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Predatory lending??? Although Predatory lending has been documented for over a decade and despite being "a financial professional", my attention was drawn to it for the first time in February by a Gaelic documentary on the subject. But this practice has been hitting the headlines. A Bush nomination for US Ambassador to the Netherlands, California billionaire Roland E. Arnall, has been stymied because the nominee, one of the world's richest individuals has derived this wealth from a sub-prime financier, Ameriquest Mortgage Co., which has been found guilty of defrauding poor and uneducated people out of what little equity they owned. (This may be news from last year, but the review process has heated up in recent weeks.) Also two bills to regulate sub-prime lending markets in the US are being debated. The report was published on the subject: The Best Value in the Subprime Market State Predatory Lending Reforms - A report by the Center for Responsible Lending. (Further resources here and from the US government here.)
This phenomenon in the US financial structure is interesting for two reasons apart from its unethical practice. It is a product with similar features to micro finance, an area of increasing value, but performs differently in its particular economic environment, and is therefore a useful comparator. And, more presently, it the detail of the financial flows is obscured by the overall picture and the detail obscured might be a significant additional risk to national economic stability: institutional mortgage investors are not seeing devaluation because middle market buyers are coming in and buying the security at securitised values, while a significant niche of the market which should get the most support and protection from the state is bearing the cost of this wealth transfer. The general conclusion is "watch this space". And specific conclusions are expect predatory lenders to be penalised and be wary of a collapse of this niche market which sends ripples through the rest of the economy, perhaps the pin that pricks the debated US housing bubble, with global repercussions.
The following quote from Franklin Cudjoe,Director of Imani, The Centre for Humane Education, refers to Africa but is relevant to the poor in America who are being left behind by society and preyed upon by well resourced organisations like Ameriquest.
Christian Aid and others (Letters, February 20) repeat the simple fallacy that inequality causes poverty and lack of development and that redistribution of wealth causes growth. Poor people are not laboratory rats; they are just like everyone else, and what they need is the freedom and security to plant, to work, to accumulate and to exchange. Dependency on aid has undermined people and economies while subsidising tyranny, corruption and state economic mis-management: after $450bn of aid over the last 30 years, the average African's gross domestic product and life-expectancy are lower now than at independence. Are Africans just stupid or is something holding us back and grinding us down?
Poor people, like everyone, need property rights, the rule of law and free markets, not subsidies, officials, corruption and five-year plans.
I would also like to draw your attention to an enlightened and plausible solution to the seemingly intractable problems facing the world which is introduced in a piece by Harold James in the section below on Holonics.
Investment, Finance & V. C.
Japan's economy grew at a faster pace than expected in the final three months of 2005, boosted by a pick-up in exports. Gross domestic product rose by 1.4% during the fourth quarter, topping market forecasts of 1.2%. On an annualised basis, the world's second-biggest economy grew by 5.5%. The upbeat GDP data provided the latest indicator pointing to a sustained recovery for the Japanese economy.
European economic growth will accelerate this year, according to forecasts by the European Commission. It predicts that growth across the whole 25 European Union member states will hit 2.2% in 2006, and by 1.9% across the 12 nations with the euro. The Commission puts the growth down to a number of factors, such as increased private investment, strong corporate profits and favourable financing deals.
The Irish economy was lauded by the OECD saying that it has enjoyed a decade of "remarkable" growth but is facing clear risks. The economy doubled in size in the 1990s, achieving the fastest growth in the OECD over that period. The Organisation for Economic Cooperation and Development said that although Ireland had produced "exemplary" results it needed to boost competition, improve education and encourage enterprise. It also called on the country to improve its infrastructure. However, if growth slows down the economy is likely to experience a soft landing - "Growth remains strong, foreign investment is still coming in, industry has shrugged off global shocks and house prices keep on climbing," it said in an economic survey of the country. It is now weaning itself from EU subsidies and protection of the last 30 years as it becomes one of the richest economies. While it must increasingly compete on a level playing field it continues to appear dynamic and is a magnet for eastern European workers which provide a cost effective engine for development.
Prosper Marketplace, or California US, launched its website in February. It is an unusual financial vehicle - a bankless bank. Prosper offers to directly intermediate between borrowers and lenders. Zopa, a UK peer to peer lending intermediary, opened in March last year and has had a positive experience so far. While pitfalls remain it appears that this innovation allowed by the internet will continue to grow. It may in fact be a service that banks can consider offering since they already have screening systems in place.
In Perspective above, we highlighted the growth and problems of predatory lending. Here are some extracts from the recent survey The Best Value in the Subprime Market: State Predatory Lending Reforms. "For years, the debate over predatory lending has been conducted in an information vacuum," said Keith Ernst, senior policy counsel at CRL, who supervised the study. "Now we know, beyond a doubt, that these laws work, and that they don't harm consumers." The study, which examines more than 6 million subprime mortgages in 28 states with various reforms against predatory lending from 1998 through 2004, finds predatory lending in many of these states dropped by almost a third. "States with the strongest laws--Massachusetts, New Jersey, New Mexico, New York, North Carolina, and West Virginia--showed the largest declines in loans with predatory terms," states the report. The study also reveals unexpected findings: "A central goal of predatory lending reform has been to shift lender compensation away from fees--both front-end charges and back-end prepayment penalties--into more transparent interest rates, since a borrower can refinance out of a high rate loan but cannot escape from high fees," write Wei Li and Keith Ernst in the report they authored "With this in mind, we expected to find a combination of fee reductions accompanied by offsetting marginal interest rate increases. We did find that fees in the form of prepayment penalties were reduced, but, to our surprise, we also found that many families paid lower interest rates. Among states with reforms, interest rates on fixed-rate mortgages showed no statistically significant difference in eight states and actually were lower in 19." These findings offer a strong rebuttal to industry nay-sayers who claim that these laws stifle the subprime market where low-income borrowers, who are often strapped with credit problems, must operate. "This study demonstrates that critics who claim anti-predatory lending laws will dry up people's access to credit are just plain wrong," said Tom Miller, Attorney General of Iowa, a state with strong anti-predatory lending laws. "This research shows that sound legislation curbs abusive lending, and it does not reduce responsible lending . . . [and] that leads to one more conclusion: consumers would be harmed if federal law preempted state regulation." The two competing bills currently making their way through Congress. HR 1182, or the Miller-Watt-Frank bill, seeks to strengthen existing federal legislation while allowing states to extend further protections, while HR 1295, or the Ney-Kanjorski bill, which would erase state laws without strengthening federal laws. Needless to say, CRL supports the Miller-Watt-Frank bill and opposes the Ney-Kanjorski bill.
While the study focuses on the state level, it extrapolates its findings to the national level. "There are strong indications that state reforms are having a positive effect on the national subprime market," the report states. "For example, over the course of our study, the overall incidence of prepayment penalties peaked at 67.7 percent and then dropped to 51 percent by December 2004. For balloon payments, the corresponding figures went from 13.6 percent to zero." The study concludes by advancing two significant implications for state and federal policymakers confronted with choices on how best to address predatory lending. "First, the findings suggest that strong state laws like those in place in New Mexico, Massachusetts and North Carolina can serve as successful models," the report states. "Second, the findings call into question the advisability of federal proposals that would nullify state efforts and substitute a weak national standard. In fact, this study shows that overriding state laws would be harmful--and costly--to consumers, since states are successfully cutting back on predatory loans without cutting off access to credit. From a homeowner's perspective, it appears that mortgages protected by strong state laws may be the best deal in the real estate market." As Social Funds points out "Low-income home-shoppers are vulnerable to (and hence very reliant on laws protecting them from) "predatory lending," which includes exorbitant fees or subprime prepayment penalties as well as steering borrowers to higher priced loans when they could qualify for better terms."
The food and beverage industry should be increasingly concerned about the backlash against unhealthy foods. An SEE risk briefing in February targeted obesity and according to a report by the World Health Organisation, three million deaths annually are attributable to being overweight or obese! Evidence that this is already happening is the announcement by McDonald’s that it is to close 25 outlets in the UK. The decision comes as the company has been suffering falling sales. There has been tougher competition from other high street food operators, but the closures are also being seen as a sign that the negative publicity surrounding Morgan Spurlock’s documentary Super Size Me has damaged the company’s image. Despite adding salad and fruit options to its menus, and switching its fresh milk products to organic, McDonald’s has been unable to prevent a decline in profits and sales. The company blames this on stiffer competition from younger food to go companies. McDonald’s itself has a stake in one of these successful young pretenders - Pret a Manger.
Despite increasing hype by global banks that they are taking responsibility for social and environmental impact, many are failing to meet standards. In a January 2006 report Shaping the Future of Sustainable Finance: Moving the Banking Sector from Promises to Performance by BankTrack, a global nongovernmental organizations (NGO) coalition including WWF-UK, Friends of the Earth (FoE), Rainforest Action Network (RAN), and the Berne Declaration, 21 of 39 banks' financing policies earn a failing grade. The grading system ranges from 0 (no publicly available policy) to 4 (policy meets almost all international standards), with average scores across 13 environmental and social categories translated into letters corresponding to school grades. The 39 banks assessed fall far short on global sustainability standards, and fail to disclose enough information on implementation to even be assessed by NGO coalition BankTrack. Even more shocking than the failure rate is the level achieved by the best performers: ABN AMRO (ticker: ABN) and HSBC Group (HBC) both earn the highest overall average score of 1.31, which translates into a letter grade of D+. And top scores of 4 within individual categories (which cover policies related to from human rights, climate change and energy, indigenous people, extractive industries, transparency, and environmental and social management systems) are exceedingly rare.
Investors looking for insight on evaluating the environmental, social, and governance (ESG) performance of large U.S. companies just received some help from the Calvert Group which recently released ratings evaluating the ESG performance of the 100 largest US companies by market capitalization. The Calvert Ratings disclose how the Calvert Social Research team ranks these companies on a scale from one (worst) to five (best) in five categories--environment, workplace, business practices, human rights, and community relations.
Assets managed in accordance with sustainable development values nearly doubled in 2005 in France. Caisse des Dépôts subsidiary Novethic, an SRI (socially responsible investment) resource center, presented its assessment of SRI funds marketed in France including: percentage change in assets under management, number of funds, major trends. This year, two key highlights emerge: total assets under management rose by 94%, and assets under sustainable development management by funds domiciled in France increased by more than 55%. For the full press release in English please go here.
Whole Food Markets says it will drop the Fresh & Wild name when it starts opening its first Whole Foods stores in Britain next year. It bought Fresh and Wild last year and appears to be reengineering the business model to reflect its US approach. While this will probably work it is strange that they do not keep the current model and brand which is currently successful and appeals to buyers that do not want to be in a supermarket. This may leave the way open for a Fresh & Wild imitator to grow.
We noted a couple of VC transactions in education: Providence Equity Partners and Goldman Sachs Capital Partners have agreed to acquire Education Management Corp. (Nasdaq: EDMC), a provider of private post-secondary education. The total transaction is valued at approximately $3.4 billion, with EDMC common shareholders receiving $43 per share. Leverage will be provided by Credit Suisse, Goldman Sachs, Merrill Lynch and Bank of America, while Education Management was advised by Merrill Lynch. www.provequity.com www.gs.com www.edmc.com Also, Apax Partners has acquired a minority stake in The Learning Annex, a New York-based provider of adult self-improvement education. No financial terms were disclosed. www.learningannex.com
The VC hype in the middle east was illustrated at the first meeting of the Gulf Venture Capital Association in Manama, Bahrain where one analysts noted 21 venture capital and private equity funds seeking to raise at least $17 billion by the end of 2006. This ballooning of interest is reflected in industrial growth too as oil revenues boosted by higher prices over the past year have funneled huge amounts of cash into the region.
Another U.S. venture-capital firm is moving into the increasingly competitive China market. Ignition Partners, the boutique Bellevue, Washington, firm founded by several former Microsoft Corp. executives, has hired Gary Rieschel, the founder of Silicon Valley’s Mobius Venture Capital, and Duane Kuang, the former director of Intel Capital China, to help run a new $200 million China investment fund.
For those interested a China VC gathering takes place in Shenzhen on April 7th: China Venture Capital Forum 2006 Program.
Fiona Harvey of the FT reports that its a good time to be a green entrepreneur as interest continues to grow. Her article quotes a number of key players both industrial and financial.
In the UK, Treasury and Revenue & Customs are considering substantial tax rate increases on private equity firms, according to a letter sent to members of the British Venture Capital Association. The news was first reported by The Sunday Times.
To get an rss feed of PE Week wire please go here.
Interest Rates and Currencies
Interest rates in Europe were increased by 1/4% and many analysts expect further increases. There is also talk of rates increasing in Japan now that the economy seems to be well on the mend. And US increases are expected to continue as inflation jumped to 4% in January. Higher food, car and electricity costs also pushed US producer prices up by more than expected in January with the producer price index rising by 0.3% during the month, above forecasts for a 0.2% rise. Separate figures also suggested that US consumer sentiment unexpectedly weakened in early February, hit by low stock prices and higher gasoline costs as the University of Michigan's preliminary consumer sentiment index for February fell to 87.4 from 91.2 in January.
These increases are putting pressure on mortgage borrowers. If the housing market does become depressed there will be knock on effects in general consumer spending (because consumption is being buoyed by home equity withdrawals), in housing related sectors like construction and estate brokerage, and in banking where the pain might be very significant as mortgage assets are 60% of US bank assets - a long term high.
The housing market appears buoyant. US home prices rose 12.95% on average in 2005, despite a string of mortgage rate rises, says the Office of Federal Housing Enterprise Oversight (OFHEO). Home values in the fourth quarter were up 2.86% on the previous period, at an annualised rate of 11.4%. Analysts have been predicting that the five-year US housing boom is slowing. But despite indications of a slowdown, "house price appreciation during 2005 continued to hover at near-record levels," said OFHEO in a statement. Also, the US has recorded the fastest pace in construction of new houses for more than 30 years with the Commerce Department's building activity index rising 14.5% in January, pushing construction to an annual rate of 2.27 million units (the fastest rate of growth since March 1973, but expected to be a one-off blip caused by unusually warm weather in January). The 14.5% rise in building activity in January followed a 6.9% fall in December.
But this buoyancy may not last. Interest rates have risen from 1% to 4.5% over the past 18 months and while this does not seem to have slowed the housing market it has certainly increased its sensitivity to shocks. And as John Mauldin notes that the January 2006 Monthly U.S. Foreclosure Market Report by RealtyTrac , the leading online marketplace for foreclosure properties, shows 103,540 properties nationwide entered some stage of foreclosure in January, a 27% increase from the previous month and a 45% increase from January 2005. The report shows a continuing upward trend in which the national foreclosure rate rose in every quarter of 2005.
America is saying "so long" to its old greenback $10 bill and "howdy" to other colours. The US Treasury's $10 bill has a host of anti-counterfeiting tricks - such as many more colours, new watermarks and dozens of tiny 10's all over the design.The new, harder-to-counterfeit bill in reds, yellows, oranges and greens entered US circulation at the end of February. The $10 makeover follows similar colourisation of the $20 bill in 2003 and the $50 note in 2004. The $100 bill one of the most popular with counterfeiters - is due to be redesigned in 2007, but there are no plans to change the $1, $2 or $5 notes, yet.
Trade and FDI
Welcome to the world of block-thy-neighbour protectionism. We have seen a rapid escalation from Cartoon War to Trade War - sparked by cartoons, Danish products have been boycotted in many places. The French have blocked a bid by Italian firm Enel for energy company Suez and claim a pre-dated discussion with Gaz de France. Cries of concern have been raised in the US over the acquisition of the management contracts for 6 ports by a Dubai company. Even the EU has hamhandedly drafted cross-border regulation of trade in services which is restrictive to new members preventing them from considering supplying the older core members. Meanwhile the US has managed to get a WTO ruling preventing EU states from banning GM foods!
The short historical story from PPI clearly shows why protectionism does not help. The Smoot-Hawley Act of 1930 is one of the few Jazz Age policies (apart from Prohibition) to call up echoes in modern America. It attempted to protect American economy by raising barriers to imports. For example from 1922-1929 the U.S. egg tariff was 8.0 cents per dozen, in 1930 it was 10.0 cents per dozen. This initially was a rise in egg tariff of about 30% but as egg prices fell the ratio rose to over 70% completely hindering trade. Between 1930 and 1932, Australia, Britain, Canada, Cuba, Denmark, India, Italy, France, Germany, Mexico, New Zealand, Spain, Sweden, Switzerland, and others retaliated. By 1933, American exports had dropped from $5 billion to $1.2 billion, and imports dropped equally fast. Total world trade, according to statistics kept by the League of Nations, fell from $68 billion in 1929 to $24 billion by 1933.
The innuendo against Arabs has grown in Washington as the tumult over allowing a Dubai-based conglomerate to operate six U.S. ports continues. In handling the Dubai ports affair, the US Administration has displayed a refreshing shift from their security apparatus which has singled out most individuals with Arab names, including toddlers and infants, who enter any U.S. airport. While the UAE government may be critisised for legitimate reasons, such as human trafficking, discriminatory security concerns are not appropriate. It appears that politicians, commentators and the public are increasingly confused about what they want.
In several eastern European capitals, the sombre reality about the future of service liberalisation in the European Union has been sinking in. The east Europeans have realised that they were short-changed by a vote in the European parliament in February that places heavy restrictions on the free movement of services. The goal of the services directive was to remove national barriers. Its main instrument was the country-of-origin principle, which placed service providers under the legal and regulatory control of their home country. The European parliament managed to get rid of this principle altogether, but left some minor bureaucratic improvements in place. For example, service providers will no longer have to carry identity documents with them, or need to establish an office in the host country. But these small advantages will be more than offset by the directive's protectionism. There is a long list of excluded sectors, ranging from healthcare to gambling and lotteries. Governments can also impose restrictions on grounds of public safety, social security, health and the environment. Most importantly, they can enforce domestic employment law and collective agreements.
Most worryingly, however, is the continuing saga of liberalisation of GMO. For many sound reasons we see liberalisation of the use of GMO in Europe and globally as a far more dangerous risk to global prosperity than the Iraq war. The outcome of the complaint by the US, demanding that EU states be prohibited from restricting GMOs, is still not clear. While the US has claimed a victory in their application to prevent EU states individually banning the planting of GMO, Friends of the Earth has pointed out that the ruling does not prevent countries from restricting or banning GMOs. Friends of the Earth today made available online a confidential World Trade Organisation (WTO) ruling on the trade dispute on genetically modified (GM) foods. The 1000-page WTO report, distributed in February only to the countries involved in the dispute, was leaked to Friends of the Earth, which has published a preliminary analysis. The leaked report reveals that: Despite claims of victory by the US Administration and the biotechnology industry -widely reported in the media in February 2006 - the three countries that started the trade dispute against the European Union (US, Canada and Argentina) failed to win most of their arguments; and The World Trade Organisation did not rule on two of the most important questions before it, namely whether GM foods are effectively the same as non-GM foods, and if they are safe. The WTO report is available online: http://www.foei.org/media/2006/WTO_report_descriptive.pdf and http://www.foei.org/media/2006/WTO_report_findings.pdf. The Friends of the Earth preliminary analysis is online at http://www.foei.org/media/2006/WTO_briefing.pdf
The WTO was also in the headlines in connection with the possible inclusion of Russia. Oil revenues are now making Russia an ever more attractive place to do business. And bringing Russia into the WTO is an oft-repeated foreign-policy goal of Russian President Vladimir Putin and President Bush. While US movie companies and music makers claim that theft of intellectual property in Russia is unparalleled and a wide spectrum of American businesses, including beef, poultry, and pork producers, and banks and insurance companies, have problems in the Russian market, the combination of oil, Bush and Putin might be enough to get Russia its seat at the trade table.
For trade specialists, you may wish to engage in the Oikos Model WTO on June 12 to 16, 2006 in St. Gallen/Geneva, Switzerland. Check it out here: www.modelwto.org
Another new resource is the Global Evian Trade Update. GETUp! is the Evian Group at IMD’s new quarterly publication to inform members of the Evian Group community of the association’s ongoing initiatives, publications and positions.
Activities, Books and Gatherings
February was exciting though hectic with more travelling than expected and new ventures growing in VC and business support. The growing season is also starting up in the garden with early seeds being planted like broad beans and tomatoes.
I picked up Spiral Dynamics by Beck and Cowan again and read the second half. It is a great piece of work providing a practical tool kit for personal and organisation development. If you are interested in management, HR, psychology or business development you should read it.
I also finally picked up Fueling The Future edited by Heintzman and Solomon. This gift from my brother-in-law has been sitting on my desk for a couple of months but once I cracked it I found it to be a valuable addition to understanding the energy challenges facing earth today. With articles by a wide range of experts in various aspects of the energy industry a balanced view can be gleaned. This should be read by anyone involved in energy industries, especially investment in alternatives, or carbon trading.
I enjoyed Pratchett's Hogfather which cleverly explores the fantasies we create to help us stay sane in a world we don't understand. I've also worked half-way through Pratchett's Jingo which brilliantly builds the tension of politics over nothing!
Black Eyed Peas recently released the album "Monkey Business", which I enjoyed. In particular the lyrics to one song "Union" (a translation of yoga) which Neil Crofts has diligently transcribed:
As before, I recommend BeTheChange
to anyone who can spare three days in London (May 11-13). It has
proved to be a broad based enlightening gathering.
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