Would You Invest in a “Veritable Volcano”?

Would You Invest in a “Veritable Volcano”?

The spin continues.

Today’s The Age reports, “ANZ bumper proft [sic]”.


Source: The Age

We assume a “proft” is the same as a profit.

The paper explains:

“ANZ Bank has posted a record first-half profit of $2.664 billion, up 38 per cent on the corresponding period last year…

“Mr Smith said Australia’s economy was now entering a ‘new normal’ phase and the impact of the global financial crisis had largely washed through…

“Mr Smith said, while the housing market was not in a bubble, housing affordability was still a concern.”

We won’t even bother commenting on the last statement.  We’ll just show you a picture instead:


Source: ANZ Bank

The light blue area is ANZ Bank’s exposure to the residential mortgage market.  59% of ANZ’s loan book is exposed to residential mortgages.  [cough]

The dark blue area represents “institutional” lending, the medium blue “commercial”, and the olive colour “other retail & wealth”.

In other words, just 17% of ANZ’s lending is directed towards commercial enterprise.  The majority of its lending goes towards propping up the housing bubble.

Yet if you listen to most mainstream commentators, they’ll tell you how important a strong banking sector is… and how if it wasn’t for Australia’s strong banks, the economy would be in a dire condition.

While it’s true the inevitable banking collapse will be pretty miserable, the ultimate outcome will be for the better.  Because the current banking set-up inhibits the economy from growing.

Besides, holding gold and silver will provide some insurance against the meltdown.

While we’re on the subject we’re wondering if Australia has found its own Peter Schiff.

Over the weekend we stumbled across our old pal, Wesley Legrand from Grand Private Equities in Adelaide, schooling Sky Business Channel host Peter Switzer on the value of gold.  You can catch the interview here.

False prophets and profits

Anyway, back to our point.  The fact is, the banks are false prophets.  They do nothing more than gain central bank and government support for their activities, and then once they’re established they ensure continued support by warning of the consequences of withdrawing the support.

It’s similar to US Treasury Secretary, Timothy Geithner’s series of letters to the US Congress.  He warns about the dire consequences if the US government is denied the ability to go further into debt!

In reality, banks aren’t the economic saviours they’re made out to be.

The banks and the people who run them are just bean-counters and pen-pushers… they’re long on bureaucracy, but short on initiative.

Think about it, when was the last time a bank identified and supported an innovative new business?  And I mean properly supported it.  I don’t mean giving a business a loan where it has to post residential property as security.

Because as a Money Morning reader recently pointed out to us, that’s just another housing loan disguised as a business loan.

And it’s true.  When a bank asks you to post a property as security, what the bank is really saying is, we don’t like your business idea, but we do like your house… so have the money and we’ll take your house if you fail.

And why do banks favour housing?  Because it’s backstopped by the government of course.  Unlike businesses which can be much harder to stop from collapsing.

Trouble is because the banks know this, it concentrates their loan book.  Rather than diversifying their exposure to naturally lessen risk, the banks take advantage of their special gift from the government and central banks – that is to take as much risk as they can reasonably get away with.  Because the taxpayer will ultimately provide a bail out.

The concentration of risk has resulted in the current house price bubble.  If they hadn’t shifted so much of their lending towards housing the bubble wouldn’t have been created and the collapse of the property market needn’t happen.

Missed opportunities

But that’s not all.  There’s also the missed opportunity.

Thanks to the banks only lending about one-sixth of their loan book to commercial enterprise, entrepreneurs find it hard to gain access to capital.

Let me show you what I mean.  Remember the graphic I showed you above.  Here it is again:


Source: ANZ Bank

From left to right you’ve got institutional lending, commercial lending, residential mortgages and finally other retail and wealth loans.

Now take a look at this interesting snapshot.  It’s from the 1978 ANZ Bank annual report:


Source: ANZ Bank

You’ll notice that just one-quarter of the trading bank lending in Australia was to persons – we’ll make a guess this includes mortgages.  In New Zealand it was even less – about one-sixth.

But look at the rest of the numbers: manufacturing alone accounted for 17% of the bank’s lending.  Today the bank’s entire commercial loan book accounts for 17% of all loans made by the bank!

In 1978, total lending to the business sector made up over half of all the bank’s lending.  Yet today it’s a pathetic 17%.

It’s a perfect illustration of how the banking sector has all its eggs in one basket – the house price basket.  No wonder they’re so keen to downplay the idea of a housing bubble.

The result is less credit flows through to business, including entrepreneurial business.  It means just as private enterprise can be crowded out by government spending, private enterprise can be crowded out by a misallocation of resources by retail banks.

And that’s exactly what’s happened.  That’s despite the fact that it’s entrepreneurs and genuine capitalists who provide the real benefits to any economy.

Economic progress denied

While researching for the latest issue of Australian Small-Cap Investigator, we read Thomas J. Misa’s, A Nation of Steel.

It tells the story of “The Making of Modern America, 1865-1925”.

You may wonder what that’s got to do with Aussie small-caps.  Simply this: it’s a story of progress and innovation.

There are plenty of interesting stories in the book.  The key ones being how entrepreneurs and businessmen sought to adapt and improve the economy through innovation.

For instance, at the time iron was the most used material for making railroad rails.  But it had limitations.  It was relatively brittle and less durable compared to steel.

However, steel was expensive – about five times the cost of iron.

But by the 1870s, all that was about to change.  And it was thanks to a man named Henry Bessemer.  Partly by accident, he invented a process “for making steel by blowing steam or air through molten iron.”

This process caused the rapid decline of the iron railroad industry as the cost of steel rail production fell by 80%.  But this change didn’t happen easily or overnight.

As Bessemer noted at the time, as he was experimenting with his new process:

“Then followed a succession of mild explosions, throwing molten slags and splashes of metal high up into the air, the apparatus becoming a veritable volcano in a state of active eruption.”

At the time there was no guarantee the Bessemer Process would be a commercial success.  Just as there’s no guarantee a new business today will be a commercial success.

But that’s why entrepreneurs and capitalists are so important to an economy.  They aid progress.  They put their ideas and their money on the line in the hope they’ll make a fortune.

Whereas bankers simply use the privileges given to them by governments and central bankers to inflate a once-safe asset class into an asset class that’s riskier than small-cap shares!

An asset class that used to account for one-quarter of a bank’s balance sheet but that now accounts for three-fifths of it.

Innovation leads to more innovation

But there’s more to innovation than just creating “a veritable volcano”.  In the case of Bessemer and his new process, the innovation didn’t stop there.  As with all innovations, the discovery of something new leads to more discoveries.

That’s where US engineer Alexander Holley appeared on the scene.  A contemporary of Holley’s noted at the time:

“Holley seems to have at once broken loose from the restraints of his foreign experience.  Where Bessemer left the process which bears his name, Holley’s work began.  Very few of the features… of Mr. Bessemer’s practice as thus given were embodied in the American work.”

In other words, Holley adapted and improved.  Innovation breeds more innovation.  In fact, even though Bessemer is probably a better known name than Holley, it’s Holley’s innovation that developed into the open-hearth method of steel production.  A method that’s still in use today for steel production – although even that has been improved upon with newer processes.

Facebook is another good example of adapting and improving an idea.  Last week your editor watched The Social Network on Foxtel.  We don’t know how much of the movie is factual and how much is artistic licence.

But nevertheless it makes a valid point.

According to the movie, Facebook founder Mark Zuckerberg, was accused of [ahem] borrowing the idea for Facebook from fellow Harvard students, the Winklevoss twins.  They had come up with an idea to allow university students to interact with each other on a new social networking website – we forget the name they came up with.

According to the film, they asked Zuckerberg to work on the idea with them.  But again, according to the film, Zuckerberg though their idea sucked (or should that be “zucked”?).  He allegedly took their basic idea and turned it into today’s fifty-billion dollar valued Facebook.

What did the Winklevoss twins do?  Not much at first, they just carried on trying to develop their business.  But eventually they sued.

Of course, what they should have done is use the art of quid pro quo… they should have taken note of Facebook and its popularity and used those ideas to adapt and improve their own product – you take our ideas, we’ll take yours.

Who knows, if they’d done so, maybe their social networking website would now be the market leader.

That’s entrepreneurialism.  We’re sure someone famous said, “there’s no such thing as a new idea”.  And that’s probably true.  Social networking isn’t a new idea, people have interacted socially since Adam was playing fullback for the Arsenal.

Zuckerberg and the Winkelvoss twins just took an old idea and adapted it… one more successfully than the other.

But if entrepreneurs are denied capital from capitalists because capital is being consumed by housing and fancy financial derivatives, how can there be any progress?

Well, you’ll still get progress, it’s just that it’s harder to achieve.  Entrepreneurs aren’t just competing with other entrepreneurs for financing, they’re competing with housing estates and negatively geared property investors.

I ask you, if you’re a bank manager and you read in a business plan about “mild explosions”, “molten slags” and “a veritable volcano”, are you going to lend someone $300,000 for a process that could change an entire industry and economy, while creating untold profits?

Or would you instead throw the money at a negatively geared property investor who tells you he’s going to lose money on a property for the next ten years?

Sadly, we know exactly what the bank manager would do.

Cheers.

Kris Sayce
For Money Morning Australia

Kris Sayce
Kris is never one to pull punches when discussing market developments and economic events that can affect your wealth. He’ll take anyone to task — banks, governments, big business — if he thinks they’re trying to pull a fast one with your money. Kris is also the editor of Microcap Trader — where he reveals the best opportunities he’s discovered in the markets. If you’d like to more about Kris’ financial world view and investing philosophy then join him on Google+. It's where he shares investment insight, commentary and ideas that he can't always fit into his regular Money Morning essays.
Kris Sayce is the Publisher and Investment Director of Australia’s biggest circulation daily financial email, Money Morning Australia.Kris is a fully accredited advisor in shares, options, warrants and foreign-exchange investments. Kris has close to twenty years’ experience in analysing stocks. He began his career in the biggest wasp’s nest in the financial world — the city of London — as a finance broker back in 1995.
It’s there where he got his ‘baptism of fire’ into the financial markets, specialising in small-cap stock analysis on London’s Alternative Investment Market. This covered everything from Kazakhstani gold miners to toy train companies.After moving to Australia, Kris spent several years at a leading Australian wealth-management company. However he began to realise the finance and brokerage industry was more interested in lining its own pockets with fat fees, commissions and perks —rather than genuinely helping out the private investors they were supposed to be ‘working’ for. So in 2005 Kris started writing for Port Phillip Publishing — a company which was more attuned to his investment outlook. Initially he began writing for the Daily Reckoning Australia— but eventually, took over Money Morning. It’s now read by over 55,000 subscribers each day. Kris will take anyone to task — banks, governments, big business — if he thinks they’re trying to pull a fast one with your money! Whether you agree with him or not, you’ll find his common-sense, thought-provoking arguments well worth a read. To have his investment insights delivered straight to your inbox each day, take out a free subscription to Money Morning here. Kris is also the editor of Tactical Wealth and Microcap Trader where he reveals the best opportunities he’s discovered in the markets that you could profit from. If you’d like to learn about the latest opportunity Kris has uncovered, take a 30-day trial of Tactical Wealth here or Microcap Trader here. Official websites and financial e-letters Kris writes for:

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12 Comments on "Would You Invest in a “Veritable Volcano”?"

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michael francis
Guest

A relationship with the bank is no different when a hooker charges $500 bucks for sex (or a $1000 if your fat and sweaty) and you believe she’s doing it for love.

Jt
Guest

This is a great effort about how incentives to invest in the mortgage sector pull away capital from entrepreneurs. It is absolutely essential for the government to realise this.

Australia is already enough of a Saudi like economy, with resources crowding out other sectors. We do not need, on top of that, government policy further encouraging banks to lend to stupid unproductive sources like housing.

carl
Guest

That’s why Australia can never be like USA… full of dumb politicians in the government.

dood
Guest

So the chinese are just being entrepeneurial when they steal ideas and develop them?

Peter Fraser
Guest

It’s a little incorrect to say that lending for business and commerce is only 17% when a large proportion of small business loans are written as home loans because it is easier. It changes nothing except the stats, which is what you are concerned about.

On another point – I think you will find that it was the “Open Hearth” furnace that really changed steel production, still it’s not an important point in this context.

dood
Guest
Kris says: “But that’s why entrepreneurs and capitalists are so important to an economy. They aid progress. They put their ideas and their money on the line in the hope they’ll make a fortune.” and then bangs on about the banks not lending to entrepeneurs. Surely thats what venture capitalists are for. So why do they need my ( bank ) money to gamble with? Banks used to be a place where people stored money. Deregulation , ( requested by the capitalist camp ), of the banking system allowed the banks to gamble with derivatives etc. eventually creating a financial… Read more »
Anthony G
Guest

Having struggled in businesses for a very long time a saying my Dad uses has always been true: the banks will only lend you money when you can prove that you don’t need it.

Jt
Guest
Dood…venture capitalists play a role, but so do banks. In fact, banks probably play a much bigger role. Do not think of the extreme innovators – the most risky ones. Most of the “innovations” are normal businesses – small startups that have a good idea, or a good product. Often, they can put together a good business case, and get a loan from a bank. Which is obviously becoming a lot harder now that banks prefer not to lend to commercial enterprise. The house being a “security” behind them lending out your money is irrelevant – it also means that… Read more »
J.C.
Guest

The Wesley Legrand interview on Switzer is priceless. Why Switzer has to behave in such a gormless fashion is not unexpected, but you would have thought that he could have challenged Legrand just a smidgen. It’s encouraging to see such people getting some airtime in Australia.

Peter Fraser
Guest

So after two whole days my comments at #4 are still “awaiting moderation” Are they really that “explosive” – I thought they were quite tame.

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