Business Irish

Monday 22 April 2019

Why our leveraging love affair soured

WERE Groucho Marx alive today and residing in Ireland he'd be carrying a 12-gauge shotgun hunting stockbrokers.

You see during 1929 while acting on Broadway's 'Animal Crackers', Marx, who had built up a personal fortune of about $250,000, got caught up in the American passion for investing in the stock market. He wasn't the only one. The development of railways, the automobile and mass electrification had convinced many Americans that the market could only go in one direction.

Everybody was giving stock tips at the time and Marx listened, then borrowed money to buy shares.

That was before Black Thursday, which was followed by Black Tuesday, as Wall Street lost all of the gains which had built up over the previous thirty years.

It was 1954, almost thirty years later, before the Dow Jones Industrial Average recovered to pre-1929 levels.

Marx lost his entire fortune. He took it so badly that he went into a severe depression and a stand-in had to take his place on 'Animal Crackers'.

The only thing Marx gained from the experience was a joke, albeit a classic: "I made a killing on Wall Street the other day ... I shot my broker".

There are obvious parallels between the Great Crash which many believe prompted the Great Depression, and the current turmoil afflicting the markets, particularly for Irish investors.

Causes

In his seminal 1954 book, 'The Great Crash', John Galbraith argued that there were five underlying causes, including an imbalance in income distribution, and America's trade imbalance.

The other causes he identified were new complicated corporate investment entities, poor banking and "the poor state of economic intelligence".

New complicated structures have globalised exposure to the American sub-prime market causing a lack of trust among banks and bringing the trade in inter-bank loans to a halt.

Many people also blame the crash on margin trading where people such as Marx borrow to buy stocks. That the Iseq has had falls which are greater than its peer indices is due to a similar phenomenon today -- the Irish investors' love affair with CFDs (Contracts for Difference).

These are complicated financial instruments which allow you to leverage exposure to stock without technically owning the underlying share. Some estimates suggest that up to 50pc of trades in the Irish market can be attributable to CFDs.

As much as 3pc of Ryanair stocks are held on behalf of CFD holders. As the markets have gone into freefall CFD holders have been faced with margin calls.

A 10pc fall in the share price of a particular stock could be enough to wipe out a CFD holder's entire investment.

There are unsubstantiated rumours that one Irish investor had exposure to 100m of CRH stock through CFDs, which might explain the unusual volatility of that stock.

Many serious investors eschew the use of CFDs. While they can be a useful instrument for the sophisticated investor, most shareholders in Ireland and elsewhere do not fall into that category.

The use of CFDs to quietly build up a position in a company, such as Sean Quinn's position in Anglo Irish Bank, has already prompted calls for their review.

Exposure

But while the regulators look at CFD at a macro level, many investors who have lost small, and large, fortunes over the past week are also questioning their exposure to the instrument.

Perhaps it is our experience with property which has prompted our exposure to CFDs. People, already used to leveraging up to buy property may find it easy to accept the risk of leveraging up to buy shares. The difference is that if you put €500,000 into a €3m property investment and the value of the investment falls by 10pc you do not have your bank ringing you up on holidays saying you have to inject another €500,000 or lose the property.

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