Investment Commentary

May, 2010
By Richard W. Boyer, CFP, CFA

Goldman Accused and Greece Refused

Last week’s Senate hearings regarding alleged improprieties at Goldman Sachs provided some of the best daytime television since the late 80’s when the Senate grilled Oliver North regarding his role in the Iran-Contra scandal.  North was a member of the National Security Council which was secretly selling weapons to Iran in order to encourage the release of U.S. hostages from Lebanon.  The proceeds from the sales were then diverted to the Contra rebel group in Nicaragua.  As complicated and convoluted as that chain of events may sound, it’s nothing compared to trying to understand Collateral Debt Obligations (CDO’s) or Credit Default Swaps (CDS’s). 

Very few people employed in the investment industry understand these highly complex securities and most would be ill-prepared to attempt to explain how they function.  So it is no surprise that a group of senators would be equally ill-prepared to question Lloyd Blankfein and his group of subordinates from Goldman.  Ill-prepared is putting it mildly.  If you tuned in, you may have thought from time to time that the senators seemed to have the upper hand and that the guys from Goldman seemed at a loss for answers.  Don’t be fooled.  We’re talking quantum physics here.  My guess is that the guys from Goldman were instructed to play dumb, offer nothing and wait to see if the senators showed that they actually knew anything.  They didn’t.

I don’t know if Goldman is guilty of a crime.  What they are accused of is a failure to disclose material information about an investment to a client.  As you may be aware, investment firms all over Wall Street were packaging mortgages together and selling them to investors.  Throughout the past decade, the quality of those mortgages gradually declined because we, as a country, needed to ensure that every American had an opportunity to purchase a home regardless of whether they could afford it.  There was so much demand from investors to purchase more pools of mortgages that the brilliant minds on Wall Street created “synthetic” pools of mortgages (the CDO’s).  That’s right….you could purchase fake pools of mortgages.  Investors didn’t care.  If it looked like a pool of mortgages and paid back interest and principal like a pool of mortgages, they didn’t care if it was real or fake.

What Goldman allegedly failed to inform one of their clients who was purchasing a synthetic CDO was that another one of Goldman’s clients was “shorting” the same synthetic CDO.  (Shorting means you think the value of the investment will decline.)  In addition (and herein lies the alleged transgression), there is some suspicion that the client who was “shorting” the CDO also had a role in how the CDO was constructed….in other words, he was able to stack it with riskier mortgages, thereby increasing the likelihood of the investment going “bad” (which would make the short position a winner). 

If the seller of an investment possesses material information that might cause the potential buyer of the investment to reject the investment, the seller must disclose that information.  In real estate, it would be the equivalent of knowing a house has radon contamination but not telling the potential buyer. 

Whether the charges against Goldman are true will be for the courts to decide.  Of greater concern is the “Court of Public Opinion”.  Not just the public’s opinion of Goldman but their opinion of the investment industry in general.  In the past decade, our trust in “Wall Street” has been destroyed.  From Enron & Worldcom to Bernard Madoff & Allen Stanford, many of the most prominent names on Wall Street are being accused of activities that, if not illegal, certainly lack a moral compass.

However, with all those “bad guys” doing all those bad things it never occurred to the average investor that he/she could also be misled by the ratings agencies.  Moody’s, Standard & Poors, Fitch….we were sure that if we didn’t know anything about a security, we could rely on those agencies to provide us with a modicum of guidance.  Oops!  It turns out that they were giving AAA ratings to securities loaded with toxic mortgages.  Why?  Well, it also turns out that Moody’s, et al were compensated by the same companies on Wall Street who were creating the securities with toxic mortgages. 

If you increasingly feel like putting your money in your mattress, we understand.  For the first twenty years of my career, the stock market seemed to move upward almost every year.  So I couldn’t understand why the generation ahead of me….the generation which grew up during the depression….had such a cautious aversion to the stock market.  With age comes wisdom.

Don’t mistake a V-shaped stock market for a V-shaped economic recovery.  The stock market has had a furious rally since March 9th of last year.  As the Fed holds interest rates near zero, funds continue to search desperately for a place to earn a return.  No one wants to sit in a money market fund earning virtually nothing, particularly while watching the stock market steadily climb.  The Fed held rates too low in the late 90’s.  In March, 2000 the market peaked, crashing 47% over the next year.  Several years later, suffering from a poor memory, the Fed again held rates too low for too long creating a real estate bubble AND another stock market bubble which peaked in October, 2008, crashing 56% over the next six months.

Maybe this time it’s different.  Maybe this time stocks are going up because we ARE having a V-shaped recovery.  Maybe this time the market is rallying because global economies are healthy, corporate earnings are increasing and faith in Wall Street has been restored.  Maybe not.

• Unemployment remains stubbornly near 10%.  In ANY previous recession, unemployment has at least showed small signs of improvement long before now.
• New foreclosure filings in March hit a record, 367,056.  Foreclosures are occurring at an annual rate in excess of 4 million homes!
• Bankruptcy filings were higher in March than in any month since the personal bankruptcy law was tightened in October, 2005.  Even more interesting is that Chapter 7 bankruptcies are rising faster than Chapter 13.  The reason?  Chapter 13 is somewhat more complex and requires the consumer to repay a portion of their debts so they can remain in their home.  Today, walking away from the home has almost become de rigueur.
• Of the 15 million unemployed people, 44% have been unemployed for over 6 months.  In the 1983 recession, the peak for this statistic was 26%.
• Freddie Mac recently asked the Treasury for another $10.6 billion in aid (which means they are asking for $10.6 billion to come from the U.S. taxpayers).  The reason Freddie, Fannie or Ginnie are asking the Treasury for aid is because homeowners are not making their mortgage payments.  This will bring the total provided to Freddie Mac to $61.3 billion since the bailout began.  That does NOT include the funds provided to Fannie Mae and Ginnie Mae.  And it’s not over.

It’s not all bad.  There are signs of life.

• U.S. auto sales increased 24.3% in March vs. March of 2009. 
• Apartment rents increased in the 1st quarter, ending five quarters of declining rents.
• Consumer credit decreased at an annual rate of 5 ½% in February and it has declined in 13 of the past 14 months.  The consumer is de-leveraging.
• Retail sales increased 1.6% from February to March and 7.6% from March to March.
• Industrial production increased 7.8% in the 1st quarter.

As I am writing this, Greek citizens in Athens are not happy.  Protesters are demonstrating in the streets and there have already been three deaths related to Greek outrage.  Austerity measures are being forced upon them as they come to grips with years of spending more than they earned.  A few days ago, Greek bonds with a maturity of two years were trading with an interest rate of 14%.  That means investors are very skeptical that Greece will be able to pay its debts.     

You may think that, because the U.S. is also spending more than it is earning, that we might have austerity measures thrust upon us, we might experience high interest rates and we might eventually have protests and riots.  Without speculating about the likelihood of those events, I think it is important to note that one major difference between the U.S. and Greece is that we have our own currency.  Last month I wrote about the problem Greece has sharing the Euro with 26 other European nations.  Greece does not have access to the presses that print the Euro.  And their German speaking and French speaking brethren are not anxious to keep funding Grecian profligate lifestyles.

 If the U.S. runs out of money, it can print more money.  Of course printing more dollars would likely lead to a decline in the value of the dollar.  Increased supply almost always leads to a decline in value.  And, like Greece, it would be followed by inflation, high interest rates, austerity measures (by natural causes…when you don’t have any money, you can’t spend it), protests, demonstrations and riots. 

At Boyer & Corporon Wealth Management, we continue to focus on risk, not return.  One doesn’t have to reach very far back in time to remember the consequences of taking excessive risk.

Continuing Education & Professional Development at BCWM

At Boyer & Corporon Wealth Management, an important part of our job is to actively pursue ongoing education in the various aspects of our profession. To do our job well, it’s imperative we stay on top of the very latest news, rules, trends, and forecasts in a wide range of topics. From regulatory issues to the latest economic outlook, BCWM team members regularly seek out learning opportunities, often attending several webinars, workshops or conferences in a month.

Also important to our culture is engagement with our community – whether it be membership in local professional groups or supporting philanthropic causes. That’s why our calendars often include benefit walks, luncheons and other events that support nonprofit organizations in our community.

Here’s a look at our activities during the past three months:

February
Brian Hackleman, Chief Compliance Officer, participated in a seminar, “Protecting Confidential Client Communications,” sponsored by IA Watch, an industry publication that focuses on regulatory news and compliance best practices.

March
Brian attended “Navigating Amendments to the Custody Rule,” sponsored by Charles Schwab, and “Amendments to the SEC Custody Rule,” sponsored by ByAllAccounts, an industry workflow solutions provider.

Rich Boyer, Managing Member and BCWM founder, attended a conference hosted by the Phoenix CFA Society in Phoenix, Az. The “Wealth Management 2010, Strategies for Private Clients” conference offered such sessions as “The Economic Picture: Stimulus, Deficits, Deflation and Inflation” and “Optimizing Charitable Giving using Retirement Assets”

April
Mindy Corporon, Managing Member and BCWM founder, along with Rich and BCWM team members Pat Burns, Emily Sims and Kim Brown, attended Strengths-Driven Performance, a presentation by Marcus Buckingham sponsored by Johnson County Community College. Buckingham is considered the world’s foremost authority on helping people maximize their strengths, rather than simply improving their weaknesses, to increase work efficiency and personal growth. He worked for nearly two decades as a senior researcher at Gallup, and is the author of several best-selling books.

Mindy, Pat, Kim, Emily and Laura Boyer, BCWM Para-planner, attended the Women’s Employment Network Annual luncheon, where BCWM had sponsored a table for the event. The Women’s Employment Network (WEN) is a nonprofit organization that offers job-search training and resources, individualized coaching and professional case management to help women raise their self-esteem and achieve economic independence through sustained employment. BCWM supports and attends this event each year.

Rich and Chris Harrington, Portfolio Manager, attended a presentation sponsored by the Kansas City Chartered Financial Analyst® Society, “Outlook for Credit Markets & Financial Services Industry.” The KC CFA Society serves its members by providing a regional forum for the discussion of investments, economics and finance.

Mindy, Laura and Jay Beebe, Financial Planner, attended the Kansas City Estate Planning Symposium, sponsored by, among others, the UMKC Law and the Financial Planning Association of KC.