After the GFC: lessons learned and mistakes to avoid

People are talking about green shoots indicating the emergence of an economic spring. As we all know, spring is a wonderful period in the year, punctuated by retreats into winter and occasional hints of summer.

What is really happening is an emergence from a catastrophic tsunami which has wiped out the wealth of many individuals, closed down businesses, put people out of work and created social disruption. In addition, it has impacted heavily on the public purse causing governments to take on enormous debt and place bets on untested strategies.

There are now signs that governments are becoming alarmed at their own adventurousness. A just-completed meeting of the G8 concluded that things were well on track for a recovery and, at some time soon, there might be a necessity to rein in the stimulus largesse that has been coming off the printing press with abandon. The International Monetary Fund has ‘upgraded’ its growth targets for the world economy for next year.

My goodness, how many times does this institution come out and say “oops, we made a mistake with our last estimate”? Accordingly, it might be just as well to wait and see what growth is achieved next year rather than act on the estimates of economists who have no credibility – based upon their previous erroneous predictions.

Everyone has to move forward in this uncertain world, but in a climate where confidence is gradually returning despite the ongoing aftershocks that will inevitably visit us. The sharemarket has had a remarkable run, albeit with quite a deal of caution now appearing. It is a time for prudent caution coupled with a degree of optimism that the worst is over.

The cowboys are still riding

However, there are some unappealing facts that need to be factored into our equation as we go forward. The guys who brought on the catastrophe are still at large and are still up to their old tricks. Have you noticed the price of oil lately? In the last six months it has doubled in price from just over $US30 to around $US70. However, consumption has gone down rather than up.

These famous but faceless pinstriped geniuses are back into speculation, which is a principle reason for the dramatic increase in the price of oil and it was the reason that the price of oil hit $US150 a barrel last year. We can’t be rid of them and so we have to put up with them, which means that as we go forward there will continue to be the odd shock.

We can however, learn some lessons from the crisis. The first one that occurred to me related to the number of well-off people who put money into the hands of cowboys and lost. Quite a number of seemingly sensible people lost their life’s savings. I find it quite amazing that people would trust so much money to low level institutions. The biggest of them all was Madhoff who persuaded people to give him $US50 billion, which he blew. Here in Australia, from that major centre of investment, Townsville, down to another city more famous for football than investment, Geelong, people entrusted millions to institutions without any financial credibility but on the promise of returns that were far greater than those promised by traditional institutions. I am amazed at how many people entrusted their money to others to invest for them without thinking of the risks.

If you buy a share in BHP or NAB and the price goes down, at least you know where your money is and you take responsibility for the investment decision. If you invest it with Jo Blow & Co, no matter what reputation that guy might have, you have no idea of what happens once it gets into his or her bank account. You leave not only the investment decision but the investment in their hands.

Know your investor

So, one lesson that should emerge from this crisis is to have your name on the investment and know what it is. Don’t go giving your money to another institution to invest for you unless you do your own due diligence and determine that the company to which you are giving your money has a decent balance sheet that can withstand a run on the bank or losses.

There are basically three kinds of assets, which are cash, property and shares. If people have money and they want it in cash, they can keep in under their bed or place it with a reputable institution with their own name on the deposit. If they want to use the money to buy shares, they can quite easily use a reputable broker of simply buy the shares through a web-based process operated by major banks that have their name on the scrip. If they buy property, it is quite easy to do so and have your name on the certificate of title.

Once you find yourself getting away from this direct process of investment, extra caution needs to be exercised and if people find it impossible to get a handle on the credit worthiness of the person or institution to which their money is entrusted, then don’t pass company with your money because if you do, you might never see it again.

Lest we forget

We go through phases of memory lapses. For the time being, the people who promise to make you a fortune will go into hiding but they will be back in the hopes that a new generation will be unaware of the tricks they play. So, the next thing I have learnt is to tell your kids and keep telling them so that when the gangsters are out on the street again, they will be recognized.

But above all, a great lesson from the recent catastrophe is that greed is not good and it gets people into lots of trouble. Greedy people have about the same statistical chances of success as people who go to the casino.

The other lesson that has emerged and should be kept in the forefront of people’s minds as we go forward is that people who took on debt without balancing the risk or factoring in how it could be repaid from the basic income or operations of the borrower, got into terrible trouble.

Debt is a phenomenal tool for growth but it is also a terrible weapon of destruction. At the moment, people are wary of debt because of the trouble that it caused to so many in the recent meltdown. However, as memory fades, the loan brokers will be back there in the marketplace pushing the stuff like heroin, damaging financial situations with catastrophic addictive consequences.

As we go forward, there are some simple rules about managing debt. “Why am I borrowing this money? Is it to grow my business?” If so, what security are you putting up for the loan and where will it leave you if you can’t repay that loan? Am I going to have my name on the asset I am going to acquire with the money I borrow? Can I safely convince myself and others that I am not influenced by greed? What will be the consequences if I don’t borrow the money? Will I be better or worse off?

Avoid the double whammy

In the recent financial saga it appeared that people did a double whammy and borrowed money to lend to people to invest for them. Hell! Putting together an asset which we can use as security for a loan is hard work. Treat that asset like it is your life support. For heaven’s sake, don’t give it to someone who hasn’t gone to the trouble and pain of acquiring that asset.

Finally, as one of my professor tutors was want to say “the future arrives just a little earlier than we expect”. While things are starting to look up and we move forward with optimism, it doesn’t hurt to keep in the back of our minds that every now and then something emerges out of the woodwork that is totally unexpected. The prudent person will always be able to weather the storm but those addicted to making a fast buck might come up short.

One cloud on the horizon is the problem created by the attempt to soften the consequences of the financial crisis, and that is the demand of governments and institutions for money. I don’t know how much money there is in the world but there needs to be plenty because that is how much governments want to pour into the market place and that is how much companies want to shore up their balance sheets.

Don’t forget supply and demand

There used to be a law of economics called the law of supply and demand. For a while in recent years, we forgot about this commonsense principle. However, money is a commodity just like oil and the greater the demand, the higher the price. I just worry about the enormous demand being placed upon the available supply of cash in the world and how long it can continue without increasing interest rates. There is nothing like the high cost of money to take the sting out of optimism. The alternative to borrowing money and a trick, only in the hands of government, is to print the stuff and nothing is more likely to result in inflation, which is then followed by an increase in interest rates.

As we move forward in this post GFC world, it is a time for cautious optimism. We need to keep our name on our money or investments and be prudent when it comes to borrowing.

Lou Coutts left law and became a successful entrepreneur. He has qualifications in Advanced Management from Stanford; turnarounds and strategic alliances from Colombia; International Marketing from the University of California and Changing Strategic Direction from the Kellogg Graduate School of Management in Chicago.