Ruminations On "MRP"

How “Mighty” is Mighty River Power?

In New Zealand the government is selling down 49 percent of some Crown owned businesses.  The objective is to reduce government borrowing and debt service.  It is all part of the drive to get the country back into fiscal surplus within a couple of years or so.  This objective is laudable and to be strongly commended.

The first of the businesses to be floated is Mighty River Power (“MRP”), a state owned electricity generator and retailer. The float looking like being wildly popular.  We are not so sure. 

All investments have positives and negatives. MRP is no exception. It can be assessed on a long term basis versus a short term basis.  Probably on a short-term basis the share price will appreciate.  Share demand hangover will likely contribute to post-float demand. Who knows?  But on a longer term basis more serious questions about the company emerge.

 

Here are some longer term positives (to our mind):

-Strong renewables power generation (hydro and geothermal)

-Based in the North Island where the majority of electricity demand is centred.

-Strong dividend policy: the company intends to pay out 75% of net profits after tax.

-Government ownership of 50% will likely ensure that the company will continue to pay dividends: the government is cash hungry and will keep pressure on the company to keep paying dividends, even if it is imprudent to do so.

But there are also longer term risks.  (A quick reading of the “official” statement of risks addresses none of these, apart from a short statement: “Insufficient access to future capital” .  To our mind, this is one of the biggies, as we argue below.)

-Political risks. Will a future incoming government want to re-nationalise MRP and compulsorily purchase shares at a price to be determined by the government of the day?  Unlikely?  Eventually Labour will get voted back into government and the Greens will probably have a substantial say.  Re-nationalisation is a distinct possibility.  Whilst some have argued that privatising 49 percent of the company will increase the quality of governance, since company actions will be publicly announced and scrutinised, the brute reality is that the government of the day retains control–51 percent to be exact.  That ought never to be forgotten.  Is such a controlling shareholding a positive or a negative?  To our mind, it is a long term negative. We believe the Crown would have preferred to sell a controlling stake in MRP; selling only 49 percent was an attempt to make the sale more palatable to the electorate.  The outcome is that the risks to investors are increased, not decreased.

-Government ownership can constrain the way the company can access capital going forward. Governments these days do not want to put more capital (taxpayer funds) into State Owned Enterprises (“SOEs”). This means that the only way for an SOE  to get more capital is to borrow more, which increases the risks of the company. With respect to Mighty River Power, the company cannot go to the market to raise more capital, without the government being willing to stump up with more capital to match additional private investment.  If the government refuses to participate, the company is stymied, since the Crown must retain 51 percent of the shares.  

This places MRP in an invidious position.  It cannot raise more equity capital.  The only options are retaining more profits (which will affect the dividends) or raise more debt.  

Current government policy is to demand higher and higher returns from SOE’s which means more dividends, not less. 

These factors will likely reduce the ability of the company to reinvest profits in the business and will increase the risk of paying out too much in dividends. When companies do this they usually try to “cover it over” by borrowing more. Thus, there is a substantial risk that MRP will have to take on more and more debt going forward.

-These risks are not academic.  The government over recent years has not been a long term passive shareholder of the businesses it owns. It has a history of demanding increasing returns from SOE’s.  We suspect MRP has already faced some of this pressure.  It has sought to expand its business–offshore.  It has put up  US$250m investment offshore in high-risk, speculative geothermal development. It is now starting to write off some of that investment.  This has increased the risk profile of MRP.  How much this has rolled out as a benighted response to government pressure to increase earnings and pay more dividends in the future is unknown.  But . . .

-The company has a BBB credit rating, which is not high. This also confirms that it is a higher risk company and that its balance sheet is not particularly strong.  Its debt is very close to being rated as “junk”. 

-It has a 50 percent gearing ratio, which means that it has borrowed up to 50% of the value of its total asset base. This is not considered a high gearing rate, but it is certainly not a conservative one.

-Most of the assets of the company are in property, plant and equipment—largely hydro dams, powerstations, and the like. The problem with this is that over time these assets get revalued upwards on paper, so on paper the company is worth more. But these assets are large, chunky and illiquid.  They are hard to sell and realise the value should the company ever need to.  Were the company to suffer a credit downgrade or be forced to realise assets to fund borrowing costs it would be in a potentially difficult position.  Meanwhile the company is likely to continue to borrow more against the (higher valued) assets, whilst keeping its borrowing ratio at 50 percent of total assets. The risks will be rising without the appearance thereof. 

-A good question to ask is whether the company can sustain a significant business downturn or reversal. At present the level of free funds from operations (the amount of cash MRP generates from its business once all existing commitments and costs are paid for) is only 4.2 time the annual interest expense on current borrowings. This is pretty low: 10 times would be much better. What this means is that if interest rates were to rise significantly (due to a ratings downgrade, for example) there is not much free board to whether the storm: the company might come under financial strain.

-Finally, the amount of shares a small investor will be able to buy is likely to be pretty small. Problems arise should a small investor want to sell, since small parcels of shares usually attract higher brokerage to sell (between 2 and 3 percent).

In the short term things may well look rosy for a time. The market may possibly appreciate the share price quite strongly, at least initially. Smaller investors and overseas institutions may want to purchase larger holdings. But the risks of this company are medium to longer term.  The capital structures and access to capital going forward are not positive.  The risks are all longer term, in our view. 

Letter From America (About the Great Market Crash of 2012)

So, how’s your green energy stock doing?

A fool and his money are easily parted.  Overreaching, arrogant scientists, bureaucrats, legislators, and media are more foolish than most. So they are more easily parted with money than most.  Which is poetic justice, apart from one great problem.  The money they so easily parted with was actually ours and our children’s.  They has squandered, wasted, speculated upon, and gambled with our money, and recklessly borrowed our children’s for their rash speculations.  

The great investment crash of 2012 was not the housing market, nor the derivatives market, nor Wall Street speculators–it was green energy.  The market has crashed by ninety percent!

This from the Washington Post.

Steve Goreham
Washington Post

 

CHICAGO, December 6, 2012 – Is green energy a fad that has run its course? The investment community seems to think so. RENIXX^® World, the Renewable Energy Industrial Index of the world’s top green energy companies, hit an all-time low below 146 on November 21, down more than 90 percent from the December 2007 peak.

The RENIXX index was established in 2006. It’s composed of the world’s 30 largest renewable energy companies with more than 50 percent of revenues coming from wind, solar, biofuel, or geothermal energy, or the hydropower or fuel cell sector. The index includes equipment producers, such wind turbine companies Vestas (Denmark), Gamesa (Spain), and Suzlon (India), solar equipment companies such as First Solar (USA), Suntech Power (China), and Sun Power (USA), and also utilities such as Enel Green Power (Italy) and China Longyuan Power Group. Of the 30 companies, 10 are headquartered in China, 10 in Europe, and 7 in the US.

During the heydays of 2007 and 2008, the RENIXX index was on a roll. Former Vice President Al Gore’s book An Inconvenient Truth reached number one on The New York Times best seller list in July, 2006. His documentary movie by the same name became a worldwide hit the same year. In December 2007, Mr. Gore shared the Nobel Peace Prize with the Intergovernmental Panel on Climate Change. The world was whipped into global warming frenzy.

Subsidies and mandates for green energy existed for many years, but during 2006—2008 governments redoubled the emphasis on renewables. California enacted the Global Warming Solutions Act in 2006, establishing greenhouse gas emissions targets and renewable mandates. Illinois, Michigan, and other states passed or strengthened Renewable Portfolio Standards, requiring electrical utilities to buy an increasing percentage of renewables or pay fines. The European Union approved the Climate Action and Renewable Energy package in 2008, requiring increased renewable energy and biofuel use and tighter emissions restrictions.

Money poured into green energy stocks. Kevin Parker, Director of Global Asset Management at Deutsche Bank, talked about Mr. Gore and a green investment fund that the company created:  “He [Al Gore] impressed us all at Deutsche Bank Asset Management. We invited him to an internal meeting in April, 2007 during which we discussed the issue of climate change extensively. A few months later, he received the Nobel Peace Prize for his commitment. We then created a fund that invests in companies that position themselves as climate-neutral. Within two months almost 10 billion dollars flowed into this fund. Can you imagine? 10 billion! There has never been such an overwhelming success.” The RENIXX index rocketed to over 1,900 in December of 2007.

But the subsidy-driven green energy wave soon hit a brick wall of fiscal reality. Spain paid solar operators up to ten times the rate for conventional electricity with a 20-year subsidy guarantee. With a guaranteed annual return of 17 percent, every hombre entered the solar business, making Spain the largest solar cell market in 2008. But the nation’s subsidy obligation soon mounted to $36 billion dollars. In 2009, Spain cut the subsidies and its solar market dropped by 80%.

In Germany, feed-in tariffs of eight times the market rate resulted in the installation of over one million roof-top solar systems by 2010. But the 20-year guarantee also produced a subsidy obligation of over $140 billion. German electricity rates climbed to the second highest in the world and continue to climb to pay for green energy. To stop the bleeding, Germany cut feed-in subsidies three times in 2011 and announced a complete phase-out by 2017. Spain, Germany, Italy, Netherlands, the United Kingdom, the United States, and other nations cut subsidies for wind, solar, and biofuels during the last three years.

At the same time, solar manufacturers built huge capacity to meet expected demand for green energy. But with cuts in subsidies, demand crashed and so did solar cell prices. Dozens of companies went bankrupt, such as German companies Solon and Solar Millennium, and US-based Solyndra.

The failure of global climate negotiations also drove the RENIXX index down. Investors expected a binding agreement from negotiations, but no pact could be reached at the 2009 Copenhagen, the 2010 Cancun, or the 2011 Durban conferences. The current climate conference in Doha, Qatar is also unlikely to produce a binding agreement.

It’s interesting to note that a single oil company, Exxon Mobil, has a market capitalization of over $400 billion, or about 40 times the capitalization of the RENIXX index of the world’s top 30 renewable companies. It looks like investors are betting on oil and not green energy.

Steve Goreham is Executive Director of the Climate Science Coalition of America and author of the new book The Mad, Mad, Mad World of Climatism:  Mankind and Climate Change Mania.

Euro Break Up Being Priced Already

Watching the Smart Money

One of the issues being discussed at this blog is the survival of the Euro.  It is obvious that financial markets get really jittery when the break-up of the Euro portends.  Equally obvious is the relief rallies in markets when the risk-du-jour fades and the survival of the Euro is assured for another week or so.

What is often missed is that the smart money has already decided the Euro is going to break up.  When we refer to “smart money” we don’t mean the billions upon billions traded daily in global stock markets and bond markets.   We mean instead the banks, investors, and companies putting real money (their own capital) at risk in actual trading of goods and services in Europe.  These participants are dealing with reality as best they are able to discern it, not speculation, rumours, or apocalyptic visions.

A recent article in The Blaze by Becket Adams looks at what the “smart money” is doing in Europe.

Conflicts of Interest

Big Brother Shareholder

Mighty River Power will be a dirty float.  The Prime Minister, John Key has confirmed it.  The dirt in this float usefully illustrates how governments “do” commerce badly.

Firstly, let’s paint the more general picture, before addressing the dirt.  For governments, politics matter: their real constituency is not the owners of a business, but the voters whom they must either impress or placate.  Governments always stand ready and willing to trade off the rights of property owners, making them the fall-guys for the “greater good” which just happens to be the good of the current governing political party.

SS Facebook Floats Then Sinks

Take the Money and Run

Did you get some Facebook shares?  Well, good for you.  You will now be part of the glorious rags to riches story.  But maybe not.

There are some uncomfortable rapids ahead.  Firstly, an old sage once observed that only fools and horses buy initial public offerings (IPO’s).  OK, so you are going to miss a bargain occasionally.  But the whole purpose of a public offering in almost every case is to dress the company up for sale, hype it, promote it, tell all the goods news that is to come so as to get the best possible share price. IPO’s parade mutton dressed as lamb.

Thus with Facebook. And that leads to our second point: Facebook shares at the IPO were priced at one hundred times current earnings.  That means, if earnings stayed the same as today, you would have to hold the shares one hundred years just to earn back the price you paid–let alone get a return on your investment.  Care to hang around that long?  No, of course not, you say.  Why not?
  Well, Facebook is going to increase its earnings in the years ahead so much that the current price will seem a bargain.  Maybe.  But how will Facebook do this?  This is the key issue.  Sure, there are plenty of ideas, but at the moment it is all vapour-ware, as they say in the software business. 

Ross Douthat, writing in the New York Times, explains the problems.

The Facebook Illusion

By ROSS DOUTHAT

THERE were two grand illusions about the American economy in the first decade of the 21st century. One was the idea that housing prices were no longer tethered to normal economic trends, and instead would just keep going up and up. The second was the idea that in the age of Web 2.0, we were well on our way to figuring out how to make lots and lots of money on the Internet.

The first idea collapsed along with housing prices and the stock market in 2007 and 2008. But the Web 2.0 illusion survived long enough to cost credulous investors a small fortune last week, in Facebook’s disaster of an initial public offering.

I will confess to taking a certain amount of dyspeptic pleasure from Facebook’s hard landing, which had Bloomberg Businessweek declaring the I.P.O. ”the biggest flop of the decade” after five days of trading. Of all the major hubs of Internet-era excitement, Mark Zuckerberg’s social networking site has always struck me as one of the most noxious, dependent for its success on the darker aspects of online life: the zeal for constant self-fashioning and self-promotion, the pursuit of virtual forms of ”community” and ”friendship” that bear only a passing resemblance to the genuine article, and the relentless diminution of the private sphere in the quest for advertising dollars.

But even readers who love Facebook, or at least cannot imagine life without it, should see its stock market failure as a sign of the commercial limits of the Internet. As The New Yorker‘s John Cassidy pointed out in one of the more perceptive prelaunch pieces, the problem is not that Facebook doesn’t make money. It’s that it doesn’t make that much money, and doesn’t have an obvious way to make that much more of it, because (like so many online concerns) it hasn’t figured out how to effectively monetize its million upon millions of users. The result is a company that’s successful, certainly, but whose balance sheet is much less impressive than its ubiquitous online presence would suggest.

This ”huge reach, limited profitability” problem is characteristic of the digital economy as a whole. As the George Mason University economist Tyler Cowen wrote in his 2011 e-book, ”The Great Stagnation,” the Internet is a wonder when it comes to generating ”cheap fun.” But because ”so many of its products are free,” and because so much of a typical Web company’s work is ”performed more or less automatically by the software and the servers,” the online world is rather less impressive when it comes to generating job growth.

It’s telling, in this regard, that the companies most often cited as digital-era successes, Apple and Amazon, both have business models that are firmly rooted in the production and delivery of nonvirtual goods. Apple’s core competency is building better and more beautiful appliances; Amazon’s is delivering everything from appliances to DVDs to diapers more swiftly and cheaply to your door.

By contrast, the more purely digital a company’s product, the fewer jobs it tends to create and the fewer dollars it can earn per user — a reality that journalists have become all too familiar with these last 10 years, and that Facebook’s investors collided with last week. There are exceptions to this rule, but not all that many: even pornography, long one of the Internet’s biggest moneymakers, has become steadily less profitable as amateur sites and videos have proliferated and the ”professionals” have lost their monopoly on smut.

The German philosopher Josef Pieper wrote a book in 1952 entitled ”Leisure: The Basis of Culture.” Pieper would no doubt be underwhelmed by the kind of culture that flourishes online, but leisure is clearly the basis of the Internet. From the lowbrow to the highbrow, LOLcats to Wikipedia, vast amounts of Internet content are created by people with no expectation of remuneration. The ”new economy,” in this sense, isn’t always even a commercial economy at all. Instead, as Slate’s Matthew Yglesias has suggested, it’s a kind of hobbyist’s paradise, one that’s subsidized by surpluses from the old economy it was supposed to gradually replace.

A glance at the Bureau of Labor Statistics’ most recent unemployment numbers bears this reality out. Despite nearly two decades of dot-com enthusiasm, the information sector is still quite small relative to other sectors of the economy; it currently has one of the nation’s higher unemployment rates; and it’s one of the few sectors where unemployment has actually risen over the last year.

None of this makes the Internet any less revolutionary. But it’s created a cultural revolution more than an economic one. Twitter is not the Ford Motor Company; Google is not General Electric. And except when he sells our eyeballs to advertisers for a pittance, we won’t all be working for Mark Zuckerberg someday.

The smart guys in the Facebook float were those that sold shares and got their cash.  Even cleaning staff apparently became multi-millionaires.  Time to head for the doors at a gentle trot, guys.  

Siren Songs of Populism and Easy Money

Becoming Serfs in Our Own Country

Economic xenophobes.  Welcome to the wonderful world of New Zealand populist politics.  Actually, it’s a bit worse than that.  We are economic racist xenophobes. How cute to see the Green party revealing its anti-Chinese prejudice on the matter.  This from Kiwiblog:

When Bill English is over in Australia talking about how more and more Australian companies want to invest in New Zealand, and no politician says a word. But then you have a Chinese leader visit and promote investment from China, and the Greens rush out a press release. It is absolutely playing to xenophobia. Not all opposition is xenophobic, but much of it is – and politicians play to it.

But, there is an argument on the other side to be made.  The Prime Minister, John Key has said that he does not want a New Zealand where citizens are serfs in their own country.  That is a powerfully visceral line.  It raises a spectre that is not unrealistic at all.
  Imagine a country where most productive assets were owned by one company and the vast majority of citizens were employed by that company.  Such an arrangement would leave that company with far too much control over the destinies of citizens.  We would be a bit like feudal serfs.

Assume that the analogy changes from one dominant company to a cluster of international conglomerates or companies that were to own most of the productive assets in New Zealand.  A similar parlous situation begins to emerge: we would have lost control of the economic destiny of our own country.  Being a mere speck of dust on a global scale, if that situation were to develop it would be virtually impossible to get out of it, short of wholesale state nationalisation of the productive economy–which, of course, carries another set of devastatingly negative effects.

There is no free lunch.  Doubtless this is offensive to most citizens of this country, who have been taught from their mother’s (sorry, caregiver’s) knee that there is such a thing as a free lunch.  It is called “other people’s money”.  Being a nation of socialists we have been conditioned to thinking that life would be just dandy if we were to extract more money from others via government taxation and handouts.  Long ago, domestic capital for investment and economic development ran out in New Zealand.  It was sucked into the maw of state health, education, and welfare–never to return.  This ugly trinity consumes sixty-seven percent of government expenditures.  It is a voracious beast which eats up exponentially more capital and wealth every year.  Now we have run out of money and the beast’s relentless appetite can now only be funded by government debt. Other people’s money–only this time the “other people” are those not yet alive.  We are merrily mortgaging our grandchildren to pay for our lusts and pleasures.

It’s what the people want.  But the consequence is that progressively we are becoming serfs in our own country.  Now we cannot develop our country economically without relying on international investment. We don’t have sufficient capital left.  It’s all been spent.  Capital from overseas must of course generate a return, which is repatriated overseas.  Consequently, New Zealand’s balance of payments has been in deficit for as long as human memory serves. We are a recidivist, long term debtor nation.  It ain’t going to change–until the whole house of cards comes crashing down–and we get to be owned by other nations. 

Meanwhile the vicious circles bites ever more bitterly.  Those kiwis with gumption, get up and go–literally.  Long ago they left our shores to pursue their own economic aspirations overseas.  Every year they have thousands of “fast followers”.  This makes our labour force less productive than otherwise.  The demand for increased capital investment rises to compensate for the skilled labour drain.  Still more earnings repatriated overseas is the outcome; even less capital is available for reinvestment.  And so on. 

Those who complain about New Zealand losing its economic sovereignty are right.  But we lost it a long time ago when the decision was taken to embrace what historian Michael Bassett has called “socialism without doctrines”.  Once that fateful move was taken, it was only a matter of time.  The end game is rapidly approaching.  Now we have no other options, remotely palatable.  It is overseas investment in New Zealand or the progressive “Nauruising” of our economy and nation.  No choice really.  Does not the borrower become the lender’s slave?  Serfs in our own country is our inevitable future.  As long as we are willing to feed the three headed hydra of government health, education and welfare with other people’s money there is no other option.

But to sneer at Chinese investment as if it were tainted, whereas “wasp” investment from the UK, Germany, Australia and the US is not, is truly xenophobic–racist xenophobia, and despicable for it.  As for those raising the siren of New Zealanders not becoming serfs in their own country–sorry, that decision was made decades and generations ago.  For goodness sake, let’s get our heads out of the sand and face reality. 

Over time there are only two things that could turn the Titanic around.  Firstly, families lowering their living standards, denying themselves, paying off their debt, and saving relentlessly for themselves and their children and grandchildren.

Secondly, wisely investing their saved capital in productive enterprises for the long term–both here and offshore.

Re-Thinking the Sale of Crafar Farms

Unintended Consequences

The decision of High Court Justice Miller to introduce a new interpretation of  legislation pertaining to overseas buyers of New Zealand assets will no doubt be scrutinised carefully in a number of quarters.  What appears at first glance is yet another activist decision by a Judge who interpreted the law to mean what he thought would be a better outcome for New Zealand.  If so, the Justice changed from being a judge to a political advocate.
 

Hitherto, the law appeared to require that any overseas buyer of New Zealand assets had to demonstrate it was going to add value to New Zealand and the New Zealand economy.  Previous court decisions had consistently interpreted the statute that way.  It was the prima facie meaning of the Act.  But Justice Miller ruled  that the Act really meant an overseas buyer had to prove that they could add more value to New Zealand than any other hypothetical NZ buyer (who may or may not emerge as a purchaser). 

At first glance this would appear to stop all overseas investors from significant purchases of assets.  At first glance it would appear that the property rights of all New Zealanders have been eroded by the good judge advocate. 

But we think not.  Like all activist regulators and legislators, the judge is about to discover the law of unintended outcomes.  What will most likely happen now will be a boon for sellers of farms and other strategic assets. 

If you were selling a farm or suchlike now and initial inquiries indicated there would be overseas interest in purchasing, the sales process will be different.  Firstly, you would put the asset up for tender locally.  Then when the best price/deal had been identified, you would then shop the asset offshore.  The challenge would be “exceed this price, and add more value”.  Every asset up for sale requiring the Overseas Investment Office sign-off will now likely go through this new process.  OIO approval will be more likely than ever before–and, the price achieved by the seller is likely to be better than it otherwise would have been. 

The law of unintended outcomes remains firmly in place.

The Smart Money

Buyer Beware

We have been approached by several folk wondering about the investment wisdom of buying some of the state owned electricity companies when they come on the block.  On the surface of it, power companies usually provide stable income flows, a good dividend stream, and solid earnings growth.  The stuff blue chips are made of.

But–there is always a but–let’s not neglect the big-picture, or helicopter view.
  The government will remain the majority shareholder in all cases.  That means the government of the day will ultimately control and direct the businesses.  Now, it is true these companies are run on an arm’s length basis.  But the government for the next decade will be starved for revenue.  The temptation to run these companies as cash cows for the government’s coffers will be intense.  Politicians are known for persistently favouring short term gain and long term pain (when someone else will have to deal with the problem), whilst keeping their eye firmly on the next election.

Some will spring to the defence of government.  They will point out how both Labour and National administrations have maintained majority shareholdings in “our national” airline, Air New Zealand.  Yet through a very difficult time for the aviation industry the government has have kept itself at arms length, allowing the company to chart its own commercial destiny.  Surely that will equally apply to Mighty River Power and Genesis Energy etc.

Maybe.  But consider this.  Would the owner of Air NZ have kept its “hand’s off” stance if Air New Zealand had delivered financial results like Qantas has recently?  What if Air NZ needed an injection of capital because its losses had been so severe?  What then?  

Moreover, the energy industry is now highly politicised.  It was not always the case, but with global warming mania it now most certainly is operating in a highly politicised sector, where government is taking upon itself the task of changing commercial behaviour for the “good” of mankind.  Our state owned power companies are in the front line of that Canutian struggle.

As a rule of thumb, any electricity company which is touting investment in “clean, green energy” where the economics simply don’t stack up should be avoided like the plague.  Such companies can be expected to bleed into deepening pools of inefficiency and low margins.  “Doing the right thing for mankind” might make the management and directors and the government-of-the-day feel morally self-righteous, but shareholders are going to pay for their master’s scruples.

Geothermal is OK.  Hydro is fine.  Nuclear, the sooner the better.  But wind farms?  Economic lunacy and moralistic myopia.  Expect huge write downs for years to come, once the capital investment has been made.  Bottom line earnings are going to be pretty thin for such companies and certainly volatile.  And guess where most new investment in generation in New Zealand is occurring.  You guessed it. 

Finally, would you invest in an industry which is effectively price controlled?  And the controls are ultimately reflective of populist outrage over rising power prices which shows up at the polling booth.  Normally, this might not be such a big issue, but when government indirectly, but ultimately, controls the prices charged to consumers, and is the majority shareholder in our generation companies, and has eyes always on the next election which is always so close in the New Zealand electoral system be warned.  The risks are enormous. 

Just remember, government can tolerate low, sub-par financial performance of its businesses far longer than private investors.

Our conclusion–by all means look at the offer documents, but be aware of the big picture and the intrinsic riskiness of power companies in New Zealand.  Don’t be fooled by the “safe, solid, blue chip” image of yesteryear–which will “frame” the offer documents.  We expect that a bunch of NZ financial institutions, Maori financial interests, and KiwiSaver funds will buy up big–in fevered haste.  They will have plenty of time to repent, in their leisure.

Sam Stubbs of Tower Investments has boldly stated that his company would be selling up overseas investments in order to purchase NZ power companies.  That implies Tower must have some pretty sub-par international assets already in its portfolios.  Commercial advantage and shareholder return is the only justifiable reason for quitting international investments in favour of NZ power companies, right Sam?  Not company image.  Not PR.  Not national pride.  Please, tell us none of these things will be influencing your investment decisions.  Pity your investors if they do.

>Descendants of a Mad Emperor

> Fiddling While Rome Burns

Here is Bill Gross–one of the more sane and sage voices in investment markets today.  He explains why the debt situation in the US is much worse than that in Greece. It will drown us all.  Politicians not facing up to this reality are beneath contempt, guilty of a swingeing dereliction of duty on the grandest of scales.  How long must we endure political leaders attempting to lead by focus groups?

Such politicians either perpetually back up or follow the herd.  Either way they are supine vacillating fools, not leaders.

http://plus.cnbc.com/rssvideosearch/action/player/id/3000027178/code/cnbcplayershare

>A Fool and His Money are Easily Parted

>Not Worth a Tilt

Not long ago we were cutting down through Ashhurst on our way to the Manawatu Gorge, and then on to Mangatainoka (you will all know what that’s famous for) and eventually Carterton.  Those of you who have travelled this route will know that as you approach the Gorge it is wind-turbine city.  Since someone else was driving, we were able to count the number of turbines we could see that were not turning.  Seven.  Seven broken down turbines–at a quick glance.

To fix them requires a 600 tonne capacity crane–trucked out into the wop wops.  Access roads have to be maintained on some of the steepest country in New Zealand.  Slips and washouts are common.

The New Zealand Herald has a piece on maintenance being done at the Makara West Wind Farm, the country’s largest.  It has 62 turbines.  It went live on April 29th, 2009.  So it is almost exactly two years old, operationally speaking.

>Grumpy

>A Different Form of Fun

New Zealand does not have many resident bears (economically speaking).  Bernard Hickey is about the only one.  The vast majority of economists and investment market sages have a pollyannaish “she’ll be right” attitude, possibly because they believe so strongly in the competence and power of the State to make things right.

It is refreshing to read Hickey.  He has a happy knack of pointing out the elephants in the room which his colleagues have chosen not to see or to dismiss and inconsequential.  Here is his most recent column in the NZ Herald.

>Well Said . . .

> Kiwi Cargo Cult

Here is Bruce Wills of Federated Farmers commenting on the prospect that New Zealand dairy farms are going to be sold to offshore interests:

Bruce Wills, who heads the lobby group’s meat and fibre division, agrees the stance is purely pragmatic. But it is also necessary, he insists, if farming is to have a future. A former banker and valuer, he notes that debt has more than doubled in the agricultural sector over the past seven years to around $47 billion.Wills agrees the Chinese seem to be taking a long-term view of the value of New Zealand farmland, given their concerns about feeding their own population. Although Fonterra is doing its best to capitalise on the same trend, most Kiwi farmers simply can’t afford to take a similar long-term view, he says.

While a few dairy farmers are indeed creaming it, most are still deeply mired in debt, says Wills.   And the only way that debt will be repaid is if the milk payout stays at record levels for another few years yet, or through large injections of fresh capital. “Where’s that fresh capital going to come from? It’s not coming in great speed from existing farmers because we’re still a bit cagey about what we’ve been through, and we’re not sure what’s around the corner. A bit of stuff is coming out of the cities… but the big dollops are from those countries with the cash and the real drive to secure some more food assets.”

As we have all learned in the wake of the global financial crisis, the bottom line is that far too many Kiwis – in the country and the cities – have borrowed far too much money and few are in any position to borrow any more. “Sure, we’ve got to be careful of not losing too many of our assets offshore where we do have a competitive advantage, but we also have to recognise that we do need outside capital. We are over-indebted. We’ve seen what’s happened to our forestry assets and our banking assets and we all look back in hindsight and say: ‘What a shame we all let that go’. But basically it’s our own fault. Whether we’re going to learn this time, I just don’t know.”

No, things will not change this time around.

>The More Things Change . . .

>When a Snake Oiler Meets Venality

We have seen this before! In the early noughties a troop of investment banking marketers descended upon New Zealand and Australia, flogging structured finance instruments. Some wore pinstripe suits, spoke in plummy accents and hailed out of London. Others wore braces, loud ties, and hailed out of New York. They were selling “collateralised debt obligations” (don’t you just love the euphemistic jargon), parcelled up into various risk tranches, each with respective credit-ratings and various statistical models assuring us that the risks of default were exceedingly low. And all this was being wrapped into managed funds, so that retail investors, the proverbial mums and dads, could get a slice of the heady action. And they did–in their thousands.

One had the distinct impression that it was the last gasp hurrah of a glorious party. Go out and flog this stuff one last time. Go to the end of the world, to the antipodes, to the colonies, where the gullible still reside. Sell and run. And they did and did. Now, when it all collapsed, shrieks were heard, blaming rotten and corrupt America for letting this happen.

But now it is a case of “fool me once, shame on you; fool me twice, shame on me”. Bloomberg has reported that Illinois, that bastion of fiscal rectitude, has been struggling to find US citizens, pension funds, and institutions to buy its debt and fund its profligate entitlement, featherbedding, pay-off, deficit spending. So, guess what? The braces and loud ties have been dusted off again, and off shore the bond salesmen have trooped. A seven-country road show, with lights, bells, whistles, and back-slapping.

And, lo and behold, the stupid punters are once again stumping up their money. Lending to the most corrupt political establishment in the US! Why? Who would be so stupid?

The seven-country visit worked. The state sold one-fifth of the federally subsidized securities abroad the next month, tapping investors who are the fastest-growing source of borrowed cash for U.S. municipalities. Illinois, with the lowest credit rating of any state from Moody’s Investors Service, dangled yields higher than Mexico, which defaulted on debt in 1982, and Portugal, which costs more to insure against missed payments.

“U.S. states are among the cheapest sovereign credits in the world,” said Patrick Brett, a Citigroup banker who marketed the Illinois securities overseas. “You’re actually picking up a good amount of spread for arguably better credits relative to equivalently rated corporates and sovereigns.”

Don’t you just love that language from Mr Brett of Citigroup: “arguably better credits relative to equivalently rated corporates and sovereigns . . .” This is a euphemism for “spin, spin, spin”. If Illinois credit was sound, US investors would have picked it up. Because there is a real smell about state and local body deficits in the US–the smell of desperation–the locals know the risks and know that Illinois is the most intractably wretched, they fear the worst, and avoid them.

But, those greedy gullible overseas investors just cannot resist loud ties and braces. And we ask, who is the more culpable? Is it the dissembling snake oiler from Citigroup? Or is the greedy, smart-timing investor. But we are sure of this: when it all blows up, everyone will be unanimous that there is only one culpable entity in the dock–the big, evil investment banker. And those throwing the biggest, sharpest stones will be the oh-so-easily gulled investors who foolishly lent money to the most corrupt political establishment in the US, but whose venality willed them into a suspension of disbelief and prudence at the time.

>Irrational Exuberance

>Housing Bubbles and Cool Calculations

We are all aware that kiwis have willingly deluded themselves into thinking that residential housing is a yellow brick road to wealth. Actually, for a long, long time they have been quite right. But it is unsustainable. It is pyrrhic prosperity. Smart folk will be very aware of this and will be planning accordingly.

Now, in these matters timing is always critical. As Keynes once observed, “the market can stay irrational far longer than you can stay solvent”. In other words, an investment market or asset may be way, way out of synch with fair value, but a return to reasonable prices may take years, decades, even generations. If you get exposed by betting the family farm or the household silver on the “market” pirouetting nimbly from irrationality to rationality–without considering that it may take decades to happen–you are speculating. Don’t complain if the markets fail to perform within your required time frame.

Residential housing investment is a case in point. Let’s be clear on what a rational market in residential housing would “look like”. In case you missed it, a residential house is, well, a house, a building. And buildings depreciate over time, as does all plant and equipment. Houses eventually need maintenance and repairs. They wear out. They have to be replaced. This means that a ten year old house should be worth less than on the day it was first built. In general terms the land on which the house is built could be expected to appreciate in value over time because there is a finite and limited supply of land. There is only so much of it in NZ. Moreover, land never wears out (unless you are living in an area subject to coastal erosion).

So, a rational housing market should see the land on which the house is built increase in value over time, due to limited supply, while the house built upon the land decrease in value over time. But this is not the experience of New Zealanders in general. They have an expectation that whatever one pays for a house today, it will be worth more in three to five years time. This is a cultural axiom beyond dispute. It is a financial nostrum which only a fool would deny. Consequently, New Zealanders believe that housing is “safe” in financial terms. They are prepared to take considerable financial risks to own it. Even if they have to mortgage up their lives, in the end it will pay off as their house rises in value over time.

But it remains a fools paradise. Inflation–caused by a general increase in the supply of money–obscures the real fall in value of houses over time. A ten percent rise in market value of a house might actually be a five percent decline in real value by the time inflation is taken into account. Inflation is annoying in that it sends the wrong price signals that obscure real value.

But a far more significant factor distorting the housing market in this country, making it an irrational bubble, is the artificial limits upon the supply of housing. It is this which has worked more than any other factor to create a distorted, protected, housing market. The supply of houses has been artificially restrained not by a shortage of timber or other construction materials, but by local and central government restrictions upon house building. The Resource Management Act and local government town plans have restrained the supply of houses, reducing their supply, thereby jacking up prices of existing houses. This in turn has led to the nostrum that houses always rise in value. In the living memory of most people they have.

So, when you bet the family silver on a house you are probably going to be OK. Unless you are the one caught when the bubble bursts. But what would cause the bubble to burst?

A real depression. A really serious economic depression, lasting ten or so years, goes through phases. The first is the rapid contraction due to firms laying off staff and going bankrupt. Unemployment rises, spending falls, and credit contracts. The fall of demand and the turning off of the money-spigots means that prices fall, cash is king, bargains can be found. This is the first phase.

The second phase is the contraction of central and local government. Tax revenues drop sharply; limits upon government borrowing are reached; and government spending cuts begin.

It is at this point that local municipal governments start to wake up and smell the sewage. First up they realise that they have swathes of land which they had bought up in the halcyon days for one grand project or another. It is lying vacant; there is no revenue for the council being generated. Secondly, as indigent people are forced out of their houses, they “inherit” a bunch of houses due to non-payment of local government rates.

It gradually dawns on local bodies that a growing housing stock is a good thing. Querulous greenie voices fade to whimpers. Local bodies become pro-development and a building boom commences. But, every new residential house completed, lowers the value of the existing housing stock. Depreciation–a rational economic force–kicks in. A more sane and stable housing market develops–but one which sees the artificial wealth which people believed they held in ever appreciating residential property ebbs away. This is the third phase of a really serious depression.

Everyone is poorer. The fourth phase is when it dawns on the entire populace that the only way wealth can be created and sustained is to produce marketable goods and services at a profit. In other words, we have to work and earn our way out of economic recession. Then–and only then–a sustainable recovery begins.

In New Zealand, folks can makes lots of money from housing. If you are one of them, just keep reminding yourself that you have been fortunate and that it will not last. Warn your children.

Here’s a good rule of thumb. Assume that the life of your current house is fifty years. Then it will be bulldozed and a new one constructed on the site. Look at your original QV statement and subtract the unimproved land value. The residual is the house value. If the house is ten years old, consider it depreciated by 20 percent. In other words the economic value of the house is worth one fifth less than its original sale price, if it is ten years old.

Such calculations will serve to keep you economically rational when you consider the residential housing market.

>A Hard Fight From Here . . .

>Economic Hangovers From the Debt Binge

The IMF has just published its latest Global Financial Stability Report. It makes explicit what we have always known, ever since the Great Credit Crunch of 2008. The past two years have seen a massive transference of risk from the private, non-government sector to the public or government sector.

All over the world governments have “bailed out” their banks, commercial enterprises, and households. The term “bailed out” is really misleading, because all that has occurred is that liability and debt has been transferred from private sector balance sheets to the balance sheets of governments, which in the end will be paid for by those same households and businesses (or at least their successors). The debt will be paid either through inflation or taxation or both. But, according to the IMF, the expansion of debt on sovereign balance sheets is not going to lessen any time soon.

But the biggest threats have moved from the private to the public sectors in advanced economies. Governments not only took on many of the bad assets from private institutions but due to the recession face continuing heavy borrowing needs for the next few years. Slow growth in the real economy and high unemployment will retard tax revenues and require higher government spending—such as on unemployment benefits and job creation activities.

“In spite of recent improvements in the outlook and the health of the global financial system, stability is not yet assured,” Viñals said a news conference April 20. “If the legacy of the present crisis and emerging sovereign risks are not addressed, we run the very real risk of undermining the recovery and extending the financial crisis into a new phase.”

For the present, the risks have passed over the banks to governments, and banks have survived. So risks of systemic bank collapse have been avoided for the present. We can all breathe easier. Or can we?

Improving economic and financial conditions have helped private bank balance sheets in advanced economies. The IMF sharply reduced its estimate of the writedowns or loan loss provisions banks will have to take—or have taken—to account for bad loans and securities on their books. The improving quality of bank assets means that banks will probably need less capital than previously estimated to absorb losses. But banks still will face funding difficulties in the next few years, as their bonds mature and the special government assistance programs are withdrawn.

Two problems will persist over the next few years, according to the IMF. Firstly, the vast expansion of government will inevitably crowd out the private sector’s innovation, efficiency-on-the-ground, and access to inexpensive capital. Governments will be soaking up more and more capital to fund their bail-outs, borrowings, and increased spending. There is a world of productive difference between borrowing to expand a business, on the one hand, and borrowing to fund the life-style of entitlement classes, on the other.

The IMF warned that the increase in sovereign risk can hit banking systems and the real economy that produces goods, services, and jobs. Even with weaker private credit demand, governments could crowd out business and household borrowers, retarding recovery.

Secondly, bank lending to the private sector is going to remain subdued for several years to come. This is because banks are continuing to write off bad assets, improve their balance sheets, rebuild capital reserves, and pay back their government loans. Moreover, interest rates are going to rise due to governments competing to borrow more and more money to fund their deficits. What most people don’t realise is that banks usually make more money in low interest rate conditions, than higher. Thus, not only will banks not be lending as much, they will make less on what lending is undertaken.

Although the worst of the credit contraction may be over, banks are unlikely to boost lending substantially in the near term—both because of the continuing overhang of bad assets that remain on their books and the funding pressures they will face. Moreover the withdrawal of the special government support will further constrain bank lending.

Although private credit demand remains modest—households and businesses continue to reduce their debt levels—sovereign borrowing threatens to overwhelm it, potentially driving up interest rates, forcing private demand to shrink, or both.

What are the implications? Economic recovery in New Zealand is likely to be anaemic. Tax revenues will remain subdued–risking longer, more protracted fiscal deficits. A foresighted and smart government would take an axe to government spending, would curtail payments to the entitled classes, would sell off commercial enterprises owned by the state, and would do all within its power to reduce deficits. At the same time, smart government would systematically drive down tax rates to encourage activity in the productive economy. We will see just how smart the present National government is come next election.

The housing sector–that long favoured engine for debt fuelled enrichment–will likely remain subdued for several years, unless immigration sharply increases, pushing up demand for houses. Household debt reduction is likely to continue, particularly as interest rates rise.

All in all, if the IMF is right, the next five years in New Zealand are likely to be the economic equivalent of a prolonged enervated weakness due to lingering fevers and infections–sort of like a national economic equivalent of Tapanui Flu. But, at a micro-level, well capitalised businesses, with sound (but not flashy) leadership, with good cash flows are likely to do very well, thank you. However, the get-rich-quick, flash Harry, golden chained, mover and shaker types that used to frequent the Ponsonby and Parnell bars, boasting of their latest deal are likely to become an extinct species.

Hopefully our political representatives at central and local government levels will get the message. The last thing we need is politicians with “visionary” ideas, promising to create “Party Central” on decrepit wharves. If President Reagan was right, and the most dangerous sentence in the English language is, “I’m from the government, and I’m here to help,” surely the second most dangerous must be, “I’m from the government and I have a really big bright idea.”

>Some New Year Investment Resolutions

>Bernard Madoff is an Object Lesson

As the year comes to an end, most people who have had investments are probably licking wounds. With the S&P index down 40 percent for the year, few investors would have escaped. So, adversity is always a good time to learn some good lessons, and learn them well.

Here are some possible New Year investment resolutions.

If it sounds too good to be true, it probably is. How often have we heard that proverb? Yet still people get suckered and end up losing lots of money. Big returns mean big risks, and big risks kill.

Bernard Madoff is a name unknown to us until recently. We had never heard of him. However, those in an exclusive and very wealthy niche group had not only heard of him, they invested money in his securities business. The returns he provided his investors were outstanding. When you are running a Ponzi scheme you can manufacture extraordinary returns, as long as new investors keep walking in the door and your existing clients leave their money with you. You take your new clients’ money and use it to pay out returns to your existing clients—everyone is happy, until the scheme collapses. And getting good returns is the very best way to attract new clients. The prospect of high returns always draws investors like bees to the honey pot.

If you throw in a dose of generosity and charitable works, the lure becomes irresistible. People love to make good money with a clear conscience. Madoff was well known in charitable circles; he was a generous donor; many charities invested with him. The fact that so much good was being done was one more reason not to look the gift horse in the mouth.

But apparently no-one knew how he was able to achieve such good returns. The smart people were the dumb ones who could not figure out how he did it, and declined to invest in something they did not understand. And apparently there were quite a few who made the “no” decision.

That leads us to our second investment maxim: we should never invest in something we don’t understand. What we mean is, you do not understand how the money is being made, or where the returns are coming from. Some have applied this maxim in such a way they would never invest in a business where they did not understand how the product was made, or the particular technology, or whatever. But this is not necessarily what we mean. we may not understand all the in’s and out’s of how a computer works—but we know what functions a computer performs, why people find it has utility, and why they buy them. Therefore, even though we don’t understand all the science represented in a personal computer, we know how Dell or HP make money.

But generally the more complex a business is, the more difficult it is to understand, the less attractive it should be as an investment. Once again the dumb money is the smart money. If people had applied this maxim they never would have invested with Bernard Madoff.

But there is a third investment maxim that would have been helpful. Never take advice—ever. Always make your own decisions, and hold yourself completely accountable for the decisions made. If you lose money, it is your fault—no-one else’s. Never, ever hand over the control of your investments to someone else who will make the decisions for you. And never invest in something because someone else told you it was a good idea.

The buck has got to stop with each one of us. That helps us focus the mind. Now, we do not mean, of course, that you ought not to listen to others’ views and opinions, but in the end you yourself have to be certain that the investment is sound. If we end up investing because of the recommendation of the broker or the adviser or the relative, or the other person who we believe is smart, don’t invest.

Professional investment advisers will always be biased towards recommending what will sell. Investments with high returns are very easy to sell. Never trust their advice. We are not implying that all investment advisers are crooked or dishonest, as Madoff clearly has been, but that they are in business to make money, and money depends upon transacting investments, and there is an inevitable bias towards those investments which are easy to transact. The advisers may genuinely believe in the merit of the investment. They may recommend it honestly. But stay away from it—unless you understand it thoroughly, and you yourself come to believe in its merits. Let’s remember, the dumb money is the smart money: don’t try to make our dumb money smart by listening to advisers who we (and they) believe are smarter than us.

A good test is to ask yourself whom you would blame if you lost all your money on an investment. If it is someone other than yourself, the chances are you have probably invested very unwisely.

>Drowning in a Sea of Panic

>Is Breathless Panting Appropriate?

The world appears to be gripped by a spate of catastrophism where disaster is seen on every hand and from every quarter. Most of these catastrophies are figments of imagination, but they continue to provoke and fascinate, alarm and entertain—in the same way that horror movies do.

In New Zealand we have not escaped. While the gloss has gone off global warming as the catastrophe du jour—as the world has cooled over the past ten years—it has been replaced by a vision of an economic armageddon. Once more the world as we know it apparently is coming to an end. Several opinion leaders have been urging the rival political parties to “wake up” and realise just how dire our situation is, and to take appropriate action. If it were not so pathetic, one would almost die laughing at journalist, John Campbell’s breathless panting, as he pleaded with the Helen Clark and John Key to demonstrate they had some understanding of just how serious things were. “Don’t you realise we are all about to die,” one could almost hear him saying.

Even the normally measured Fran O’Sullivan—who has more than a clue about matters financial and economic—has succumbed, arguing that the urgent exigencies of the moment called for a “war cabinet” where both Labour and National would suspend political hostilities and work together for the salvation and protection of the nation.

Fortunately, calmer heads appear to be prevailing.
This is the time for a sober, yet sanguine approach. The real crisis has passed. It is very unlikely to return. The real crisis was the potential collapse of the global banking system that would have severely restricted, if not removed borrowing completely from the world economy. Sound, and well capitalised institutions would have collapsed. This, indeed, was a serious matter—and which, if allowed to play out, would have opened up the possibility of a nineteen thirties style of years of depression.

Given that central banks and governments acted in time, and largely in concert, this crisis has passed. Yes, as we have argued elsewhere, the regulatory regime governing financial institutions needs to be overhauled and brought into the reality of a globalised market place. Yes, greater disclosure and capital adequacy standards need to be enforced. Yes, there needs to be an end to an acceptance of “netting off” as a risk reduction tool for derivatives. Yes, there needs to be capital set against purported “off balance sheet” liabilities, and so forth. Yes, the central bank money spiggots need to be turned down, then off, and the excess emergency liquidity siphoned back out of the system. All this will probably come in due time—and it is not the sort of thing that can be done quickly. It needs careful consideration, lest it create even bigger problems.

But the immediate crisis has passed: governments and central banks have adopted a “whatever it takes” approach, so that in the end banks were able to start lending to each other again, which in turn meant that credit would still flow through the economy. The interbank lending market has now settled down.

So, we now face another “problem”—an economic slowdown, possibly of global dimensions. But this had to happen. Asset and commodity prices had got way beyond market equilibrium, due to the global monetary system being flooded with cheap credit for nearly two decades. Prices have now declined rapidly and substantially; both individuals and businesses are retrenching, spending less, laying off liabilities, cutting back. Economies will shrink as a result. But the end result will be a move to market equilibrium, where prices reflect real (not debt fueled) demand, and real (not debt fueled) supply. Capital will be scarcer; risks will be more threatening; economic activity will wane.

This is not a “problem”. It is a normal, and much needed correction. Eventually, our economy will return to a much more sustainable growth path—more sustainable because it will be based on production, not consumption. New Zealand is actually in not such bad shape. The consumption boom, fueled by rapid house-price appreciation, which in turn was fueled by easy credit conditions owing to Japanese, US, and Europeans being more than willing to lend to our banks, has ended. The price of money is likely to remain quite high for some time. But apart from the construction and related industries this was never economically productive: it was consumption driven.

The party is over, so now we can get down to producing the goods and services that a slower growing world will want to buy. And we have plenty. Yes the adjustment will be somewhat painful, but then so is vigorous exercise. Yes, the adjustment make take three or four years. But it is not the end of the world. John Campbell can stop panting. And we certainly do not need a coalition economic war cabinet.

>ChnMind 2:15 The Real Prosperity Gospel

>The Goal of Family Financial Self-Sufficiency

In recent years we have seen the emergence of what has been dubbed the “Prosperity Gospel”. At its most crass, the Prosperity Gospel has been a gross perversion of biblical truth for selfish pecuniary gain. Infamous “televangelists” particularly in the United States have proclaimed to their audiences that if they would send in gifts, God would reward them with financial prosperity. Money has flowed in like water. The televangelists have become fabulously wealthy through fleecing their so-called flocks. Their judgment awaits.

This perversion is of the same ilk found in the historical Christian Church, where in the early sixteenth century, indulgences were sold: the object was to raise money for building the Church of St Peter’s in Rome; the method was to promise to people that if they gave, they would secure an indulgence for a loved one, so that they would escape the pangs of purgatory and go immediately into heaven. It was this evil which was the immediate cause of the Reformation. Luther’s Ninety-five theses were posted on the door of the Castle Church at Wittenburg for debate. They condemned the practice of indulgences. The false Prosperity Gospel has been around for a long, long time.

There are other, less crass forms of the Prosperity Gospel. In some circles it has morphed into a challenge to be an active participant in the life of the church—including in its giving programme—in order to inherit the blessing of God. The blessing of God will include financial blessing. “Give and it shall be given unto you, pressed down, shaken together and running over,” (Luke 6:38) has become a favourite biblical text.

Like all perversions of the truth, there is often an element of original truth which is subsequently perverted. The Prosperity Gospel is no exception.

We have been considering the role and responsibility of one of the key institutions of God’s Kingdom, the City of Jerusalem. The Family is a crucial, foundational, fundamental institution of the City. Its central role, function, sovereignty and authority is declared in Scripture. It is protected by God’s Law, such that neither Church nor State may subsume, override, or countermand its duties and work.

The role and responsibility of the Family is to provide its members the blessing of the closest and deepest bonds of human fellowship; to act as the core institution to bear, raise, nurture and train children in the faith; and to to be the primary provider of welfare for the members of its own household, its extended household, fellow church members, and to all men.

We have been focusing upon the role and responsibility of the Family to be the centre of welfare and provision for family members at some length deliberately. This is because it is precisely here that modern Athens has subverted and subsumed these familial duties, and transposed them to the secular state. The result has been a growth in statist power, and a weakening of the Family. As the institution of the Family has been weakened, so the Kingdom of God has lost influence and power. The rebuilding of the Kingdom of God in the West requires that the Family—the Christian Family—takes back its legitimate sphere and duties, and recaptures its central social influence. This will not be achieved overnight—it will take several generations, in fact. But it must be done, if the Kingdom is to grow in influence and power over Athens. This is a high, holy, and spiritual calling. It must be done if the Kingdom is to regain the ground that it has lost in the West.

In this regard, we must recover the true biblical position on family and household prosperity.

The Scriptures make it very clear that wealth and possessions are a blessing of God. Increase and prosperity come from the Lord. It is a blessing of the Covenant itself. The Lord promises that if we are faithful and obedient, He will be faithful to us, and that He will pour forth His blessing upon us—and His blessing is both covenantal and cultural. Consider the words of the Law:

Then it shall come about, because you listen to these judgments and keep and do them, that the Lord your God will keep with you His covenant and lovingkindness which He swore to your forefathers. And He will love you and bless you and multiply you; He will also bless the fruit of your womb and the fruit of your ground, your grain and your new wine and your oil, the increase of your herd and the young of your flock, in the land which He swore to your forefathers to give you.

You shall be blessed above all peoples; there shall be no male or female barren among you or your cattle. And the Lord will remove from you all sickness; and He will not put on you any of the harmful diseases of Egypt which you have known, but He will lay them on all who hate you.
Deuteronomy 7: 12—15

Note that this abundance is to come about as a result of our forefathers’ obedience, faithfulness, loyalty, and obeisance to the Lord. The resulting blessings will certainly come because the Lord has sworn—taken an oath—that He will respond in kind. The Lord will love, bless, and multiply.

And again:

Beware lest you forget the Lord your God by not keeping His commandments and His ordinances and His statutes which I am commanding you today; lest when you have eaten and are satisfied, and have built good houses and lived in them, and when your herds and your flocks multiply, and your silver and gold multiply, and all that you have multiplies, then your hearts become proud . . . (and) you may say in your heart, ‘My power and the strength of my hand made me this wealth.’

But you shall remember the Lord your God, for it is He who is giving you power to make wealth, that He may confirm His covenant which He swore to your fathers, as it is this day.
Deuteronomy 8: 11—18

The power to make wealth is a divine confirmation of His covenant: but it will only transpire if God’s people remain humble and faithful to Him. If we, as a covenant community, remain poor and dependant, the blessings of the covenant have not yet been confirmed to us.

However, we need to be very clear on how wealth comes to pass. There are only two ways given in Scripture for people to gain wealth: hard work and inheritance. Thus, the wealth and prosperity that was to come to Israel was to be the fruit of work, labour, diligence, skill and persistence. The archetype is Jacob—whose name, we, the Israel of God bear. He went out with nothing but the shirt on his back, and came back a man of substance, the fruit of twenty years of hard and skilful husbandry, in the face of severe obstacles. Work, skill, and diligence are the means of divine blessing. The Lord makes the labour of our hands and minds fruitful and productive. He gives makes our efforts successful as we trust Him, depend upon Him, and work faithfully as He has commanded us.

This is the true Prosperity Gospel—diligent and faithful work in the callings God has given us, looking to the Lord for His blessing, and experiencing His hand multiplying our efforts, despite many trials, hardships, and reversals.

But, what to do with the multiplied wealth? It is the Lord’s. We are only stewards of what He has given. We are bound, as households and families, to use wealth as He has directed, in the way He has commanded. And His command is that each family and household strive to become self-sufficient and self-supporting, and have some left over to share with others.

There are four stages in the transition from poverty to self-sufficient wealth. The first stage is where one is unable to earn any income—whether through sickness, ill-fortune, or unemployment. At this point, the family is dependant upon the love and charity of others for sustenance. This was the condition of Naomi and Ruth.

The second stage is when one can earn enough income to meet day-to-day needs (food, clothing, and shelter). This stage is still one of poverty and the family remains at risk. The family and household is living from hand to mouth.

The third stage is where the family is able to earn sufficient income that not only can it meet day-to-day needs, but it can also lay aside funds for capital appreciation. The Christian family needs to recover the discipline of a lifetime of saving—which, in turn, means that present consumption has to be restrained and curtailed. Only then is the family moving out of poverty towards self-sufficiency.

The fourth stage is where sufficient capital has been amassed that it is possible to live comfortably off the income produced from that capital, and that there is sufficient income that some is able to be capitalised back, so that overall wealth is growing.

Most Christian families in our day remain at the second stage—living from hand to mouth. Many Christian families believe that is all the Lord requires. They are mistaken. They need to realise that there is so much further to go, and that it is the responsibility of the head of the household to strive to the utmost to ensure that the household moves to the third and fourth stages. It is their duty. Only then can we begin truly to take up our additional responsibilities to our extended families and to the needy around us.

In moving from the second to the third stage the application of a very useful rule—the seventy-thirty rule—is apposite. When we are consistently applying the seventy-thirty rule to our earned income, then we know we are moving to stage three. Huge progress is being made at this point. Ideally, it should start from the day we earn our first dollar of income, and it should continue throughout our lives.

The seventy-thirty rule is as follows:

Of all the income the Lord gives us through our work and labour, divide it as follows:

10% to be untouched—tithed—and given to the Lord. This should always be done, regardless of our circumstances or penury. It is the biblical way of acknowledging that all we have has actually comes from God’s hand. Without this faithful discipline we will not develop the heart of a faithful steward. Until we are faithful in this little thing, the Lord will not entrust us to be faithful in much more.

10% to be untouched—saved—and put to long term capital formation. This capital, except in the direst of emergencies, is not to be touched or consumed; it is eventually to be passed on down to children and grandchildren. In retirement from direct income earning, or in times of unemployment or hardship, income from this capital may be used; but the capital ought to be left perpetually intact–if at all possible.

10% to be saved, but to spend on larger items the household will need in the future (house, furniture, car, etc) or to assist with children’s education or family special needs.

70% is to fund current household expenditure.

This is not always possible to achieve, depending upon one’s circumstances—but it remains a benchmark and goal. Only as we achieve this consistently can we be confident of moving from stage two to stage three. Getting the household to stage three, and keeping it there, should be the goal of every household head, and all its members. Only then can we say that we are living as the Bible commands—as self-reliant, with some left over to share with those who have need.

>Affirmative Action Has Destructive Consequences

>How Affirmative Action (aka Legalised Discrimination) Brought Down the US Financial System

There have been various references over recent days to the “real cause” of the collapse of Freddie Mac and Fannie Mae, and of the need to “nationalise” hundreds of billions of dollars of bad debt.

Here is Ann Coulter’s take. It makes for sober reading.

This crisis was caused by political correctness being forced on the mortgage lending industry in the Clinton era.

Before the Democrats’ affirmative action lending policies became an embarrassment, the Los Angeles Times reported that, starting in 1992, a majority-Democratic Congress “mandated that Fannie and Freddie increase their purchases of mortgages for low-income and medium-income borrowers. Operating under that requirement, Fannie Mae, in particular, has been aggressive and creative in stimulating minority gains.”

Under Clinton, the entire federal government put massive pressure on banks to grant more mortgages to the poor and minorities. Clinton’s secretary of Housing and Urban Development, Andrew Cuomo, investigated Fannie Mae for racial discrimination and proposed that 50 percent of Fannie Mae’s and Freddie Mac’s portfolio be made up of loans to low- to moderate-income borrowers by the year 2001.

Instead of looking at “outdated criteria,” such as the mortgage applicant’s credit history and ability to make a down payment, banks were encouraged to consider nontraditional measures of credit-worthiness, such as having a good jump shot or having a missing child named “Caylee.”

Threatening lawsuits, Clinton’s Federal Reserve demanded that banks treat welfare payments and unemployment benefits as valid income sources to qualify for a mortgage. That isn’t a joke — it’s a fact.

When Democrats controlled both the executive and legislative branches, political correctness was given a veto over sound business practices.

In 1999, liberals were bragging about extending affirmative action to the financial sector. Los Angeles Times reporter Ron Brownstein hailed the Clinton administration’s affirmative action lending policies as one of the “hidden success stories” of the Clinton administration, saying that “black and Latino homeownership has surged to the highest level ever recorded.”

Meanwhile, economists were screaming from the rooftops that the Democrats were forcing mortgage lenders to issue loans that would fail the moment the housing market slowed and deadbeat borrowers couldn’t get out of their loans by selling their houses.

A decade later, the housing bubble burst and, as predicted, food-stamp-backed mortgages collapsed. Democrats set an affirmative action time-bomb and now it’s gone off.

In Bush’s first year in office, the White House chief economist, N. Gregory Mankiw, warned that the government’s “implicit subsidy” of Fannie Mae and Freddie Mac, combined with loans to unqualified borrowers, was creating a huge risk for the entire financial system.

Rep. Barney Frank denounced Mankiw, saying he had no “concern about housing.” How dare you oppose suicidal loans to people who can’t repay them! The New York Times reported that Fannie Mae and Freddie Mac were “under heavy assault by the Republicans,” but these entities still had “important political allies” in the Democrats.

Now, at a cost of hundreds of billions of dollars, middle-class taxpayers are going to be forced to bail out the Democrats’ two most important constituent groups: rich Wall Street bankers and welfare recipients.

Political correctness had already ruined education, sports, science and entertainment. But it took a Democratic president with a Democratic congress for political correctness to wreck the financial industry.

>Blame Fannie Mae and The Democrats for the Credit Mess

>Several days ago, we posted a piece on the fundamental failures that have led to the massive credit collapse in the United States. You can read it here.

We argued that the two government sponsored enterprises, Freddie Mac and Fannie Mae were substantially responsible for the problem. Today, in the Wall Street Journal an excellent piece was published explaining just how this came about, and how the Democrats remain primarily responsible for the mess.

Many monumental errors and misjudgments contributed to the acute financial turmoil in which we now find ourselves. Nevertheless, the vast accumulation of toxic mortgage debt that poisoned the global financial system was driven by the aggressive buying of subprime and Alt-A mortgages, and mortgage-backed securities, by Fannie Mae and Freddie Mac. The poor choices of these two government-sponsored enterprises (GSEs) — and their sponsors in Washington — are largely to blame for our current mess.

How did we get here? Let’s review:In order to curry congressional support after their accounting scandals in 2003 and 2004, Fannie Mae and Freddie Mac committed to increased financing of “affordable housing.” They became the largest buyers of subprime and Alt-A mortgages between 2004 and 2007, with total GSE exposure eventually exceeding $1 trillion. In doing so, they stimulated the growth of the subpar mortgage market and substantially magnified the costs of its collapse.

It is important to understand that, as GSEs, Fannie and Freddie were viewed in the capital markets as government-backed buyers (a belief that has now been reduced to fact). Thus they were able to borrow as much as they wanted for the purpose of buying mortgages and mortgage-backed securities. Their buying patterns and interests were followed closely in the markets. If Fannie and Freddie wanted subprime or Alt-A loans, the mortgage markets would produce them. By late 2004, Fannie and Freddie very much wanted subprime and Alt-A loans. Their accounting had just been revealed as fraudulent, and they were under pressure from Congress to demonstrate that they deserved their considerable privileges. Among other problems, economists at the Federal Reserve and Congressional Budget Office had begun to study them in detail, and found that — despite their subsidized borrowing rates — they did not significantly reduce mortgage interest rates. In the wake of Freddie’s 2003 accounting scandal, Fed Chairman Alan Greenspan became a powerful opponent, and began to call for stricter regulation of the GSEs and limitations on the growth of their highly profitable, but risky, retained portfolios.

If they were not making mortgages cheaper and were creating risks for the taxpayers and the economy, what value were they providing? The answer was their affordable-housing mission. So it was that, beginning in 2004, their portfolios of subprime and Alt-A loans and securities began to grow. Subprime and Alt-A originations in the U.S. rose from less than 8% of all mortgages in 2003 to over 20% in 2006. During this period the quality of subprime loans also declined, going from fixed rate, long-term amortizing loans to loans with low down payments and low (but adjustable) initial rates, indicating that originators were scraping the bottom of the barrel to find product for buyers like the GSEs.

The strategy of presenting themselves to Congress as the champions of affordable housing appears to have worked. Fannie and Freddie retained the support of many in Congress, particularly Democrats, and they were allowed to continue unrestrained. Rep. Barney Frank (D., Mass), for example, now the chair of the House Financial Services Committee, openly described the “arrangement” with the GSEs at a committee hearing on GSE reform in 2003: “Fannie Mae and Freddie Mac have played a very useful role in helping to make housing more affordable . . . a mission that this Congress has given them in return for some of the arrangements which are of some benefit to them to focus on affordable housing.” The hint to Fannie and Freddie was obvious: Concentrate on affordable housing and, despite your problems, your congressional support is secure.

In light of the collapse of Fannie and Freddie, both John McCain and Barack Obama now criticize the risk-tolerant regulatory regime that produced the current crisis. But Sen. McCain’s criticisms are at least credible, since he has been pointing to systemic risks in the mortgage market and trying to do something about them for years. In contrast, Sen. Obama’s conversion as a financial reformer marks a reversal from his actions in previous years, when he did nothing to disturb the status quo. The first head of Mr. Obama’s vice-presidential search committee, Jim Johnson, a former chairman of Fannie Mae, was the one who announced Fannie’s original affordable-housing program in 1991 — just as Congress was taking up the first GSE regulatory legislation.

In 2005, the Senate Banking Committee, then under Republican control, adopted a strong reform bill, introduced by Republican Sens. Elizabeth Dole, John Sununu and Chuck Hagel, and supported by then chairman Richard Shelby. The bill prohibited the GSEs from holding portfolios, and gave their regulator prudential authority (such as setting capital requirements) roughly equivalent to a bank regulator. In light of the current financial crisis, this bill was probably the most important piece of financial regulation before Congress in 2005 and 2006. All the Republicans on the Committee supported the bill, and all the Democrats voted against it. Mr. McCain endorsed the legislation in a speech on the Senate floor. Mr. Obama, like all other Democrats, remained silent.

Now the Democrats are blaming the financial crisis on “deregulation.” This is a canard. There has indeed been deregulation in our economy — in long-distance telephone rates, airline fares, securities brokerage and trucking, to name just a few — and this has produced much innovation and lower consumer prices. But the primary “deregulation” in the financial world in the last 30 years permitted banks to diversify their risks geographically and across different products, which is one of the things that has kept banks relatively stable in this storm.

As a result, U.S. commercial banks have been able to attract more than $100 billion of new capital in the past year to replace most of their subprime-related write-downs. Deregulation of branching restrictions and limitations on bank product offerings also made possible bank acquisition of Bear Stearns and Merrill Lynch, saving billions in likely resolution costs for taxpayers.

If the Democrats had let the 2005 legislation come to a vote, the huge growth in the subprime and Alt-A loan portfolios of Fannie and Freddie could not have occurred, and the scale of the financial meltdown would have been substantially less. The same politicians who today decry the lack of intervention to stop excess risk taking in 2005-2006 were the ones who blocked the only legislative effort that could have stopped it.

Mr. Calomiris is a professor of finance and economics at Columbia Business School and a scholar at the American Enterprise Institute. Mr. Wallison, a senior fellow at the American Enterprise Institute, was general counsel of the Treasury Department in the Reagan administration.