There was never much doubt that George Osborne would want to do something for first-time buyers struggling to get onto the housing ladder in the Spring 2011 budget.

His response – a new FirstBuy scheme that will provide a £250 million fund to help first-time buyers get on the housing ladder, via a shared equity arrangement in new-build property. It will be jointly funded by the housebuilders.

Osborne claims FirstBuy will help 10,000 first-time buyers, which is non-trivial in a market where only 43,000 or so mortgages were approved in February 2011 – way down from the 80,000 or so that was previously seen as required for stability in the housing market.

Yet in reality the £250 million FirstBuy fund is likely to prove a drop in the ocean compared to the total size of the mortgage market, which in January and February of 2011 was running at around £9.5 billion in mortgage loans advanced a month.

Who wins from FirstBuy?

Certainly, the government. In fact, it’s a double win from a politician’s perspective.

• Firstly, Osborne is being seen to support struggling first-time buyers, which goes down well with voters.

• Secondly, FirstBuy also helps prop up the wobbly housing market, which the authorities have decided – rightly or wrongly – that they can’t afford to let find its own level.

• Finally, anyone looking to sell a house or move up the ladder needs a healthy market with decent turnover (including a bottom level influx of first-time buyers or buy-to-let landlords). Existing homeowners may benefit if FirstBuy keeps the overall market moving, though the programme itself only applies to new build homes.

Sure enough, the chancellor has since gone further with his Help To Buy scheme in the 2013 Budget.

But whether first-time buyers and others benefit from being used as cannon fodder in the fight against a house price crash remains to be seen.

It’s true that first-time buyers have struggled to get a mortgage at all, due to the banks’ suddenly stingy requirements for a high deposit in the wake of the credit crisis. This inability to get a mortgage has meant that first-time buyers have ironically been denied access to the only thing making homes affordable despite the elevated level of prices versus average earnings and rents – that is, historically very low mortgage rates.

So superficially the FirstBuy scheme may seem attractive, and it doubtless will be to anyone desperate for a house who feels locked out of the market.

But I can’t help thinking first-time buyers would be better served by house prices falling the 20% or so that would seem a minimum to bring them back to their long term averages. It’s no coincidence that the FirstBuy programme is being jointly funded by housebuilders, who’ve been running their own increasingly inventive schemes for the past 18 months or so.

True, nobody who sees what the true house price crash in the US has done to that economy could be sanguine about the impact of lower prices more in line with long-term ratios here.

Yet the frightening thing is our bubble was far bigger than the American house price bubble. And there will be a price to be paid by some segment of society the longer we continue to puff it up. Rather unfairly, given they didn’t benefit from the boom, it’s surely the first-time buyers who are paying it.

Also, if you were a housebuilder, would you be thinking of increasing or reducing asking prices on your new developments in the wake of this announcement of lots of government cash coming your way?

Exactly.

Some good weekend reads from around the web.

There are many reasons to be a passive investor rather than trying to pick stocks or funds to beat the market: It’s cheaper, you’ll probably do better anyway, and it takes a lot less time than reading company reports or hunting for the next Warren Buffett.

A less frequently touted advantage is that passive investing saves you from having to make uncomfortable choices.

Regular readers will know that I actively manage a portion of my net worth, for my sins, despite suggesting most readers should follow the passive approach. And this past week brought out the best and the worst emotions in active investing.

The main reason I choose to actively invest some of my money is the most honest, but also the least edifying – it’s fun.

For example, for 12 months or so now I’ve been selling down shares a bit when the market has got ahead of itself, and loading up on companies I like when it dips. Unfortunately I only got my portfolio back up to about 10% cash and fixed interest (and only bank preference shares at that) before the recent wobble, which has limited my warchest for hunting bargains in a market I still judge decent value.

I only have a vague idea of how far my meddling has put me ahead of simply sitting in the market – and I have absolutely no idea if the outperformance is down to dumb luck. Ask me again in 30 years!

But I do know for sure that it is generally enjoyable.

That kind of attitude quite rightly enrages my co-blogger The Accumulator, but at least I’m honest about it. (It’s one reason why I first asked him to blog here).

Difficult choices

Taking advantage of the fear and greed of the public schoolboy traders in Canary Wharf is one thing, however. But looking at the market in the wake of a natural disaster, potential nuclear contamination, and heartbreaking loss of human life isn’t my idea of a rollicking good time.

Having previously read in some detail about the horrible human sacrifice at Chernobyl, my heart aches to think of the core 50 workers at Japan’s stricken Fukushima nuclear plant. They are likely committing themselves to a horrible lingering death in their efforts to get the situation under control. And while they are doing it for their country, it’s their bosses and shareholders in TEPCO who are most geared to their success, as well as investors and management in nuclear facilities across the globe.

As one who fears environmental meltdown on a global scale, nuclear power is an extremely difficult issue for me to make my mind up about. But I don’t need to think hard to feel awful for those workers – nor to wonder exactly what would happen if there was a similar nuclear accident in the UK or the US, rather than in a country with a strong tradition of personal self-sacrifice like Japan, or a long tradition of using troops as cannon fodder like Russia.

And what about as an investor? Here we get to the awkward moral issues.

If you’re a passive investor, you can sit through all this and look disdainfully at those who’d “try to make a buck” out of human misery. But if you’re an active investor, you can’t afford to leave crisis investing out of your strategy grab bag.

In both cases money will remain in the markets – and indeed in both cases returns will follow the decisions of active investors – but the active investor is the one who will be staring into the mirror in the morning, or washing her hands over and over in the bathroom after clicking ‘buy’.

Intellectually, I don’t believe economies benefit from the breakdown in orderly markets. Quite the opposite in fact. Japan would be in a stronger position if its market hadn’t tanked nearly 20% in a week in the wake of the magnitude 9.0 earthquake and its repercussions. In that sense, anyone buying into their cheap-looking market is doing them a favor.

Equally, I can see why that sounds like self-justification from someone who knows, for example, that an investor who bought into war-ravaged Germany in 1948 saw a 4,000% return over the following decade, whereas an investor who bought the UK’s FTSE 100 at the end of the happy-clappy 1990s is still looking at an index that’s lower 11 years on.

The case for investing in nuclear-related plays – some uranium miners have dived 30% or more – is even more fraught, with enough moral murkiness to propel along a Michael Frayn play.

I can’t tell you what to do. I can’t tell you how to sleep at night.

[continue reading…]

Not many finance books read like a thriller. Yet The Big Short, Michael Lewis’ account of the US sub-prime mortgage implosion – the trigger for the credit crunch – contains enough conspiracy, paranoia, and intrigue to keep you up at night, wondering why the perpetrators aren’t in jail.

Penetrating the black heart of Wall Street, Lewis portrays an unholy cabal of mortgage lenders, big banks, rating agencies and money managers that almost destroyed the world’s financial system.

They played a trillion dollar game of pass-the-parcel with sticks of dynamite marked Collateralised Debt Obligations (CDOs). Each player took their cut of the profits and bet that they could offload the incendiaries onto someone else before it all blew up.

Looming disaster

The story of The Big Short unfolds as a tale of outsiders (a misfit group of hedge fund managers) who come to realise the game is rigged to explode.

They fight the system the hedge fund manger way – not by taking out the bad guys, but by shorting them. It’s a giant bet that stands to make them rich but which they come to see as a bet against the entire financial system and ultimately society itself.

Just like Titanic, the story isn’t spoiled by knowing the ending, because The Big Short is really about how it all began. Uncovering the origins of the disaster that ended in the massive destruction of wealth, huge job losses, and colossal debts that we’re burdened with now.

How they got away with it

This book takes you into the black box and reveals the inner workings of CDOs and credit default swaps in language a mere mortal can understand.

Yet Lewis’ finest achievement is to humanise the event. He transforms it from an unstoppable chain reaction of market forces into a more comprehensible study of human immorality and greed.

And that’s when you become angry at Wall Street. When you realise how obscene, avoidable and unjust the credit crunch and its consequences were.

The perpetrators of the crisis became very rich. They banked fat profits while ignoring the tottering pile of risk that was building. And when it all came crashing down, the billions in losses had to be absorbed by using the livelihoods of ordinary people as crash bags.

But there’s no point getting mad, our only duty is to get even. And that means learning the lessons The Big Short has to teach us about the people at the heart of the financial system.

Lesson one: Trust no-one

According to Michael Lewis, the Wall Street banks tricked the rating agencies into approving assets that should have been slapped with a health warning. The rating agencies played dumb because they were scared of losing business from the banks. In other words, conflicts of interest are rife.

Few financial players will prioritise the interests of the small investor. As The Governor of the Bank of England Mervyn King has remarked, many in financial services believe:

If it’s possible to make money out of gullible or unsuspecting customers, that’s perfectly acceptable.

It’s buyer beware out there. Stay sceptical about everything and everyone.

Lesson Two: Know thy enemy

The smart advice is to avoid stock picking if you’re a private investor. While you might do weights once in a while, you’re walking into a bar-fight with the financial SAS. Your opponents’ access to data and computing power is the equivalent of pitting a chain-gun and airstrikes against your flick-knife. Let’s just say, you’re hoping for a lucky shot.

But it’s all easy to ignore that advice. We never look our investing opponents in the eyes. How hard can they be? Lewis puts together a compelling photo-fit of the ruthless, immoral, workholic hombres you’re up against.

Investing is a zero sum game. We lose, they win. So tread warily. Better still, don’t play the game – invest in index trackers.

Lesson Three: No one cares about you, except you

The list of the culpable in The Big Short is shocking. Wall Street’s greed may not be so surprising but the lack of due diligence by pension funds certainly is.

Many didn’t properly vet the sub-prime assets they bought into. They also hired asset managers who scooped up piles of toxic CDOs because they were paid according to the scale of Assets Under Management, not by quality of results.

In a world where everybody is out for number one, the only way to protect yourself is to do it yourself.

Lesson Four: Understand what you’re buying

People were making a killing from sub-prime before the crisis hit. Bond traders, banks, insurance companies, hedge funds and pension funds all piled in for a piece of the action.

Most had no idea what they were really buying and how dangerous it was. That’s why so many lost billions when the market turned against them.

If you don’t understand an investment then run a mile. If it seems willfully confusing then that’s almost certainly because it contains some unpleasant side-effect that the seller would prefer you not to know about.

It’s easy for small investors to ignore the warning signals. Many don’t bother to unravel complexity or just think they’re being slow on the uptake. We assume protection that doesn’t exist. An investment is probably okay, or else why would it be allowed?

The industrial-scale concealment and blundering witnessed in The Big Short puts paid to that kind of innocent thinking.

Lesson Five: It’s hard to swim against the tide

The handful of hedge-fund managers who bet against the sub-prime market set themselves up for life. But they had to endure years of doubt and ridicule from the mainstream before their bet paid off. They looked like prize chumps when everyone else was riding the sub-prime rocket ship to the stars.

It’s hard not to get swept along when everyone else is charging in the same direction. Ultimately, the heroes of The Big Short show that winning is about setting your own course and then having the mental courage to believe in yourself.

Take it steady,

The Accumulator