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The Secret Villain Behind The Economic Collapse

By sleepin'dawg ·
Thursday, October 16, 2008 | by Dylan Jovine


That's the word our Treasury Secretary used to describe how he felt begging Congress for money to bail out America. Around him were seated our Federal Reserve Chairman and our Securities & Exchange Commission Chairman.

And that's what happened in front of the camera. Behind the scenes, God knows how many foreign governments we've gone begging to. Don't sell our paper to us and hit the market. Please. Please. Please. Okay, we'll agree to include you in the bailout and buy it back from you.

Paulson had it right. Embarrassing.

Lot's of folks are looking for people to blame. People on the left want to blame Republicans. People on the right want to blame Democrats. Even reasonable, normally level-headed people feel that their government has let them down.

Our government is a Republic. The premise is that we elect "responsible" people who won't be swayed by a "mob mentality" to guide the rest of us who can be swayed in our feelings from day to day. That's why many folks are upset and are blaming government. The people we put in charge of taking care of us were asleep on the job.

Fair enough...

But whether you have a Republican government like ours, a pure citizen democracy, a king, or a dictatorship they all have one thing in common - they are all run by humans. One, few or many.

And there is one thing we as investors must never forget about human nature - at certain times, it is prone to excessive optimism. At other times it is prone to excessive pessimism.

So let other people point fingers and look for people to blame. As investors we must know that being mad at humans for being human would be like being mad at two people for falling in love. Or like being mad at myself for having dark hair. It was a bull market of the greatest magnitude, and many folks got caught up in it. It's our nature to do this and every once in a while it happens in excess.

And unless human nature itself changes, you can bet it will happen again. And as investors we can't afford to be angry about it or we won't be able to profit from it.

Let's study it together...

I think what made this bubble more powerful than most was the sheer magnitude of the people who benefited from it. In my judgment, that made the positive, reinforcing feedback loop much more powerful than the "dot com" bubble.

Rising home prices made existing homeowners very happy. They were able to take home equity loans which made the credit card and home improvement and restaurant companies happy.

New homeowners were happy because they were able to afford new homes. That made Congress happy because constituents would send in letters thanking them for creating legislation that helped Jack and Diane get their "dream home." And of course builders were really happy because they were able to charge high prices and sell a lot of homes at the same time.

Wall Street was happy because they had something to sell to fund managers starving for yield. Subprime bonds are GREAT in a low interest environment. And that meant a lot of fees and big bonuses for Wall Street. And the fund managers were thrilled because they were never quite sure how they were going to fulfill their retirement obligations to millions of baby boomers in the first place. But getting higher yields is a good place to start, so why not invest in private equity!

Insurance companies were happy because that tired industry finally had some growth. At 83 years old, Maurice "Hank" Greenberg has a stronger pulse than AIG (AIG), so let's give it some growth. We can write a policy covering the trade between Lehman Bros. (LEH) and Merrill Lynch (MER) because "they ain't going anywhere."

Even the village idiot got in on the act. He went from flipping burgers to flipping houses in two years and was well on his way to becoming the next Harry Helmsley. And that made television producers happy because if the village idiot could do it anyone could do it, and that makes for great TV.

The home improvement business was happy which made shareholders of all these companies happy because of rising stock prices. And of course government on every level was happy because big tax revenues means money to improve schools and roads.

The list goes on and on and on and on...

That's a lot of "shiny happy people." Thrilled actually. Who wants to turn off the music and shut down the bar when the party is raging? The few people who did sound the alarm sounded like party poopers. Who cares if the neighbors are complaining about the noise? Tell 'em to loosen up and join the party!

(Antiquated Regulation Strong Economic Growth Excess Liquidity = Excessive Optimism squared (or credit/asset bubble)

This ecstasy feedback loop was particularly powerful because people weren't just making money. They were underwriting "the American Dream"? Isn't that what it's all about? In that way, this bubble was stronger than the "dot com" bubble or the Tulip bubble. It was almost as powerful as a gravitational black hole. Every person who felt it paid it forward, and every person who received it felt good about themselves (wouldn't it be nice to get thank you letters from first-time homeowners thanking you for making their dream possible?) and paid it forward twice as much. Once you get sucked in, you're in.

And like all bubbles, this one had an official mascot, a single reference highlighting the level of absurdity. Whereas the "dot com" bubble had the "sock puppet," the credit bubble had the "no income mortgage."

And like all bubbles this one had an official peak. It's the corporate version of an overdose. When a company does something so dumb that it shocks the other drunk party goers. I'm talking total destruction of shareholder value. In 2001 it was AOL buying Time Warner (TWX). This time it was Wachovia Bank (WB) buying Golden West Financial. Wachovia was like the guy at the party who gets taken away by the ambulance - you know he won't ever be the same.

Paulson was right to be embarrassed on behalf of the American people. We lost our cool. We couldn't handle our buzz. We didn't know when to stop. The cops had to break up our party.

But I have a feeling this is going to be good for us. What makes America great is our incredible ability to self-correct. That's really our secret sauce. We know when we have to change course. Clean up. Get our act together.

We will analyze these problems honestly and openly. And after much self-reflection, we'll improve. We will come out of this with better regulation and a much stronger and stable capital markets system. We will come out of this with more fiscal discipline.

But most importantly, we will come out of this remembering how good we've had it and how close we came to losing it. Sometimes liver disease is the only way to get someone to sober up.


This was originally published on September 25th. It bears reading again, especially in light of last nights debate.

Dawg ]:)

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The Most Dangerous Place to Get Investing Advice Today

by sleepin'dawg In reply to The Secret Villain Behind ...

Same author as the previous. This cat is that good and well worth taking the time to read

The Most Dangerous Place to Get Investing Advice Today
Thursday, October 16th,2008 | Dylan Jovine

Regardless of which candidate you vote for in three weeks, our economic reality will not be washed away with the tide of the elections. Grotesquely high budget and trade deficits, obscene debt-levels led by off-the-chart consumer spending, low savings and impossible-to-obtain loans have all finally caught the attention of investors.

Whether in the short-term the market ends up trading higher or lower from this point, one thing is for certain: you have to be more careful than ever with how you invest your money. The market will not "save you" from a bad investment. Only your wits and a fair amount of patience will.

This does not mean you should avoid stocks - I still think there is no other place to put your money. Bond yields simply don?t compensate you for the risk of inflation. Real estate prices are still abnormally high and will remain so until people stop pricing their property based on what they owe on their mortgage. And until the government offers a bail out plan to homeowners who are underwater, they'll have little incentive to sell at prices that assure them huge losses.

What does that mean?

In my circle of friends we?re hunting for profitable game as hard as ever. It?s times like these ? big game situations ? that we want the ball in our hands.

Experience has taught me that the flip side of the panic coin is "opportunity." That's why, whenever I hear the word "crisis," I replace it with "opportunity": As in the "Greatest Opportunity Since the Great Depression."

In any market environment - but especially a market like this - the best offense is a good defense. That means that you have to work extra hard to protect your capital first, while you hunt for investing opportunities second.

A Fool and His Money Are Soon Invited Everywhere

If you?re like me, every week you get solicited by seemingly dozens of people that want you to invest in something.

I used to think it was flattering. It didn?t take long, however, before I learned the age-old lesson that ?a fool and his money are soon invited everywhere.?

A stockbroker whose been trying hard to get your business calls and wants to discuss a tech stock he or she thinks is going to ?break out? of a range and trade higher...you see Jim Cramer yelling about some new stock nobody's ever heard of on TV...you hear that some large investor just bought a gazillion shares of the next best stock since Microsoft (MSFT).

It's easy to keep your guard up when you hear investing ideas from people you don't know personally.

It's much harder, however, to keep your guard up when you're getting advice from people you do know...

Like the stockbroker you've been doing business with for several years whose telling you that now may be the time to dip your toes back in the market...Or your doctor friend casually told you about a biotech company that has a promising new drug that should be approved by the FDA...Or your neighbor opens up to you after a couple at the backyard BBQ and tells you he and his buddies just bought 50,000 shares of ?the next Microsoft? for only twenty cents per share.

Because these people aren't the ones out to get you, it's easy to let your guard down. Why on earth would you not trust a stockbroker you've been doing business with for five years?

But there's a lot of innocent money out there. And innocent money can be just as destructive as dangerous money. Before you know it, a well-meaning advisor could offer an ill-timed recommendation that sets you back five years.

So today I'd like to talk about how to create a filtering system that protects you from the innocent money that may be advising you.

If you walk away from this with a better system for filtering the good ideas from the bad, then I?ve done my job. Once you find yourself saying "no" a heck of a lot more than you say "yes" you?ll have realized one of the most important keys to becoming a successful investor: knowing when exactly to pick up the bat, step to the plate and take a real swing and knowing when not to.

(One quick comment before we begin. Countless articles have been written about how to avoid doing business with a crooked broker. That is not the focus of the article. Having worked on Wall Street for years I can say without a doubt that most stockbrokers are decent, hardworking people. But if you need to check the disciplinary and employment history of your broker go to www.nasdr.com.)

Question #1: Are You Recommending this Stock Based on the "Squiggly-Line Theory"?

Chris Rowe calls it the Squiggly-Line Theory. Most people refer to it as basic "Technical Analysis" - the art of looking at a chart or two and deciding whether or not to buy a stock.

It seems that almost every investor, whether professional or not, starts investing by using technical analysis. I'm no different: I spent the first two years of my career trying to predict the direction of stock prices by reading charts.

It?s clear now in hindsight to see why I, as most others, start that way: learning technical analysis is easy. In fact, that's why most people get into it. I can?t tell you how many new investors I've met in my career who are fascinated by the visual appeal of a graph with squiggly lines and arrows.

And when you see how much you could have made had you bought at one of the past ?buy points? on the chart then it almost seems foolproof. Who in their right mind wouldn?t want to make what looks like easy money by reading something as simple as a chart?

But lets look at the cold hard facts. Investing is about making money. And the way investors "keep score" is by how much money they make investing. Thus it was disturbing when, two years into it my career, I realized that there isn?t one technical stock analyst on the Forbes 400 list. Not one. I know it';s hard to believe, but it's true: even William O'Neil, owner of Investors Business Daily and the biggest proponent of the craft, is nowhere to be found. Neither are any of his most famous "students" that he mentions in his book.

Perhaps even more disturbing when you really think about it, is that technical analysts propose using pricing and volume to determine whether you should buy a stock. If a stock breaks out to a higher price on heavy volume, it often means that you should purchase it. If a stock drops in price. it means you should sell it.

This is the height of absurdity to me. Let me explain. When you purchase stock you are buying shares of an actual business not a floating piece of paper. And technical analysts believe it is better to buy a piece of a business at a higher price than it is at a lower price!

Imagine you took that approach to buying a new house or a car or a watch.

Would you run out a buy a new home just because its price was 20% higher today than it was yesterday? Would you avoid your dream home just because its price was 20% lower today than it was yesterday?

No wonder they're not on the Forbes 400 list: the art of financial suicide doesn?t pay over the long-term. I prefer to buy my assets cheap.

Thus, the reason I place this question first is because you first need to make sure the person giving you that stock recommendation is even playing in the right ballpark. The right ballpark is not where little leaguers play. It's where the big money is made.

Question #2: Are You Recommending this Stock Based on the Direction of the Economy, Stock Market or Interest Rates?

Trying to predict the direction of interest rates, the stock market or the economy is Wall Street's great mental game - and its great distraction.

It's a game because nobody in history has ever predicted the future of any of these on a consistent basis. Nobody. Sure, I've seen certain analysts make high-profile calls and be right. I've even seen it twice. In fact, when I started working on Wall Street, analyst Elaine Garzarelli was all the rage because she had correctly predicted the 1987 crash. But her next five calls were wrong and she faded into relative obscurity. The fact that somebody who was so well respected when I started and fell so quickly made a big impression on me: I realized that there are far too many variables for anybody to consistently predict the direction of economy, interest rates or the market. My own experience and my study of history has not disappointed me since.

Furthermore, trying to predict them is a distraction because it takes your mind as an investor away from far more profitable thoughts. We all know how easy it is to start discussing the economy over dinner. You can sit with your friends for five hours, discuss everything under the sun, and still not have solid enough evidence to start making big bets investments. Add ten economists to the discussion and you will all walk away just as confused.

Anybody who tells you that they know the direction of the economy, interest rates or the stock market is either a) inexperienced or b) selling you something you don?t want.

This doesn?t mean that I don?t watch the financial news on the television. Nor does it mean that I don?t enjoy it. I like financial gossip just as much as the next guy. I just don't take it seriously.

Question #3: What Does The Company Do?

Sure, this sounds asininely commonplace ? but it is, without a doubt, the least understood question I hear investors ask. Sure, many people know that Cisco (CSCO) is the largest router dealer in the country. But what exactly is a router? Who are Cisco?s customers? How do they buy their routers? How much does it cost to make one? What do they sell them for? Who does Cisco compete with? These questions are critical to really understanding what the company does to earn money.

Think about it in relation to your profession. You may be a doctor of oncology or an advertising executive. But does your old friend from college who became a web designer really know what you do for a living because he goes to the doctor each year for a check-up? Not likely.

But people invest in companies like Cisco just because they have a router in their house and it works. Personally, I only invest in company?s that make products I can touch, see, feel or understand.

One of the reasons I like companies like Procter and Gamble (PG) is because finding out if their razors, for example, are selling well is easy. All I have to do is walk into Wal-Mart (WMT).

Perhaps I?m a simpleton, but I simply refuse to buy companies I don?t understand. That?s why I won?t buy a company that made the latest transistor that helps keep the temperature inside of a router cool enough to get more processing speed.

I?m not even sure if what I just said about routers makes any sense. And that?s my entire point ? if I can?t see it, understand it and feel it then I really don?t know it. And if I don?t really "know" it then I?m just gambling.

But that?s just me. If you want to buy a stock, make sure you understand the business first. Or do what I do and ask the person to "explain it to me like I?m two years old."

My general rule is to invest in companies whose products are as tangible to you as a rental property you own. You?ll gain a big comfort level when you?re able to "see" the property/product each and every day.

Question #4: What Is Management?s Track Record?

First let me state the obvious: you have to be able to trust management with the cash register. For private companies it's literal. For public companies it's compensation and perks. But there are other areas that are not so obvious that you must consider as well.

Therefore, it is critical that you find out the track record of the people that have been running the show:

How long has present management been running the company? If less than one year, don't buy it yet.
How much have they increased sales, earnings and profits during the past five years? If less than 10 percent per year, avoid it.
Have there been any restructurings? If more than one in the past five years, avoid it.
Does management have a significant portion of their net worth in the company (not in unexercised options)? If not, forget it.
Does management announce ?pro forma? earnings with their regular earnings announcement? If so, stay far away.
Does the company have more than 40% of its capital in debt? Say goodbye.
Does management constantly make acquisitions? Probably not a good bet.
When management has a bad year do they admit it honestly on the conference call or in the annual report? If not avoid them.

These questions are a good starting point, not an ending point.

Question #5: What is The Business Worth?

Not knowing what a business is worth when you buy its stock would be akin to not knowing what a car is worth before you went car shopping. You leave yourself open to danger.

Let me start with a simplified but revealing example. Let?s say that you went to the local Toyota dealership to look for a new Camry. What would you do if the dealer tried to sell you the car for $250,000?

You?d probably run right out of the shop. Why? Because the car is not worth $250,000. It?s worth closer to $30,000.

Conversely, let?s say that you were shopping for the same Camry and you saw an ad in the paper that said, ?Brand New Toyota Camry?s On Sale for $5,000.?

You probably run to the dealership as soon as possible to buy the car. Why? Because you would be buying the car for less than it is worth.

Yet when people purchase stocks, they often buy Toyota Camry?s for Rolls Royce prices.

The stock market operates the same way. Every stock has an intrinsic value or intrinsic worth. The key is to determine the value of the company separately from the quality of the business.

For example, I have a good friend of mine who called me and told me that he wanted to buy shares in Google (GOOG) and Sirius (SIRI) because he thinks they?re two of the greatest companies in the world.

Although I agree with him, I wouldn?t buy the stock. Why? Because having a great company says nothing about the value of the company. They are two separate issues.

That would be like buying the Toyota Camry for $250,000 just because you feel it?s a great car. Nobody is saying it isn?t a great car. It?s just a question of what it?s worth.

An easy short-hand method is to look at the past recession the company went through. How much did their earnings decline from the prior year?

Now estimate how much you expect earnings to decline during this recession. If earnings decline by 20%, what P/E would that give the stock? How does it compare with the stock's historical P/E during expansions and recessions?

If the stock is trading at a reasonable discount to that, you may want to consider buying some. If not, just be patient and wait for the price to come to you.

Now that you have some guidance on what the company is worth, you can determine if you should be buying it.

Question #6: Is It Selling for a Discount to What It?s Worth?

The goal of any great investor is to buy a stock for less than it?s worth. That?s how investors, whether in stocks or real estate, make money.

That?s why determining the value, as discussed above, is so important. You have to first know what a stock is worth before you can tell whether to buy it or not.

To borrow from the example above: If you determine that XYZ trades at 15 - 20 times earnings during an expansion and 8 - 12 times those earnings during a contraction, you can wait for the stock to hit 8 times earnings before you buy it.

Of course, it's very likely that this recession will be more severe than the last one. But if you're sticking with companies that (a) dominate one niche, (b) have little debt and (c) have lived through many economic cycles, then even a simple rule like this will serve you well.

So wait for that stock to hit 12, 10 or 8 times earnings and buy when you are comfortable buying it.

As I?ve said many times before, George Soros, the famed investor, is fond of saying that he?s an "insecurity" analyst not a security analyst. Keep that in mind when you begin to ask these questions about potential investments ? they?re a starting point, not an ending point.

In the meantime, during times like these you have to keep a wary eye even on people you trust for advice. They may be great during expansions but unless you've tested them through markets like these, then you have to use your own judgment to filter the good, the bad and the ugly.

Dawg ]:)

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Very good reads!

by NotSoChiGuy In reply to The Secret Villain Behind ...

Thanks for posting these.

The second one reminded me of a phrase my foster dad/mentor used to use: "There's a reason they're called brokers, and not richers!" :)

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So very sad, but so very,very true.

by sleepin'dawg In reply to Very good reads!

Thankfully, I've played the markets like Graham and Buffet. I've made mistakes, everyone does, but my winners outnumber my losers. Most of my mistakes originated by ignoring my own advice and letting my self be influenced by a broker.

Remember this : "if their advice was any good, why aren't they rich and why would they continue doing what they do???"

Dawg ]:)

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When I sold cameras....

by JamesRL In reply to So very sad, but so very, ...

We were trained to evaluate the needs of clients and sell the camera that best suited their needs and their budget. And then we would get promos where we would bend that training to make more money for the company and ourselves through incentive payments.

When I started the Canadian Securities Course, and was working at a brokerage, I discovered that it wasn't any different as a broker.

The broker is going to recommend you do things that make them money. Of course they will push new issues that their company profits from. Of course they want you to buy and sell to increase their commissions (as long as you don't leave the market).

I've seen brokers who do make money on the market, but they tend to be a little more risk takers than most.

I was working for the brokerage during the crash of 1987, and after the crash there were no jobs, so I returned to IT (and aren't you all happy I did?).

I trust brokers less than car salesman, and more than tobacco company scientists.


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That is sage advice

by NotSoChiGuy In reply to So very sad, but so very, ...

I was recently driving and was stopped at a light.

In the lane over was a car that had a magnetic sign on the side door that read "WORK FROM HOME AND EARN $20,000 PER MONTH OR MORE. CALL ME TO FIND OUT HOW."

The car was a Dodge Intrepid with noticeable rust.

Suffice to say, I saved my cell phone minutes for another day!

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Aw c'mon

by Pringles86 In reply to That is sage advice

You know that person was a millionaire, they just wanted to be able to relate to you. That is why they don't drive around in their Lambo.

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I guess I should have read the fine print....

by NotSoChiGuy In reply to Aw c'mon

..."I make so much money, I can have peasants like this drive around with my advertising on their family sedans"


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Reminds me of teacher unions

by santeewelding In reply to So very sad, but so very, ...

All they do, they do for the children.

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The Answers to Your Top Three Questions Right Now

by sleepin'dawg In reply to The Secret Villain Behind ...

by Louis Basenese

I always get a steady stream of questions. But in recent weeks, as the market has accelerated its descent, they've become increasingly alarmist.

As I've learned, when we give into panic, we act hastily. And often undermine our long-term investment goals.

So today, let's put to rest some of your pressing concerns. And make sure that doesn't happen.

Is my cash safe?

When my grandfather died, my grandmother found $17,000 lying around the house. He was Italian. So yes, some was stashed under mattresses. Some was in coffee cans behind the refrigerator in the basement. And more still was found in his sock drawer.

Forget the terrible investment implication of earning no interest on this money. My father almost burnt the house down when he was 12. And my great uncle was convicted of arson. So an "accidental" fire, not inflation, was a bigger threat to his savings.

My point: There's a lot of fear in the market. Banks continue to go under. Many people are trying to predict the next collapse, and move their assets in advance. (I can empathize because I bank with Washington Mutual, now JP Morgan.) But whatever you do, be smarter than us Italians. The mattress is not a safe or smart place for cash.

In all seriousness, if we take a few simple steps, we can keep all our cash in the bank, and make sure every penny is insured.

The rescue package increased the FDIC limits up $250,000 per qualified account. This increase alone brings almost 75% of deposits in the United States under coverage. The expanded coverage remains in effect until December 31, 2009.

If you have more than $250,000 in cash, you don't have to move it to another bank to get an additional $250,000 in coverage. Simply set up another account under a different ownership category (single, joint, IRA, revocable trust, corporation, etc.). For most banks, this can even be done online.

Should I be worried about my mutual fund company going bankrupt?

No. We're protected here, too. The Investment Act of 1940 requires each fund to be set up as an individual corporate entity, with a board of directors. That entity then hires the mutual fund company to manage its assets. So if the mutual fund company goes belly-up, its creditors can't touch the fund's assets. And the board of directors simply hires a new manager, after getting shareholder approval.

The only way your mutual fund can go bankrupt is if the actual value of all the stocks or bonds in the portfolio drop to zero.

What if my broker goes out of business?

Again, we're covered. Brokerage firms are restricted from co-mingling funds by SEC Rule 15c3-3 - the Customer Protection Rule. Or as they used to tell us at summer camp - boys are blue, girls are red. And we don't want any purple running around here.

As the Financial Industry Regulatory Authority (FINRA) explains, "In virtually all cases, when a brokerage firm ceases to operate, customer assets are safe and typically are transferred in an orderly fashion to another registered brokerage firm."

But we all know that Wall Street doesn't always abide by the rules. That's where SIPC insurance comes in. Created in 1970 as a non-profit, non-government membership corporation, funded by member broker-dealers, the SIPC's primary role is to return funds and securities to investors if the broker-dealer holding these assets becomes insolvent.

SIPC coverage is limited to $500,000 per customer, including up to $100,000 for cash. But again, we can easily increase coverage by establishing multiple accounts under different ownership structures.

Dawg ]:)

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