A Day at the Stock Market, A Night at the Opera

What is happening in the stock markets of the planet? Certainly, risk is being repriced across all of the world’s marketplaces. People are taking gains where and when they can, and moving the proceeds off the table to safer instruments, if not to fireproof steel boxes and comfy mattresses. Significant volumes of credit are evaporating, as some lenders are simply closing their transaction windows to wait out whatever shakeout is about to come. People with money are heading to the tornado cellars. If you hold cash right now, then good for you. Patience is a virtue, and cash may be the next best thing to godliness.

And where are these trends going to take us? We ask that question a lot here at Agora Financial. And sometimes it helps me to clear my head and collect my thoughts if I listen to some music.

Let’s Go to the Opera

So let’s go to the opera. Consider for a moment the opus Treemonisha by the great American musician and composer Scott Joplin (1868-1917). Written in 1910 and never performed in its entirety during Joplin’s lifetime, Treemonisha is the only large-scale work to survive from the great ragtime master. Overlooked for many decades, and indeed almost lost to history, Treemonisha was not performed in its entirety until 1970, but thereafter, it went to Broadway, became a hit and won a Pulitzer Prize (posthumous) for composer Joplin in 1976. Thus Treemonisha is a classic that transcends time and space, and serves well to remind us of another era with a very different set of values. And the reminders inherent in those old, value-laden chestnuts from Joplin are presented in easily understood comparisons that are almost, if you will excuse the expression in this context, black and white.

A Bag of Luck

Treemonisha has a simple plot. The story takes place in September 1884, on a plantation in Arkansas. The namesake of the opera, a young girl named Treemonisha, encounters a group of local conjurers who deal in voodoo and mysticism. These conjurers are at root nothing but scam artists, trying to sell Treemonisha’s poor mother what they call a “bag of luck.” Treemonisha refuses to go along with this transparent rip-off and denounces the conjurers. The conjurers retaliate by kidnapping Treemonisha, who is, in turn, heroically rescued by her beau, Remus (this is opera, after all). Having exposed the conjurers as frauds, Treemonisha leads a campaign to educate and improve the lives of the members of her community. And this being opera, there is much delightful singing and dancing.

What prompts me to think of Treemonisha in light of the recent market volatility is the Joplin opera’s forceful emphasis on certain basic elements of living an honest and decent life. One song is entitled, “When Villains Ramble Far and Near.” The lyrics say it all: “When villains ramble far and near/With their hearts full of sin/They do much wrong without a fear/But someday right will win.”

Or try this operatic ditty, entitled “Wrong Is Never Right.” The lyrics are, “Wrong is never right/That is very true/Wrong is never right/And wrong you should not do.”

OK, I admit it. There may be a certain dramatic lightness to the work. The libretto can legitimately be viewed as juvenile, if not condescending toward the poor, ill-educated sharecroppers (mostly former slaves) who form the characters of the tale. So the story line of Treemonisha is not exactly The Brothers Karamazov by Dostoevsky. But Treemonisha is also something of an idyll, certainly an Americana musical marvel. It is downright sweet and a resourceful and multidimensional mixture of rags, dances, waltzes, sentimental ballads and full-scale arias. Treemonisha is filled with expressive ranges, syncopated rhythms, harmonies and instrumental sonorities of ragtime. Oh, would that much else in this life could imitate such art.

In Treemonisha, composer Joplin takes a simple folk message and uses complex ragtime musical elements to create set pieces that go far beyond the conventions of the style. Joplin takes you back to the basics, back to plain old right and wrong, and with his musical background drives home the key points like a lightning bolt hitting the tree outside your window. Yes, dear readers, you can go home again.

Back to the Stock Markets

So now that we have been to the opera, let’s get back to the financial markets. What has been happening? How can Treemonisha help us to understand our predicament? Well, we are now witnessing the end result of too many economic conjurers peddling too much of the equivalent of that “bag of luck” to gullible, if not greedy, borrowers and investors over the past decade or so.

Looking back, the biggest purveyor of superstition, voodoo and a “bag of luck” was the No. 1 macroeconomic witch doctor of our era, the so-called “maestro” Alan Greenspan. Between 2001-2004, Mr. Greenspan engineered the decline of what is called the fed funds target rate from 6% to 1%. In consequence, banks borrowed cheap money from the Fed and in due course searched high and low for ways to pump that liquidity into the economy. Much of the money wound up in risky mortgages, clinically enabled — like a bartender pouring more drinks for the inebriated sot on the adjacent stool — by a convenient decline in traditional lending protocols as the subprime mortgage market took off like a rocket.

Between 2001-2005, subprime mortgages grew from 2% to 14% of all mortgages issued in the U.S. In 2003, in fact, the Fed cut rates to only 1%, causing subprime lending to increase by 150%, from 4% of total lending to more than 10%. The money supply of not just the U.S. housing market, but of the entire U.S. economy and the related dollar-using world just went haywire. But then again, as is the case with cancer and petroleum dependency, there were and are more people living with the disease than dying from it. For now, at least.

In the Olden Days

Some of those tunes from Treemonisha are still humming in my head. In the olden days, and not even as far back as the pre-Fed gold standard era when Treemonisha was composed, first-time home buyers paid about 20% of the value of the houses upfront. Borrowers took out long-term, fixed rate mortgages, and not those bizarre “interest only” or “negative amortization” loans.

On the other side of the transaction, in the olden days, the lenders were usually local bankers, and not faceless Dilberts who worked in some cubicle of a national lending institution on the other side of the continent. And the lenders tended to be from the serious, skeptical faction of the human gene pool. That is, the lenders understood that they were loaning out the depositors’ money and that the depositors eventually wanted it back. When it came to mortgage lending, those uptight bankers knew generally that, in the words of Scott Joplin, “Wrong Is Never Right.”

So in the olden days, the lending system was tilted, if not rigged and structured, so that homeowners bought houses that they could actually afford, at prices and mortgage terms that they could pay over the long term. If one did not qualify under the bank’s lending protocols, then one remained a renter. It was not considered illegal or unpatriotic redlining to deny a mortgage to someone with little or no prospect of paying it back. When borrowers ran into financial trouble (and to be sure, on occasion they did), it was usually due to some unforeseen event in their lives like the loss of a job, an illness or a divorce. Yes, as former Defense Secretary Donald Rumsfeld once said, “Stuff happens.” But in the olden days, the mortgage was almost never the “stuff” of the main problem.

Villains Ramble Far and Near

Yet in a world of easy money from the Fed, and in the words of Scott Joplin, “Villains Ramble Far and Near.” Subprime mortgages have now become the financial culprit that is wrecking the national and international credit markets from the ground up, like Samson pulling down the Temple. And by extension, those subprime mortgages are bringing down the related financial markets and disrupting the predictability of interest rates. This subprime disaster is particularly toxic due to the so-called “zero-down,” ninja loans (“ninja,” as in no income, job or assets) issued with two- or three-year terms, followed by floating rates that are keyed to reset upward (right about now, sad to say, with much more due to hit the fan in the next year) in a higher interest rate environment.

These home-wrecking loans were arranged, for the most part, by those national mortgage brokers and bankers who earned lucrative fees (and permit me to add, purchased many a flashy automobile and tawdry 14-carat bling), peddling their own “bags of luck.” The selling point was that interest rates were low and real estate prices were rising, so the overstretched borrower could eventually refinance at a lower rate or sell his overpriced hacienda into that proverbial “rising market.” Yes, and children believe in Santa Claus, while some adults think they can get rich by gambling at casinos in Las Vegas.

Where Are We Headed?

So where are we headed in all of this? I seldom make guarantees, but in this case, I will pretty much guarantee you that all borrowers, in whatever sector of the economy you care to name, are now likely to face significantly higher borrowing costs for years to come. This will be the case whether the loan is personal or business, and even for those with stellar credit histories.

And according to Edward Chancellor, author of Devil Take the Hindmost: A History of Financial Speculation, there is another profound problem:

“The credit system is losing its, well, credibility. People no longer trust the triple-A ratings that many complex debt securities carry. The risk models used by rating agencies, hedge funds and banks have also come under suspicion. The effects of subprime losses are being felt in unexpected places, including supposedly impregnable money market funds. Hedge funds and other highly leveraged investment vehicles are being forced to unwind. After years of excess, credit is beginning to contract. There has been a run on Wall Street finance… but no one knows how long it will last, or where it will end.”

The companies that we recommend in Outstanding Investments do not own, make or sell the proverbial “bags of luck.” We screen for that. Still, any company may be whipsawed by the business cycle or by an economic contraction caused by a slowdown in consumer spending or deterioration of lending or capital spending. So if you have a gain on the books and are nervous about hanging onto it, you should sell some shares and take your money off the table to the point where you can sleep at night. As we said above, cash is good. Going forward, you should keep an eye on any decline in share prices and consider it a chance to acquire great energy or mining shares for the long haul, and at a discount.

Until we meet again…
Byron W. King

P.S.: Scott Joplin’s wonderful opera Treemonisha is rarely performed these days, so if you ever have the opportunity to see a performance, you should buy a ticket and go. The only recording that is still widely available is from Deutsche Grammophon, based on a performance by the Houston Grand Opera in 1975. Enjoy the show.

September 14, 2007

The Daily Reckoning