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Getting It Right

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October 29, 2009

For some reason, a large number of people continue to rely on the advice of stock market prognosticators, long after those pundits have proven themselves unreliable, usually due to a string of erroneous predictions.  The best example of this phenomenon is Jim Cramer of CNBC.  On March 4, Jon Stewart featured a number of video clips wherein Cramer wasn’t just wrong — he was wildly wrong, often when due diligence on Cramer’s part would have resulted in a different forecast.  Nevertheless, some individuals still follow Cramer’s investment advice.

This summer’s stock market rally made many of us feel foolish.  John Carney of The Business Insider compiled a great presentation entitled “The Idiot-Maker Rally” which focused on 15 stock market gurus “who now look like fools” because they remained in denial about the rally, while those who ignored them made loads of money.

One guy who got it right was a gentleman named Jeremy Grantham.  His asset management firm, GMO, is responsible for investing over $85 billion of its clients’ funds.  On May 14, I discussed Mr. Grantham’s economic forecast from his Quarterly Letter, published at the end of this year’s first quarter.  At that time, he predicted that in late 2009 or early 2010, there would be a stock market rally, bringing the Standard and Poor’s 500 index near the 1100 range.  As you probably know, we saw that happen last week.  Unfortunately, he was not particularly optimistic about what would follow:

A large rally here is far more likely to prove a last hurrah — a codicil on the great bullishness we have had since the early 90s or, even in some respects, since the early 80s.  The rally, if it occurs, will set us up for a long, drawn-out disappointment not only in the economy, but also in the stock markets of the developed world.

Mr. Grantham’s Quarterly Letter for the third quarter of 2009 was recently published by his firm, GMO.  This document is essential reading for anyone who is interested in the outlook for the stock market and our economy.  Grantham is sticking with his prediction for “seven lean years” which he expects to commence at the conclusion of the current rally:

Price, however, does matter eventually, and what will stop this market (my blind guess is in the first few months of next year) is a combination of two factors.  First, the disappointing economic and financial data that will begin to show the intractably long-term nature of some of our problems, particularly pressure on profit margins as the quick fix of short-term labor cuts fades away.  Second, the slow gravitational pull of value as U.S. stocks reach +30-35% overpricing in the face of an extended difficult environment.

*   *   *

So, back to timing.  It is hard for me to see what will stop the charge to risk-taking this year. With the near universality of the feeling of being left behind in reinvesting, it is nerve-wracking for us prudent investors to contemplate the odds of the market rushing past my earlier prediction of 1100.  It can certainly happen.

Conversely, I have some modest hopes for a collective sensible resistance to the current Fed plot to have us all borrow and speculate again.  I would still guess (a well informed guess, I hope) that before next year is out, the market will drop painfully from current levels.  “Painfully” is arbitrarily deemed by me to start at -15%.  My guess, though, is that the U.S.market will drop below fair value, which is a 22% decline (from the S&P 500 level of 1098 on October 19).

Scary as that may sound, Mr. Grantham does not believe that the S&P 500 will reach a new low, surpassing the Hadean level of 666 reached last March.  On page 4 of the report, Grantham expressed his view that the current “fair value” of the S&P 500 “is now about 860”.

What I particularly enjoyed about the latest GMO Quarterly Letter was Grantham’s discussion of the factors that brought our economy to where it is today.  In doing so, he targeted some of my favorite culprits:  Alan Greenspan (who was pummeled on page 3), Larry Summers, Turbo Tim Geithner (who “sat in the very engine room of the USS Disaster and helped steer her onto the rocks”), Goldman Sachs and finally: Ben Bernanke — whose nomination to a second term as Federal Reserve chairman was treated with well-deserved outrage.

The report included a supplement (beginning at page 10) wherein Mr. Grantham discussed the imperative need to redesign our financial system:

A simpler, more manageable financial system is much more than a luxury.  Without it we shall surely fail again.

*   *   *

I have no idea why the current administration, which came in on a promise of change, for heaven’s sake, is so determined to protect the status quo of the financial system at the expense of already weary taxpayers who are promised only somewhat better lifeboats.  It is obvious to most that there was a more or less complete failure of our private financial system and its public overseers.  The regulatory leaders in particular were all far too captured and cozy in their dealings with reckless and greedy financial enterprises.

Grantham’s suggested changes include forcing banks to spin off their “proprietary trading” operations, wherein a bank trades investments on behalf of its own account, usually in breach of the fiduciary duties it owes its customers.  He also addressed the need to break up those financial institutions considered “too big to fail”.  (As an aside, the British government has now taken steps to break up its banks that pose a systemic risk to the entire financial structure.)  Grantham’s final point concerned the need for public oversight, to prevent the “regulatory capture” that has helped maintain this intolerable status quo.

Jeremy Grantham is a guy who gets it right.  Our leaders need to pay more serious attention to him.  If they don’t — we should vote them out of office.



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The New Welfare Queens

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February 26, 2009

In 1999, UCLA Professor Franklin D. Gilliam wrote a report for Harvard University’s Nieman Foundation for Journalism.  That paper concerned a study he had done regarding public perception of the “welfare queen” stereotype and how that perception had been shaped by the media.  He discussed how the term had been introduced by Ronald Reagan during the 1976 Presidential campaign.  Reagan told the story of a woman from Chicago’s South Side, who had been arrested for welfare fraud.  The term became widely used in reference to a racist (and sexist) stereotype of an iconic African-American woman, enjoying a lavish lifestyle and driving a Cadillac while cheating the welfare system.

Ten years after the publication of Gilliam’s paper, we have a new group of “welfare queens”:  the banks.  The banks have already soaked over a trillion dollars from the federal government to remedy their self-inflicted wounds.  Shortly after receiving their first $350,000,000,000 in payments under the TARP program (which had no mechanism of documenting where the money went) their collective reputation as “welfare queens” was firmly established.  In the most widely-reported example of “corporate welfare” abuse by a bank, public outcry resulted in Citigroup’s refusal of delivery on its lavishly-appointed, French-made, Falcon 50 private jet.  Had the sale gone through, Citi would have purchased the jet with fifty million dollars of TARP funds.  Now, as they seek even more money from us, the banks chafe at the idea that American taxpayers, economists and political leaders are suggesting that insolvent (or “zombie”) banks should be placed into temporary receivership until their “toxic assets” are sold off and their balance sheets are cleaned up.  This has been referred to as “nationalization” of those banks.

Despite all the bad publicity and public outrage, banks still persist in their welfare abuse.  After all, they have habits to support.  Their “drug” of choice seems to be the lavish golf outing at a posh resort.  The most recent example of this resulted in Maureen Dowd’s amusing article in The New York Times, about a public relations misstep by Sheryl Crow.

The New Welfare Queens have their defenders.  CNBC’s wildly-animated Jim Cramer has all but pulled out his remaining strands of hair during his numerous rants about how nationalization of banks “would crush America”.  A number of investment advisors, such as Bill Gross, co-chief investment officer at Pacific Investment Management Company, have also voiced objections to the idea of bank nationalization.

Another defender of these welfare queens appears to be Federal Reserve Chairman Ben Bernanke.   In his latest explanation of Turbo Tim Geithner’s “stress test” agenda, Bernanke attempted to assure investors that the Obama administration does not consider the nationalization of banks as a viable option for improving their financial health.  As Craig Torres and Bradley Keoun reported for Bloomberg News on February 25, the latest word from Bernanke suggests that nationalization is not on the table:

. . .  while the U.S. government may take “substantial” stakes in Citigroup Inc. and other banks, it doesn’t plan a full- scale nationalization that wipes out stockholders.

Nationalization is when the government “seizes” a company, “zeroes out the shareholders and begins to manage and run the bank, and we don’t plan anything like that,” Bernanke told lawmakers in Washington today.

The only way to deal with The New Welfare Queens is to replace their directors and managers.  The Obama administration appears unwilling to do that.  During his February 25 appearance on MSNBC’s Countdown, Paul Krugman (recipient of the Nobel Prize in Economics) expressed his dread about the Administration’s plan to rehabilitate the banks:

I’ve got a bad feeling about this, as do a number of people.  I was just reading testimony from Adam Posen, who is our leading expert on Japan.  He says we are moving right on the track of the Japanese during the 1990s:  propping up zombie banks — just not doing resolution.

. . .  The actual implementation of policy looks like a kind of failure of nerve.

*   *   *

On the banks — I really can’t see  — there really seems to be — we’re going to put in some money, as we’re going to say some stern things to the bankers about how they should behave better.  But if there is a strategy there, it’s continuing to be a mystery to me and to everybody I’ve talked to.

You can read Adam Posen’s paper:  “Temporary Nationalization Is Needed to Save the U.S. Banking System” here.  Another Economics professor, Matthew Richardson, wrote an excellent analysis of the pros and cons of bank nationalization for the RGE Monitor.  After discussing both sides of this case, he reached the following conclusion:

We are definitely caught between a rock and a hard place.  But the question is what can we do if a major bank is insolvent?  Sometimes the best way to repair a severely dilapidated house is to knock it down and rebuild it.  Ironically, the best hope of maintaining a private banking system may be to nationalize some of its banks.  Yes, it is risky.  It could go wrong. But it is the surest path to avoid a “lost decade” like Japan.

As the experts report on their scrutiny of the “stress testing” methodology, I get the impression that it’s all a big farce.  Eric Falkenstein received a PhD in Economics from Northwestern University.  His analysis of Geithner’s testing regimen (posted on the Seeking Alpha website) revealed it to be nothing more than what is often referred to as “junk science”:

Geithner noted he will wrap this up by April.  Given the absurdity of this exercise, they should shoot for Friday and save everyone a lot of time.  It won’t be any more accurate by taking two months.

On a similar note, Ari Levy wrote an illuminating piece for Bloomberg News, wherein he discussed the stress testing with Nancy Bush, bank analyst and founder of Annandale, New Jersey-based NAB Research LLC and Richard Bove of Rochdale Securities.  Here’s what Mr. Levy learned:

Rather than checking the ability of banks to withstand losses, the tests outlined yesterday are designed to convince investors that the firms don’t need to be nationalized, said analysts including (Nancy) Bush and Richard Bove from Rochdale Securities.

*   *   *

“I’ve always thought that this stress-testing was a politically motivated approach to try to defuse the argument that the banks didn’t have enough capital,” said Bove, in an interview from Lutz, Florida.  “They’re trying to prove that the banks are well-funded.”

Will Turbo Tim’s “stress tests” simply turn out to be a stamp of approval, helping insolvent banks avoid any responsible degree of reorganization, allowing them to continue their “welfare queen” existence, thus requiring continuous infusions of cash at the expense of the taxpayers?  Will the Obama administration’s “failure of nerve” —  by avoiding bank nationalization — send us into a ten-year, “Japan-style” recession?  It’s beginning to look that way.

Manipulating The Markets

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July 17, 2008

On Wednesday night, Jon Stewart pointed out that President Bush saw fit to hold a news conference about the economy at exactly 10:20 a.m. on Tuesday, July 15.  As luck would have it, this was the very minute when Federal Reserve Chairman, Ben Bernanke, was to begin his testimony before Congress about the state of the economy.  Stewart deftly contrasted the “spin” message presented by Bush with the sworn testimony of the Federal Reserve Chairman.  Bush was obviously out to blunt any negative impact Beranake’s testimony might have on the markets.  The 180-degree difference between Bush’s spin and Bernanke’s reality was hilarious.  Regardless, Bush’s plan didn’t work.  The Dow Jones industrial average dropped 92 points (.84 percent) on Tuesday and the Standard and Poor’s 500 index (which includes many financial stocks) fared worse.  Wednesday saw a dramatic shift in the markets due to a drop in the price of oil – the only thing that ever gives the stock market a boost these days.

July 15 was also the day when the Securities Exchange Commission enacted a new, emergency rule against “naked” short-selling of financial stocks.  As Dane Hamilton reported for Reuters, the rule drew mixed reactions among hedge fund managers and traders.  Hamilton described the SEC’s reasoning that:

…  naked short selling, which is putting in a short stock order with no intention of actually borrowing it to drive down the price, may have contributed to this year’s collapse of Bear Stearns and sharp declines in other financial stocks this year.

As Mr. Hamilton explained:  this new, temporary rule was enacted to protect 19 financial stocks, including battered mortgage guarantors Fannie Mae, Freddie Mac and a number of banks, against “a substantial threat of sudden and excessive” stock price movements.  What other industry could count on the Federal Government to protect it from the predatory tactics of a handful of unscrupulous “short sellers”?  Some of these traders make multiple short sales on a single share of stock.  The net effect of this is that they are actually “counterfeiting” stocks to be sold short and bought back at a lower price, before anyone might realize the shares never existed.

Investors have been victimized by such tactics for decades. However, until now, the SEC has been of little or no help in regulating these tactics.  In an article from the March 23, 2007 issue of USA Today, Matt Krantz reported on the boasts of MSNBC’s TV host, Jim Cramer, about how Cramer had used “short” sales to manipulate stock prices:

A lot of times when I was short (stocks) at my hedge fund … meaning I needed it (the stock) down …I would create a level of activity beforehand that would drive the futures … It’s a fun game, and it’s a lucrative game.

If you are wondering how the 19 financial companies covered by the July 15 emergency SEC rule, were able to obtain the kind of protection afforded by that measure, you may want to consider some of the observations made by Lisa Lerer in her July 17 article for Politico.com:

If you want to know how Fannie Mae and Freddie Mac have survived scandal and crisis, consider this: Over the past decade, they have spent nearly $200 million on lobbying and campaign contributions.

*   *   *

When their stock prices took a dive last week, their government allies extended another helping hand with a plan for the Treasury Department, the Federal Reserve and, possibly, Congress to shore up the companies.

It’s nice to see the SEC doing something to protect investors from predatory trading practices.  The only reason the SEC is protecting investors in this instance is because investors are the collateral beneficiaries of a rule written to protect 19 financial institutions.   We just don’t see enough government action to stop the manipulation of the markets on a broader scale.  Worse yet, when the President gets on TV to compete with the Federal Reserve Chairman’s testimony in order to paint a contrasting, more favorable picture of the economy – what do you call that?  How about:  manipulation of the markets?