03 August, 2011

Telling it straight

One of the nice things about quality financial writing is it not only tells you what's going on, it does it in a clear and personal way. If I want to know what's going on, I usually find more value in the Wall Street Journal than the New York Times, and FAR more than anything coming out of Washington. This is because if you are financial advisor--and you're not "too big to fail"--you need to tell your clients the truth as you see it.

A good example of this is a recent letter from Oaktree Capital Management to its members. The letter was posted online by Oaktree (here), and it's pre-"compromise," so I assume I can now quote a couple of paragraphs. (If I'm wrong, let me know and I'll immediately remove this post.)
One of the most striking aspects of debt in the modern era is that little if any
attention is paid to repayment of principal. No one pays off their debt. They merely
roll it over . . . and add to it. Thus credit ratings are highly deficient (shocker!) in a way
that few people talk about. What ratings describe isn’t the borrower’s ability to repay
principal, but its ability to make interest payments and refinance principal. But the
assessment of their ability to roll their debt – likewise – isn’t based on an ability to repay,
but rather to refinance again. So ultimately the security of capital providers stems not
from the borrower, but from the continued willingness of other capital providers to roll
debts in the future. (It was their occasional refusal in 2007-08 that caused the worst
moments of the financial crisis.) 
With no one asking how debt could be repaid, nations were allowed for decades to
increase their deficits and debt non-stop relative to their GDP. And then, in the first
quarter of 2010, the little boy stepped out from the crowd, took note of the
emperor’s non-existent new clothes, and said “Hey, wait a minute: Greece will never
be able to repay even the debt it has, forgetting that it takes on more all the time. Its
economy is non-competitive and stagnant, and tax compliance is non-existent. They
shouldn’t be able to borrow.”

That’s all it took. Greece was denied further credit. And then people took a look around
peripheral Europe and saw more of the same. Today, although the situation is nowhere
as dire, they’re also looking at the U.S. and some of its states.
The entire letter is a thirteen page pdf, and well worth a read.

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