Saturday, 16 April 2011

Should you bet your life on a sinking ship?

Friday the Irish Times published some interesting facts about the tale of the Quinn group receivership. Mr. Quinn, a 63-year-entrepreneur, was a typical self-made millionaire who started in 1973 using a £100 loan to extract gravel he sold at a profit to local contractors and rose to become Ireland’s richest man in 2007.

In the summer of 2008, in the middle of the financial crisis, he was building up a stake of 28.5% in the Anglo Irish Bank, financed by the bank itself, and aimed at propping up the bank’s stock price. The attempt was futile and the bank ended-up being nationalized in early 2009. Quinn’s shares become worthless and he was left with €3 billion in debt secured by his business and family holdings. Anglo has now executed those guarantees and has taken over his entire group and family estate.

Similar bets were made by investors in Lehman Brothers which cost them dearly or by Warren Buffet on Goldman Sachs which made him a $3.7 billion profit. There is nothing wrong with betting on troubled companies. They are high risk investments, and as such they generate either a large pay-out or a large loss. The fundamental rule to follow is that investors must diversify their bets and should not bet more than they can lose, i.e. you should not bet your life on such investments.

So why, an experienced investor like Mr. Quinn, committed the stupid mistake of betting his fortune on Anglo? Was he blinded by greed? Or was he blinded by the lender of last resource argument that views banks as too important to go bankrupt? Probably both.

The important lesson here is not about Mr. Quinn. The important lesson here is why the Anglo was bailed out at a huge cost to the taxpayers in order to partially save some of the lenders to Anglo. This action by the Irish authorities not only left a serious burden on future generations but, most importantly, jeopardizes the future of market capitalism in Ireland by discriminating between bondholders and shareholders. Both should have suffered the full extent of their losses (100% for shareholders) and the percentage of losses incurred by bondholders and depositors. Once you start on this slippery road of saving some but not others there is no going back. Politics becomes a game of privatizing gains and socializing losses and capitalism is in danger.

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