would take place every several billion lifetimes of the universe.

Given the fact that so many of such Triple-A securities in the US had already blown up, it is simply too ridiculous for anyone to believe that each of the blow-ups is a one in ten thousand year event.

The question is, why are such Triple-A securities given such high ratings when clearly, they are junk? To answer this question, we will refer you to our earlier article, Collateral Debt Obligation?turning rotten meat into delicious beef steak, to understand how CDOs work. Basically, through some ‘brilliant’ financial innovation that utilises complex mathematical models, junk bonds get re-engineered into AAA bonds. Unfortunately, there is a major flaw in those mathematical models. As this article from Platinum Asset Management said,

In particular lower rated tranches of mortgage securitisations (say BBB rated tranches) were pooled. The first cash flow on these tranches was sold as a AAA-security – the argument being that it was improbable that most of the BBB securities would default. This would be true provided that the BBB pools are themselves not highly correlated. If they prove to be highly correlated (as appears to be happening in the subprime mortgage area) then just three BBB tranches defaulting would indicate it was likely that a majority would default. Then the seemingly safe AAA paper might actually be quite risky.

If you do not fully understand what we mean, do not worry about it. The complex maths behind these toxic derivatives are meant to be un-decipherable to mere mortals and we do not pretend to understand all of them ourselves. But this fundamental fact remains: these models are convoluted and wrong. For this reason, perhaps we cannot blame John Stewart for having stuff up because he (and by extension, NAB) is probably being suckered by the dazzling world of derivatives.

Personally, we do not think John Stewart is deliberately being deceptive. Rather, we believe it is more likely that he (by extension, NAB) are simply not well-informed enough. In other words, NAB do not know what is going on. The same probably goes for the other banks too.

How safe are Australian banks?

Wednesday, July 23rd, 2008

There are widespread beliefs that the Australian banking system is safer and more conservative than their overseas counterparts. Thus, it is generally assumed that the sub-prime and credit crunch problems that affected the US will not happen in Australia. But is this a reasonable assumption?

First, as we showed in Australia has no sub-prime debt? Think again!, there are real-life examples of dodgy lending by Australian banks. The question is, how widespread is such lending? Are these examples of dodgy lending indications of a systemic problem? In any case, it is obvious that it is not in the banks’ best interest to be forthright about their dubious lending practices. Perhaps you may want to do your own scuttlebutt research on this. If you have any stories about dodgy lending practices or dodgy borrowing, please feel free to share them in the comments section below.

Next, our suspicion is that Australian banks are severely underestimating their vulnerability. As Brian Johnson, a banking analyst from JP Morgan was quoted in Banks to feel more pain: analysts,

Mr Johnson believes that Australia’s banks are failing to envisage the possibility of a loan-loss cycle where asset prices [such as housing] fall, and banks struggle to recover loans from defaulters and forced sales.

Mr Johnson said Australian banks are actually more vulnerable to the credit crunch than many of their global counterparts because of their high levels of gearing, or loan to capital ratios.

We’re talking banks geared 25-30 times, whereas the global peers may be geared 15-20 times… even a moderate loan-loss cycle creates negative earnings,” he said.

As we said before in Aussie household debt not as bad as it seems?,

A severe downturn to the Australian economy may or may not be statistically likely, but given the level of unprecedented leverage, you can be sure the impact will not be small. Be sure to understand the concept of Black Swans (see Failure to understand Black Swan leads to fallacious thinking).

In addition, the Australian banking system has a vulnerability not shared with other countries. As this news article, Fast rise of round robin lenders, reported,

The Reserve Bank of Australia has a dark worry about our banks: they get 90 per cent of their cash from each other. If one bank gets into trouble, the Australian financial system could be snap-frozen overnight.

We will give a highly simplified analogy of this problem. Imagine an economy of 3 people: Tom, Dick and Harry. Tom owes Dick $1000, Dick owes Harry $1000 and Harry owes Tom $1000. Each of them will have a balance sheet that looks something like this:

Asset: $1000
Liabilities: $1000

For each one of them, what they owe are their liabilities and what they are owed are their assets. Let’s say, for whatever reasons, Tom is unable to honour his debt repayment to Dick. In that case, Dick’s asset will go bad. As a┬áresult, he is unable to honour his debt repayment to Harry. This in turn caused Harry’s asset to go bad, which affected his ability to repay his debts to Tom. Therefore, one person’s debt problem becomes a contagion that spreads to everyone else.

In a similar way, this is the current vulnerability of the Australian banking system. It is unique to Australia because of the shortage of government debt that could be used as bank assets and collaterals, thanks to the previous government’s budget surplus. We suggest that you read our earlier article, Banking for dummies for more details about bank balance sheets.

Of course, though it may be possible that such things may happen, it does not necessarily mean that it will happen. It’s the job of the RBA and APRA to prepare the drills in anticipation of this worst case scenario. But should it happen, what can be the possible triggers? For the answer to this question, one news article, ANZ is the big local bank most at risk, caught our eye:

ANZ Bank has been singled out ahead of other big Australian banks as most at risk of further material provisions because of its long credit default swap positions, potentially running to $2.4 billion, based on international comparisons.

National Australia Bank is not far behind in the structured credit risk stakes.

As we highlighted before in How the CDS global financial time-bomb may explode?, Australia is not going to escape unscathed when this potential disaster strikes.

In view of all these, perhaps there is little wonder that, as Fast rise of round robin lenders reported,

At a recent conference held by one of the world’s largest banks, the Australian banking system was identified as one of the best investment opportunities, for going short.