Saturday, July 19, 2008

"FREE" Markets- Only On the Way UP

From the SECURITIES EXCHANGE ACT OF 1934 RELEASE NO. 58166 / July 15, 2008

“False rumors can lead to a loss of confidence in our markets. Such loss of confidence can lead to panic selling, which may be further exacerbated by “naked” short selling. As a result, the prices of securities may artificially and unnecessarily decline well below the price level that would have resulted from the normal price discovery process. If significant financial institutions are involved, this chain of events can threaten disruption of our markets.”

Wow, now I am really starting to get concerned. The SEC has decided to educate financial markets about the normal price discovery process. I wonder if the person who wrote this paragraph has ever traded stocks let alone engaged in a short sale. I am asking this question because anyone who has a clue about financial markets would never write such garbage.

Rumor-“an unverified account or explanation of events circulating from person to person and pertaining to an object, event, or issue in public concern"

Chairman Cox and the rest of the gang at the SEC need to understand that there is a very good reason for all these “false rumors”. What is this reason? Well, to put it simply, investors have no way of verifying what exactly is the value of the assets sitting on the balance sheets of financial institutions. To make matters worse these opaque balance sheets carry assets that are 30-100x shareholder equity. As an equity holder, you are facing in many situations a potential 100% loss if your bank can’t adequately recapitalize. On the flip side, as a counterparty or debt holder you face default risk if the bank’s assets are not worth what they say they are worth. Solution: sell first ask questions later. For the SEC to actually call these rumors false they need to be able to confirm that every financial institution has adequate capital to weather a prolonged housing downturn. To be able to do this….they need to be able to verify that housing prices will not fall precipitously from present levels. Since no one is capable of doing this, the rumors are by definition not false. Every bank is carrying a certain level of housing related toxic waste on their balance sheets. Human nature tells us that the ones with the most toxic waste have a huge incentive to hide it as best as they can while they try to figure out ways to ride out the housing storm.(i.e raising more capital through dilutive offerings, selling assets, borrowing from the fed, or just praying that the bottom is around the corner) As the crisis has developed the only thing we have learned is that every bank is exposed.

It’s pretty sad to see the SEC focusing on shorts who are doing their jobs by exposing the weak links and bringing them to their knees before they sucker people into giving them capital that they clearly don’t deserve. If the regulators had done their jobs, the shorts would be failing and investors would be buying. My view is simple, stay out of the shorts way and let the market sort things out. If the system is healthy, buyers will emerge and bank stocks will stop falling. If it isn’t, the bad ones will fail quicker and we can get this whole mess behind us and start fresh.

We are now approaching the 1yr anniversary of the credit crunch, and it appears that we have made little to no progress with respect to shoring up our banking system. Why? Well, it’s because there is still too much dead weight out there dragging things down. Cut these banks loose, and let’s move on. Any institution that is over leveraged and incapable of surviving should be allowed to fail. If that means we are dealing with 90% of the system…than so be it…we can start over. Though my guess is it isn’t that bad.

…and the good news from wells fargo and jpm should be taken with a grain of salt. Wfc extended charge-off acknowledgement from 120 to 160 days. What does this mean? Well, for a bank this means you get to postpone taking loan loss reserves for another 40 days and actually hold onto precious capital. As for JPM, their loan loss reserves somehow actually came down from q1. At least the accountants are earning their salaries.

Oh, and one more thing…if there are no shorts in the market who is going to be left to buy these stocks? Maybe you should think about that. Shorts can at least make money by covering on the way down. If they didn’t exist, the market would only have sellers….and then Chairman Cox would get to see what real panic selling looks like.

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