BLUE MONDAY

The third Monday of each new year, this year January 21, is called “Blue Monday”, the most depressing day of the year. On that day I attended the 2008 Conference of mining venture companies in Vancouver where about 500 junior mining companies, with properties around the globe, set up shop to exchange information, promote the potential of their properties and to try to raise capital from investors. I happened to be in Vancouver for other reasons but was interested to hear the keynote speech and various panel discussions dealing with the Sub-Prime Crisis.

On ”Blue Monday”, while the US markets were closed for Martin Luther King Day, ‘out of the blue’ Asian stock markets crashed. Understandably, gloom settled over the mining conference and more people were clustered around TV sets following the market turmoil than were visiting the exhibitor’s booths. With a show of humour the first speaker reminded the audience that on such days even good stocks turn into “owl stocks”. They are “owl stocks” when you call your broker and say: “Sell” and his chirpy answer is “to whoo, to-whoo, to-whoo?”

The days’ major news story, the Market crash, reminded me of a phenomenon known as “Black Swan” - the occurrence of a highly improbable event.

Before the discovery of Australia, Europeans thought that all swans were white. It was an unassailable belief, 100% confirmed by empirical evidence. The sighting of the first black swan in Australia showed that there could be a serious problem with what we learn by observation. A single observation invalidated a general statement derived from confirmatory sightings of millions of white swans.

A “Black Swan is an event with the following three attributes:

First, it is unexpected because it is outside the range of earlier observation.

Second, it carries an extreme impact and the element of surprise.

Third, in spite of the fact that it is completely unexpected, human nature makes us concoct “after the fact” explanations, to make it seem retrospectively predictable.

From my ringside seat, among venture capitalists seeking to find worthwhile investment opportunities from a sea of proposals with unpredictable outcomes, I realized that a “Black Swan” event is not always negative. A high grade mineral discovery, for example, can result in a huge payoff. The reward comes from recognizing an opportunity when you see it.

Nassim Nicholas Taleb, author of the highly informative and entertaining book “The Black Swan”, points to our blindness with respect to the life consequences of significant random events. He also points out that our life paths are also determined by the cumulative effects of small random events, chance encounters and decisions which might not change the world but do completely structure our lives.

“Black Swan” events have always occurred, but today, earthquakes and hurricanes for example have more severe economic consequences than in the past because there are more of us in vulnerable areas with more complex and valuable infrastructures.

I first became aware of the “Black Swan” phenomenon while in San Diego in 2006, when the author was interviewed on TV and was asked to explain the spectacular implosion of the high flying ‘Amaranth’ fund, named after the flower that ‘never dies’, which lost $7 billion dollars in a few days. His laconic answer was ‘a case of Black Swans’.* (see my letter “Black Swans” of January 2007)

The current Sub-prime Crisis is another “Black Swan” event with global consequences. The fact that millions of mortgage borrowers are losing their home equity should bring us to understand that equity, the difference between the value of a home and a mortgage, cannot be protected. I see it as the typical “Black Swan” scenario that has implications for all of us. Let me explain.

A recent CMHC study determined that approximately 75% of Canadian home owners have the elimination of mortgage debt as their number one financial priority. While the goal of owning one’s home free and clear, as a nest egg for retirement, has long been widely applauded, the fact is that there are many wealthy people, who could buy their homes with cash, who choose to have a mortgage, often the largest possible mortgage. What does the ‘smart money’ know about money that most of us don’t know? The answer is that they know how to make their mortgage interest tax deductible and how to find investment opportunities elsewhere that generate returns that more than offset the cost of the mortgage.

What if most of what we think we know about money is not true or no longer relevant? Is it possible? Most of the conventional wisdom about mortgage financing is based on the experience of the Great Depression, some 80 years ago, after which well meaning financial planners formulated mortgage financing and investments strategies to protect home owners from the adverse effects of another such calamity. During the intervening years a lot of legislation has been passed to better protect consumers, but life expectancy has also increased with the result that we need asset protection for many more years than before.

We are now in the 21st Century with thinking that might be out of touch with today’s reality. We should consider the opportunity cost of maintaining “dead” home equity, which earns us nothing, and which may be vulnerable to future “Black Swan” events.

Recent innovative mortgage products make it possible to take advantage of a strategy that allows the conversion of mortgage interest payments from the “after tax” to “tax-deducible” category. Using this strategy it is possible to increase total assets faster than by using the conventional approach of minimizing mortgage interest payments by paying down the mortgage as quickly as possible.

Vancouver was only a stop on my way to San Diego where I met with the author of the book “Stop Sitting on Your Assets”. We agreed that I would co-author a Canadian version of her book. I will team up with financial planners and conduct seminars to bring this new thinking to the attention of a larger audience – but I can assure you that as my client, you will receive your VIP back stage pass before this takes place.

I realize that my enthusiasm for the new approach to ‘mortgage planning’ may not resonate with everybody. It is however an option, for those whose circumstances and temperament it fits, to safely leverage the equity trapped in their homes and to transform it into a source of increased wealth and security.

Stay tuned, and beware of Black Swans!