Simon Burnett

Between 2003 and early 2008, fifteen thousand risk-averse and financially illiterate people in New Zealand were persuaded to invest their savings in packages of hyper-speculative securities. They were assured that these were reasonable alternatives to bank deposits. The investments crashed. The shell-shocked investors, mostly elderly and in no position to recover from financial disaster, banded together, formed a national committee, set up regional groups, took the battle on to the streets. Backed by a group of forty rebel financial planners who were angered at being misled, they won. 

 

The securities, known as CDOs, were packed into two mutual funds (or unit trusts) managed by the New Zealand arm of the Dutch financial giant, ING. Its joint-venture partner and half owner, the Australia and New Zealand Banking Group (ANZ) was the main sales agent. When the CDOs tanked and the funds tanked with them, the ANZ and ING blamed unforeseen circumstances. This was baloney. 

 

Lew Ranieri, the former Salomon Brothers bond dealer who pioneered the use of mortgages inside CDOs, compared dealing in them to gambling with dice.

 

One rebel financial planner, Paul Markham, said, "I feel dreadful that I ever recommended these funds to clients. Frankly, I regret now that I ever believed and trusted ING."

 

Angry investors demonstrated outside ANZ branches up and down the country in a campaign lasting almost two years and forced the ANZ and ING to return most of the invested money. 

 

This is the story of the biggest investor revolt in New Zealand history, told not by a financial expert but by the author, who himself was one of the ANZ/ING investors and who took part in demonstrations. 

 

                                                                      xxxxxxxxxxx

​

During what became known as the "frozen funds" campaign in 2009 and 2010, the ANZ and ING continued to anger protesters and rebel advisers alike by offering "explanations" that that bore little relation to reality.

ING did not apparently perform any fundamental research into CDOs before setting up the funds. If it did, this takes the story to a dark place.

• In January 2002, the Financial Times said that, “CDOs are weak credits dressed as strong ones.”

• In May 2002, the Economist warned that, “The shell game being played around CDOs should be enough to alert investors and regulators to a looming danger.” 

• In March 2003, Warren Buffett said that, “Central banks and governments have so far found no effective way to control, or even monitor, the risks posed by these [derivatives] contracts.” (CDOs are derivatives)

• The same month, the Economist said CDOs were a “clever way of exploiting anomalies in credit ratings; they were “vulnerable to downgradings” and “not transparent. . . many CDO debt pools have suffered.”

• In mid 2003, rating specialist Mark Adelson described CDO credit performance in 2001 and 2002 as “poor.”

But, in July 2003, ING set up the Diversified Yield Fund (DYF), which it described as a "portfolio of (but not limited to) Collateralised Debt Obligations (CDOs)".

The prospectus appeared with the words, “Without unnecessary risk” on the cover.

The black clouds continued building:

• In September, 2004, the Economist said that CDOs were “complex beasts” and “portfolios of credit risk.”

• In April 2005, one observer told the Financial Times that, “We are in uncharted territory. If a crisis hits, we think the market will absorbs shocks smoothly—but the truth is that no one knows for sure.”

• In May, Grant’s Interest Rate Observer decided that, “the CDO machine resembles some giant monetary snowblower, scattering dollar bills into the open hands of underwriters, investment banks, investment managers and rating agencies.”

• Also in May, BusinessWeek magazine said, “CDOs are the casino of choice for investors seeking high yields from bonds.” 

Undeterred,  ING set up the second CDO-based fund, the Regular Income Fund (RIF). Its sales brochure declared condescendingly, "income is that critical cashflow that enables you to do the things you need, and want, to do--like living the way you want to."

When both funds crashed, the "explanations" offered were so crude that they did not pass basic checks. The ANZ and ING both blamed the GFC of 2008-2009, the general financial crisis--yet the funds were plunging long before the crisis began.

 

ING specifically blamed a "liquidity squeeze"--jargon for a lack of buyers. But CDOs never did have "liquidity". Once bought from the issuing bank, there was no market to sell them back to.  Purchasers needed to hold the securities until maturity--and hope to come out on top. This should have signalled to ING that CDOs were grossly overpriced. 

 

But ING tried to have it both ways. In 2009, the new chief executive, Helen Troup, refused to identify the securities the funds held by saying "we trade in these assets. If we put their names out and we're known as a distressed seller, it just pushes the prices down."

 

ING did not "trade in these assets". There were no buyers except--with prices at rock bottom-- "vulture funds" on the prowl for "distressed" sellers. At this time, all CDOs were "distressed." 

 

Because CDOs lacked a market where they could be traded, they could not be valued. If they could not be valued, nor could ING's two funds. Instead, the funds' quoted prices were guesses by bank trading desks--in other words, fiction.

 

A major component of CDOs was junk bonds--high-risk bonds issued by financially troubled companies. However, Troup insisted that the funds had not invested in junk bonds. She thus contradicted her own fund manager, David Jansen, who said in 2005 that the funds invested in "high-yielding securities"--"high-yielding" being a banking platitude for "junk".

 

The ANZ claimed that the funds had invested in securities rated "investment grade" by the rating agencies. But CDO ratings had been publicly discredited. "Investment grade" was a fig leaf for upgraded "junk". The ANZ, a bank employing teams of financial experts, apparently did not know this. 

Graham Hodges, the ANZ National chief executive, went as far as describing the securities held by the funds as "all highly rated". Where he got that idea is a mystery.

Jansen, who claimed to be an investment analyst, was in 2009 still quoting S & P's 2008 default estimates when the funds were in deep peril and rating assessments meant nothing.

Yet this ratings trap was widely known. Here's one view: in early 2008, Howard Marks, founder of Oaktree Capital hedge fund, which manages cash for 75 of America's 100 largest pension funds, said, "the rating agencies’ greatest failing lay in giving their blessing to securities whose risk they couldn’t accurately assess. The eventual default rate was crucial and unknowable."

Marks added, “Running a bond portfolio from ratings is nuts.”  Oaktree avoided CDOs.

In December, 2008, Marks was asked what he needed to steer clear of CDOs. Was it computers, sophisticated programs and exceptional analysis? Genius? No, Marks said. It was skepticism and common sense. 

Another ING manager, Wayne Becker, said the CDOs in the funds were not leveraged. But all CDOs were leveraged, often heavily. Leverage boosts gains but it is also the assassin behind the curtain--it magnifies losses. 

Hodges continued by saying that ANZ customers who invested in the funds were “properly advised” of risks.  That was pure effrontery. If investors had been "properly advised" that CDOs were opaque (nobody could see what they contained), that their quoted values were fantasy, that they could not be sold after purchase except at a steep loss (which means that the holder was unable to trade out of trouble), and that they were created out of junk-rated bonds, they would have fled.

Few people anywhere in the world understood CDOs, which was an excellent reason to stay clear of them. The ANZ sales staff,  billed as "advisers", certainly had no idea. They merely spouted the sales pitches as they had been schooled to. 

The crassness between reality and the ANZ/ING self-serving fantasy plumbed new depths on November 9, 2009, when the ANZ's head of wealth, Joy Marslin, rejected a married couple's request for top-up compensation by saying that "risk is inherent in any investment" and "we believe the DYF was a product in which it was appropriate for you to invest in."

Marslin might have written a very different letter if, that same day, she had read an article in Fortune magazine in which Ranieri, the one-time bond trader who pioneered CDOs, chopped the entire idea of CDOs to pieces, saying, "I do feel guilty. I wasn't out to invent the biggest floating craps game of all time, but that's what happened."

Marslin might have learned something if she had read the Financial Times' Gillian Tett a few months earlier: "Most tragic of all, millions of ordinary families who never even knew that CDOs existed, far less dealt with them, have suffered shattering financial blows. They are understandably angry. So am I. It is a terrible, damning indictment of how twenty-first century Western society works."

Unlike the ANZ and ING, financial blogger Yves Smith, did know about CDOs. In mid-2007, she said: "I don't know how anybody with an operating brain cell could have bought this stuff." 

At the time the ANZ and ING were enticing punters into their funds, thousands of other fund managers were devising safer ways of getting returns. The Pennsylvania-based Vanguard Group invested in various combinations of shares, bonds, cash and other assets. It did not trust CDOs. As chief executive Jack Brennan said dismissively in mid 2008, “Vanguard didn’t own the CDO stuff.”

The vast majority of mutual funds survived the crisis of 2007-2009. Some slumped before picking up again, while others hardly blinked. Investors could have doubled their savings by investing in mutual funds such as those run by Vanguard, PIMCO, Putnam and Fidelity.

(Source notes for this text are in the book)