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September 22, 2008

You Bet Your Life…

Steven R. Berryman

The market psychology of the financial investment world has now changed forever. What had been betting essentially on the fortunes of businesses will at least – for the short term – be replaced by betting on how we suspect the rules of the game will change.


In actuality, it is very difficult to boil down what had been the game. Insiders know it, but many whose money is in-play have but a superficial knowledge of the mechanics.


So, you think you are not in the market? If you have a pension plan or money market account, then you are. Have a variable interest rate loan on your home? That too makes you a fringe “player.”


With the simple purchase of a stock, we are presumably buying a piece of that company in hopes that it will increase in value over time. What we are really doing is betting that others will buy more of that same stock at a higher price than you paid, thus “bidding up” the value of that stock.


In reality no profit is realized until the moment that stock is sold. Otherwise your paper wealth is “ether.”


To those not interested in such details, consolation is typically that – in the long-run – the market always goes up. Any interest stops there.


Perhaps so, but over what time-frame and for what segments of business is the operative question now, more than ever. This is especially true if your investments are in purchasing shares in the very investment houses and mortgage companies that have precipitated our current crises.


The very incestuous relationships of these companies are breathtaking to behold. These chickens are coming home to roost.


The illiquidity of assets is the direct cause of our dysfunction now. This boils down to the ability to sell something for what you think it is worth. An example of this is when one has borrowed against a home at its peak value, and then found that its actual value has gone down.


Mortgage originators have gotten rich by making loans in bulk, and then selling off the good ones to secondary markets for a profit. The unsellable loans remain “in their portfolio.”


When they hold enough such “bad loans” that go into forfeiture or bankruptcy, this becomes a cash outlay needed by the originator. Without enough profit or cash coming in to cover this, the crises of illiquidity is realized.


The gambling facets of Wall Street are manifest. “Short selling” is another piece of investment sleight-of-hand. This involves the borrowing of stock overnight for a quick sale, and then hopefully buying it back at a lower price right away.


This example of a “tool” of trading has proven deadly, especially regarding AIG and Lehman Brothers. As this scheme only works when the price of stock is depressed, either the foresight of insider trading or market manipulation can be employed deceitfully. This can be accomplished as easily as spreading an unfounded rumor of bad prospects.


As part of the plan to stop the bleeding, The Securities and Exchange Commission (SEC) has banned all short selling of 799 financial companies – so far. Also, a reporting requirement has been added to show transparency. This “naked selling” is a sure disincentive to traders using this technique.


Futures trading can also be manipulated thus and are being reexamined. Under normal circumstances, they can add liquidity to the market, but not so during crises times.


The results can be profiteering for a few at the expense of your investment!


Currently there are investigations taking place to verify problems.


Another root cause of our crises of illiquidity manifested itself with funding giants Fannie Mae and Freddie Mac, which also required a massive cash infusion to stabilize. The impact of “political correctness” forced upon us in the name of diversity by certain radicalized social progress groups – such as The Association of Community Organizations for Reform Now (ACORN) – contributed to the glut of bankruptcies.


This took the form of incentives for entry-level loans and quotas that ended up enabling loans on a massive scale to those that could never pay them back. Especially hard hit and abused were the poor and immigrant populations, some illegal, conned into high rate loans.


Potentially a “Resolution Trust Corporation” Version 2 is in the works, so the rumor goes. Such an organization bailed out the savings and loan crisis in the 1980s.


By packaging and taking over bad debt, our government may come to the rescue. This will unburden companies and enable them to get back to business and profitability. The very rumor of this and other fixes got the overall markets back on track for all of last week’s trading.


Let’s be sure that the final version of rescue legislation works for the people directly, as opposed to the greedy institutions that have been addicted to risk.


But what of the system oversight that has been mandated to our Congress as a most vital role? The House and Senate have abrogated their responsibilities by looking the other way in the guise of “trusting the market.” This is code for do-what-you-will, and the results are in every news outlet today.


Back to the gambling analogies, how do you think they afforded to build all of those grandiose casinos in Las Vegas? Answer: With the full expectation of getting your money. How does Wall Street afford to pay those exorbitant salaries and bonuses, even in off years? Same principal.


Beware the changing game.


Originally, banks loaned out money to worthy businesses based on the assessed risk and their ability to repay. This worked when our national saving rate was above zero and provided the cash to loan out.


Now more than ever we rely on the markets to provide the capital pool of money to run and improve businesses. A fix now is essential to sustained recovery and confidence in our system. Will the new game allow China to continue to participate?


Surely there will be many sermons forthcoming about “money being the root of all evil.” Even that’s incorrect, as it really is: “The worship of money is the root of all evil.”


There is a difference between deregulation and irresponsibility. But in the end, it is the people who are charged with overseeing our overseers in Congress.


This happens most notably on Election Day.


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