Category: Finance

Yes, it did. The Facebook IPO valued the company at approximately $100 billion! Are they mad? What were they thinking? Easy to say that now but I think I have ranted at length to friends about insane valuations on Web 2.0 companies. These companies haven’t really proved that they can make all the much money off the many millions of users that they have. I for one can’t remember that last time that I clicked on a Facebook advert. I would like to say I never have but sometimes stray mouse clicks occur (I remember this causing accidental friend requests which is awkward and annoying). I can’t say I even notice them there much. I have definitely not bought any Facebook tokens/credits or whatever they call their attempt at a digital currency.

So what was the route of that crazy valuation? Web 2.0 companies burn cash at alarming rates. They have all that server hardware to keep running and must constantly innovate to remain relevant. Its likely that the venture capitalists behind building Facebook into what it is today wanted some of there money back. Not only that I assume that they too where taken in by that headline figure of 900million users or whatever it is. So based on promises of untold access to millions of people and pressure from venture capitalists the valuation had to be sky high. They didn’t have any other choice. Not to value highly would be to admit that the whole business plan wasn’t what they lead us all to believe. The problem is that it doesn’t matter how many users you have if all they do is turn cash into heat via looking at some pictures of their mates.

So after leaving it to the very last second (well maybe hours) America avoids a voluntary default. Most people didn’t seem to think it was going to happen. Although I suspect that it was more hope than insight. Not only has a default been avoided, it looks that for now at least there will be no downgrade of US treasures. Odd that I think; the US looks in a bad way. The economy is slowing. Growth slowed for the last quarter and the previous quarter was revised down. Manufacturing is down too. However this new data might serve to support a watered down deficit reduction plan. The new debt deal will cut spending by about $2.5T, about half what the rating agencies were calling for. if the economy is slowing then perhaps this isn’t the time for tax increases and spending cuts. In some ways the US and UK are following different paths. Who will fair better? On the face of it the UK is getting support from the markets. With interest rates on it borrowing dropping to an all time low, 2.75%. I can’t thinking that perhaps the world is just looking the other way at the minute. Problems in the US, and further crises brewing in Europe (Spain and Italy have seen there borrowing costs increase sharply) mean that no-one is paying close attention to the UK right now. How long will that last I wonder.

So are exchange traded funds (ETFs) the next CDO? That is, are they a likely cause of the next financial crise? Well, its possible that is for sure. Particularly as they are linked in some ways. First of all it is worth pointing something out. Lets imagine I want to set up an ETF that tracks the FTSE 100 stock market. I have two possible options. One is to set up a fund that buys an equal amount of shares in all the FTSE 100 companies. That fund will then track the movement of the FTSE 100 exactly. People can give me money I buy the shares and everyone knows what they are getting. The fund will go up and down with the FTSE 100. This is very simple and its is easy to understand how it works. This is a standard ETF.

Now, lets muddy the waters. Enter synthetic ETFs. An organisation can offer a synthetic ETF that tracks the FTSE 100. The provider of the fund grantees that its value will change in line with the FTSE100. However, the provider can take the money that people invest and put it where ever they like. The idea is that the provider thinks its really smart, and that it can take your money and invest it in such away that it beats the FTSE 100. It has only guaranteed you what the FTS100 makes and therefore it can keep any additional profit.

So in theory everything is great. You get your relatively safe investment fund. The clever people in the bank get more money to invest and make prophet on. The problems come when the bank makes a loss on the investments that they really make with your money. In theory they have guaranteed it, so they have to pay up. This is where things get even more complicated. In order for the bank to take your money elsewhere to invest it they have to put up some collateral in case those other investments do loose money. This collateral is then used to fore fill any obligation to you.  Ok, fine. Its complicated but it sounds sort of ok. However it is the quality of hat collateral that is what scares me and it is scaring other people too.

So lets say that instead of buy FTSE100 shares with your money in my EFT. I setup a synthetic ETF and buy something else. I then put collateral up to guarantee the fund in case I go bust. Lets say I do go bust. You don’t get your share of FTSE 100 companies, you get a share of whatever I put up as collateral. That could be a real mixed bag of sovereign debt, company bonds, whatever really. How would you feel if I had put Greek sovereign debt up as collateral for my FTSE100 EFT?

Things get ever more murky and hard to follow as that collateral could be wrapped up in a nightmare of collateralized debt obligations (CDOs), credit default swaps (CDS), over the counter (OTC) swaps. What would all that mean? Where would you go for your money should I fail? It does start to look like the makes of another credit crisis where know one knows who owes what to who and how much. There are calls to increase the transparency of synthetic EFTs, particularly what the collateral is. I think we need that.