How pension plans, savings & other investments can distort the value of anything. Homes, gold, oil,gas, shares and big businesses....1

Here is our first example of how the abuse of innocently invested money can distort values in the stock markets as well as the cost of many products and services we use every day including homes. In this particular example the victim is a business.

Example 1:

   A tycoon buys a company with private equity money borrowed from a bank with a loan that is being initially paid for by 100,000 individual pension plans.
   A tycoon colleague with the help of another investment company could buy the same company later in exactly the same way. Only this time there are 120,000 individual pension funds. Even though the company may have changed little since the previous buy out, because the tycoon has as good as guaranteed the mortgage payments on a 20% higher amount (with the pension fund), the bank could be tempted into lending 20% more money.
   All the major players in this deal can benefit from it.
i)The private equity management company selling will benefit from a good profit from the sale of the company which will allow them to pay off their own mortgage on the subject company and leave a large profit that will have been relatively easily achieved.
ii)Both banks involved will benefit on the selling side of the deal and the buying side. The bank on the selling side of the deal will receive there mortgage completely paid off as well as an early repayment charge which will no doubt give bankers bonuses a boost. The bank on the buying side of the deal will receive fees involved in a new mortgage, as well as the interest which will continue to flow in. These could actually be the same bank, which would add to its vested interest in making this deal happen as double the fees would be received. .. You can see exactly why banks and private equity companies have struck up such a good relationship in the years leading up to the economic crisis!
iii)Individual investors will benefit from interest on their investments which is paid by the private equity management company when successful.

So there are no losers in this situation?
Well, there are, but you can see all about that in depth elsewhere in Anti-Crisis Economics.

Those directly involved in the deal can all benefit from the buyout deal, but unfortunately there are constraints on the buyout business which can become more restrictive on this type of 'business' with the passing of time.
   For the private equity buyout business to be successful, certain specific economic conditions are required. One condition is that there needs to be a growing amount of available money for investment into pension funds. If the total amount of money going into the financial system for these types of investments was to stop growing, it would affect the size of the loans that could be made available by the banks. This would make it difficult to sell big businesses at a profit. Basically when everyone who can afford a pension fund has one, and the rest of the population can not afford one, this business is likely to hit a wall. In this event pension funds invested in private equity  buyouts would suffer. However, whilst this may happen, bankers and private equity company staff will continue to collect their salaries even though bad decisions have been made on how the pension funds were invested.

   In the example explained above, a second pension fund has increased the value of the private equity subject company. The problem is the company does not have to actually improve its product or service or make any other changes to the business for this to happen. But in financial system that was based on reality, major changes in the purchased company would have been required for the value to grow this substantially. The first reason being that the company was in substantial debt after the first buyout, which should have de-valued it immediately.

NORTHERN ROCK ; The New Owners, The Virgin Group.

On 17th November 2011 it was announced that 'Virgin Money' were going to buy Northern Rock PLC for £747 Million.

Virgin Group is a British Branded Venture Capital Conglomerate and consists of more than 400 companies around the world.
A Venture Capital Conglomerate  borrows from banks to buy businesses which obviously increases the costs of those businesses as the debt for the buyout increases its costs until the finance is paid back to the bank.

Although it may be that Richard Branson has paid his own money for this bank the normal procedure would be to borrow 80% to 90% of the money from a bank and back the mortgage with a pension fund which would initially pay the mortgage. This would also remove most of the risk from Virgin Group.

As far as we are aware there are no rules which would prevent the Northern Rock Bank from providing the mortgage to Virgin Money to buy the bank.

Although the Bank will be in debt for some time, the price paid is judged by many to be a give away. If so the debt incurred will hopefully not become a problem for the new bank.

What is of more significance to us is how the new bank will operate.

The failure of Northern Rock was blamed mostly by the media on Sub-prime Loans. But what was not made quite so clear by parts of the media was that the debt for the U.S. sub prime loans had also been mixed with other types of U.S. debt which for some reason has had far less publicity. This debt included debt linked with Private Equity Buyouts. The problem with Private Equity Buyouts is that it adds costs to a business often without adding any benefits to the business.

-In the run up to the crisis, many businesses which were owned by private equity management companies in the U.S. were running into problems due to the debt they were burdened with. Due to the way that banks mix up debt, mortgages were being affected by failures in private equity and other precarious investments in banking. Endowment type mortgages were failing as a consequence. (Endowment mortgages are funds where your mortgage does not immediately pay for your home, but will pay for other business investments instead. The return on this investment should then pay your mortgage unless of course these investments should go wrong.-Anti-Crisis Economics explains why these investments go wrong!). In addition to this, many people were losing their jobs as companies managed by private equity management companies were going out of business.-Some had sub-prime loans, but if they still had their job they would still be paying their mortgages. 

The future of the Northern Rock Bank must be to learn from the mistakes of the past. Linking the business of putting roofs over peoples heads of ordinary working people and their families to the pointless and            un-sustainable re-mortgaging of businesses and property portfolios as well as investing in 'casino banking' in the stock markets is what led to the bank having to be bailed out. It was not caused by lending money to buy homes for the working people and families of Britain.

We would therefore wish good fortune on the Virgin Group and the new bank. But we do hope that the bank gives priority to the needs of the British people in the way of mortgages for people to buy their own homes as opposed to the kinds of investment which contributed to the crisis which has been high-lighted in Anti-Crisis Economics.

The Shocking figures in Private Equity 'Buyouts' in the months that lead up to the Financial Crisis.

   In 2006 British based Private Equity management companies raised £34 Billion for investment in company buyouts. This is almost 4 times the total for 2003. This money would be used as the equity or deposit on a buyout deal. The figures lent by the banks would be something in the region of 8 times these figures. Figures from the  British Venture Capital Association.
The United states figures for the same type of business however dwarf the U.K. In the U.S. £24 Billion raised for Private Equity investments in 2003 increased to a staggering £152 Billion in 2006.(Again this would form the equity or deposit in a buyout deal).

   In 2007, the big international lending banks were unable to off load $300 Billion of loans to private equity financed companies. This means basically that the stock markets would not buy the debt from the bank in the form of 'stocks' which is the normal procedure for banks to off load debt along with any risk. The cash can then be used for new deals. (It might be worth noting that this is a totally un-sustainable unless the bank of England was generating new cash at the same rate that the banks could invest it otherwise a cul de sac would be reached when the day would inevitably come when there would be no money available to buy the banks debt!)

   In  the Spring of 2007, the U.K.s biggest private equity deal prior to the financial crisis took place. Kohlberg Kravis Roberts (KKR) bought Alliance Boots (The company that owns Boots Chemists) for £11.1 Billion. Of this total £9 Billion was mortgaged by major banks.
   Due to the safety nets involved which protect the banks, these types of deals could continue as routine procedure and have done for a number of years before the banking crisis surfaced.
 Those safety nets include;
1... Pension funds are first in line to pay the mortgage on the company, so they take on the risk should the company fail after taking on masses of debt after the buyout.
2...The initial money involved in financing the mortgage does not belong to the banks as this comes from deposit accounts and other types of 'high' interest bank account. So here there is still no risk to the bankers themselves. The risk to these savers is however restricted due to safety net three.
3...Safety net 3 is one we have all contributed to in the years since the banking crisis surfaced. This comes into affect when a large bank runs out of money due to its investments turning bad (Many are bad to start with).  This is where a national central bank such as the Bank of England will bail out banks who have insufficient funds to continue operating as a bank. Although this should be an event which should occur only in exceptional circumstances, for most of us, those exceptional circumstances will be hard to find with today's banks. When I say exceptional circumstances could justifiably cause this event I refer to an Act of war or a national natural disaster. The 'events' that lead to the banking crisis however were none of these. The bail outs by the bank of England, Bank of America, and other central banks have been as a result of every day investments in 'business'. What is more incredible, is that this 'business' after all the turmoil it in-questionably has caused continues today.
  
   In addition to the safety nets involved in the Private Equity business, the following is also a factor which would encourage lending by banks as the purchased business is likely to 'add value' to its self in the future. The reason for this has absolutely nothing to do with the actual product or service offered by the business. The reason is that otherwise innocent investors into pension funds need to be fed buy investments. What would otherwise be idol money, is pumped into businesses which then obviously over values those businesses. But this doesn't matter to the private equity management companies as long as they know there are other private equity companies with growing amounts of cash which must be invested. If they don't invest this money the pension fund investor will stop investing as there will be know interest to pay to the investor. This is a no go area for these types of investment company. You simply do not sit on heaps of invested cash, even when there may seem not to be any thing of good value to buy. This provides Private Equity Management Companies with good opportunities to sell a company at a good profit.
   There is an other factor which contributes to the confidence that large banks have in lending money for big business buyouts, and one that gives the private equity management companies a Plan B. This is that if a private equity company is unable to sell a company to an other buyout company it can be floated on the stock market. In the stock market, stock brokers are in much the same situation as the private equity management company who has stacks of money which belongs to individual investors to invest which simply must be invested ... in something. Therefore companies off loaded by private equity companies who may have sold off many of the assets of the subject companies will still make a profit or at the very least cut their losses so they can go on to more lucrative deals. The secret of all this success basically comes down to the fact that the money the stock brokers will use to buy up these off loaded de-valued businesses is not their own money so they need not go into to much detail of justified values of companies and shares. The money they use belongs to investors with high interest  (Relatively speaking) bank accounts. In the case of the Private Equity Management Company (Buyout Company), the money they invest is not their money as it belongs to the investors into individual pension funds. The money provided by the banks for mortgages for buyouts does not belong to the banks as this to belongs to investors with bank accounts. All in all the individuals earning millions and in many cases billions of Pounds, Dollars or Euros are taking on very little of the risk involved in these deals.
   As a conclusion to this, you would have to say that the people involved in these deals though directly linked with the profits involved find themselves completely detached from any losses that may be incurred as these are passed on to other parties not directly involved in the deals.This has clearly had an affect on the lack of responsibility by the bankers in lending the vast amounts of money to business which will often de-value any product or service of a company along with the company its self.
   As above I mentioned that the secret to the success of the bankers (And the bankers themselves have been individually successful financially regardless of the crisis) , Private Equity Management Companies and the Stock Markets is down to the fact that they never use their own money. Its pretty much a case of 'Heads' the banks win and 'Tails' the economy and the rest of us lose. May be the secret for the solution in preventing a future crisis is in how individual investors in pension funds, deposit accounts and other types of individual investments choose to invest their money in the future.

Banking, Economics & the Media 1.....Capitalism.

There are many words in banking and economics which vary in meaning depending on a persons knowledge of the subject. Capitalism is one of these words.

The people who believe it to be a good thing are those who immediately benefit from it. Examples of those who immediately benefit from capitalism are ;

Bankers, Private Equity Management  (Buyout) Companies, Hedge fund managers, Property Tycoons, Stock Brokers and Bankers.

Unfortunately many of the rest of us also believe capitalism to be a good thing, but this is because the media has misled the public on what capitalism today involves. (See Anti-Crisis posts on Private Equity (Buyouts), Stocks &Shares, Hedge funds ).

Much of the money used to fund capitalism is borrowed from banks. Therefore top bankers will report to the media what is likely to be a biased point of view, which is that ;"Capitalism is funding entrepreneurs so they can make the world a better place for all of us." Well, they would say this. They need the public to deposit money in bank accounts so they can use it to make money and boost bonuses for themselves. The problem here is that bankers have a vested interest here, and need the public to believe they are doing great things with our invested money. Otherwise we might stop giving it to them. All too often the bankers will be re-branded as economics experts by the media and their total lack of expertise (and bias) in real world economics will be forced onto the general public. Because it may be transmitted by a mostly respected media company, the public in general don't question the information given. Unfortunately, I have to mention the United Kingdom's highly respected BBC on this point. It seems that every time the BBC gets an expert point of view on the economy it comes from a so called economics expert but they are from some form of investment business. Due to the nature of a lot of the business (I didn't say all) which is being invested in by these investment businesses, to treat a representative of one of these companies as an expert is much like asking a demolition expert to design and build a palace! The BBC advertises the fact that it does not allow advertising on the channel, yet seems to have no hesitation in allowing representatives from investment businesses, hedge funds promoting their own business. It doesn't matter whether there is a boom or a recession, you know that a representative from an investment company is going to tell you that there are good opportunities for investment. If they said anything other than this  they would probably be sacked from the company they represent. So what is the point of them taking up air time and wasting our time?

    One reason could be to create a smoke screen over the real capitalism that is being funded by our financial system. The capitalism I am talking about is not the funding of genuine entrepreneurs. In fact these people are no doubt losing out to the kind of businesses which capitalism is now funding. This type of capitalism ;

i)   Costs many thousands of jobs throughout the world.
ii)  Puts big businesses at risk due to massive debts incurred due to investment.
iii) Home costs become inflated due to investment in homes by property tycoons.
iv) Costs of vital services increase uncontrollably due to the nature of investments.

Combined, the effects of the above increase inflation, decrease our standard of living for most except for the wealthy. Unemployment increase due to the rising costs which need to be covered by employers wages. Taxes increase due to higher welfare costs.

If an economics 'expert' tells you his view on the current economy is that there are very good opportunities for investment in businesses, the chances are that he is encouraging investment into 'business' which is going to make us all worse off.

..The Media....
   Until the media takes its responsibility more seriously, the majority of us will be left with the distorted illusion we are being brain washed with. If so we will never see a real end to the current economic mess we are in. We will simply have to be satisfied with some demolition experts wall papering over the cracks in a collapsing economic system.