IT´S BUBBLY ALL AROUND BUT REALLY, DOES ANYONE CARE ? / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( VERY HIGHLY RECOMMENDED READING - A MUST READ )

It’s bubbly all round but really, does anyone care?

By Tony Jackson

Published: December 4 2009 22:12

There was something heart-warming about this week’s news that US bankers are resuming their carefree habits from the days of the credit boom. In lending to private equity, it seems, they are once more issuing so called covenant-lite and payment-in-kind loans, whereby borrowers are freed from irksome conditions and can pay their annual interest by simply borrowing more.

All this at a time when companies acquired by private equity last time round are sliding into default in record numbers. To paraphrase the satirist Tom Lehrer, it makes a fellow proud to be a banker.

The wider theme here is one of business as usual. Think only of bonuses, where bankers seem honestly perplexed by the notion that they should accept less because of a few unfortunate incidents now best forgotten.

The same slightly surreal atmosphere obtains across the world of investment. Not only are investors aware they are in yet another bubble, they seem not to care. It is as if the survivors of the first world war, having paused only for a cup of tea and a sit-down, were hurling themselves into the second.

The objective causes of this are familiar enough: continued rock-bottom real interest rates, the flood of liquidity from governments and so forth. But the more interesting question is one of behaviour. In the literal sense, what do these people think they’re doing?

Begin with portfolio investors. Anthony Bolton, the veteran UK fund manager who has just emerged from retirement to set up shop in Hong Kong, made some enlightening points in a recent FT.com opinion piece.

Granted, he said, Chinese equities might be heading for a bubble. But as an Asian acquaintance of his had remarked, a bubble is what you call it if you failed to get in at the beginning. If you did get in, it is a bull market. Besides, he continued, experience suggests that bubbles usually last for several years. To those more cautiously inclined, that might seem adventurous. But you cannot fault the logic.

It is also worth considering how this might apply to investors in general. The underlying premise must be that we can all ride the tiger, and we will all know when to get off. And there will, of course, be willing buyers at that time.

But Mr Bolton’s thinking is by no means unusual. In recent years, world markets have become so unstable that spotting and exploiting the next bubble has become the name of the game. So if doomsters warn that a bubble is forming, that is taken not as a threat but as a promise.

All this seems rather lost on policy-makers. Think of Gordon Brown, who was convinced, as Britain’s chancellor of the exchequer in the good years, that he had abolished boom and bust. When politicians now insist that the recent crisis must never happen again, one is tempted to suggest they should get out more.

As for bankers, there seems to be another psychological factor at work: a powerful sense of entitlement. This is reinforced, no doubt, by a kind of group-think, whereby those who count their pay cheques in millions tend to hang out with like-minded folk who understand.

Hence the outrage in Royal Bank of Scotland at suggestions the government might curb bonuses merely because it happens to be the owner. Hence too, presumably, the rumours of senior Goldman Sachs executives buying handguns to protect themselves from the baying mob – the alternative of prudent self-restraint perhaps not occurring to them.

That sense of entitlement is not confined to bankers. In the UK, it was recently calculated that chief executives of FTSE 100 companies had pay rises in the past year twice those of shop-floor employees. Defenders, including this paper’s own Lex column, argued that the fall in their bonuses meant that in overall terms they got the same.

Fair enough, some might say. When times are good, the bosses get more than the workers, and when they are bad, they settle for the same. Others might find that as a description of the process, the term “ratchet” has an appropriate ring.

None of the above, though, accounts wholly for the behaviour of US bankers in extending soft loans to private equity. This has raised eyebrows in Europe, where the practice has yet to recur. But European bankers were newer to the joys of private equity lending in the recent boom and the scars are evidently still fresher.

Nor are they yet following the US in reviving the practice of so called dividend recaps. This is a particularly deft way for banks to damage their own interests, whereby they make further loans to companies controlled by private equity.

The private equity owners promptly pocket that as a “dividend”. If the companies then buckle under the increased weight of debt, the private equity guys keep the cash and the banks lose their security.

This leads us into the murkier areas of human behaviour. You might think bankers are doing this to maximise their compensation at the expense of the business. But as the last crisis showed us, it is not that simple.

Over and over again, executives at the likes of Lehman Brothers and American International Group showed themselves capable of blowing their own fortunes through apparently gratuitous risk-taking. Alan Greenspan later commented how astounded he was that bank chiefs had not consulted shareholders’ interests. He might have added that the biggest shareholders were often the bank chiefs themselves.

Taken all round, this tells us that people are a lot less rational than we thought a few years ago. Beyond question, that is useful information to have. Whether it is comforting is another matter.

The writer is an FT columnist

Copyright The Financial Times Limited 2009.