By John Mauldin
Quick: I say "German banks," and
what's the first thing that comes to your mind? The Bundesbank? Staid,
no-nonsense central banking? The Bundesbank is all about maintaining the price
of money – forget QE. Deutschebank? Big, German – must be stable and low-risk.
The fact that southern Europeans are opening accounts left and right in DB must
mean that DB is lower-risk than the local wild guys. Except that they have the
largest derivatives portfolio, at $70 trillion (but don't worry because it all
nets out, sort of, and of course there is no counter-party risk!), and they are
the most highly leveraged bank in Europe (at 60:1 in the last tests – not a
misprint), which might give you pause. Although their CEO argues that their
leverage doesn't matter. And keeps a straight face. Just saying…
If something happens to DB, they are, in
all likelihood, Too Big To Save, even for Germany. But Deutschebank is not my
focus here today. It is their much smaller brethren, Too small to be called
siblings, actually. More like first cousins twice removed. But there are a lot
of them, and they all piled into some very interesting and, as it turns out,
very questionable trades. And the story begins with the American consumer.
This Christmas, we will all engage, as
will much of the world, in an orgy of gift giving. (I helpfully offer a few
ideas of my own at the end of the letter.) The iPads and Xbox Ones and GI Joes
with the Kung-Fu Grip (gratuitous esoteric movie reference) will be flying off
the shelves. But the one thing that ties all those gifts together is The Box,
the humble container unit, the TEU, which allows the world to transport all
those items ever more cheaply. That story is resoundingly told in a book that
Bill Gates featured in his Best Reads for 2013, simply entitled The Box. You can read a great review here. It turns out that the shipping container was created in the '50s by a
force-of-nature entrepreneur who fought governments and regulators (who
typically tried to protect unions rather than help consumers) to bring the idea
to market. It finally took off when the military decided it was the best way to
ship material to the troops in Vietnam. It is one of those things that make
sense and would have happened anyway, but as often happens, military spending
drove the ramp-up.
The container was not without controversy.
Longshoreman unions fought it aggressively, as containers meant fewer
high-paying jobs. But The Box also meant far cheaper transportation of goods,
and so it helped boost international trade. Now it is hard to imagine a world
without containers. And even though the container business started in the US,
there is not one US firm in the top 18 container shipping companies. The
business is dominated by European and Asian firms.
And container ships were profitable. Oh
my, fortunes were built. And they were so successful that a few German bankers
looked at the easy money made by US bankers securitizing and packaging
mortgages and decided they could do the same with ship financing. I know it is
hard to believe, but the German government decided to create pass-through tax
vehicles that gave serious tax preference to high-tax-rate investors for all
sorts of things, including movies (such cinematic monuments asTerminator 3, I Robot, and the forgettable Stallone flick Get
Carter were financed
with German "tax shelters"); but my research has so far unearthed nothing
to equal the German passion for financing ships. Seriously, would any US
government entity give tax breaks to a favored industry? Would a Canadian or
Australian or [insert your favorite country here] government? Such things are
done by many governements, of course. Here we may apply Mauldin's Rule (stolen
from someone else, I am sure): Any seriously out-of-whack financial transaction
requires government involvement (generally in the form of some
market-distorting law).
Cargo ships, especially container ships,
were serious cash machines for long-term money. Buy the ship with some
leverage, put it to work, and watch the cash roll in. The Greeks were
especially good at this, but the Germans and Scandinavians caught on quick. The
Germans went everyone one better and allowed small high-net-worth investors to
put their money into funds that financed these ships. At one point, I am told,
German banks might have been financing 50% of the world's cargo ships. (They
control at least 40% of the world's container ship market today.) Anyone
familiar with limited partnerships in the US in the late '70s and early '80s
knows how this story ends for the investors.
I came across this story from the inside,
as a business partner of mine is in the shipping business; but he owns and
operates a special type of ship: massive tugboats that move ocean drilling-rig
platforms, and those are still in healthy demand. But his original financing
many years ago was from Germany.
It turns out that if a little leverage
makes a deal look good, then a lot makes it look even better. In 2007, ships
were financed at 75% leverage (on average). It looks like 2008 vintages were
financed in the 90% range! (Data is from a presentation I was sent, done by Dr.
Klaus Stoltenberg of NordLB.)
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