George M. Mangion | Wednesday, 14 January 2009

Fuzzy money

The news that another mega scandal perpetrated by Bernard Madoff has hit the headlines rarely sounds auspicious now that for the past weeks we have had nothing but opprobrium in financial press. Many who have been viewing broadcasts by foreign networks have become immune to bad news. They have been inundated with horror stories of how the financial behemoths have fallen into disgrace. Last year saw the advent of the sub-prime banking debacle and with it the ushering of the deepest economic recession in US since the great depression of the 1930s. This is coupled with higher unemployment and a steep fall in interest rates, matched with a universal drop in the property market that last bastion behind which investors usually scurry for shelter in troubled times. One need not mention the property collapse in Ireland, Spain and Portugal to reflect upon the perceived trend in relentless slide of property prices. It goes without saying that the property and construction boom of the last decade is over and now we are witnessing a severe correction in values of commercial and residential real estate. Realtors tend to wait for the storm to pass and foolishly pride themselves that the bad news will pass quickly boasting they are the only ones sitting on real estate located in the premium sites. They hope banks will bale them out asserting that location is king in all times and their assets are Teflon coated in times of recession. But so did the mortgage barons such as Fanny Mae and Freddie Mac in America and they went bust, cap in hand pleading for bailouts to the US taxpayer.
Banks such as Lehman Brothers who up to six months ago carried the Rolls Royce badge of the banking elite also licked the dust of bankruptcy procedures. Confidence has morphed into thin air. Once banks start refraining from lending to each other then this is when serious trouble ensues. Back to Malta, one hails the strict regulation of banks which so far has saved us the misery of unpaid depositors. Yet the financial virus that is eroding business in Europe cannot be swept under the carpet and sooner rather then later recession will start to bite. Already the construction industry is sending smoke signals showing its distress on lack of work.
Are we feeling the early stages of the malady that is now festering in other European cities? The answer seems to be blowing in the wind when one contemplates how much debt has been piled on by local banks on the property and construction sector. Their exposure is legendary particularly on larger projects which tend to seek their attention. But is this not a repetition of the greed associated with the juicy profits reaped by US banks from the sub-prime business which has triggered off the demise so much so that a specific fund has been allocated out of taxpayers money to weed out toxic debts. Reverting back to the $50 billion fraud by Madoff, it appears that commentators are so familiarised to the fracas in financial markets that it came to us as no big deal. Yet, sadly banks and investment funds across the world lined up last month to admit investing billions of dollars in the companies of Bernard Madoff, whom US authorities accused of masterminding a massive fraud. None of the flamboyant names in the banking hierarchy were spared. Europe’s biggest bank, HSBC, joined a list of top names in world finance admitting huge potential losses in a suspected pyramid fraud scam run by ex-Wall street impresario Madoff .
Britain’s HSBC Holdings Plc is alleged to be the latest bank to join the growing list, saying it had exposure of around $1 billion, making it one of the biggest victims of the alleged fraud. Last month it stated that its exposure to the alleged fraud, concerned custody clients who had invested with Madoff. In another case , it was reported that a Swiss private bank Hyposwiss has said some of its clients were directly touched by the Madoff scandal through investments. It comes as no surprise that the scam was widely spread since the Luxembourg financial watchdog had opened an investigation into funds that had assets deposited with Madoff to establish the responsibility of all parties involved, including those of depositary banks.
But beware… There were many victims such as Spain’s leading bank Santander.
Shares in Santander, the second-largest in Europe after HSBC, plunged after the lender said it had an exposure of more than €2.3 billion ( $US3 billion ) to Madoff Investment Securities in New York. He is alleged by US prosecutors to have confessed to defrauding investors of €38.5 billion ($US50 billion ) in a long-running scam that collapsed after clients asked for their money back as a result of the global financial crisis. It is not known how much of the scam affected Maltese investors but one cannot but stop to ponder if top banks and highly placed investment advisors fell for Madoff ‘s charms it is not inconceivable that Maltese investors were lured to part with their cash. The competitive coupon rate on offer is always attractive. It will not be the first and the last financial scam that local investors were unavoidably lured into. The Argentina collapse left many bond holders licking their wounds after into unsecured and non guaranteed exotic instruments defaulted.
It forms part of the frailty of human nature to gamble with money in high risk securities in the hope of superior returns. Some are wise and cash in while the going is good but most will be tempted to stick on to their investment waiting for better times in hope that the upturn will be around the next corner. Inevitably it is always too late.
Similarly, the investment of millions in unsecured bonds in Malta has always been popular and well received in the national press. In the absence of a local credit rating agency, the local investor had to be guided by the detailed prospectus and the professional guidance of independent investment advisers who are licensed under Investment Services Act. This type of external financing has opened the route for a cheaper source of much needed capital for companies who would otherwise have to tie up massive assets secured in special and general hypothecs if they reverted to retail bank borrowing.
To conclude one never doubts the force of attraction that bonds with a high coupon rate will end up being over-subscribed as has been the norm in the past. It is a consolation that investors are better informed than before not to rush in where angels fear to thread and are more risk averse having read the Madoff scary stories that have hit the headlines in the international markets.

George Mangion
Partner at PKF – an audit and business advisory firm



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14 January 2009

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