By Gary North
And so you get what I call the natural progression, the three I’s: the innovators, the imitators, and the
idiots. — Warren Buffett
That was Mr. Buffett’s assessment of the housing bubble and the institutions that financed it. He made this statement last October on the Charlie Rose show on PBS.
http://www.cnbc.com/id/26982338/page/4
He made this statement on October 1. A year before, the Dow Jones Industrial Average peaked at 14,164. That was the highest it ever closed.
On November 4, 2007, Charles Prince resigned as CEO of Citigroup, which was the largest U.S. bank at the time.
On November 5, I told my GaryNorth.com subscribers to get out of stocks and short the S&P 500. I knew it was over. Done. The bubble was about to burst.
Citigroup shares were $30 when Prince departed. They are under $4 today.
The largest bank is now Bank of America. Yesterday, the press ran a story that BofA needs more billions of Treasury money, to add to the $25 billion already received. It seems that the Merrill Lynch deal did not work out as planned.
On July 30, 2008, I wrote an article, “Pathetic Merrill Lynch.”
Merrill Lynch is the great emblem of the old Wall
Street. It made its name and its fortune in the days
when government regulation prohibited price competition
by brokers. Merrill Lynch’s model was doomed the day
the Charles Schwab showed up. The discount brokerage
houses have undermined the main source of income for
the stodgy old brokerage firms that relied on
government intervention to prevent competition.
Now these firms try to make up for vastly reduced
brokerage income by selling advice and putting together
specialized deals. The classic example of this approach
to moneymaking is Bear Stearns. It went bust in three
days. It got in on the new leveraged markets, and it
got its investors into these markets, and then went
belly up. It got bought for a song by J.P. Morgan.
Merrill Lynch now says that it has to raise $8.5
billion in new capital. The sweetheart that came in to
rescue Merrill Lynch is the sovereign wealth fund of
Singapore. This is a Singapore government operation.
What is basically a socialist operation has to bail out
the symbol of American capital. This is where Wall
Street has led us. This is what Alan Greenspan’s bubble
economy has produced.
The sovereign wealth fund of Singapore lost billions in the Bank of America deal two months later. At first, BofA offered $50 billion in stock. The CEOs of the two firms did not ask their respective shareholders. It was a weekend sweetheart deal to save Merrill. Lehman Brothers went bankrupt that weekend. Merrill was failing fast.
By the time the Merrill deal was consummated two months later, the BofA stock was worth $20 billion.
How smart are the bureaucrats who run the export surplus governments’ sovereign wealth funds? Not very.
So far this month, the Treasury has supplied $10 billion to the BofA to buy Merrill. This was in addition to an earlier injection of $15 billion to save the bank.
http://GaryNorth.com/snip/768.htm
Now, the BofA is back for more.
The news did not affect Wall Street. The Dow rose a whopping 12 points for the day.
Two weeks after Buffett made his comment on the idiots, BofA shares were at $40. Today, they are around $8.
As I mentioned, Citigroup’s shares are under $4. The only reason they are this high is that the Treasury absorbed $306 billion of bad assets last November. This was the nation’s largest bank in 2007, with only BofA giving it a run for its money.
BofA is still giving it a run for its money. But it’s a run for our money.
It is the end of an era. Confidence in the stock market will takes years to return. Nobody is going to believe in the now dead New Era. This time it wasn’t different. These two banks were symbols of the power of American capitalism. They are now busted shells, whose CEOs must go to the Treasury, hats in hand. “Hey, buddy, can you spare $300 billion?”
They are wards of the state.
The banking cartel had an impressive run under the protective wings of the Federal Reserve System. But the days of wine and roses are over.
THE END
In December, Portfolio.com published a fascinating essay by Michael Lewis, “The End.” Two decades ago, Lewis became an overnight sensation with his book, “Liar’s Poker.” It was a study of the hottest of hot shot investment bankers. The term, “liar’s poker,” got into common usage.
His article features one of the cleverest pieces of art work I have ever seen. It is a morphed image of the famous bronze bull on Wall Street, located just outside the New York Stock Exchange. The bull is on its side, dead.
Lewis begins with a description of his three years at Salomon Brothers, beginning in 1985.
I’d never taken an accounting course, never run a
business, never even had savings of my own to manage. I
stumbled into a job at Salomon Brothers in 1985 and
stumbled out much richer three years later, and even
though I wrote a book about the experience, the whole
thing still strikes me as preposterous — which is one
of the reasons the money was so easy to walk away from.
I figured the situation was unsustainable. Sooner
rather than later, someone was going to identify me,
along with a lot of people more or less like me, as a
fraud. Sooner rather than later, there would come a
Great Reckoning when Wall Street would wake up and
hundreds if not thousands of young people like me, who
had no business making huge bets with other people’s
money, would be expelled from finance.
That day has now arrived. It began in August of 2007, a few weeks after the Dow closed at 14,000, and fell back the next day. The first tremors hit the world’s capital markets. The U.S. stock market shrugged it off. Two months later, the Dow hit its all-time high. Optimism was universal. The great bull market, which in fact was lower in terms of purchasing power than it had been in March 2000, was on a roll.
It in fact was on a roll over.
Lewis continues.
I thought I was writing a period piece about the 1980s
in America. Not for a moment did I suspect that the
financial 1980s would last two full decades longer or
that the difference in degree between Wall Street and
ordinary life would swell into a difference in kind. I
expected readers of the future to be outraged that back
in 1986, the C.E.O. of Salomon Brothers, John
Gutfreund, was paid $3.1 million; I expected them to
gape in horror when I reported that one of our traders,
Howie Rubin, had moved to Merrill Lynch, where he lost
$250 million; I assumed they’d be shocked to learn that
a Wall Street C.E.O. had only the vaguest idea of the
risks his traders were running. What I didn’t expect
was that any future reader would look on my experience
and say, “How quaint.”
Lewis said he had no great agenda in writing the book. The best he hoped for is that it would serve as a warning for college students. They should do something better with their lives than come to Wall Street. What he found was the opposite. He began getting letters from college students, asking him how they, too, could get in on a good thing. “They’d read my book as a how-to manual.”
The system kept rolling along. He gave up hope that it would finally break down. Pay rose, scandals had no effect, and the beat went on.
Then it came to a screeching halt. On October 31, 2007 — Halloween or Reformation Day, depending on your taste — an unknown analyst with Oppenheimer issued a report warning that Citigroup was in danger of going belly-up. It had to cut its dividend. For some reason, Meredith Whitney was believed. Financial shares fell like a stone all day. The industry lost $369 billion in market value in one day.
On November 4, Prince departed. Citi cut its dividend in January.
This woman wasn’t saying that Wall Street bankers were
corrupt. She was saying they were stupid. These people
whose job it was to allocate capital apparently didn’t
even know how to manage their own.
That was the heart of the matter. These people, for all their IQs, for all their contacts, for all their inside
information, were stupid.
They were, in Buffett’s graphic term, idiots.
For a year, Lewis says, she has warned that it isn’t over, that the write-downs are not enough. Events keep bearing her out.
Lewis called her last March. He wanted to know if there were people on Wall Street who had seen it coming. There had been: the man who had taken her under his wing when she arrived on Wall Street as a recent history major. His name was Steven Eisman.
THREE WHO WENT SHORT
Lewis’ article is really about Eisman and his two partners. These three Jewish guys — two who grew up in New York City — spotted the emptiness of the entire system, and they got very, very rich shorting it.
They did not just short the S&P 500, as I advised my readers. They figured out how the mortgage market had been sliced and diced. They shorted subprime loans. Even better, they shorted the bonds issued against the collateral of the subprime loans.
Eisman had contempt for the supposed geniuses, who did not understand the contracts their lawyers created and they signed.
In 1991, Eisman had been hired by Oppenheimer. He was a lawyer, but he hated being a lawyer. His story is a classic in entrepreneurship. He was there at the right time.
He was hired as a junior equity analyst, a helpmate who
didn’t actually offer his opinions. That changed in
December 1991, less than a year into his new job, when
a subprime mortgage lender called Ames Financial went
public and no one at Oppenheimer particularly cared to
express an opinion about it. One of Oppenheimer’s
investment bankers stomped around the research
department looking for anyone who knew anything about
the mortgage business. Recalls Eisman: “I’m a junior
analyst and just trying to figure out which end is up,
but I told him that as a lawyer I’d worked on a deal
for the Money Store.” He was promptly appointed the
lead analyst for Ames Financial. “What I didn’t tell
him was that my job had been to proofread the
documents and that I hadn’t understood a word of the
[!@#$%] things.”
Oppenheimer handed the task of analyzing the Money Store and its mortgages. That was how he became the guru of subprime mortgages.
He and his two partners were convinced of one thing: that Wall Street was not interested in clients. The clients were the victims.
Danny Moses was one of the three. He knew the system. When he would negotiate a deal for the hedge fund with a large Wall Street trading firm, he always asked this question: “How are you going to [@!#$%^] me?” The trader insisted that this would not happen. No deal, said Moses. We both know what can happen. If
you want the deal, tell me how you’re going to be able to do it. The guy would tell him, and Moses would do the deal. He knew how much risk to accept.
You and I don’t. The retirement fund managers didn’t.
The three figured out in 2004 that there were major problems looming for the housing market, especially in the “sand” states: California, Florida, Nevada, and Arizona. The median home price had risen from the traditional 3 to 1 to 10 to 1 in Los Angeles.
Eisman realized in 2006 that the credit ratings agencies were ignoring this mess. The brokerage houses and investment banks would take low-rated BBB mortgages, slice and dice them, and the ratings agencies would rate the top end AAA. Now get this.
He called Standard & Poor’s and asked what would happen
to default rates if real estate prices fell. The man at
S&P couldn’t say; its model for home prices had no
ability to accept a negative number. “They were just
assuming home prices would keep going up,” Eisman says.
These were the best and the brightest. These were the masters of the universe.
These were idiots.
The team went to Orlando in late 2006 to attend a trade show on subprime mortgages. They had expected a small, specialized group. There were 6,000 people there, Eisman says. It turned out that the show in Las Vegas was larger.
Note: in late 2005, I reported on a report by Las Vegas banker Doug French on the looming disaster in Las Vegas real estate. I warned of a similar disaster looming in California. No one paid any attention. You can read it here:
http://www.lewrockwell.com/north/north416.html
If I knew, why didn’t the geniuses of American finance know?
Which brings us back to Merrill Lynch.
“We have a simple thesis,” Eisman explained. “There is
going to be a calamity, and whenever there is a
calamity, Merrill is there.” When it came time to
bankrupt Orange County with bad advice, Merrill was
there. When the internet went bust, Merrill was there.
Way back in the 1980s, when the first bond trader was
let off his leash and lost hundreds of millions of
dollars, Merrill was there to take the hit. That was
Eisman’s logic — the logic of Wall Street’s pecking
order. Goldman Sachs was the big kid who ran the games
in this neighborhood. Merrill Lynch was the little fat
kid assigned the least pleasant roles, just happy to be
a part of things. The game, as Eisman saw it, was Crack
the Whip. He assumed Merrill Lynch had taken its
assigned place at the end of the chain.
http://GaryNorth.com/snip/769.htm
And so, this week, the Bank of America, America’s largest bank (this week), has learned to its dismay that . . . Merrill is there. The Bank of America wants billions more from the Treasury.
I can hardly blame them.
CONCLUSION
We are witnessing the nationalization of what remains of American financial capitalism. The government is the owner now. The government promised the voters that nothing bad would happen. This guaranteed that something very bad would happen. Now it has happened.
On January 15, on the day of the announcement by Bank of America, a CNBC commentator admitted that this was a tipping point for him, after 22 years. The government is now running the show. It’s not the free market any more. He asked two of the other commentators –one of them was the cute lady with the bags
under her eyes, who was in the elementary school 22 years ago — whether it might have been better to let the bad firms go belly- up, so that the good ones could rebuild. You have to see it to believe it. See it.
http://www.garynorth.com/public/4487.cfm
If they are beginning to figure it out on CNBC — though in a moment of weakness — then word will get out. The Federal Reserve System and the Treasury are running the show.
In short, we are now in part 2 of stage 3.
Part 3 will be even worse.
