What Wall Street Needs is a Few Good Men
What a week in the financial markets! I recently returned from a trip through New England’s scenic vistas. Tourists were plentiful and cheery. Most enjoyed blissful ignorance of the credit crisis – and how the government’s response to it will ultimately impact their lives.
And few got the memo from Wall Street strategists that they are supposed to stop driving because oil is over $100 per barrel. Americans love their mobility, and they will pay a premium to keep it. I expect the resilience of energy demand to surprise many.
I checked the markets at the end of each day as the list of bear market casualties grew: Fannie, Freddie, Lehman, Washington Mutual, and now, AIG. It’s amazing how well the financial stocks we’re selling short in Strategic Short Report are holding up, since they’re all loaded with leveraged exposure to credit risk. But I’m confident our patience will be rewarded in the coming quarters.
My week off allowed plenty of time to think about the future of this credit crisis from a much broader perspective. Driving though Vermont’s scenic Green Mountains and New Hampshire’s White Mountains, we had plenty of time to listen to audio books.
One in particular – David McCullough’s excellent book 1776 – offered perspective on how far the U.S. has strayed from its founding principles. 1776 is a historical narrative of the American Revolution, with a focus on the early military engagements between General George Washington’s Colonial Army and the powerful, yet overconfident British Army.
Two themes from the book seem to parallel recent financial market events:
First, in one scene, British soldiers express their surprise at what motivated the colonists to revolt. Most Americans enjoyed a high standard of living, and nearly all were better off than British regulars. Why did they risk life and limb in a fight against British rule, when they had such material wealth and a decent amount of sovereignty? With historical perspective, we can appreciate even more just how much freedom most colonists enjoyed; taxes in particular were a pittance compared to today’s U.S. tax burden.
Despite their many sins – most notably slavery – the colonists had amazing sense of sacrifice and honor. Their willingness to fight for freedom from government abuses stands in stark contrast to the attitudes of most modern Americans. Now, politics focuses on wealth redistribution, rather than harness the American entrepreneurial spirit and human capital to compete effectively in the global economy. It’s gotten so bad that most Americans hardly seem to care when the federal government virtually takes over the mortgage industry – and most don’t even understand how we got into this mess in the first place.
Will my one-year old son Ben apply directly to the federal government, a.k.a. "Frannie," for a mortgage when he grows up? Will politicians now directly manage the mortgage industry? After this week, it’s far more likely to happen. We are watching the slow creep of socialism. That holds enormous long-term consequences for financial markets.
The second interesting point I drew from 1776 concerns leadership. George Washington didn’t posses the brightest mind, or the best oration skills, but he quickly learned how to lead through success and failure while maintaining great humility.
After a stinging defeat at the Battle of Long Island, Washington engineered a brilliant overnight retreat that salvaged the awkward, inexperienced Continental Army. Rather than gamble his army on a low-probability recovery of lost ground, he swallowed his pride, and retreated to fight another day.
Washington’s humility in retreat stands in stark contrast to the type of leadership we’ve seen in the boardrooms and executive suites on Wall Street. In nearly every big financial blowup of the past year, executives have failed to make tough choices that might have salvaged shareholder value, and instead gambled on a miraculous future turnaround.
Think about how much better off Lehman Brothers would be if its management hadn’t put off the process of reporting losses, dumping impaired assets, and raising new capital. Would its stock be $4 today? Probably not.
While all of those decisions would have been painful at the time, they could have salvaged much more shareholder wealth – just as a successful retreat preserves an army’s ability to fight another day.
The speed of Lehman Brothers’ deterioration is shocking even to its skeptics. Despite my already low opinion of Lehman management, expressed several times in this space, I’m amazed at its failure to structure a deal or asset sale to salvage a respectable amount of shareholder value. Lehman even had the advantage of immunity to a "bank run," thanks to the Federal Reserve’s lending facilities. Bear Stearns wished it could have used the same; it was finished as soon as creditors lost faith in its solvency. Lehman shareholders and its 25,000 employees deserved better.
These are tumultuous times – times that show us all the importance of good leadership. The importance of management leadership skills is never greater than it is in a crisis.
Dan Amoss, CFA
for The Daily Reckoning
September 18, 2008
The above essay was pulled from the most recent issue of Strategic Short Report.
Dan Amoss, CFA runs Strategic Short Report, and is a contributing editor for Strategic Investment. Dan joined Agora Financial from Investment Counselors of Maryland, investment advisor for one of the top small-cap value mutual funds over the past 15 years.
Dan brings with him the unique experience of an institutional background and a drive to seek out the most attractive investments within favored "big picture" trends. He develops investment ideas for his readers with a global network of geopolitical and macroeconomic analysts. Dan holds the Chartered Financial Analyst designation, a professional designation widely recognized within the investment community.
Yesterday, the earth shook. It was an important day. The Dow dropped another 450 points. But what really moved yesterday was an inert metal – gold.
The gold market rumbled and shot hot prices into the air. Alert investors knew what the shaking was all about. Our modern financial Vesuvius is beginning to boil…
You’ll recall the story of Pompeii. The mountain began groaning…and sending up clouds of smoke. Smart residents took to their boats. They didn’t want to stick around and see what would happen next. Others stayed behind, believing it would blow over. But instead of blowing over, Vesuvius blew up, burying the whole town under ash and lava.
Gold rose as much as $100 in intraday trading yesterday and ended up $50 – its biggest move ever. Investors were looking for a safe place to put their money. From the time of Pompeii, gold has been the refuge of choice for investors everywhere. It still is. And, looking at the market, gold is going to become the obvious choice for more and more investors. Get your gold now – and beat the rush.
But what exactly is blowing up?
A few days ago we warned against a "collision of scams" – in which the desire to get something for nothing in the markets runs headlong into the desire to use government to live at someone else’s expense. People invest in scammy investments – such as subprime MBOs – in the hope of getting rich…and then, when the investments go bad, they look to the government to bail them out. Then, when the scale of these deceits gets big enough…the whole system blows up.
That is what investors are worrying about now. Wall Street is melting down. Stock markets all over the world are headed down. Property prices in most places are going down. And the U.S. government is desperately trying to keep things going up – in the only way it can…by bailing out, injecting funds, lending money at negative interest rates, propping up, and guaranteeing everything.
Today brings news that the Fed is providing the biggest central banks in the world with liquidity to injection in the financial markets. MarketWatch reports:
"The move will allow the European Central Bank to auction as much as $110 billion in one-day and other short-term dollar loans to commercial banks in the 15-nation euro zone, up from its current level of $50 billion. The amount available through the Swiss National Bank was increased to $27 billion, a rise of $15 billion.
"The Fed also authorized new swap facilities that will enable the Bank of Japan to provide $60 billion in dollar liquidity, $40 billion by the Bank of England and $10 billion by the Bank of Canada."
A few weeks ago, the feds bailed out the mortgage industry…by nationalizing Fannie and Freddie and promising to put up $200 billion. Congratulations fellow taxpayer; now we own the world’s largest source of mortgage finance. This week, it was the insurance industry. They nationalized the biggest insurer in the world – AIG – with an injection of $85 billion. Congratulations again. Now we own 80% of AIG. Next in line is the auto industry, asking for $25 billion.
Where in the U.S. Constitution does it authorize the executive branch of government to go into the insurance business? We don’t know…but no one cares anyway…
The French nationalized their auto companies after the war. Then, when the socialists took control of the government in the ’80s, they nationalized the banks too. "Silly frogs," said American economists. "Don’t they know that a free market works best?" And so you see, dear reader, in all time zones and all languages, people are the same – always hustling up something for nothing, whenever they can get away with it.
But wait. Where do the feds get an extra $300 billion or so? The federal budget is already in deficit, about $400 billion worth. The only choice for the feds is to borrow more. But even the full faith and credit of the U.S. government has its limits. The sub-prime crisis came about because people borrowed money they couldn’t pay back. When investors realized what they had done, they dumped the packaged, AAA subprime credits…and ended a 26-year-old credit expansion. And what did they do with the money? They took refuge in the prime credits of the U.S. Treasury. The dollar rose. Bond yields fell.
Now they’re having second thoughts. And if they’re not…they should. The more the economy and financial sector weaken, the more money the feds must put up to rescue them. The more dollars they need, the more they must borrow. And the more they borrow, the more they don’t pay back… Already the amount unpaid – the official national debt – is almost $10 trillion. The interest alone is nearly $2 billion per day. Meanwhile, tax revenues are falling. Social costs – as people need more unemployment compensation, more free food and medicine, more subsidies and giveaways – are rising. Some economists are predicting budget deficits of $1 trillion…others say it could go to $2 trillion…
Oh yes…dear reader…this is where we hear the volcano heating up…
And this is when smart investors take to their golden barks… Not that they know what will happen. But they know the safest way to find out – from a distance…and, like refugees from time immemorial, with gold coins in their pockets.
*** "Nothing like this has ever happened before," said Peter Bernstein to Barron’s. "There have been credit crunches and housing crises and dollar crises, but having all the chickens coming home to roost at the same time and interacting with one another is unique. We have historical perspective on the parts, but not the whole, and that makes things both interesting and scary…"
Goldman fell off a cliff yesterday. The stock sold for $240 last November. Now, you can buy all you want for just $120.
So far this year, the Dow is down 16%. That makes it one of the world’s best performing markets! English stocks are down 22%. In Paris, the Bourse is off 27%. Indian stocks are down 33%. But Chinese stocks have lost twice as much – 67%.
Getting back to our "collision of scams," as Peter Bernstein puts it, there are a lot of feathered scams…and they’re all coming home to roost at the same time. There’s bound to be trouble in the coop.
In from the front yard comes the scam of ever-rising house prices. And it collides head on with the scam of the consumer finance coming from the henhouse roof (that people could borrow from their houses in order to increase spending)…
…that runs into the whole humbug of the consumer economy (that people can get richer by spending money they don’t have)…
…that smashes into the flimflam of subprime mortgage lending…
…which bumps into the scam of the financial industry’s business model (the masters of the universe claimed to be adding value by "allocating capital efficiently; what they were really doing was merely loading people up with debt)…
…which crashes into the big birds of Wall Street (now going broke)…
…which runs into the fraud of government bailouts (that the feds can put in money that comes out of thin air; in fact, any resources the put in to prop up failing institutions has to be taken from healthy ones…)…
…which creates one heck of a mess when it slams into the dollar and the counterfeit global monetary system since 1971 (in which the supply of paper money is unlimited…and the full faith and credit of the US government is thought to be infinite!)
We’re talking chicken gumbo! And the convergence of all these scams could wreak havoc on your portfolio…but only if you are unprepared. Take advantage of the resources available to you in the Strategic Financial Survival Library.
*** "That’s Louis de Monfort. And that’s Pierre Lamonte and his wife Louise. And over there, in the blue dress, is Anne-Marie…and that’s her husband, Jean-Louis…."
Elizabeth was helping us avoid social faux pas. We were at a party, with hundreds of people…many of whom we knew well…and many your editor thought he had never laid eyes on.
"Oh yes you have…" Elizabeth corrected him. "They were at dinner with the Roussettes… You met them at the Polignac’s wedding…"
"Well, how do you remember so many names and details?"
"I have to remember. You get away with not knowing peoples’ names. You’re a foreigner. You’re a man. And you’re an intellectual. At least, that’s the way they consider you in France. So they give you an enormous amount of slack. They imagine that you’re thinking about other things…important things…like the national deficit…or the price of EDF stock. You put your head back and they think you’ve got lofty thoughts on your mind. They don’t realize that you’re really just looking for the bar.
"But women don’t get away with that. We’re expected to remember names…dates…relatives…who’s married to whom…and what people were wearing when we met them 10 years ago. Of course, men don’t care about that…but women care…and they care that other women remember these things.
"Now, over there is Sophie Remarck…do you remember her? We met her at the Declerc’s…the tall woman with the blond hair…
"Oh, yes you do."
"No. I don’t remember the face…and I don’t remember the name…I’ve never met her…"
"Yes you have…she’s married to Henri…he’s from a very rich family…he owns a huge estate in Normandy, and a huge advertising business in Paris. They have a sumptuous apartment on the Avenue Foch…remember…we went there…"
"Oh…ooooh… Well, I can’t remember names. And I can’t remember faces. But I never forget a bank account. Yes, I remember Henri…nice fellow… the guy in the light jacket."
"No, that’s Pierre Verget. You are hopeless…"
The Daily Reckoning
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