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The margin lending debacle

The margin lending debacle

Will banning margin lending stop the 'inevitable parting of ways between fools and their money', writes Brisbane barrister David Topp of the recent BrisConnections and Storm Financial examples.

Those with a substantial-looking share portfolio at the commencement of 2008 are holding statements today that paint a far less rosy picture. And this is even more so for those with exposure to the two of the biggest share market related debacles of the recent past: Storm Financial and BrisConnections.

It is well known (now anyway) that the funding model for BrisConnections’s Airport link project in Brisbane depended on three separate $1 per unit instalments from subscribers. The first BrisConnections instalments were duly paid for and units listed on the ASX. However not only did they fail to list at their notional $1 price, it did not take long for the units to fall so far in value to the lowest price that securities can be traded on the ASX: a trifling $0.001.
At those prices a mere $1,000 investment would translate into 1 million BrisConnections units. The apparent value was, in real terms, illusory given that those purchasers had two more $1 per unit calls to face. In other words, translating into an overall liability of $2,001,000. Of course this is not nearly as promising as it initially looked.
Hence the apparent motivation behind moves to wind up the trusts that together comprised the listed BrisConnections vehicle. After Macquarie Capital Advisers Ltd & Anor v. Brisconnections Management Co Ltd & Ors [2009] QSC 82, BrisConnections trusts were not wound up. But even if that had been the outcome, unit holders would have remained liable. As it presently stands, the second instalments are due and payable tomorrow, 29 April 2009.
Much negative comment has therefore been made about why retail investors were not warned about their future obligations under the second and third $1 per unit calls. The merits of this argument can be debated at another time. It does however reinforce that investing in the share market is inherently risky and people who don’t take due care can and will lose.
So far as Storm Financial’s recent history is concerned, Justice Logan of the Federal Court quoted the following extracts from the administrator’s report: “The initial catalyst for the dramatic reversal of Storm’s financial position was, without a doubt, the very large and sustained drop in the Australian share market. Whether the company could have withstood the drop in the share with the assistance of its bankers, whether the investments recommended by Storm to its clients were appropriate … are all issues that have been called into question …”
A great deal of the Storm Financial anger related to its model whereby retail investors mortgaged their homes to be able to leverage the purchase of substantial numbers of shares. While this strategy would likely work during a bull market, when the markets started to tumble once the GFC became a reality, the flaws in the model became obvious.
But should margin lending be, if not banned, substantially critiqued? Granted banning the practice is a controversial proposition. But what would society’s reaction be to any entity promoting loans to people to gamble at racetracks or poker machine venues? Moral outrage. 

Yet share market investing, though not an exercise in pure gambling, is nonetheless risky. And while the constant refrain in the recent past is that empirical evidence over the last century proves that markets can and will recover, retail investors and/or superannuants close to retirement who have seen their portfolio values plunge simply do not have the luxury of waiting out the next three to four years for the markets to recover to their beginning of 2008 peaks. Especially as margin lenders, noting the falls in the value of the securities for the funds lent by them, increasingly make margin calls so as to maintain a form of equilibrium level for their security interests.
Add to this the general tenor of the complaints from all who lost money in Storm Financial, and stand to lose in BrisConnections when future calls become due, that “we didn’t know”, “no-one told us of the risks”, “we’re facing bankruptcy” - it all causes me to remember the sage advice given to me when young of “only bet what you can afford to lose”.
So will margin lending be banned? Most likely not; despite my dislike of the practice, and hence my refusal to ever participate, there is enough controversy as it is about the increasing tendency towards so called “nanny statism”.

Moreover banning margin lending won’t stop the inevitable parting of ways between fools and their money. Nothing ever will. However far more needs to be done to reinforce the fabled buyer beware notion that has existed from time immemorial but tends to get swiftly forgotten about during boom times – especially during the pre GFC salad days. 

If one good thing can come out of the Storm Financial and BrisConnections debacles, let’s hope that it is better financial and risk education for those who need it most.   

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The margin lending debacle
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