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Making Margin Calls on Pork Bellies

September 29, 2011

Below is a submission I wrote back in March 2008 for Heckler, a reader’s column in the Sydney Morning Herald, but for some reason I never sent it in. It was in response to the Global Financial Crisis, and what I saw as the ludicrousness of a financial system that had become so self-referential that people are making money from intangibles completely removed from the source of the original unit of productivity, and had created an ecosystem where a crisis in one part of the market could bring down everything else. We are still seeing this today – for example, the concerns over European sovereign debt blamed for the fluctuations in the Australian share market.

I don’t think our financial markets have learnt much from the GFC, and most of what I wrote in 2008 still holds true three years later. (I’ve added URLs to the original article I wrote.)

Making Margin Calls on Pork Bellies

Money markets and matters of finance have always been a mystery to me. However, the latest string of financial collapses has taught me a lot about modern economics.

When I heard the news that the US subprime mortgage crisis had caused a meltdown on the world’s financial markets, I wondered, “what is a subprime mortgage?”

Apparently, that is where companies lend money to people to whom they really shouldn’t. Most do this through what they quaintly call “low doc” or “no doc” loans – otherwise known as the “what I don’t know won’t hurt me” loan. When some of these subprime mortgage lenders went belly-up because too many of their borrowers (the people they shouldn’t have lent money to in the first place) reneged on their loans, it had a domino effect on various investment houses around the world who thought it was a good idea to sink funds into these businesses.

One of those was 140-year-old French bank Société Générale, where one of its futures traders lost an estimated €4.9 billion in trades involving European stock index futures. I was a bit more confident with this one – I’d seen the movie Trading Places, where Eddie Murphy discovers he has a gift for predicting pork belly futures, which is based on the future unit price of 20 tons of belly. This is a tradable commodity in the US because Americans like their bacon to be streaky. I guessed that European stock index futures were something similar.

Back in Australia, the subprime mortgage crisis affected one of our companies. Allco Finance Group’s share price has plummeted, with concerns raised about the level of related-party transactions undertaken by the company. What on earth are related-party transactions? I looked it up on the ASIC website, which defines them as transactions you enter into with someone who has a close, and possibly privileged, relationship with the company. It’s a bit like buying a car from your parents.

However, Allco’s big problem was margin loans, the same thing that hit ABC Learning Centres. This Australian childcare success story found itself in a hole when the share price fell and the founders were subject to a “margin call” from lenders. I’m still a bit in the dark on how this all works, but it seems that people borrow money to buy shares, but then have to pay it back if the shares fall below a certain level.

Armed with all this knowledge on how our global financial systems work, I’ve got a great concept for a new business. I am going to offer low doc, margin loans to related-party companies looking to invest in stock market futures. Now I just need to borrow some money to finance my new venture.

Any takers?

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