Agora Financial’s Rude Awakening

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Laguna Beach, California

• Introducing the “Level Playing Field Act of 2008,”
• $42 billion: Citi raises it in distress, Exxon posts it in profit…so where are they now?
• Sows dressed up in lingerie and plenty more to rock your socks…

Eric Fry, reporting from Laguna Beach, California…

Mr. Market answers to no one…and even if he did answer, his answer might not make any sense. He is one part James Dean, one part Rain Man. He is not only a rebel without a cause; he is also a lunatic without a scrap of logic.

Just consider, for example, that GM announced a $300 million loss for the first quarter and its stock soared nearly 10% on the news. Then ExxonMobil announced a $10.9 billion profit – that’s billion with a “b” – and its stock fell 4%!

The message is clear: If you want to make the big bucks in the stock market, you gotta put your chips on the companies that are losing the biggest bucks. Exxon would not qualify. The oil giant has earned more than $42 billion during the last 12 months – a figure that just happens to be identical to the amount of fresh capital that Citigroup has raised, just to stay in business.

But don’t waste your time trying to explain these differences to Mr. Market. He couldn’t care less. Since that fateful day in Mid-March when the Fed and Treasury engineered the takeover of Bear Stearns, Citigroup shares have soared 40%. Exxon shares, meanwhile, have tacked on a mere 5%.

Mr. Market’s behavior isn’t always this wacky. But for long periods of time, he seems to takes leave of his senses. He just seems to check out for a while, like a celebrity in rehab. These are the moments when investing is very baffling and difficult…and also the moments when the best investment opportunities tend to present themselves. These are the moments when courageous – or foolish – investors will dare to sell the stocks that
everyone is eagerly buying and to buy the stocks that everyone is desperately selling.

That’s why some courageous – or foolish – investors are seizing the current moment to sell the newly popular financial stocks like Citigroup and to buy to the suddenly unpopular energy and resource stocks like ExxonMobil.

Mr. Market will come to his senses eventually.

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The “Goldman Sachs Phenomenon”
By Eric Fry

Now that the American financial sector is safe and unsound once again, has the threat of serious economic crisis genuinely passed? And has the structure of American capitalism actually improved? Or did the Fed merely dress a sow in lingerie and call her a raving beauty?

In other words, what did the Fed accomplish by lavishing billions of dollars upon the financial sector? Was the Fed’s inflationary rescue mission really worth all the trouble? Or would the nation have been better off if Bernanke and Paulson had simply gone golfing while Bear Stearns failed?

At first glance, the Fed’s rescue seems to have halted a serious crisis in its tracks. The rescue also seems to have preserved the viability of the American banking system. But upon closer inspection, we discover that the Fed’s rescue also preserved at least one dysfunctional characteristic of our economic system – namely, an over-reliance on “asset-swapping” activities, rather than “asset-producing” activities.

Australian author, James Cumes, asserts that the US economy has become overly dependent on trading things back and forth, rather than manufacturing goods and selling them. He calls this new reality the “Goldman Sachs Phenomenon.”

“In the larger Anglo-Saxon economies,” says Cumes, “transfer of ownership [has] supplanted fixed-capital investment as the most common form of what purported to be ‘investment.’ Investment has become a means of making a fast buck, not by entrepreneurial effort, construction of factories and installation of productive equipment, but by gambling to add market value through mergers and acquisitions…that would lead to higher shareholder value in the marketplace…

“Despite the higher, short-term market values [that might ensue], they would not necessarily add anything to productivity or to the volume or value of final output” –

“Inevitably,” Cumes continues, “there are social impacts from this deal-maker, day-trader, casino-like type of ownership investment, especially to the extent that it spreads over a more and more major part of the economy…Inequality is dramatically intensified by generous bonuses for senior executives and others in financial firms in the United States and such other financial centres as London.”

The Fed’s bailout of the financial sector seems to have supercharged the Goldman Sachs phenomenon.  Not only do the top dogs at publicly traded financial firms “make bank,” they continue to make bank even after destroying billions of dollars of shareholder wealth. And the top dogs enjoy their privileged positions under the watchful, doting eyes of the Federal Reserve and Treasury. No bad deed goes unrewarded.

“Of course, there is justice in rewarding effort and enterprise,” Cumes concludes. “That is historically one of the ways in which a capitalist system has justified and maintained itself; but there are other considerations too.

“Indeed, if our present essentially democratic capitalism is to survive - and survive securely - it must pay attention to social outcomes. Poverty in the midst of plenty is not a comfortable social situation. Some inequality there will always be but gross and growing inequalities must, over time, be a threat to social, political and even strategic stability, as well as economic and financial stability.”

But these “big picture” concerns do not seem to concern the head of the Fed and Treasury. In fact, throughout this crisis, Bernanke and Paulson have assiduously avoided implementing (or even suggesting) any regulatory changes that would impinge upon the limitless liberties of Wall Street’s investment banks. The perpetrators of the crisis remain in power and the corporate structures that supported their recklessness remain in place. Instead, incredibly, Treasury Secretary Paulson wags his regulatory finger at hedge funds.

Huh? Why? Hedge funds did not create the crisis, they merely profited from it.

Aren’t the investment banks the ones who created trillions of dollars of crazy derivatives? And aren’t they the ones who loaded their balance sheets with suicidal quantities of leverage? And aren’t they the ones who are now receiving billions of dollars of government support?

So here’s a radical idea: How about regulating the perpetrators of the crisis, rather than the profiteers? Or maybe the Fed should require all the top-ranking officers of every company that receives a bailout to resign? Or how about one upper-level resignation for every $1 billion a Wall Street investment bank borrows from the Fed’s discount window.

This isn’t complex stuff, folks. If the Treasury Secretary sincerely wished to clean up and re-regulate the banking system, his new regulations would only require about 50 words:

1) No officer of any publicly traded financial institution may receive more than $10 million per year in total compensation.
2) No financial institution may borrow more than $10 for every one dollar of readily marketable assets (I.e. “Level I” assets) on its balance sheet.
3) No financial institution may incur any liabilities “off-balance sheet.”
4) No exceptions.

Implement these regulations and you would have forever eradicated the DNA of financial catastrophe from the American financial system.

But what would critics say about such “draconian” new regulations? (We’ll call these regulations the “Level Playing Field Act of 2008.”) After choking on their foie gras, they would probably protest, “That’s not nearly enough compensation for top officers! You’d lose the top talent!”

Then they would protest: “What! No off-balance sheet financing? Are you crazy? That’s where all the juice is! You would lose the ability to ramp up return on equity!”

To which we would reply: “Hallelujah!” and “Amen!…Finally, we could purge the financial system of all the “talent” that has delivered America’s most severe credit crisis since the Great Depression. Finally we could purge the system of the “creative” leverage that the “talent” has amassed over the last several years. Finally, we’d have a banking system that would operate like one – a banking system that would provide capital to entrepreneurial endeavors, rather than to catastrophic speculations.

The American financial system does not need “talent” and “creativity.” It needs prudence and perspicacity. It does not need creative bankers. It needs dull bankers.

Why? Because the American financial system needs to safeguard its capacity to finance creative and talented entrepreneurs. It needs to safeguard its capacity to preserve the purchasing power of our currency and to safeguard the legendary America capacity to create wealth from the bottom-up, not to destroy wealth from the top-down.

But the American financial system still possesses too much talent and creativity to operate prudently. In fact, Ben Bernanke and Hank Paulson may be the most creative finance officials in American history.

Consider yourselves forewarned!

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[Rude Endnote: In yesterday’s issue of your Rude Awakening, we asked the reader to decide: Is the worst of the financial crisis over, as the majority of talking heads in the mainstream would have us believe? Or are we still early into the pain game, with plenty more to come?

“In an environment with escalating losses still to come in the later parts of 2008,” observes one Rude Reader, writing from Canada, “how can anyone in their right mind say the worst is over?
 
“Talking heads that speak without admitting the truth only serve to prolong the systemic denial that something is wrong and keep us from doing what is really necessary to get ourselves back on track.
 
“The financial market has little to lose either way, as traders can gain as the value of goods rise or fall. It is the ‘common man’ that operates outside the sphere of stock market that truly loses, as their ‘basket of goods’ is first overpriced, then undervalued later.
 
“Although the current Fed policy is to undercut the value of the dollar in an attempt to avoid a total collapse, it is entirely possible their strategy will achieve the exact opposite - a forced return to debilitating interest rates that finally choke the last breath out of the economy and drive consumer prices into the stratosphere. 
 
“If I were Bernanke I would be keeping my bags packed and the car running.”
 
And this, from another reader in Arizona…

“A rather apropos column for ‘Mayday’. Whether ‘Mayday’ is interpreted in the Communist or international distress vernacular, the message is the same: Screw the taxpayer.

“No, this mess isn’t near over. As Eric points out, we know neither the depth nor the location of the problem. I find it hard to believe that Goldman Sachs had the foresight to avoid (or unload) the MBS problem. Until I see evidence that GS is as human as the other greedy Wall Street dogs and get their hands smacked for being in the cookie jar, I refuse to believe this mess is anywhere near over.

“In the interim, I choose to believe they just haven’t got caught yet and we are still being rocked to sleep by the mainstream media and other assorted talking heads (or other bodily orifices).”

And finally…

“I don’t see any way out of economic doom for America. The fed brought us to this place by printing loads of money and its solution on how to get us out is to print more money. Why do we look to those who brought ruin to be the ones to fix what they destroyed?

“It all started with the end of the gold standard in 1971. It was an automatic system of monetary control, one congress could not get around and one the fed was forced to follow.

“We have to take care of our self now! Buy gold and silver, short the market, hold foreign currencies, get out of the dollar and move to the country to protect and defend our assets and our family. The great depression was a picnic! Get ready!”

And there you have it: Rude Reader, you are in the minority. Congratulations and enjoy your weekend.

Cheers,

Joel Bowman
Rude Awakening