Abaci's Common Sense Investing

Watching all major central banks are busy printing money and lowering interest rate, injecting more and more money in the market, this reminds me like in a game of monopoly, when one player is about to go bust, he would usually suggest 'why don't we all get $500 each so I can continue the game and everyone is $500 richer?'

Except that this time the sum is a lot more than $500 and everyone is asking for it at the same time. Well the lucky break is unlike in Monopoly there's unlimited supply of $500 notes in central banks.

Yet I'm confused because in Monopoly you can't have all losers without a big winner? So I tried to imagine myself in a game of Monopoly.....................

In the beginning every player is buying properties with cash on hand and cashflow received each round, nothing fancy. After a few rounds someone with a bit of luck will have built up a connecting block of land. Houses and hotels are erected to increase rental but more importantly this block can be mortgaged to the banker or other players to get new loans to continue expansion. This is still within normal boundary of business, for players have to be careful about cash-flows received each round is enough to pay off the interest.

Then for some reason the banker lowers the official interest rate, perhaps a bit too low, and that alters the dynamics and risk appetite. Players begin taking up more loans for 'rents' collected from land can increase with development but interest cost has gone lower. So in theory one can gear up indefinitely to increase return, hence properties are bid to higher levels. Rent soon gets higher too for more properties become fully developed into hotels. At this stage there are happy buyers who look forward to continual appreciation and happy sellers who are willing to sell off and hold on to the profits.

Then comes another big event, suddenly there's whole bunch of late comers with a large pile of cash and desire to become monopolies too! The reason for their late arrival is not known but unimportant. They bring up the pace of buying and the property price. At about the same time all land and properties have been mortgaged to the banker and there isn't enough cashflow each round to support the buying. So all players figure they could invent a 2nd mortgage market at a higher interest, given prices have appreciated by much. So rules are changed and new rounds of refinancing are done to support new buying. And markets for 3rd and 4th mortgages are soon becoming the norm. Early sellers are buying back too because they reckon they'd out of the game soon, eaten alive because of the ever increasing rent. There isn't an exit mechanism, for monopoly is played until there's only one man left standing.

What about bankruptcy risk which are supposed to counter irresponsible financing? Some smart players who are holding more cash than properties figure he could make some extra income by insuring against the default of other players, so rulebook is changed again. Lending become more rampant because of the 'safety' of insurance. Very soon the amount insured is greater than the cash and assets the insurer has, and worse, those assets reserved for claims are properties too! But he reckons players can't go bust together so he's safe. A few other players get envy in this new business and start to insure others too, figuring this can increase income and reduce its own insurance cost. Very soon we have a situation where player A insures B, B Insures C, C insures D, and D insures back A, yet in essence they all insure against a fall in price of an asset which they all hold themselves.

Then one day one player wants to sell down, for no reason, perhaps he suddenly finds reducing debt is a good idea, and then he can't find one buyer in the market. Everyone has run out of cash and borrowing capacity. And during this time the banker has increased interest rate for various time already so all the properties have become cashflow negative. When price can't increase any further, down it goes. and it goes down hard.

Property price plunges and that forces more selling. Those holding on aren't faring better because cashflows are draining each round. Players suddenly find out properties prices are elusive while loan balance is rock solid! Before long all players are into negative equity territory. All 2nd, 3rd, 4th mortgages become worthless. Bankruptcy now is a real threat, but at this important juncture the 'insurer', finds the impossible happening, that all players are bankrupting and it backing assets are vanishing too. Counter insuring also becomes a joke as neither can pay off the claims of the other nor survive himself.

So in the end we have all players owing large sums to the banker (and to each other too), with collateral grossly insufficient in value and technically bankrupt. The banker in order to allow the game continuing then has to convert a large part of that debt into equity, hence becoming a player himself. Next is the cancelling or offsetting of all those inter-player debt and counter insurance contracts which are now proven useless and senseless (i.e. A releases B, B releases C, C releases D, D releases back A). In other words, eliminate all liabilities against losses. With sufficient time all players are largely back to a position where they begin. Meanwhile interest rate is lowered again to its beginning low level so properties become cashflow positive again to induce buying. Players will soon react because no matter how scared they have become, they are still in the game of monopoly, and their job is to win this game. In short, let's start another game ASAP!

I really wonder if this game creates wealth? If this is negative then perhaps the resultant loss of wealth is just one part of the game, for the thrills. And we're all part of this game.