A Cautionary Tale

Last Wednesday, the Reserve Bank of Australia (RBA) left rates unchanged.

This is the 17th RBA meeting in a row where interest rates have remained at the record low of 1.50%.

Central bankers around the world have been keeping interest rates low to fuel inflation. But so far they have failed to do so.

Instead they have boosted almost every asset class, from stocks to property.

As Jim Grant, publisher of the newsletter Grant´s Interest Rate Observer, recently told The Australian Financial Review, central bankers are creating ‘less desirable forms of inflation’:

There is a huge inflation in the cost of retirement.

When interest rates were at 6 per cent, retiring with $1 million would be enough to live comfortably and securely.

Not anymore.

Fast-forward a generation, and there has been this magnificent bull market in financial assets,

Except to retire you need $5 million. How many dollars does it take to buy a dollar of earning?

The answer?

More and more and more, with more and more risk.

Keeping interest rates at record lows punishes savers. With banks paying meek returns on savings, investors are increasingly taking on more risks to boost returns.

Trying to get more bang for your buck may get you more returns…but it could also leave you penniless.

Take Michael, for example, our cautionary tale lead character.

He is a 55-year-old businessman.

Michael has a great mind for business…or so he thinks.

Back in 2007, his daughter was dating a banker, George, who was bursting with ideas on how to make him money.

So, Michael followed his ‘insider’s’ advice.

The timing couldn´t have been better.

The country was booming, money was flowing and credit was cheap.

The banker´s first recommendation was property.

The apartment was set in a new development, just 30 minutes from the country´s bustling capital.

Michael saw the opportunity of a lifetime.

His wife was more sceptical. They already had one mortgage, and she thought the apartment was too expensive. ‘Who is going to rent an apartment in the sticks?’

But Michael and George reassured her.

‘Don´t worry honey, the country is booming.

‘The way property is going, this apartment could double…or even triple by next year…’

‘At the city´s current growth rate, this apartment will soon become the capital´s CBD…’

George´s next investment idea: Philatelic Forum.

The company invested in collectible stamps on behalf of investors.  It promised much higher fixed income returns than conventional investments, as stamps become more valuable over time.

As George told him, it was a very serious investment.

Once again, his wife was sceptical. With two mortgages, she thought it was best not to run any risks with their savings.

But Michael disagreed. What was the point of having their savings in the bank? As George had told him, ‘the only thing saved money does is lose its value.’

So Michael invested.

George´s third investment was — in George´s words — a ‘gold mine’.

Not literally of course.

His idea was an exclusive bank product that they were only offering to their ‘best customers’.

Michael had most of his money in a savings account, which was only bringing him a miserable 1% return.

As George told him, his savings had been travelling in ‘tourist class’. But with the current opportunity, they could be travelling in ‘priority class’…

The product George was talking about was ‘priority participations’.

The bank paid a whopping 7% return on these.

Enticed by the prospect of high earnings, Michael invested all his life savings… 

…OK, I admit it.

Michael and George are fictional characters from the Spanish movie We Have to Talk. The film pokes fun at the investment frenzy that overtook Spain during the country’s property bubble.

The characters may be fictional, but the investments described are very real.

So, let´s look at how Michael´s investments performed.

When the going gets tough…

By 2008, the property market had crashed and the apartment had lost 50% of its value. It never even came close to becoming part of the capital´s CBD, which made it impossible to rent out.

In fact, the whole development became a ghost town, as you can see in the photo below.

Ghost Town Development 08-03-2018


Source: El Confidencial
[Click to enlarge]

His investment in Philatelic Forum ended up being a classic Ponzi scheme.

Collectible stamps get their value from scarcity. Yet the company was taking investor´s savings by the truckload and buying millions of stamps…which meant stamps plummeted by 80%.

The ‘priority participations’ also turned out to be a clever play on words.

You see, George had failed to explain a few things.

For starters, ‘priority participations’ were not a guaranteed fixed term deposit, as Michael had been led to believe.  They were actually high-risk bank shares, sold as savings products. The banks had conveniently replaced the word ‘share’ with ‘participation’ in their marketing efforts.

Michael had assumed that the word ‘priority’ was derived from the bank only offering this product to ‘priority’ clients. Nothing could be further from the truth.

The name actually refers to the order in which shareholders receive their money. That is, priority participation holders receive their money before regular shareholders — but after every other creditor.

Which meant that when Spanish banks hit financial trouble and needed to be rescued with public money, investors like Michael had to share the bank´s losses.

Needless to say, Michael went bankrupt…in the movie.

But let me assure you, people in Spain lost lots of money with these investments…real money.

This is not a cautionary tale about listening to banker’s investment advice…well, maybe it is. When investing, always do your own research and due diligence.

But, this is also a cautionary tale about investing in high-risk high-reward investments.

As editor Vern Gowdie says, ‘High risk DOES NOT equal a corresponding high return. In some cases HIGH RISK results in complete LOSS OF CAPITAL.

After years of low interest rates and high risk, Vern thinks we are heading for a ‘big one’. That is why he has created a survival guide to protect investors from a massive crash. For more information on his step-by-step guide, click here.

Kind regards,

Selva Freigedo,
Editor, Markets & Money


Selva Freigedo is an analyst with a background in financial economics. Born and raised in Argentina, she has also lived in Brazil, the US and Spain. She has seen economic troubles firsthand, from economic booms to collapses and the ravaging effects of hyperinflation, high unemployment, deposit freezes and debt default. Selva now writes from her vantage point here in Australia. She is lead Editor at the daily e-letter Markets & Money. And every week, she goes through each report and research note produced by our global network of trusted advisors to find the best investment opportunities for you in Australia and overseas. She packages these opportunities for you in Global Investor.


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