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Market Review: July 2009 Commentary

Real recovery will take a while.   Peter Lynn describes how people will start to spend again.  But, that could be more than a year away.

Tuesday, July 7th 2009, 1:25PM

When he first came to many people's attention, he was a Thriller.  Then he became Bad, followed by Dangerous.  He thought he was Invincible.  He was always Off The Wall, Now, he is History.  I am referring, though, not to the sad end of Michael Jackson, but to one Bernie Madoff.

I have talked about Bernard before in these columns.  He perpetuated the largest Ponzi scheme in history, ripping off investors to the tune of what Madoff himself estimates as about USD50 billion.   US prosecutors actually have no idea how much was lost, but have said it could well be USD65 billion.   The judge who sentenced him demanded that he hand over USD170 billion in assets that had flown through his scheme's accounts.   Yes, you read right, USD170 billion - that is over NZD260 billion! NZ's GDP is only around NZD180 billion!



Madoff has now been sentenced to 150 years in prison.   That, apparently, is the maximum sentence.   Madoff is 71 years old and felt that a 12 year sentence was far more reasonable.   Dream on.

His sentencing involved hearing nine of his former clients/victims tell of their despair and outrage.   At the end he turned and faced them and said "Sorry.   I know that doesn't help you."

This case, though, may never be fully uncovered.   Madoff will shuffle off to his cell/grave taking the full blame for the crime.   It is hard, though, to imagine that he was the only criminal here.   Apparently, he never invested a cent - just used the money being "invested" to pay investors.   This is the most purest form of Ponzi scheme.   How can one man do this on his own for decades?  What did the employees at his firm actually do all day?  If they actually thought they were investing money through brokers, were the brokers involved in the scam?   Regrettably, we will probably never find out the full story, as Bernie's secrets will likely be kept with him to protect others, including, possibly, his sons.

His wife, Ruth, got to keep USD2.5 million (after being forced to give back most of the USD90 million in her name).  This was supposedly money that was hers - that she had saved up over the years.  I hope she releases a book to tell me how to save USD2.5 million without having any form of income.

Whatever the truth in this whole sordid mess, it does not do a lot of good for the investment management industry.  It has been easy enough for investors to lose money on sensible investments without fraud entering as a viable method of also losing money.  Madoff's wasn't the only scam around - Allen Stanford (the 20/20 cricket sponsor) was also arrested in June for the same crime.  Unfortunately, these scams usually unravel when the markets can no longer disguise the frauds.  So we may well see a few more financial crimes get punished as this recession drags on.

The judge who sentenced Madoff wished to make a statement to would-be financial criminals that the law will deal with them very harshly.  Well done to him for sentencing Madoff to such a lengthy time in jail.  Whether it has any impact on financial fraud, though, remains to be seen.

At the very least, this fraud suggests that there needs to be a greater level of scrutiny made before funds are invested.  Such scrutiny should be made not only by those doing the investing, but also those regulating these investments.  It is an indictment on the regulators that such a Ponzi scheme was allowed to exist for so long.  The end result is that the level of regulation is likely to be stepped up.  This is both good and bad - good in that such frauds get detected more quickly, bad in that the general costs of extra compliance generally get passed on to investors.  We await to see the full impacts of this.  In the meantime, just beat it, Bernie.

On a different theme now, I was fortunate to recently have a vacation in the US, specifically the Southwest (Arizona, Nevada, Utah).  On my return, many people have asked with interest as to what I witnessed in terms of tangible evidence of the true impact of this financial crisis on the US economy, which seems to have suffered the most from it.

The three states I spent most time in are not the wealthiest states in the US, although in cities like Phoenix/Scottsdale (and parts of Las Vegas) there is an awful amount of wealth - and an abundance of people who are happy to conspicuously flaunt it.

There are certainly a huge amount of deals/bargains available in the US at the moment.  Whether these take the form of massive discounts on hotel rooms or large sales at almost every shop, the land of the promotional opportunity has become even more opportune.

This is manifesting in where US citizens seem to be spending their time.  Upscale shopping malls (the ones with Gucci, Prada, etc) only seem to be used as an air-conditioned escape from the early summer heat, whereas outlet malls are generally packed with people with numerous shopping bags on their arms.  However, that only applies to outlet malls that are close to main residential areas - those out in the wops that you have to drive half an hour to were almost completely empty.

Similarly, restaurants seems to be struggling a fair bit and offering all sorts of incentives to encourage patrons to actually sit down and have a nice dinner.  Go into a fast-food restaurant, though, and the queues are massive.

Movie box offices in the US are having bumper weekends, while the far more expensive production shows are struggling.  I went to a show in Las Vegas that was less than a quarter full.

Las Vegas is the epitome of the American Dream and now also the American Recession.  The hotels are offering ridiculous prices for rooms - I got a room at the four-star Las Vegas Hilton on a weekend night (which are much more expensive than weeknights in this city) for USD55.  That is exceptional value and it appeared that many other people had also taken advantage of it.  The queues at the check-in desks were massive (as they were for every other hotel I saw in the city) and the pool areas had every deck chair occupied.  The casinos, though, while busy on the weekend nights, were dead on the week nights.  However, there were an awful lot of people out enjoying all of the free shows and attractions during those week nights.  It appears that the recession is not stopping people from enjoying the opportunities available, as long as they don't cost too much money (or, even better, are free).

As is well known, the construction industry in the US has taken a massive blow over the past 18 months and nowhere is this more apparent than in Vegas - a city of perpetual building/demolishing/rebuilding.  The largest construction project in the US is a hotel/residence/commercial group of large towers that fill in a big block on Las Vegas's famous "strip" between the dancing fountains of the Bellagio and the Monte Carlo casino.  Its cost is US11 billion and it is due to open soon, however, it was almost cancelled in March as one of the partners, a Dubai-based firm, could not put up a USD200m payment.  Fortunately for the project, the bankers of the main backer, MGM Mirage, were able to grant enough credit to keep the venture continuing.  MGM, by the way, has about USD14 billion in debt already. 

Two other casino projects on the strip (both around the USD5billion level) have recently gone into bankruptcy and many other massive projects (in various stages of construction) have been put on indefinite hold.  
Even the most optimistic self-promoter, Donald Trump, who, on the success of his very tall hotel tower immediately announced the construction of another tower building right beside it, has had to quietly announce that nothing is going to happen on that front for a while.

Now, as long as interest rates are kept relatively low for a longish time, people will eventually get a bit sick of only taking advantage of free or discounted things and actually start to spend some money.  This will help the corporates and the economy and eventually these projects in Las Vegas and elsewhere in the world will get completed and the Great Recession will be over.  However, to get to that stage, we need to get a brake on the rising unemployment and a return of more economic certainty.  These could well take until midway through 2010.  It is going to take a lot longer than people originally expected.

Peter Lynn, CFA
Head of Strategy

« Market Review: July 2009 London CommentaryChinese recovery could be 'biggest disappointment yet' »

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