You’re going to love this joke. Seriously. It’s classic. And it’s all true.
Two gay guys walk into a mortgage broker. The mortgage broker says, “Do you have some undisclosed assets?”…
“That’s what he said!”
Ok, this isn’t quite how the story goes. But it does start with two men, pretending to be gay, walking into mortgage brokers across Western Sydney.
This is the story of a beautiful sting.
Last week, you might have heard a story doing the rounds about a special undercover-exposé conducted by a mildly-famous economist into Western Sydney’s housing market – which caught a special run on 60 Minutes.
In case you missed it, this is the story as we know it:
Economist Jonathon Tepper from Variant Research, together with his employer John Hempton from hedge fund Bronte Capital, pretended to be a gay couple, and went undercover into Western Sydney’s mortgage market. They shadow-shopped a number of mortgage brokers across Western Sydney, and found that mortgage brokers were encouraging them to be creative with their applications, and even lie about their details.
Some, apparently, offered to forge up tax returns on their behalf. They were also encouraged to borrow an ‘excessive’ amount.
Tepper and Hempton then blew the story though a short release to the AFR – the bulk of the report was reserved for Bronte Capital clients. They combined their shadow-shopping results with an overview of market fundamentals. The words “insane”, “crazy”, and “ponzi” were bandied about like nobody’s business, as well as a prediction for a price crash of 50-80%!
(Any of this sound familiar?)
The story went viral – not just here in Australia, but across the world. It had that viral factor. Economists pretending to be gay. An undercover sting. Irresponsible lending practices. A financial system at risk. Some of the biggest banks in the world caught with their pants down…
The story spread like wild-fire.
Markets freaked out. Banks shares were hammered.
That’s what we know.
What we didn’t know was that Bronte Capital and its clients had taken out short positions on the banks ages ago. That is they had bets in place that bank share prices would fall.
They had also gone “long” credit default swaps (CDS), which appreciate in value when investors think that bank repayment risks have increased.
Chris Joye at the AFR reckons Bronte Capital had established short positions around February 9 – over three weeks ago.
Back then, it seemed like a good bet. The property market looked a little shaky after Christmas, and banks were facing funding pressures off-shore.
But then on February 10, CBA released its half-year results, which showed default rates across CBA's home loan, personal loan and credit card portfolios declining from what were already among the lowest levels in the world. It turned out that the plunge in oil prices that had rocked markets had been a blessing for households.
That’s not news a short-seller wants to hear.
It got worse. In the following week NAB, ANZ and Westpac also published trading updates that revealed few impairments and modest default rates.
And despite the wobbles over Christmas, property values increased in January, auction clearance rates steadied, and the “crash” started to look a long way off.
And so despite the worse predictions, the banks looked solid.
Cue PR campaign.
Hempton and Tepper’s released their “research” on Februrary 23, and it quickly went viral.
As a result, bank share prices were hammered. CDS spreads (their cost of capital) jumped 18 to 35 basis points – the biggest single day move since the GFC!
The short-sellers had a field day. Tepper, Hempton and Bronte Capital made a crap can of money.
The sting worked like a charm.
As one trader in Asia said:
“It's pretty obvious this was a well-planned drive-by from the hedgies. They were putting on the short equity and long CDS trades weeks in advance and started taking profits after the media campaign hit home.”
That last point is important. If they genuinely thought a crash was coming, they wouldn’t have cashed out so quickly. They would have waited for things to get worse. If they were expecting a 50% fall in prices, why weren’t they waiting for it?
Because they never really believed it.
Sigh. Just another day in the markets.
It’s tempting to laugh it off. One big hedge fund makes a lot of money at the expense of other hedge funds and the big banks. It’s almost a victimless crime.
Or it would be if it wasn’t for the impact such scare campaigns have on the public – which in turn can shake the value of the houses average Australians own.
But we’ve seen it before, we’ll seen it again.
Banks have left themselves open to attack. By effectively outsourcing a good chunk of their underwriting functions to external mortgage brokers, they encourage doubts as to whether those processes are up to scratch.
Those doubts might be justified.
But at the end of the day, this is just a clever sting to turn a quick buck.
Just goes to show. Believe half of what you see and none of what you hear.
But don’t let me wind up in the talk-is-cheap camp. I’ll put my money where my mouth is.
Let me offer up a little bet to Tepper or Hempton. If any suburb within a 25km radius of the CBD of Sydney or Melbourne sees a fall in median prices of 20% or more in the next 2 years, I’ll pay them $100K.
That’s not even half of what they’re “predicting”.
If not, then I get the money. Heck I’ll even give him 2:1. $200K to him or $100K to me.
Funny? ‘Ha-ha’ funny?