Two more reasons why investors shouldn't trust governments
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MoneyWeek Editor
John Stepek Dec 02, 2009
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The key lesson from the Dubai debacle is this: don't put your faith in governments.
Earlier this week, the Dubai government said that it didn't have to stand behind Dubai World, its commercial arm. And, it said, if investors had only read the small print, they'd have known that all along.
But investors hadn't read the small print. They'd assumed that state-owned meant state-backed. And no one had said anything to dissuade them during the good times.
It goes to show the dangers of trying to invest alongside the government. And it's not restricted to Dubai.
In fact, over here in Britain, RBS shareholders have just had a nasty reminder that government promises are frequently broken...
Investors can't trust governments
Dubai's decision not to stand behind Dubai World clearly came as a big surprise to some investors, as the market reaction last week showed. But it's a reminder of one of the most important rules when doing any deal: "always get it in writing".
As David Robertson points out in The Times, "in the past loans had been arranged on 'a nod and a wink' because it was assumed that state-owned companies would be backed by their governments." Not any more (at least, not until the next big bull market, or until Abu Dhabi bails them out).
It's a reminder that as an investor, you can't trust governments. That's not cynicism speaking, it's just the way things are. A government's job is not to serve shareholders or bondholders in a specific company. Its main goal – democracy or dictatorship – is to stay in power for as long as possible. This goal doesn't always coincide with the best interests of the companies it runs, as Royal Bank of Scotland shareholders have just discovered.
RBS institutional shareholders are up in arms over the government's demand to have approval over both the structure and size of this year's bonus payouts. They put forward all the usual arguments – it'll be hard to hold on to good staff, pay decisions can't be dictated by the government, etc. But regardless of what you think of the rights and wrongs of these arguments, it's hard to have sympathy for anyone still hanging on to RBS shares.
RBS is 70% owned by the government, and is dependent on it for its continued existence. More than any other British bank, it symbolises the folly of the banking sector and the huge costs that have been dumped on British taxpayers.
Sure, Lloyds is heavily government owned too. But at least Lloyds has some political leverage, in that it only sank itself because it stupidly agreed to do the government a favour and mop up the toxic mess that was HBOS.
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RBS - a political football
But RBS beat its own path to hell. So you'd have to be naïve in the extreme to imagine that the bank wouldn't become a political football. And with 'ordinary' people up in arms over bonuses being paid out by banks which have chewed up billions in taxpayers' money, this is the high-visibility issue that the government really cares about, regardless of the impact on the overall business.
The pro-bonus arguments do seem somewhat overstated. How much genuine star 'talent' is left at RBS anyway? Most financial whizzkids would surely have recognised the dangers inherent in working for what is, in all but name, a nationalised bank. I'd be surprised if all the top headhunter fodder hadn't already been poached by other banks. And the list of countries for disillusioned financiers to flee to is shrinking by the day. When the initial furore over bonuses began, many threatened to head to Dubai. You won't be hearing that particular threat for a long time.
Of course the government shouldn't be directly setting pay policies in what is ostensibly still a private sector company. That should be up to management and the shareholders. But with a 70% holding, like it or not, the government owns RBS, just like it owns the NHS, and the school system. It can do what it wants with it. Not all of those decisions will be sensible ones. And as we can see from the way the public sector works, most decisions will be made on the basis of maximising short-term political gain, rather than shareholder returns, or efficiency, or customer satisfaction. But the minority shareholders should have known that from the minute RBS went bust.
Avoid gilts and buy gold
This is one reason why at MoneyWeek, we prefer to invest in markets that aren't being manipulated by governments. For example, we don't like the market for UK government debt (gilts). As well as being historically over-priced, we don't like the idea that ongoing demand turns largely upon the Bank of England's next decision on quantitative easing.
And it's one reason that we do like gold. As my colleague Dominic Frisby regularly points out, unlike paper money, gold's value isn't dependent on a government promise. Gold's rising price is largely because investors are concerned, not about inflation or deflation as such, but about the undermining of paper currencies.
Getting back to the Dubai situation, investors already seem to be sweeping it under the carpet somewhat. But a lot of promises that couldn't be kept were made during the bull market. We suspect Dubai is far from being the last nasty shock of the credit crunch. We've more on Dubai in this week's edition of MoneyWeek magazine, out on Friday – if you're not already a subscriber, claim your first three issues free here.
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