MORON Capitalism

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MORON Capitalism

Moron capitalism
By Julian Delasantellis 9-2-2009

Former top gun Fidelity Investments stock picker Peter Lynch used to advise investors to "invest in what you know" as the key to picking potentially profitable equities. Thus, instead of analyzing endless investment arcana such as price/earnings rations or momentum oscillators, he said that the amateur stock picker could do just as well by finding good products, be they laundry detergents or instant coffee, and just buy the stocks of these companies.

One of Lynch's best picks, that of Reebok far before it got hot, was not the result of diligent, MBA-level financial analysis; it came into mind when he saw all the teenagers at what he had been told were the cool local hangouts wearing Reeboks.

But what if it were the other way around? What if, instead of providing a nice snug fit, a person who put on a new pair of Reeboks had their foot lacerated by ground glass purposely sewn into the innersole, and still the stock rose? What if a hot new instant coffee seeing its stock rally every day had on its jar a warning to "consult your physician before using if overly sensitive to arsenic?"

What if the proprietor of Monty Python's famed Whizzo Chocolate Company saw his company's shares skyrocketing, even though prominent among the firm's product line were confections such as "ram's bladder cup", "garnished with lark's vomit", "cockroach cluster", "anthrax ripple", "crunchy frog", made with "only the finest baby frogs, dew picked and flown from Iraq, cleansed in finest quality spring water, lightly killed, and then sealed in a succulent Swiss quintuple smooth treble cream milk chocolate envelope and lovingly frosted with glucose ," and "Spring Surprise", the surprise in that treat being that it features, after you put in your mouth, "steel bolts spring out and plunge straight through both cheeks".

If you think that investors would never reward corporate performance such as this, you haven't seen what's been going on in the share prices of some big US banks and financial institutions lately.

A common moniker used to describe government infrastructure spending projects ready to be funded is that the projects are affirmed to be "shovel ready", but no project is more ready and eagerly awaited than to have the world's stockmarkets dig and climb out of the deep ditches they threw themselves into last September.

Much has been accomplished since most world markets bottomed out in early March; the Dow Jones Industrial Average is up by more than 3,000 points, or over 50%, but for most of August the rescuers seem to have taken a break, with the benchmark index only rising 4% up to August 28, as opposed to an over 8.5% rise in July. The rescuers probably needed a break; there's just so much more further to go.

But like all the serious denizens of Bacchus know, that there's always a party going on somewhere, so it was with stocks in August. That revelry was quite surprising, for it happened to be located at what many informed observers quite correctly assume to be American finance's most fulsome foundation of feculence, the stocks of its major financial institutions.

Yes, you would have done a lot better than the general averages in August with the BIX, the nationwide banking stock index that purposely excludes the shares of the big New York "money center" banks - it was up about 20% for the month. The banking index that dares to take a bite of the big apple, and its big stocks, the KBW, struggled by with only about a 3% rise in share value.

So was that the moneymaking secret for August, banks and financial stocks, just not very big ones? Was the market still punishing the big money-center banks for their wanton and callous profligacy in tranching, bundling and selling all those worthless mortgage-backed collateralized debt obligations? In pushing capital towards smaller, even small town, American finance, was the market finally offering up a belated mea culpa for being so disastrously wrong in following the siren songs of those glittering metropolis lotharios into worldwide catastrophe?

Not on your life. In the same way that St Augustine once pleaded to the Lord to "make me good, but not just yet", American capital, reaching again for the brass ring, is apparently out for another spin with Mr Danger.

Almost all August US stock averages, especially the ones that deal in finance, are grossly distorted by the performance of just five singular names, Citigroup, which was up almost 65% for the month to August 28, Bank of America, up 21.5%, Fannie Mae, up 251%, Freddie Mac, up 287%.

In much the same way that the Yiddish word chutzpah is defined as a man who kills his parents and then begs the court for leniency because he is an orphan, investors in the stock of American International Group, the company whose over-enthusiastic embrace of credit default swaps torpedoed the economy of the entire planet when the company failed, actually had the chutzpah to enjoy its now ward-of-the-state's 282% rise in August. (For an account of credit default swaps see Jaws close in on Bernanke, Asia Times Online, July 16, 2008.)

For the sake of comparison, Goldman Sachs, a bank now making so much money that no one really knows or understands how, had to settle for a paltry, puny August rise in its stock of under 1%.

Not only are these five delinquents August's best show in town, it's almost that they were the only show in town. According to Matt Phillips in the Wall Street Journal, for most of the month, trading in just these five stocks alone has represented just under a third of the total volume on the New York Stock Exchange. Last Monday, August 24, it was over 43% of total; NYSE volume being accounted for by just these stocks.

Phillips has rounded up a now usual suspect for the extraordinary price and volume moves - the "high frequency" flash trading I discussed last month in relation to Goldman Sachs. (See Goldman Sachs - the lords of time, Asia Times Online, August 5, 2009.).........

.......And a year later, on the stock market, the first are last and the last first. Why?

For the answer to that, you can look to your own behavior. What prevents you from doing really, really stupid things? If your $5,000 mortgage payment is due, what prevents you from using that money to instead cover the two hectares of the town's football pitch with 50 centimeters of cotton candy? What prevents you, should you see your surgeon in the cafeteria prior to your scheduled surgery, from slipping him some Scotch in his coffee when he's not looking? If you're on an airplane that you see is passing over your neighborhood, what stops you from opening the door, jumping out, and thus bypassing the terrible luggage carrel lines?

The answer is that there would be substantial negative costs, in terms of your health and wealth, to all that behavior. You would lose your home with the candy stunt, an internal organ or worse with your surgeon's mickey, probably your life leaving the airplane.

But what if this was not true, what if you were protected from the consequences of your worst decisions? You blow $5,000, but someone is there to give you another big check; you've got another surgeon to operate on you, or a parachute to put on as you leave the plane.

In other words, if you were continually bailed out of your worst, most risky decisions, wouldn't you do a lot more of them?

What is "too big to fail" but a government promise to bail out the banks come what may? As investors come to realize the influence and motivations of this now huge new market-influencing player, relationships and previously established market practices are changing, and that's what we are seeing in the outsized performances of Paulson's plunderers this month.

If "too big to fail" is no longer seen as a policy result to be avoided, but as a free ticket for a bank or other financial institution to receive nearly lifetime government protection, then it's not all that surprising that banks that now see themselves as too skinny to receive the government protection are trying to fatten up a bit.

Just in 2008, Wells Fargo's combined assets grew by 43% after swallowing up Wachovia; JP Morgan Chase's increased by 53%, after it assumed control of Bear Stearns and Washington Mutual. The Washington Post recently reported an unintended consequence of the rush from the huge to the gargantuan; the bigger banks, operating under the presumed guarantee of the government, are borrowing cheaper than smaller banks in the money markets - lenders apparently, with very good reason, feel that their loans to institutions that the government will be forced to stand behind are a safer bet than loans to smaller banks and financial institutions that the government might let fail.

As a result, local competition for customers among banks in America's small towns and communities is becoming a thing of the past; America's vaunted small-bank centered financial system, significant in the dynamism of the country's small-business-based economy, may soon, in a manner reminiscent of local retailers being put out of business and replaced by such national competitors as Wal-Mart and Target, be signified by, from sea to shining sea, just having a Chase or JP Morgan on one corner, and a Bank of America or Wells Fargo on the opposite.

If both the banks and their investors feel that the negative consequences of excessive risk, loan default and insolvency, are being handled by the government, it can't be all that surprising that both the banks and their investors are hungry to whet their palette with more of it. Some reports have it that the big banks are wading back into the market for highly leveraged mortgage-backed securities, the same type of instrument that sunk them the first time.

But at that time they didn't have the implied government guarantee. That frees the banks to make relatively risk-free decisions to take on more risk, and it frees the bank investors to engage in the mad bidding for big bank shares we are now seeing.

Mind you, this is in no way a prediction for endlessly sunny skies in the financial sector as a whole; on the other side of the banks being protected by the government camp's barbed-wire fence things are pretty lousy. Twenty percent of US banks lost money in the first quarter, and these days not a Friday goes by without the Federal Deposit Insurance Corporation's commissioner, Sheila Barr's bank closure team being dispatched into the heartland to put more financial institutions out of their misery - last week three banks, in California, Maryland and Minnesota, met their fate as their doors closed for the last time.

Already, 84 US banks have been seized by the FDIC this year, and its list of "problem banks" has swollen to 416. Since it is highly doubtful to more likely absolutely impossible that Obama will be sending out Geithner's cavalry to save this bunch, as one wag put it recently in the Huffington Post, perhaps the best operating investment philosophy for these curious times might be to "sell the FDIC [small banks] and buy the TARP" (big banks).

It's not as if the Obama administration does not see the inherent dangers of allowing the big financial institutions to plunder the countryside with too big to fail, but, during the current moment, Obama can ill-afford the poll-busting consequences of another Lehman shock, just as George W Bush and Paulson couldn't.

The Obama financial reform plan, released in June, did not call on the big banks to be broken or split up into more of a regulation-friendly size (the now trademark Obama/Geithner caution in dealing with the financial system was once again on obvious display there), but it did call for extra auditing, extra "stress tests" for the biggies, presumably to steer them in the right direction before they sail right off over another precipice.

Still, the entire financial reform effort has degenerated into one big semi-public sniping match between Geithner and Barr; besides, one wonders just how many more fights Obama will have the stomach for once he emerges bloodied, battered and bruised - whether he wins or loses - with healthcare.

All these things are undoubtedly seen by the players bidding up the big banks' stocks. Why not? This is probably as close to a sure thing as you're ever going to get in investing. Heads, the extra risk pays off, tails it doesn't, but you still get bailed out by the government.

As for Peter Lynch's dictum to "invest in what you know", well I know that this system, one that rewards the corpulent incompetents of the banking system over those who display innovation and entrepreneurialism, is just about the most dysfunctional thing I've ever seen; it's a virtual plea for foreign scavengers to come in and buy up the system's assets on the cheap.

Perhaps a future economics teacher, after lecturing on the previous historical epochs of agricultural capitalism, feudal capitalism, industrial capitalism and finance capitalism, will look down into his textbook to see the chapter heading that covers our current era - "moron capitalism".


Cheaper than going to a SHRINK FOR COUNSELING, this article helped my distraught psyche.

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