“It’s time to play the music,
It’s time to light the lights…”
You don’t need to be a Goldman Sachs client to become a muppet, although it helps.
Fact is, any service you buy where you do not understand the way the procedure works gives the vendor an opportunity to overcharge. And you can become so desperate to make your life work smoothly when things go wrong, you ignore what you need to pay to put them right again.
I found that out the other day, when I asked my garage to fix a new wing mirror on my car, for a price three times higher than its underlying cost. My wife found the same, when she asked the engineers round to mend our central heating boiler.
Over at Goldman Sachs, according to former executive Greg Smith, traders excel at persuading clients to tidy up their portfolios by selling them complex products at a high price. The bankers have some affection for their clients. How could they not? But they also like to take advantage of their ignorance and despise them for being stupid. So they call them muppets.
The world is packed full of muppet risk, as services are routinely mispriced and mis-sold. There will always be a good living to be made for the owners of garage and central heating companies. But there will be a better one for investment banks. And governments, in their ponderous way, can also be relied on to take advantage of the situation.
Right now, the UK’s chancellor, George Osborne, is playing around with issuing a 100-year gilt to push the maturity of government debt to beyond the current 14.5 years.
In theory, he can raise 100-year money at 3.5% by selling it to institutions that do not want to put capital at risk. His plan to sell the UK road network to pension schemes could get funding at a still finer rate, if he is prepared to offer them an inflation-linked return. Taking direct control of the Royal Mail pension scheme would further increase his ability to conjure up cheap funding packages with capital under his purview.
Following a volatile five years, Osborne knows institutions are keen to buy sovereign bonds to help them withstand any future crisis and service their liabilities. The regulators reinforce this behaviour in their determination to protect institutions from themselves.
They have told western banks to bolster their reserves by buying sovereign bonds, often using access to debt, whose interest rate has been set at low levels for two or three years to come by the central banks. Insurance companies in Europe are being told to buy government paper through a new regulatory measure known as Solvency II. UK pension schemes have been encouraged to crowd into bonds for years, through accounting rules.
Governments call this process macro-prudential regulation. Others call it financial repression.
Force feeding on sovereign bond purchases don’t stop there. Through quantitative easing, central banks are printing money to fill their balance sheets with government bonds to kick-start the economy. Capital controls being introduced by emerging market governments are making it harder for western investors to export capital to overseas providers of debt at a more generous rate.
As private and public sector institutions have hoovered up government bonds, their yield has fallen to lower and lower levels, producing the kind of exceptional performance record capable of seducing yet more investors.
It can’t last, of course. All we need is a steady increase in the rate of inflation, to reduce the value of all this money owed by investors and western governments. In fact the process is already under way, with inflation currently exceeding 10-year bond yields by 1.5 percentage points.
The process was used to bring down excessive western government debt after World War II, and there is no reason why governments reluctant to raise taxes and cut spending shouldn’t want to try it again while raising yet more debt finance to meet their spending commitments.
Are investors anticipating this? Is money in motion? Is a big switch from bonds to equities looming?
Not necessarily, just yet. But market volatility is down at levels not seen since the onset of the sub-prime crisis and shares have seen their best start to the year for a long time.
Clearly, the muppets are getting restless.