NEWS // The credit crunch has sent shockwaves round the world’s financial markets...
The credit crunch has sent shockwaves round the world’s financial markets with dire warnings that Credit Defaults Swaps (CDSs) may have a much greater impact than collateralised debt obligations (CDO). Property Funds are having to delay redemptions because of the decline in the property market, the FTSE 100 index is still to recover to its peak of 8 years ago and the AIM index is only now trading at around its launch level of 1000 in 1995.
Private Equity has come in for much criticism and last year more capital was raised in the City for Private Equity Funds than was raised in the stock market. The principal activity of Private Equity Funds is buying existing businesses (as distinct from investing into them) typically in highly leveraged deals. Once of the country’s major strategic assets, British Airways Authority, was the subject of one such deal which was 95% debt funded. It has been the subject of a recent television investigation suggesting that it may be in danger of breaching its banking covenants.
It is therefore a good time for investors to reflect on the fundamentals of investment to consider what has gone wrong in the financial markets and what, if anything, might be done to achieve positive returns over the long term.
The one common thread which runs through all of this is that the vast weight of capital which supports Western economies is concentrated in the aftermarket. Investors trade ever more sophisticated financial instruments in the hope of short-term returns but the money which changes hands passes over the top of the businesses concerned and is not invested into them. It is a zero sum game which creates winners and losers but does little if anything to support the overall process of wealth creation.
This may help to explain why economic growth in the “BRIC” (Brazil, Russia, India and China) economies far surpasses that of Western economies. In the BRIC economies vast amounts are being invested both in infrastructure and in primary investment to create vibrant new businesses with the result that Western economies are being transformed in a single generation from manufacturing to service economies.
The economic dominance of the West over the past 200 years comes about because of a very simple formula:-
“Capital plus Innovation = Wealth creation”
This has been made possible by a basic legal structure which we in the West all take for granted – the joint stock company with transferable shares and limited liability. It is this fundamental legal concept which has facilitated the engagement of capital and innovation and in doing so precipitated the whole process of wealth creation which has driven Western economies for the past 200 years.
Many would be forgiven for thinking that Western capitalism has lost its way when the world’s biggest wealth management company has had to be baled by the Government of Singapore and many of the world’s leading financial institutions have had to turn to Sovereign Wealth Fund in the Middle and Far East for the financial support required to repair their balance sheets damaged by the CDO crisis. Continued...