Bearish News

Ok, so that might be an exaggeration/lie. But I was flattered when I first read Who cares if Wall Street ‘talent’ leaves?. It looked an awful lot like something I wrote in April, Don’t Fear the Brain Drain. The dozen or so readers I had at the time may remember it.

Actually, the CNN/Fortune article is quite good. And it warms my heart to see an outlet like CNN publishing rabble-rousing stuff like this. The fact that the piece is spreading like wildfire is good news. It means more people are waking up to the fact that our finance sector needs to be downsized.

The editorial focuses on exec pay caps; whereas mine was about how the “brain drain” is a necessary part of rebalancing our economy. And that many of these executives are essentially glorified salesmen, rather than the financial geniuses they are often portrayed as. (I wonder…. does a statement like that hurt my chances at landing a 7-figure job on Wall Street one day?)

Anyway, here are excerpts from Fortune/CNN’s piece:

There’s no need to fear a Wall Street brain drain — despite the crackdown on pay by Washington…

Critics warn that reining in pay makes it hard to keep talented employees. Hemmed in, institutions like AIG, Bank of America and Citigroup could lose their best people.

Still, we say Godspeed to this ‘talent.’ After all, the traders and suits in the corner offices don’t exactly have an unblemished track record. In 2008, Citigroup, BofA and Merrill Lynch (since acquired by BofA) posted a grand total of $51 billion in losses.

Yet even as they were running themselves into the ground, the firms managed to pay out more than $12 billion in bonuses — including 1,606 million-dollar-plus bonuses, according to a report from the New York attorney general’s office.

I would add that America’s leaders are not allowing finance to heal itself. Orderly bankruptcies would cure the brain drain naturally. We need to press them to do so, but it’s probably already too late.

I’m a free-market guy, so it pains me to say the following. But if they don’t put these zombie banks out of their misery, we need to force them to at least break up the TBTF institutions (or SDIs, systemically dangerous institutions, as William Black calls them).

Share and bondholders need to be wiped-out at insolvent firms. Moral hazard is one of the most pressing issues we face. In many cases, boards and upper management also need to be replaced. You can be sure that if the shareholders were wiped, this would happen naturally.

I’m torn on pay caps for financial firms, but am coming down on the pro-side. Those who say that this is socialist are misguided. Every big bank (and quasi-bank) is essentially a government-backed entity. They are huge beneficiaries of public support.

It is unacceptable to have bonuses like we’re seeing at Goldman Sachs and others. These “banks” depend on the taxpayer in many ways. I’ll list a few:

• FDIC Debt Guarantees, TLGP
• TARP, direct bailouts
• Artificially low interest rates, which benefit banks while punishing savers and retirees. Also forces people into riskier asset classes
• Selling garbage mortgage-backed securities to the Fed
• Transferring mortgage risk to Freddie, Fannie, and the FHA

It’s been 80 years since Black Thursday. On that day in 1929 stocks plummeted on record volume. Big banks got together and propped up the market by buying huge blocks of shares. That only delayed the pain, of course. It reminds me of our current short-sighted attempts to prop up the markets. More info.

In the spirit of “those who don’t learn from history…” I suggest watching The Crash of 1929, a great documentary from PBS. There are some fascinating first-hand accounts from the people who lived through it. Ignore the fuzzy image, that’s just Google Video being wonky. It’s a full 53 minutes long, and the picture isn’t bad. (For more historical perspective, see these cartoons from the Great Depression.)

h/t Jesse.

Gotta love Colbert…

H/T Paul Kedrosky

Here are some of my favorite quotes from the Buttonwood conference. Note: some are paraphrased.

Elizabeth Warren, Chair of TARP oversight panel and Professor of Law at Harvard:

The reason banks lost confidence in each other is because they looked at their own books. (in reply to a question on the role a “loss of confidence” played in the crisis)

We need the toughest possible accounting standards… You can’t trust anyone’s books these days.

What we have confidence in is the fact that big institutions will be bailed out. (in reply to a question about the importance of confidence)

Tim Geithner, Treasury Secretary:

We’ve got unsustainable deficits over a five- to 10-year window.

We have been ‘remarkably effective’ in stabilizing the financial system.

We need a way to put them [too big to fail institutions]… how can I say this, ‘out of existence’

The emerging world will be a much stronger source of strength, it is showing resurging strength that will support us

George Soros, chairman of Soros Fund Management (arguably the most successful currency trader in history):

The US will remain a drag on the world economy. World growth is bound to be flat for a number of years.

Yes. (in response to Michael Panzner’s question: Has Wall Street captured the U.S. government, as Simon Johnson argued?).

Niall Ferguson, Laurence A. Tisch Professor of History at Harvard University. These quotes were taken during a panel titled The geopolitical shift: Is this the end of US finance?

In 10 years we will all look back and say, ‘that was when it happened, the shift of power from West to East’

The problem of being a declining empire doesn’t have a solution (in response to a repeated question on how to fix America’s ongoing problems)

China is the Germany of our time, they are increasingly nationalistic and economically powerful (referring to post-WWI Germany)

Diane Garnick, Investment Strategist at Invesco (during a session on executive compensation in finance):

The credit crisis may be over, but the credibility crisis is just getting started

Our most important resource is human capital, and we won’t maximize our potential as long as such a large percentage of our the top talent is attracted to finance (paraphrased, it was a long sentence)

Compensation in the Western World is a bit like Dolly Parton, there is a huge bubble at the top (Diane prefaced the simile by mentioning that the joke always bombs in Asia. For the record, it basically bombed to the ~40 people in this session, but I liked it).

Jeffrey D. Sachs, Columbia University Economist and Director of the Earth Institute

Wall St. is patting themselves on the back for making lots of money, for making profits on fantastically easy monetary policy

They [Goldman and other investment banks] have been allowed to “feed at the Fed” on loose money, and profited from it.

Richard Bookstaber, Risk Management expert and author of A Demon of our own Design. The following quotes were from a debate on this proposition: Financial innovation boosts global growth. Bookstaber was on the con side.

Derivatives are the current weapon of choice for gaming the system

Derivatives create risk, not protect against it

I’m all for capitalism, but Wall St. is only half-capitalist. When things are good, they’re capitalists. When things turn bad, they become socialists.

Jeremy Grantham, Chairman of Grantham Mayo Van Otterloo (aka GMO, a firm with $89 billion under management. His role as a money-manager make his comments that much more interesting)

Finance produces nothing of value, no widgets. All we do is shuffle money around and collect fees.

The more complex and opaque the [financial] instrument, the more likely that it is ripping people off.

Larry Summers, Director of the White House’s Economic Advisory Council, former Treasury Secretary under Clinton:

We need financial regulation that recognizes human nature, trying to change it is pointless. Even in the annals of speculation, there are few successful careers based on predicting bubbles and going the other way (short).

To be sure, it is easy to predict bubbles. Just predict them all the time. But that is surely not a realistic view to regulate based on.

Note: Quotes are as accurate as possible. Some are sourced from Rolfe Winkler, Michael Panzner, and Elizabeth Macdonald, who were also at the conference.

David Tice expects the Dow to return to its book value of 3100. I agree with his fundamental analysis, but think he is discounting the effect of government intervention (and market manipulation, if you’re into conspiracy theories). More on that here.

David Rosenberg and his firm, Gluskin Sheff, just published a special report on earnings and valuations. It’s a great read, lots of historical data. He also touches on one of our favorite topics – the operating vs. reported earnings issue. See this telling chart:

Earnings manipulation, or “scrubbing” as Mr. Rosenberg calls it, is clearly out of control. Look at the charts. The real P/E ratio for the S&P 500 is currently around 140. David notes how everyone is ignoring this blatant fact. They’re in denial, dismissing huge losses as a meaningless blip, a one time event.

While we will not belabour the point, when all the write-downs are included, the trailing P/E on “reported” earnings just widened to its highest levels in recorded history of nearly 140x, which is three times the levels prevailing during the height of the tech bubble…

It is interesting to hear market bulls talk about how distorted it is to be using trailing multiples that include ‘recession earnings’ (even though using ‘forward’ earnings means relying on consensus forecasts on the future and these are rarely, if ever, correct).

I’ve been harping on this subject for a while. We’ve had recessions before, and nothing has come close to these levels of corporate losses, ever. The only thing holding this market up are loss-hiding measures, government intervention, and accounting changes.

Back in August I graphed just how big the difference between “headline” and “real” earnings has become:

I added:

Some might say, “but wait, look at Q1 2009! Looks like they’ve cleaned up their act”  Nope. That is the result of mark-to-imagination accounting. This change by the FASB “eased” mark-to-market rules just in time to make Q1 bank earnings palatable. The change boosted Citi alone’s bottom-line by $3b. Why again, are we so dismissive about Chinese accounting? Yes, they’re up to some tricks of their own. But you know what they say about glass houses. Well, we’re in one.

To get Mr. Rosenberg’s research, you have to sign up at their website. You’ll receive the PDF links via email. Unfortunately they aren’t publishing the reports on their site. I advise signing up now, as it may not be free forever.

Past Related:

• Earnings Distortion Over Time
• Earnings: Open to Interpretation
• S&P Sports Eye-Popping 134x P/E
• About Those Q2 Earnings….