Turning Point by John Francis Kinsella
The root of the trouble was when investors started buying CDSs to cover the possible default of bonds they did not even own!’
‘I don’t even know what CDSs are!’ said Sarah cheerfully.
‘Credit default swaps,’ explained Smeaton. ‘They’re what you could call contractual bets between two parties on whether a third party would default on its debt — invented by JP Morgan in 1995.’
‘Trillions of dollars,’ Barton added for good measure.
‘The most incredible thing is if a bond falls into default the loss could be claimed from the underwriters by punters, who’d insured against its default, even if they did not own it,’ mused Smeaton.
The sub-prime crisis had suddenly become a hot point of conversation for just about everybody, from bankers to homeowners. Smeaton had little doubt the roots of the crisis went back to the start of the new millennium and the dotcom stock market bust, after which interest rates had been forced down by governments to stimulate their economies. In doing so investment grade bonds became attractive, offering good returns for financial institutions. This led to a boom in CDOs and CDSs, the performance of which was considerably better than government bonds.
Default risk was covered by insurance and credit ratings agencies calculated risk based on historical default statistics. The trouble was the data was more than insufficient to make a realistic evaluation of the risk as these products were relatively new and when the sub-prime crisis struck CDOs, CDSs were caught up in the storm.
Sarah looked lost by the talk of technical terms of which she, and most other people understood little or nothing about, including Barton, who if honest, would have had to confess his own very fuzzy understanding.
‘Look, let me give you an example,’ said Malcolm. ‘Imagine you’re an investor and you’ve bought a million pounds of corporate bonds from a building firm with a yearly interest rate of say 5%...’
Sarah raised her hand: ‘What precisely do you mean by corporate bonds?’
‘Money raised by a firm on financial markets for its different business needs, like a loan.’
‘I see,’ smiling as to excuse her ignorance.
‘So your bonds could be insured against the risk of firm going broke for example, or the non-payment of interest — naturally for a premium — until the bonds reached their date of maturity or were sold.’
Smeaton refilled his glass.
‘If the building firm does not go broke and pays its interest then the insurer pockets the premiums, if on the other hand it does go bust then the insurer has to pay out compensation.’
‘Tough.’
‘Like any insurance company.’
‘Does it happen often?’
‘No, at least it didn’t up until the sub-prime crisis,’ said Fitzwilliams smiling grimly.
‘The biggest seller of credit default swaps has been the American insurance company AIG. They sold a lot of CDSs thinking that there was little or no risk. So since the crisis broke they’ve been in deep trouble. Their shares have collapsed, and they can’t raise the capital they need to function.’
‘Everybody tried to get on the bandwagon when things were good,’ said Fitzwilliams ruefully. ‘Even us.’
‘Yes, I’m sorry to say that’s true,’ said Barton. ‘In the US mortgage brokers sold sub-prime loans with low introductory rates to working-class Americans with little concern about their ability to keep up the repayments. It was like selling hot cakes and Mortgage businesses like New Century boomed.
‘At the peak of the market, sub-prime loans made up twenty percent of all mortgages, loans to people who had little prospect of fulfilling their commitments. Naïve buyers were pressurized into taking out loans by unscrupulous brokers. Falsified income declarations with seriously exaggerated property evaluations were almost normal.’
Barton spoke with experience; he himself had been drawn into the frenzy. His decision to quit had been motivated by his innate conservatism and sense of self preservation.
‘I suppose the rot really set in when these sub-prime loans were then sold to investment banks through auctions,’ Smeaton sighed. ‘Investment banks made a fortune packaging these into mortgage backed securities bonds to be sold to institutional investors.’
‘So why did they do this if it was risky?’ asked Sarah.
‘Money my dear, filthy lucre. Nobody stopped to consider the real risk. Salespeople worked on commission. The more loans they sold, the bigger their bonus. So from the beginning to the end everybody lied: the borrowers who were getting their dream homes, the mortgage salespeople, the investment banks, and last but not least the investors who bought the bonds believing they would make a nice profit.’
‘But can banks do things like that?’
‘Normally no,’ said Fitzwilliams self-righteously. ‘But many banks put their traditional caution to one side in the name of even greater profits, throwing due diligence to the wind, bringing banking into disrepute.’
Smeaton gave his friend a strange look.
Malcolm Smeaton had been one of the many friends of the late Irish banker David Castlemain, Fitzwilliams’ uncle, with whom his own small trading bank had been a partner for over half a century. After Fitzwilliams had been appointed head of the Irish Union Bank, later the Irish Netherlands Bank, he visited the Caribbean with a stop in Dominica to renew business ties and relations and was invited to stay at the Smeatons. He was enchanted by Pondok Indah and the spectacular natural beauty of its site.
It was not long before Fitzwilliams persuaded Smeaton that a fortune could be made by developing part of the land, without of course spoiling the view from his home, which stood to one side of the point. His idea was to build a small though luxurious hotel surrounded by a dozen or so villas designed in the much-admired style of Smeaton’s Pondok Indah. The villas would be entirely serviced by the hotel so that whenever the owners or wealthy vacationers arrived everything would be in perfect working order for instant comfort and stylish living.
The most luxurious villas were planned to stand ten or fifteen metres above the sea with stunning views overlooking the beach to the west and the lagoon to the south. The interiors were designed in a combination of modern and tropical themes, exotic woods, marble and granite, and of course panoramic windows. Mahogany doors were to open onto the spacious living area and terrace, offering a one hundred and eighty degree view of the Caribbean. On the first floor the bedroom suites would be surrounded by terraces offering the magnificent vista of the island’s breath taking scenery.
At the time the plans were conceived nouveaux rich buyers were not lacking; wealthy businessmen from North and South America, Russians, Europeans and of course those who had made fortunes in the City of London.
Dominica was described as the Nature Island of the Caribbean, an alluring land of majestic, mist-covered mountains spilling with waterfalls. The luxurious homes were advertised as an investment in an unspoilt paradise, a vision of swaying palms overlooking beautiful beaches and a pristine sea. As Sarah had explained prices began at three million dollars, the homes were for the rich, the nouveaux riche, sports personalities and showbiz celebrities. They very private holiday residences serviced by a team of impeccably trained personnel to care for the whims of even the most spoilt.
The list of those who were said to have signed up for the Emerald Pool development in Dominica read like a who’s who of rich and nouveaux riches. Smeaton offered them a corner of paradise and all they had to do was choose the finer details of their luxurious villas whilst waiting to enjoy the privileges of the wealthy far from snooping eyes.
Dominica was different, it was almost a virgin territory compared to many other Caribbean islands, a sleepy backwater where life was uncomplicated, without crime, off the package tour circuits, and where hippies and their likes were firmly discouraged. The absence of the kind of infrastructure that went with mass tourism made it haven of tranquillity just waiting to be discovered by the newly rich.
It was for the kind of people
who wished to remain anonymous, far from the flashbulbs of the paparazzi and gawking tourists, and especially the invading hordes of cruise ship day-trippers. The Emerald Pool was designed to cater for discreet wealthy couples seeking a short break from the stresses of New York or London, for winter and Christmas breaks.
Smeaton was discussing a Mandarin Oriental franchise for the hotel to provide it with a prestigious name and a worldwide booking system capable of reaching out to the kind of client whose primary concern was seclusion.
Dominica, not being a destination for mass tourism, offered the rich advantage of its private beaches, where they could enjoy the tranquillity for their own secluded stretch of sea compared to other Caribbean islands where the most beautiful beaches were public.
Much to Smeaton’s regret things had somehow gone awry, the timing was wrong; work on the site had come to a halt. The splendid project was in suspended animation waiting for the world economy to return to the halcyon days before the crash.
The Emerald Pool had been modelled on Pondok Indah, Smeaton’s Dominican home, which had been designed in the style of his childhood home in the residential district of Kebayoran Baru, in far off Jakarta, built from native hardwoods and volcanic stone, where his father had managed the Indonesian business of the family’s Anglo-Dutch Commercial Bank. On arrival in Roseau, decades earlier, Smeaton had paid just one hundred thousand dollars for the forty acre site from the hard-up heirs of a local planter.
Fitzwilliams put up the financing for the development as Smeaton hopped from island nation to island nation peddling the project to wealthy potential buyers or inviting them to his thirty metre yacht, anchored in the bay in full view of the superb site.
The Emerald Pool was not Smeaton’s only ambitious venture, he together with his local political friends dreamed of turning the sleepy island into an offshore tax haven in the same way the billionaire Stanford had done for Antigua, another tiny island with a population of just 85,000. Smeaton’s home had long been a venue for the island’s most influential decision makers who regularly enjoyed the pleasure of the hospitality he showered on them, arranging tennis tournaments, garden parties, and diners on his yacht.
Smeaton’s personal offices were on the same small city block as the modestly imposing Anglo-Dutch Commercial Bank building in Roseau. He preferred to separate his more important affairs from the everyday detailed activities of the bank, discretely meeting his business friends, many of whom were rich travellers and investors who from time to time visited the island to watch over their accounts.
The island turned inward when the final curtain came down on the British Empire. Britain granted most of its small island colonies in the Caribbean independence, an event that many were to regret. V.S.Naipul had described them as part of the jetsam of an empire. The British Foreign and Commonwealth Office when asked how they would survive retorted: they would turn themselves into tax havens.
Six British Overseas Territories remained in the Caribbean, including the Cayman Islands and the Virgin Islands. Amongst those that had been granted the dubious privilege of independence certain been more successful at transforming themselves into tax havens than others, especially the Bahamas, which enjoyed a per capita income on the same level with that of the US or Canada. The standard of living on island nations, such as Antigua — higher compared to certain other Caribbean nations — was considerable lower than in the British Overseas Territories. As for Dominica it was a long way down the scale, poorer and less developed, where the per capita revenue was a mere tenth of its richer neighbours, much nearer that of impoverished Jamaica.
Dominica had therefore been a virgin territory for Smeaton, a place where he could feel at home, it reminded him of his childhood Java, uncomplicated, and without the constant pressure of competition. On first sight, as a person, he would have never been described as a flamboyant individual, physically he was not tall; somewhat frail in appearance and had a modest, almost shy, friendly demeanour. That was deceptive; he liked the company of friends and those who knew him well were mindful of his terrier like determination.
Smeaton’s popularity on the island was, to a large part, owed to his generosity and of course the jobs he provided. Over the years he earned the admiration of local businessmen and politicians who had to acknowledge the success of his astute investments in finance and property development.
The Commonwealth of Dominica
‘I don’t even know what CDSs are!’ said Sarah cheerfully.
‘Credit default swaps,’ explained Smeaton. ‘They’re what you could call contractual bets between two parties on whether a third party would default on its debt — invented by JP Morgan in 1995.’
‘Trillions of dollars,’ Barton added for good measure.
‘The most incredible thing is if a bond falls into default the loss could be claimed from the underwriters by punters, who’d insured against its default, even if they did not own it,’ mused Smeaton.
The sub-prime crisis had suddenly become a hot point of conversation for just about everybody, from bankers to homeowners. Smeaton had little doubt the roots of the crisis went back to the start of the new millennium and the dotcom stock market bust, after which interest rates had been forced down by governments to stimulate their economies. In doing so investment grade bonds became attractive, offering good returns for financial institutions. This led to a boom in CDOs and CDSs, the performance of which was considerably better than government bonds.
Default risk was covered by insurance and credit ratings agencies calculated risk based on historical default statistics. The trouble was the data was more than insufficient to make a realistic evaluation of the risk as these products were relatively new and when the sub-prime crisis struck CDOs, CDSs were caught up in the storm.
Sarah looked lost by the talk of technical terms of which she, and most other people understood little or nothing about, including Barton, who if honest, would have had to confess his own very fuzzy understanding.
‘Look, let me give you an example,’ said Malcolm. ‘Imagine you’re an investor and you’ve bought a million pounds of corporate bonds from a building firm with a yearly interest rate of say 5%...’
Sarah raised her hand: ‘What precisely do you mean by corporate bonds?’
‘Money raised by a firm on financial markets for its different business needs, like a loan.’
‘I see,’ smiling as to excuse her ignorance.
‘So your bonds could be insured against the risk of firm going broke for example, or the non-payment of interest — naturally for a premium — until the bonds reached their date of maturity or were sold.’
Smeaton refilled his glass.
‘If the building firm does not go broke and pays its interest then the insurer pockets the premiums, if on the other hand it does go bust then the insurer has to pay out compensation.’
‘Tough.’
‘Like any insurance company.’
‘Does it happen often?’
‘No, at least it didn’t up until the sub-prime crisis,’ said Fitzwilliams smiling grimly.
‘The biggest seller of credit default swaps has been the American insurance company AIG. They sold a lot of CDSs thinking that there was little or no risk. So since the crisis broke they’ve been in deep trouble. Their shares have collapsed, and they can’t raise the capital they need to function.’
‘Everybody tried to get on the bandwagon when things were good,’ said Fitzwilliams ruefully. ‘Even us.’
‘Yes, I’m sorry to say that’s true,’ said Barton. ‘In the US mortgage brokers sold sub-prime loans with low introductory rates to working-class Americans with little concern about their ability to keep up the repayments. It was like selling hot cakes and Mortgage businesses like New Century boomed.
‘At the peak of the market, sub-prime loans made up twenty percent of all mortgages, loans to people who had little prospect of fulfilling their commitments. Naïve buyers were pressurized into taking out loans by unscrupulous brokers. Falsified income declarations with seriously exaggerated property evaluations were almost normal.’
Barton spoke with experience; he himself had been drawn into the frenzy. His decision to quit had been motivated by his innate conservatism and sense of self preservation.
‘I suppose the rot really set in when these sub-prime loans were then sold to investment banks through auctions,’ Smeaton sighed. ‘Investment banks made a fortune packaging these into mortgage backed securities bonds to be sold to institutional investors.’
‘So why did they do this if it was risky?’ asked Sarah.
‘Money my dear, filthy lucre. Nobody stopped to consider the real risk. Salespeople worked on commission. The more loans they sold, the bigger their bonus. So from the beginning to the end everybody lied: the borrowers who were getting their dream homes, the mortgage salespeople, the investment banks, and last but not least the investors who bought the bonds believing they would make a nice profit.’
‘But can banks do things like that?’
‘Normally no,’ said Fitzwilliams self-righteously. ‘But many banks put their traditional caution to one side in the name of even greater profits, throwing due diligence to the wind, bringing banking into disrepute.’
Smeaton gave his friend a strange look.
Malcolm Smeaton had been one of the many friends of the late Irish banker David Castlemain, Fitzwilliams’ uncle, with whom his own small trading bank had been a partner for over half a century. After Fitzwilliams had been appointed head of the Irish Union Bank, later the Irish Netherlands Bank, he visited the Caribbean with a stop in Dominica to renew business ties and relations and was invited to stay at the Smeatons. He was enchanted by Pondok Indah and the spectacular natural beauty of its site.
It was not long before Fitzwilliams persuaded Smeaton that a fortune could be made by developing part of the land, without of course spoiling the view from his home, which stood to one side of the point. His idea was to build a small though luxurious hotel surrounded by a dozen or so villas designed in the much-admired style of Smeaton’s Pondok Indah. The villas would be entirely serviced by the hotel so that whenever the owners or wealthy vacationers arrived everything would be in perfect working order for instant comfort and stylish living.
The most luxurious villas were planned to stand ten or fifteen metres above the sea with stunning views overlooking the beach to the west and the lagoon to the south. The interiors were designed in a combination of modern and tropical themes, exotic woods, marble and granite, and of course panoramic windows. Mahogany doors were to open onto the spacious living area and terrace, offering a one hundred and eighty degree view of the Caribbean. On the first floor the bedroom suites would be surrounded by terraces offering the magnificent vista of the island’s breath taking scenery.
At the time the plans were conceived nouveaux rich buyers were not lacking; wealthy businessmen from North and South America, Russians, Europeans and of course those who had made fortunes in the City of London.
Dominica was described as the Nature Island of the Caribbean, an alluring land of majestic, mist-covered mountains spilling with waterfalls. The luxurious homes were advertised as an investment in an unspoilt paradise, a vision of swaying palms overlooking beautiful beaches and a pristine sea. As Sarah had explained prices began at three million dollars, the homes were for the rich, the nouveaux riche, sports personalities and showbiz celebrities. They very private holiday residences serviced by a team of impeccably trained personnel to care for the whims of even the most spoilt.
The list of those who were said to have signed up for the Emerald Pool development in Dominica read like a who’s who of rich and nouveaux riches. Smeaton offered them a corner of paradise and all they had to do was choose the finer details of their luxurious villas whilst waiting to enjoy the privileges of the wealthy far from snooping eyes.
Dominica was different, it was almost a virgin territory compared to many other Caribbean islands, a sleepy backwater where life was uncomplicated, without crime, off the package tour circuits, and where hippies and their likes were firmly discouraged. The absence of the kind of infrastructure that went with mass tourism made it haven of tranquillity just waiting to be discovered by the newly rich.
It was for the kind of people
Smeaton was discussing a Mandarin Oriental franchise for the hotel to provide it with a prestigious name and a worldwide booking system capable of reaching out to the kind of client whose primary concern was seclusion.
Dominica, not being a destination for mass tourism, offered the rich advantage of its private beaches, where they could enjoy the tranquillity for their own secluded stretch of sea compared to other Caribbean islands where the most beautiful beaches were public.
Much to Smeaton’s regret things had somehow gone awry, the timing was wrong; work on the site had come to a halt. The splendid project was in suspended animation waiting for the world economy to return to the halcyon days before the crash.
The Emerald Pool had been modelled on Pondok Indah, Smeaton’s Dominican home, which had been designed in the style of his childhood home in the residential district of Kebayoran Baru, in far off Jakarta, built from native hardwoods and volcanic stone, where his father had managed the Indonesian business of the family’s Anglo-Dutch Commercial Bank. On arrival in Roseau, decades earlier, Smeaton had paid just one hundred thousand dollars for the forty acre site from the hard-up heirs of a local planter.
Fitzwilliams put up the financing for the development as Smeaton hopped from island nation to island nation peddling the project to wealthy potential buyers or inviting them to his thirty metre yacht, anchored in the bay in full view of the superb site.
The Emerald Pool was not Smeaton’s only ambitious venture, he together with his local political friends dreamed of turning the sleepy island into an offshore tax haven in the same way the billionaire Stanford had done for Antigua, another tiny island with a population of just 85,000. Smeaton’s home had long been a venue for the island’s most influential decision makers who regularly enjoyed the pleasure of the hospitality he showered on them, arranging tennis tournaments, garden parties, and diners on his yacht.
Smeaton’s personal offices were on the same small city block as the modestly imposing Anglo-Dutch Commercial Bank building in Roseau. He preferred to separate his more important affairs from the everyday detailed activities of the bank, discretely meeting his business friends, many of whom were rich travellers and investors who from time to time visited the island to watch over their accounts.
The island turned inward when the final curtain came down on the British Empire. Britain granted most of its small island colonies in the Caribbean independence, an event that many were to regret. V.S.Naipul had described them as part of the jetsam of an empire. The British Foreign and Commonwealth Office when asked how they would survive retorted: they would turn themselves into tax havens.
Six British Overseas Territories remained in the Caribbean, including the Cayman Islands and the Virgin Islands. Amongst those that had been granted the dubious privilege of independence certain been more successful at transforming themselves into tax havens than others, especially the Bahamas, which enjoyed a per capita income on the same level with that of the US or Canada. The standard of living on island nations, such as Antigua — higher compared to certain other Caribbean nations — was considerable lower than in the British Overseas Territories. As for Dominica it was a long way down the scale, poorer and less developed, where the per capita revenue was a mere tenth of its richer neighbours, much nearer that of impoverished Jamaica.
Dominica had therefore been a virgin territory for Smeaton, a place where he could feel at home, it reminded him of his childhood Java, uncomplicated, and without the constant pressure of competition. On first sight, as a person, he would have never been described as a flamboyant individual, physically he was not tall; somewhat frail in appearance and had a modest, almost shy, friendly demeanour. That was deceptive; he liked the company of friends and those who knew him well were mindful of his terrier like determination.
Smeaton’s popularity on the island was, to a large part, owed to his generosity and of course the jobs he provided. Over the years he earned the admiration of local businessmen and politicians who had to acknowledge the success of his astute investments in finance and property development.
The Commonwealth of Dominica