The Different Types of "Bank Run" and why the Greek Situation is Unique

Police guarding the National Bank of Greece

Amid Greece's current high-profile debt crisis, there has been a slow bank run picking up pace in the country. This occurs where the depositor's start to take their cash out of the bank, in the fear that the bank will become insolvent and lose the depositor's hard earned cash. 

Bank runs are often talked about in the media as if all of them are catastrophic for the banking industry, and will most likely cause default by the incumbent bank and potentially causing contagion across all other banks in the country. 

However a bank run is normally overstated and in most cases do not cause any banks to go insolvent. This is due to the different types of bank run: 

When depositors start to withdraw cash from a particular bank that they believe is going under, the depositor can do 3 things: 



1) They can put the cash back into a different bank in the country (For example taking money from Barclays and putting it into Santander).This is known as direct redeposit. 

2) If they don't deem any of the banks safe, they could potentially take their cash out of the banks and buy government bonds (Lending money to the government). This is known as a "Flock to quality" and reduces any risks of the cash disappearing as a government is unlikely to default. 

3) Stuff it under the mattress / change it to other currency (Typically Dollars) 



In a typical bank run, the bank that has experienced the run will be solvent, and the bank run is more caused by scaremonger or media pressure and the bank is actually fully functioning. In this case, the other banks in the country that have received the funds taken out of the incumbent bank will likely make short term loans to the bank and this will increase their liquidity and allow them to run normally until the negative press has cleared.
This is known as "recycling money/direct redeposit"

However if the bank/banks are not solvent, like the bank run on Northern Rock at the height of the financial crisis, then it is very unlikely that other banks in the country will make short term loans and they will likely become insolvent and close. 

If point 2 occurs and the banking industry is seen to be safe despite the run, then the people that sold the government bonds in the secondary market, will take this cash and put it in the bank. This is known as "indirect redeposit" 

If 3 occurs, you have a big problem. Especially if the run is on all the banks in the country. This is what happened in Cyprus in 2012/2013 and this will usually lead to the government putting capital controls on the country. This allows only a certain amount of money to taken out of the banks and small amount of money to be changed up for other currencies. 

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What is different in the UK? 

The difference with the UK and many developed economies around the world with a solvent Government, is that they will guarantee savings by its population. In the UK it is up to £85,000 for single accounts or double if they are joint accounts. 

What this does is when a bank is in the media with potential liquidity problems but is still deemed to be solvent by experts, it prevents the population from being scared and running to the bank to take all their money. As they know that in the rare chance that the bank does close it's doors, the government will cover the cash that was lost by the bank. 

These regulations came in after the Northern Rock bank run (Even though they were an insolvent business) 

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Why the Greek bank run is so very different:

The Greek situation is much more serious than a typical bank run. Normally bank runs are due to specific problems with a particular bank or even fears over the industry and in many cases is covered by the government. However with Greece, there is a triple effect and three main reasons why the population want their money out of the banks. 

1) They have the typical scaremonger about the banking industry as a whole collapsing so want their money out.

2) Their Government is insolvent. This is completely unique to many other runs and they have absolutely no security that the Government could bail out the banks and save the depositor's money as they cannot pay off their own debt and are likely to default on their own debts by years end. This also stops money being taken out and exchanged for government bonds.

3) They are scared that should Greece leave the Euro, they would see a return of the Drachma (Greece's old currency). This is a problem as the population hold their wealth in Euros, and should they return, it is more than likely that the currency will devalue by up to 50%, which could potentially half the wealth of every individual overnight.

Therefore they are looking to take their money out of the bank and change it up for a safer currency like Dollars. 

Should the country default, you could see a horrible situation whereby the country take its cash out of the banks, change it for dollars and have an insolvent Government which defaults on its debts and insolvent banks which can't pay off its debts that are now more expensive (due to it's debts being in euros). This would therefore be a case for capital controls which would see the population lose a substantial proportion of it's wealth. 

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Conclusion: Typically you can see that your average bank run is nothing to worry about as it could see savers not losing a penny and in most cases the bank continuing to operate through the mechanism of direct or indirect redeposit. 

However in a severe case like Greece, things could be disastrous and this is the poster boy example for why the media and the population are so scared about bank runs!

‘Modern Portfolio Theory’, The Biggest Con Since Enron.

I am a current CASS Business school student second year studying ‘Investment and Financial Risk Management’ who recently has undertaken a module called ‘Portfolio Theory and Investment Valuation’. At first, I was excited, a module which will help towards my goal of managing a portfolio of stocks with a long-term investing thesis. Having read many investing books from legends such as Peter Lynch, Warren Buffet and Benjamin Graham, I was excited to delve further into the concepts I have learned about and seek to get a good grade in my coursework and examination.

I was shocked when I walked into the class and was being taught how to devise a portfolio solely on past price data. Using statistical concepts such as standard deviation, beta and correlation to decide whether I should invest my wealth into a business operation.

For some background knowledge, my thesis on stock investing is based upon some core principals set out by the world’s greatest investors. You are buying a portion of a business, so you should invest based on the quality of a business model, the integrity of the management and their position within their market place. You should seek stocks for your portfolio as if you are a business analyst, as whilst stocks in the short term, they may not correlate to the quality of the business and its earnings, in the long-run, there is 100% correlation.

MPT took a drastically different view to the top investors of our time. They seek a portfolio based on past price data of stocks having little correlation with each other, having a small standard deviation (small changes in the stock price relative to the stock market), and having a beta relative to your specific risk preferences.

MPT takes a science approach to the stock market. It believes in an efficient market, whereby all available information is related to the stock market prices. Basically saying that you don’t need to understand a single business principle to become a market wizard. In Lehman’s terms, if you are of high mathematical competence and have no prior business knowledge or experience, you can decide which business’ will do better than others. Something which is clearly wrong.

Here are some horrifying assumptions that MPT makes.

   - Asset returns are normally distributed random variables

   - Correlations between assets are fixed and constant forever

   - All investors aim to maximize economic utility (in other words, to make as much money as possible, regardless of any other considerations)

  - All investors are rational and risk-averse

   - All investors have access to the same information at the same time

   - Investors have an accurate conception of possible returns

   - There are no taxes or transaction costs

   - All investors are price takers, i.e., their actions do not influence prices

   - Any investor can lend and borrow an unlimited amount at the risk free rate of interest

The first is a biggy. Appreciation in the valuation of a business operation, is a random statistic which is normally distributed. I find it hard to even explain why this is wrong, as it is so very clearly stupid. In this thesis, no matter what top business managers do, they could never escape from the random chaos of their stock price and the stock variance. This assumption also suggests that great investors such as John Templeton and Peter Lynch are statistical anomalies and that despite their hard analysis of the quality of management and business model, they became the rich by calling heads on a coin toss more times than any other portfolio manager.

Another big problem I have with MPT is beta. For anyone that hasn’t heard of this before, I will try to explain it in simple terms (Rather than the Greek letter jargon that business school professors love).
Beta is a single figure placed on a business’ head, that tells the investor how risky the business is. It calculates this figure by assessing the movements of the business’ stock price in comparison to the stock market as a whole. If it moves more than the market, it is more risky, less and its less risky. Now this is a ridiculous way to measure risk, for two main reasons:

   1) Beta changes huge amounts over a period of time. If a great business like apple was assessed 20 years ago, it would have a specific beta based on historical data. Since then, it has completely outperformed the market due to great innovation and exponentially growing revenues. However due to this increased stock movement, beta will now be larger. Labelling Apple now as a more risky business, because it has performed better than its peers and gained greater market position.

   2) Should a business’ stock price irrationally move down with no change in the business fundamentals. This will increase the stocks’ standard deviation, labelling it as more risky which in turn means you should look to stay away from the stock. Therefore suggesting that it would have been okay to buy the stock when it was valued higher because of the low standard deviation, but is now too risky since the price has fallen and is now much cheaper. Buffet would have the completely opposite opinion. He would be buying at the depressed stock priced as opposed to the higher price.

To quote Warren Buffett:

 “A stock that has dropped very sharply compared to the market, becomes ‘riskier’ at the lower price than it was at the higher price, that is how beta measures risk.”

Here is an illustration of the research you should entail when devising a portfolio: 

Ultimately I believe people looking to invest in the stock market, should look at his/her investments as portions of a business. They should look to invest in companies that they have knowledge about specifically and stick to what the know. They should also ignore short term prices as they do not reflect business performance, if they have good reason to believe that a business is going to perform in the long term and then the share price falls, they should look to buy some more. They should look for integrity in managers and also in their economic moat.

This scientific rip off formula for investing in the stock market will never make you rich in the long term and I will eat my words if in 50 years’ time I am recommending young wannabe investors, to read a book about an investing legend that used the MPT thesis.

A fundamental principle that the teachers of MPT missed out is that it is better to be approximately right than precisely wrong.

So here is my plea that business schools, including CASS Business School should stop teaching this finance dogma and teach us more about business fundamentals, sound analysis and forget the Greek alphabet.  

Introduction To Financial Markets: Currencies

Welcome to part two of my series. 

Today we will be looking briefly at the determinants of foreign exchange markets and the economics behind them. 

Currencies are all about how much demand there is for a currency (And supply if there is an increase in the money supply through QE).The main determinant that moves the currency markets is interest rates.

 If interest rates increase in country A it makes it more attractive to invest money in that country A due to a higher interest rate on the money invested, therefore global investors must buy currency in country A to benefit, this lifts the price of currency A due to the extra demand.

Additionally if interest rates are rising in a country, this indicates that this country is experiencing economic growth which attracts foreign investment in domestic equities and other investment avenues – all of which require the local currency (raising the price).

Investors must look for economic indicators that may indicate a rise in the interest rate such as inflation, unemployment and GDP figures. If investors can predict potential changes in the interest rate they can profit from the appreciation of the currency compared to another.

Technical analysis is also inherent in the FX market due to the inherent slow moving pace along with the $2tn of liquidity provided every day. Technical levels such as supports, resistances, moving averages and Fibonacci retracements are all indicators that will move the market in the short term. Also there are many opportunities for technical traders after significant events such as central bank meetings.

Introduction To Financial Markets: Oil

Welcome to my short series on the financial markets! 

Here I will explain how simple economic theories are used in a way to understand, predict and profit from the markets. 

If you have limited exposure to the markets but have a good mind for economics, this is the perfect introduction for further interest and learning. 

Hope you enjoy and thank you for reading. 

Energy and in particular crude oil moves with global demand and supply of the product. With OPEC producing 44% of the world’s crude oil, OPEC is the main determinant of the amount of supply being supplied to the world. If OPEC announces a decrease or increase in production the price for oil (Given demand stays the same) will increase and decrease relatively. The main things that can affect OPEC output include their desire for high oil prices (Acting as a cartel to maintain high oil prices for self-benefit), public conditions within the OPEC countries (For example civil unrest may cause oil plants potentially closing down indefinitely) and exogenous shocks such as plants closing down due to problems.

Along with this, oil reserves play a part in the short-term supply conditions of oil - if there is an underestimation of oil reserves then prices will fall, over estimation will cause the opposite.

Demand for crude is derived from many needs such as gasoline (automobiles), heating oil, diesel, kerosene etc… Ultimately along the supply chain for any good or service, oil is needed. Whether it be in the manufacturing of goods, the long transportation of input goods even all the way to the petrol needed for employees to drive to the workplace. This is why the demand for oil is very much in line with global GDP and output. So oil traders will always consider global demand and production to gauge their demand for oil.

Besides demand and supply, there are also other factors:

Speculative buying and selling is also very inherent in the price of oil, very often the price overshoots the market equilibrium which increases volatility but also creates inefficiency in the price which is a trader’s best friend.

Finally the exchange value of the dollar. Oil is sold in US dollars, therefore if the dollar depreciates it becomes cheaper for foreign countries to buy oil which raises the price of oil in dollars. Therefore there is an inherent inverse relationship between the dollar and the price of oil (When ignoring other factors) 

The biggest FX play of 2014: EUR/USD.

8 months later and the euro can only buy 80% of the dollars it could back in May 2014, but what has been behind this huge move? And where can it go in 2015?

1    Why the big move?

The big move has been based on investors views of the two differing economies and what stage they are at in their economic development post crisis. On the Europe side, investors have seen a loosing of monetary policy with ultra-low rates and an asset buying programme of 60bn euros a month (QE). Overall a very dovish central bank. But then these investors look to the USA and see a completely different story; GDP @ 5%, inflation around 2% (pre-oil shock) and a central bank feeling hawkish with a plan to raise the rate maybe in 2015 and also turning QE tap off in the bank end of 2014.

This complete divergence is why investors have shifted their euros to dollars in the classic carry trade. 

Here in this chart you can see the currency fall from a high of 1.3930 to a low last week of 1.1116.

Along with this clear interest rate/economics trade, there has been another big factor which was the Swiss National Bank unpegging its currency to the euro, in a clear signal that shows the Swiss cannot realistically value their currency at the devalued euro. This moved the euro even more against the dollar.

1   Where can the currency go in 2015?

This is the big question on currency traders’ minds across the world. From a fundamental view point, nothing has changed. Europe is still in the position it is and has only just announced its QE program, suggesting there is much more devaluation let to play. Also the Fed still is to raise the rate which would again see great strengthening on the US dollar. In fact the dollar is set to have a great year in 2015, as it outstrips all major economies in terms of growth.

The problem investors see is whether all this information has already been priced in. All of this information is already available to the market and investors have traded accordingly, therefore the question is with no new information, there should be no reason to see a big devaluation.

On the psychological view point (which is one of the major influences in the currency markets, especially medium-term) when there has been news flow all pointing towards one trend, a small piece of information in the opposite way can cause a big move.

Overall I believe this will still be down trending in 2015. Not at anywhere near the same pace, however there are too many expected/potential events that will happen in 2015 that make me bearish the euro against the dollar:

       Fed rate rise?

2       Continued Deflation in Europe?

3      German recession?

4     Uneffective QE?

5       Greece exit worries again?

6       Increased GDP in US?

Therefore on my recommendation I would hold this trade over the next year until something fundamentally changes at which point will be the time to re-assess.

Stock Valuation comparisons to Football Player Valuations

Stock investing is seen by the people not in the finance world as some sort of wizardry act and is not accessible for the average Joe without a ‘flash’ degree in mathematical finance or investment management. However this is completely not the case!!

This post is going to compare picking a stock to picking the right football player and show the surprising comparisons between the two.
Because every average Joe with a bit of knowledge about football will have an opinion on how much a top player has been bought for.

I am going to do this comparison in regards to a striker.

Stock Analysis:

As a stock investor profits and dividends are something that is vital to look at. This can be translated easily to strikers as the dividends/profits of the player are the goals that they score for the club.

Dividends/profits or Earnings per share = Goals

Looking at this is vital to valuing a football player, the more goals they score, the more valuable they are. Of course there are other variables such as assists, successful passes but to keep things simple I am going to use goals.

As an investor you need to quantify how much these goals/profits are worth. The common way to do this in stock in investing is to look at the price to earnings ratio (PE Ratio). This is the price of the share divided by the earnings. This gives a ratio that should be uniform across all stocks, and mainly is around 15. So you pay 15 times the EPS (Annualised Earnings Per Share) for the stock.

In the footballing world this would quantify to the ratio between Price and Goals scored. Call it the PG ratio. This is vital in valuing the player.

Price(£)/EPS(Earnings Per Share) = Price(£)/GPS (Goals Per Season)

As you are reading this, you may question whether this is always true and refer back to occasions where young unproven strikers have been bought for big money. And this would be absolutely right to question.

In stock investing, investors will look at the potential growth of the company. Translating to football terms, the potential of that player to grow and score many more goals per season in the future.
In investing a business will normally have great growth potential if it is a new firms with a product or service in a fast growing industry. Their profits may not be very good, but the profitability of the business has much potential in the future. This can be seen of Facebook where it was valued on the stock market at IPO at $100bn, but its profits didn’t justify that price.

This leads to a HIGH PE ratio. Where the price is much higher than the earnings per share.

This happens in football just the same, when a young striker such as Wayne Rooney is sold for £25Million despite having an unproven goal scoring record, but he goes for a lot of money because of the great potential for goals in the future.

HIGH P/E when the firm has potential to make profit in future = HIGH P/G when player has potential to score lots of goals in the future

Potential of the firm, profitability and state of the industry aren’t always enough to invest in a stock, just as age, talent and potential aren’t always enough to invest in a football player.

Management is something any investor should look closely at, what is there long term plan and is the business run well, as this is a non-quantifiable thing to look at and something very important.

This translates well to football as some players with amazing talent and very young can go for peanuts on the transfer market such as Paul Pogba and Ravel Morrison of Manchester United. This is because of the management of the player, football teams are scared to pay big money despite their potential because of the way they manage themselves. They are sometimes uncommitted, unfit, personal life risks… all risks that could harm their potential in the future.

Firm management = Personal management and attitude of players

One last thing I am going to talk about and maybe one of the most important things for investors is good value/bargains and how to identify them. This happens just the same in the footballing world.

Most stocks performance is highly correlated with the performance of the economy as a whole and of the market as a whole. A stock can decline 50% just because of the movement of the market and the economy despite nothing happening to the actually underlying business operation. If you believe that a business is still going to be successful and still has good earnings and potential, you can pick up some amazing bargains in times like these.

This is very similar in football whereby a team can be performing poorly or have had a poor world cup, but they can still be the same talent that they have always been.

An example of this would be to look to buy a football player that is good but has had an awful world cup such as Spanish players after their terrible performance at the world cup.

Stock Bargains occur in poor economic/market conditions = Player bargains occur in poor team or world cup performance

You think this would be something many investors and football managers would be very good at doing but all too many times both sets on buyers get it wrong.

A good example of buying players on the back of a fantastic world cup but performance not living up to expectations is Ozil from Real Madrid. He had an amazing world cup, his value increased and Real Madrid over paid for him.

This happens in the investing world too, many people buy into big-unchanged companies at the top of a booming economy with very high PE ratios and see their investment decrease sharply in value when the market corrects itself.

I hope this comparison has helped many understand stock picking a bit clearer and also proven to you that stock picking is not a mystical thing for the elite in the city, but is more a game of common sense and good research.

Many of you out there without fancy degrees but are interested in stock investing are probably good at putting a price on a footballers head based on variables you didn’t even realise you were taking into account and I bet you would also make brilliant stock investors.

The myth of progressive taxation

 

Before I start, I should just clarify the definitions of progressive and regressive taxing

- Progressive: Redistributing wealth from the rich to the poor through taxation of the rich providing state services for the poor

- Regressive: Redistributing wealth from the poor through taxation of the poor to provide state services for the rich (Just like the picture above)

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There is a common myth in society that many governmental programmes are based around the idea of taking from the rich and better off in life and giving back to the poorer, less well off in life. 

Most governmental programmes are sold on this very idea, in my view, the only way they can sell an idea to the public. Who would vote for a programme that takes from the poor and gives to the rich?

Governmental programmes invariably take from the poor and very rich and give to the middle income class. 

This is based on the way that governments are formed and who they should provide for. 

There are made up of 51% vote from lower middle class to upper middle class and they provide for them.

Why not the top 51 %?   

If you are providing for the top 51% you would be including the interests of the super rich for only a few votes, therefore you would be sacrificing a large share of tax from these people in order to obtain a small number of votes. Therefore this would not be effective. 

Why not the bottom 51%?

Forming a government based on the bottom 51% would not work because the people in the bottom 51% include the people that don't require the skills needed to run a government, the skills such as being literate, having a good education etc... the lack of skills that leave them at the bottom of the economic scale (Whether it be an unfortunate start in life economically, unfortunate enough to be born with a handicap which affects productivity, poor entrepreneural capacity etc... ) 

This leaves the government being made up of the middle 51% (lower - upper middle class)

This is because these are the people that have the skills, these are the people that have gone to university and also are not cost effective in terms of sacrifising their vote (unlike the rich) 

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The best example of a tax being sold as progressive but in reality is regressive.

State subsidised higher education. (University) 

University is highly subsidised in the United Kingdom (Despite the price being hiked in recent years). 

This is sold on the fact that you tax the society (whereby the richer pay more) but you provide a subsidised service that allows anyone of any class to attend. Whether you are poor and have paid little into the system or are rich and paid lots into the system. 

However what is the reality? 

The reality is that the people that use these services are prodominantly those from the middle classed families. Whilst the poor pay a smaller amount into the system towards education they take much less from this service, also the rich pay much more for this service however their numbers of attendance does not justify the amount they pay. Therefore who wins? The middle class. The middle class that wins the vote in the UK/US. The middle class that makes up the government in the UK/US.

Here are some figures to show the participation rate in the UK.




Here you can see that the middle class makes up 75% of the University participation rate in the UK. 

Whilst the lower class makes up only 10% of university participation. 

This means that every person at the lower end of the economic scale is paying for middle class higher education to enable them to become more productive and earn a higher wage. 

Not a very progressive governmental programme if you ask me.