Why Are Retail Investors Skeptical?

It's Supposed to Work in the Midwest, at Least

One of the all-time high school pranks growing up -- at least according to urban legend -- was going to the mall and acting like you lost a contact lens.

Step 2: a couple confederates join your "search."

What's supposed to happen next is, clueless passersby join the search while the perpetrators withdraw to the sidelines and watch (and suppress their snide laughs).

The Bernanke Stock Market

Having seen two bubbles -- in tech stocks and then housing -- in the last decade, not to mention the predations of Goldman Sachs, Angelo Mozilo and scores of others, my guess is that "retail investors" (you and me) are now asking themselves two things:

One. Is there really a contact lens in the middle of that growing crowd (read, the now-advancing stock market)?

Two. How expensive is it going to be -- this time -- to find out?

To paraphrase that expression, "fool me twice, shame on you. Fool me three times, shame on me."

P.S.: I can already answer question #3: 'Will anything happen to those responsible?' Answer: 'Nope.'

Bubbles as Policy Tool

Grantham: 'Almost Criminally Inept Fed'

The Federal Reserve's asymmetric policy of stimulating stock moves by setting artificially low rates and then leaving the bull markets, when overstimulated, to bubble over, is dangerous. It is probably the most dangerous thing to inflict on a peace time economy with two possible exceptions – runaway inflation and a housing bubble.

--Jeremy Grantham

Leave it to Jeremy Grantham to lay bare exactly why the Fed has so many market watchers -- myself included -- baying at the moon in exasperation.

On the one hand, it denies any duty or ability to contain the damage from asset bubbles (or even recognize them!).

On the other hand, it pursues policies -- first zero percent interest rates, now quantitative easing -- guaranteed to inflate serial bubbles.

Grantham devotes most of his current quarterly letter (see, "Night of the Living Fed") to explaining why this is irresponsible, and -- in the case of housing -- especially dangerous.

Amongst other things, in their wake burst asset bubbles leave squeezed consumers, taxpayers, savers, retirees, pension funds, states, and municipalities -- and, when they are compelled to clean up the mess, ultimately a broke Fed and federal government.

Grantham again:

Distorted asset prices have been like the deliberately misplaced signal lanterns, which the Cornish, in the stormy west of England, used to lure ships onto the rocks for plunder. Individuals, as well as institutions, were fooled into believing that the market signals were real, that they truly were rich. They acted accordingly, spending too much or saving too little.

So what does Grantham prescribe, besides not inflating any more bubbles?

Noting on the one hand the "army of non-frictional unemployed ready to get to work," and on the other hand the country's "dreadfully deteriorated infrastructure and desperate need for improvements in energy efficiency" . . . Grantham thinks it's obvious.

You owe it to yourself to read the entire article.

No (Financial) Cure Without Proper Diagnosis

"We ALL Caused This Mess??" Hardly.

Put me in the camp that says, without an accurate diagnosis, it's not possible to cure our current economic mess.

So, here are two competing narratives explaining how we got to this juncture, both courtesy of Les Leopold (thanks to Ned Krahl for forwarding the Leopold piece):

Narrative #1: 'We Are All to Blame'

"We Americans sank ourselves in debt. We consumed more than we produced. We bought homes we couldn't afford and used them as ATMs. Of course Wall Street did its part by offering us mortgages they knew we couldn't really afford. The government also contributed mightily by pushing Fannie Mae and Freddie Mac to underwrite "politically correct" loans to low-income residents who shouldn't have been buying homes at all. In short, we all are to blame.

--Les Leopold, "Why the Big Lie About the Job Crisis?"; Huffington Post (9/3/2010)

If the foregoing is correct, here's what logically needs to happen next:

The era of excess is over. We need to cut back on spending and borrowing. We need to reduce government debt by raising the Social Security retirement age and cutting social programs. We've got to streamline our public sector by laying off public employees and cutting back their lavish pensions. And all workers will have to adjust to an era of intense foreign competition: We've got to reduce our wage and benefit demands if our companies are going to compete globally. We have to live within our means.

In short, we gorged ourselves until the economy crashed. Now we've got to tighten our belts and accept less to get it going again.

--Les Leopold

Contrast that with Narrative #2, "An untethered Wall Street crashed the financial system (and broader economy) while engorging itself."

Starting in the late 1970s . . . the financial sector was liberated from its New Deal-era shackles. Freed from any limits on constructing complex new financial products, hedge funds and too-big-to-fail banks and investment houses created an alphabet soup of new securities with the sky-high yields. The rating agencies abetted the crime by blessing these flimsy products with AA and AAA ratings.

Wall Street built this flim-flam of finance out of junk debt -- like sub-prime mortgages -- which it could pool, slice, and resell for enormous profits. In fact, selling these bogus securities was the most profitable enterprise in the history of Wall Street. Wall Street wrapped credit default swaps and collateralized debt obligations into pretty packages so that they could literally sell the same underlying junk assets again and again.

The whole scheme worked just fine as long as the underlying collateral (our homes) appreciated year after year. But as soon as housing prices peaked, it was game over. The upside-down pyramid of debt and junk financial instruments came crashing down. The entire credit system froze, tearing a gaping hole in the real economy.

--Les Leopold

Guess which narrative I find more accurate?

Prescribing Cures

Only once the disease has been diagnosed, can a cure be promulgated.

Here is Leopold's:

Through steep progressive taxes on the super-wealthy, fair income taxes on hedge funds and transaction fees on Wall Street's proprietary trading, we can keep that bubble from reinflating -- and in the process raise the money we need to put America back to work. With the revenue we collect, we can hire millions of people to weatherize homes and buildings and rebuild our infrastructure. Instead of laying off teachers we can hire more, and provide them with better training and support. We can expand universities and colleges too, and allow people to go to college for free, which will improve our peoples' skills -- and keep young people off the unemployment rolls.

--Les Leopold

The only step Leopold omits is holding Wall Street accountable -- through appropriate civil and criminal remedies -- for its transgressions.

Pearlstein: 'Profitable Goldman Better for Taxpayers'

Post's Pearlstein Gets It Very Wrong

Much of [yesterday's Senate] hearing focused on how Goldman went from having billions of dollars of exposure to the subprime mortgage market in the first half of 2006 to posting big profits from the implosion in that same market by the second half of 2007.

The more benign way to look at this dramatic rebound is that it speaks to Goldman's knack for anticipating the market and its willingness to break from the Wall Street herd. Many of us may be jealous of Goldman's success or suspicious of exactly how it came, but surely we are all better off than if Goldman had remained long on mortgages, tumbled into insolvency and required a big taxpayer bailout.

--Steven Pearlstein, "Two planets collide for three hearings on Goldman"; The Washington Post(4/28/2010)

Of all the myths and misconceptions about Goldman Sachs' role in today's financial crisis, the one perpetuated (above) by the normally astute Mr. Pearlstein is the most infuriating and pernicious.

That's because society is patently NOT better off because Goldman Sachs profited from the housing bust.

By figuring out how to make money off of "shit" -- Goldman Sachs' word for their mortgage-backed securities, not mine -- Goldman stoked demand for . . . . more shit.

That assured that even more oceans of capital would flood into the housing market, driving prices even higher -- and making any crash harder.

Ironically, the higher the housing market went, the more potential to "short," or bet against it, which sucked in even more capital.

Doomsday machine, indeed.

Instead of viewing Goldman's obscene profits as averting another taxpayer bailout, as Pearlstein does, they need to be viewed in the larger context of causing trillions of dollars of (additional) carnage in the housing market and broader economy.

And Pearlstein is dead wrong that Goldman didn't get bailed out.

What else do you call pumping $185 billion(!) into AIG; allowing Goldman Sachs to become a bank holding company virtually overnight and borrow for free from The Fed; beggaring savers with zero percent interest rates to resuscitate the banks; using The Fed's balance sheet as a dumping ground for Goldman (and other banks') toxic assets.

And on and on . . . .

"Shitty" doesn't begin to describe it.

Bubble Dynamics

Here We Go Again?

While early investors savor their gains and see their money multiply, those still on the sidelines must consign themselves to earning less than nothing on their savings.

At first, it's easy for prudent savers and investors to tune out the "siren call" of the hot market du jour, and "just say no."

But eventually, you feel like a chump sitting on the sidelines while everyone else is partying.

And if you're someone who actually needs to earn a return on your money -- like a retiree -- you really have no choice but to take more risk.

So, you hold your nose and join in.

Today's stock market?

Well, yes.

But it also describes the dynamics underlying the housing bubble, and the last stock market bubble in the '90's.

Who's ultimately responsible for creating a (promiscuously) easy money environment that creates such perverse incentives?

The Federal Reserve.

Who benefits? Banks and wanton risk-takers.

Who loses? Everyone else.

New Bubble, Same as the Old Bubble?

Be Careful What You Wish For

Recession-Plagued Nation Demands New Bubble to Invest In
--headline, The Onion (7/14/2008)

Like many readers, I'm delighted that my decimated (and much too modest) stock portfolio is showing signs of recovery.

On the other hand, I'm leery that the gains are for real.

As I see it, first came the 90's stock market bubble, fueled by Internet mania. Then came the housing bubble, engineered (or not) to counteract the effects of the punctured stock market bubble.

And now . . . exactly what?

The makings of another stock market bubble, to speed recovery from the housing bust?

I don't make stock market calls -- staying on top of the housing market is hard enough.

However, it's hard to escape the fact that better-than-expected corporate earnings -- supposedly the fuel behind the market's 40% pop since March -- are characterized by two things: 1) they're good only in comparison to previously lowered estimates; and 2) most companies are making money -- or losing less -- thanks to cost-cutting rather than top-line (revenue) growth.

To me, neither of those make for the underpinnings of a sustained, new bull market.

Or, maybe I'm just a spoilsport.

Goldman Sachs, Culprit

Regulatory Capture -- Exhibit A

Goldman Sachs made out on the housing bubble twice: it f---ed the investors who bought their horsesh-t CDO's by betting against its own crappy products, then it turned around and f---ed the taxpayer by making him pay off those same bets.

--Matt Taibbi, "The Great American Bubble Machine"; Rolling Stone (July 9-23, 2009)

Too subtle for you? Try this one, from Taibbi's blog:

Imagine a meat company that bred ten billion rats, fattened them on trash and sewage, ground their bodies into chuck, and then sold it all as grade-A ground beef to McDonald’s and Burger King, right under the noses of the USDA. [Securitized subprime mortgages] are exactly the same thing, only with debt instead of food. We’re eating it, they’re counting the money.

Looking for a culprit for today's financial mess? (plus today's oil price roller coaster, plus the '90's Internet stock bubble, plus AIG's black hole for taxpayer dollars -- plus a lot more).

Taibbi makes a damning -- and compelling -- case that Wall Street's fingerprints -- and specifically, Goldman Sachs' --are everywhere.

The piece reads like the stuff of conspiracy novels, which even Taibbi acknowledges at the end.

However, much of what he alleges -- the players, their business practices, the regulations they lobbied for (and thwarted), who profited -- is a matter of public record.

The more I see and read, the more I'm convinced that slow, creeping regulatory capture is the meta-problem at the root of all our other financial problems. Taibbi's piece is Exhibit A.

Read it, and decide for yourself.

"Greenspan Did It"

Adjustable Rate Mortgages the Missing Link

What about Greenspan's argument that he only controlled short-term rates? And that short rates became decoupled from long-term rates in 2002? Nonsense, says [Stanford Professor John] Taylor. Surely the existence of adjustable-rate mortgages (accounting for about one-third of mortgages starting in 2003) linked the mortgage market and short-term rates.

--Susan Lee, "It Really Is All Greenspan's Fault"; Forbes (4/3/09)

One of the more interesting debates within economics circles is exactly how culpable former Fed Reserve Chairman Alan Greenspan is for the housing bubble. Put me in the camp that says, "very."

Greenspan has protested -- and continues to protest -- that as Fed Chairman he was only responsible for setting short-term interest rates.

True enough.

But thanks to the explosion of adjustable rate mortgages -- encouraged by none other than Greenspan himself -- dirt-cheap, short-term interest rates quickly spilled over into the housing market.

As a result, Greenspan's drive to lower rates in the wake of the tech stock bust and the post-9/11 recession directly led to vast, new sums of capital being made available to home buyers.

The rest, as they say, is history.

Warren Buffett's Crystal Ball -- & Rearview Mirror

Memorable Quotes from
Berkshire's '09 Annual Letter

In 75% of [the last 44 years], the S&P stocks recorded a gain. I would guess that a roughly similar percentage of years will be positive in the next 44. But neither Charlie Munger, my partner in running Berkshire, nor I can predict the winning and losing years in advance. (In our usual opinionated view, we don’t think anyone else can either.) We’re certain, for example, that the economy will be in shambles throughout 2009 – and, for that matter, probably well beyond – but that conclusion does not tell us whether the stock market will rise or fall.

--Warren Buffett, 2008 Berkshire Hathaway Annual Report

Substitute "housing market" for "stock market," and you've got a pretty good long-term outlook . . .

If you've never read one of Buffett's letters, I highly recommend it; they're probably the closest thing capitalism has to Mao's "Little Red Book."

At least in my view, here are the most memorable quotes from this year's letter (last year's top line was an instant -- and much quoted -- classic: 'you don't know who's swimming naked until the tide goes out'):

"Putting people into homes, though a desirable goal, shouldn’t be our country’s primary objective. Keeping them in their homes should be the ambition."

"At the moment, it is much better to be a financial cripple with a government guarantee than a Gibraltar without one."

"Beware the investment activity that produces applause; the great moves are usually greeted by yawns."

"When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000's. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary."

"Participants [in derivatives contracts] seeking to dodge troubles face the same problem as someone seeking to avoid venereal disease: It’s not just whom you sleep with, but also whom they are sleeping with."

*Through its subsidiary, MidAmerican Energy, Berkshire Hathaway is the ultimate parent company of Edina Realty.