Drinks By The Pool (Or Structured Products Made Simple)

I visited a large house in East Anglia a few years ago and the owner outlined his plans for landscaping and extending his already extensive grounds. More a project for a French King and more a blog topic for The Irish Aesthete you might think.

I will not intrude on The Irish Aesthete’s territory, at least not today. I asked him where the money was coming from to pay for such a grandiose project and here is the story he told me.

In the 1980s he was all but broke. Interest rates and inflation were both sky-high in the UK and property prices were going through the roof. He found a commercial property that had a good rental yield and seemed likely to go up in value. But he could not raise the money as he couldn’t pay the high interest rate being demanded. In short, like Nathan Detroit in Guys and Dolls, he couldn’t get into the game.

He took advice and here is what he did. He borrowed Swiss Francs. Interest rates in Switzerland were low. He converted the Swissies, as City-types are apt to call them, into British Pounds and bought the property. He was in the game. The rental income easily covered the interest payments.

I ventured a comment. What if the Pound depreciated against the Swissie? His advisor had thought of that and this was he said the riskiest part of the deal. He bought options to sell the Pound (called Put options); actually more options than he needed to cover his mortgage. These options were typically only valid for about three months and had to be expensively renewed. However, at every roll-over he booked a huge profit as the Pound collapsed against the Swiss Franc.

In time he was able to sell the property and repay the mortgage making almost as much on the currency deal as he had on the office block. A rare example of a structured product working to the buyer’s advantage.

The best advice I’ve heard is “when you hear someone say structured products, run for the hills”. In the 1980s Hammersmith council didn’t heed this and  dipped more than a toe into the complex and opaque world of structured products via interest rate swaps. In theory the council exchanged floating interest rates with a bank, for the “security” of a fixed rate. In fact it was a one-way bet on the direction of interest rates that went very wrong.

But structured products are dull and I wanted to see my friend’s indoor pool and investigate the drinks’ fridge.