FIX IT!

2:30 pm on April 28, 2004, did you know where your SEC Commissioners were?

Stephen Labaton, in an article he published October 3 in the New York Times, provides a close up look into one of the most arcane moments of 2008, so far.  Labaton explains how an obscure Securities and Exchange Commission decision led to an out of control financial crisis.  Read it, and you'll see why Senator John S. McCain, on the day he was quoted as saying, "If I were President of the United States, I would fire Christopher Cox today.  (That's Mr. Cox, on the left, chairman of the Securities and Exchange Commission, and Roel C. Campos, on the right, at a House hearing in 2007. Mr. Campos was on the commission in 2004 when a decision was made to change the net capital rule for big investment banks.  Mr. Cox appears to be listening out of both ears.)  As recently as March 11, 2008, Chairman Cox has said, "We have a good deal of comfort about the capital cushions at these firms at the moment.”  How do you like that?  I've read Labaton's article, silently.  I've read it, out loud.  I've read it to anyone who will listen.   And I ask the same question every time: how could Mr. Cox have been so wrong?  Give it a read. 

The editors of the Times, with whom I disagree often, published a 4 minute slideshow of the April 28, 2004 meeting (pay close attention to Item #2) between SEC Commissioners and the heads of JP Morgan, Lehman Brothers, Merrill Lynch, Bear Stearns, and Goldman Sachs, in a basement conference room at the office of the SEC.   Reading the article and viewing the audio slideshow won't lower your blood pressure, but it will provide valuable insights that the talking heads haven't. 

I'm interested in what you think about this.  I invite you to use the "comments section" found beneath this post.

Days till we reach zero

On more down days than I'd like to admit, my team mates have heard me say, "At this rate, we'll be down to zero in no time."  Now they've started saying it before I can get the very words out of my mouth.  It's "tap code" at JSCO for a bit of gallows humor that our team uses to puts things back in perspective, to put the train back on the track, to put the cart behind the horse.  You get the point.  As any fool who can push a stick in the dirt can tell you, it's not going to go to zero, even though we sometimes think it will.

Stock markets are behaving as if all the indexes will go to zero in less than a month, maybe sooner. No one knows the future, but I for one have a hard time believing that this very real, very serious financial crisis will play out by going to zero. The Dow Jones Industrial Average, a proxy for the market, has in fact experienced record of volatility and panic selling this high only three times since December 31, 1946, the end of World War II:

• October 16, 2002, when the Dow Jones was 8,036.03
• November 9, 1987, when the Dow Jones was 1,900.20
• November 5, 1974, when the Dow Jones was 674.75

The summers of 1962, when the Dow Jones was 572, and 1970, when the Dow Jones was 874, experienced high but slightly lesser volatility and panic selling.   The chart below shows the Dow Jones Industrials and our fear and volatility indexes from December 31, 1946 to the present.  Click the chart to full size. 

No one knows where and when all this panic will land.  Some wonder if it ever will.  It will.  History records that extreme volatility and panic selling do not last indefinately.  At some point, the invisible hand of Adam Smith kicks in and eliminates whatever shortage exists.  Some would say his invisible hand has already been working off the shortage of buyers.  Extreme volatility and panic selling provide wonderful opportunities to buy shares of excellent businesses at bargain prices.  Today's headlines are rarely the same as what history's judgement is going to be. 

If you haven't already seen it, study the wonderfully perceptive presentation by Weston Wellington of Dimensional Fund Advisors that Justin described in his post of October 2, part of which is below:

• "Earlier this week, I came across a presentation by Weston Wellington with Dimensional Fund Advisors, called "Is It Different This Time?" Wellington reviews our nation's past and, in particular, the media's reaction during those time. He does a great job of bringing some perspective to a volatile time.  (Justin said viewing it was guaranteed to lower blood pressure 20 points for every viewing.  If current levels of volatility and panic don't ease up soon, I'll need to view it several times a day.  I guess there could be lot worse things than reinforcing one's long-term perspective. 

This is not a recommendation to buy or sell any security, market, or an endorsement of any investment philosophy, firm, or process.  This is just a call to sit down, take a breath, and study history.

If we did more of the latter, I think we could get out of this

Friday morning's broadcast about the Wachovia Takeover included two pearls of wisdom; I heard them as the interview ended and think it's safe to assume Marketplace listeners (and Renita Jablonski) might not have heard them.  The interview is only 3 minutes long and well worth hearing/reading.  Click the player's "play" button to play; hit "pause" button at 3:03 marker to stop. 

Bonus: Chris Whalen notices tremendous people at Wachovia.

TEXT OF INTERVIEW

Renita Jablonski: Wells Fargo is buying Wachovia for just over $15 billion. That takes Citigroup and the Federal Deposit Insurance Corporation out of the picture. Citi was only looking to grab Wachovia's banking operations. The FDIC said it would step in to pick up any loan losses. Wells Fargo says this morning it will acquire all of Wachovia and that it doesn't need the government's help.

We're joined now by Chris Whalen, managing director of Institutional Risk Analytics. Chris, you've been watching these developments for awhile. What do you think of Wachovia now getting together with Wells?

Chris Whalen: I think they're a much better fit for one another. I also was really a little concerned about Citi, because you know, they have the most subprime consumer focus in their business model -- Citi's loss rate on loans, for example, tends to be twice the other large bank peers'. So I am not keen on seeing Citi buy anything right now.

Jablonski: And we should mention that Wells Fargo did play a little game of hard to get here because it had initially wooed Wachovia with a $20 billion figure, kind of pulled out of that -- that's when the Citigroup / FDIC thing started and then came back. What brought Wells back to this?

Whalen: Well I think the Wells Fargo folks ran the numbers and they decided that they needed to make a bid. If you look at Wells Fargo's perspective, they have a way of getting into the northeast, into the southeast, and that's a beautiful thing for them, cause they're now a national franchise. And once they deal with the asset quality problems, they have tremendous people at Wachovia that they can integrate into the Wells Fargo. And I think they couldn't say no -- they had to get in the game. And that's great news for all of us.

Jablonski: How important is the timing of this deal, coming down on this day of the House bailout vote? I guess this raises the question, is government intervention truly necessary right now?

Whalen: Well, not this intervention. I've been opposed to the House plan since day one, and the reason is we're fighting a battle that we should have fought six months ago in terms of liquidity, the accounting rules that started this mess. And really, the big picture here is we're going through a deflation. We're having asset values fall, a lack of a bid for many assets. We have to fix that and make leverage our friend again.

Jablonski: But I have to ask you this, I mean it seems the perception at least is that Wall Street is so much counting on this bailout at this point.

Whalen: Well, don't worry about Wall Street. Believe me, Wall Street will be there tomorrow. But we've got to stop looking at short-term market indicators as an indication of reality. I think we spend far too much time looking at the television set and far too little time talking to one another. And if we did more of the latter, I think we could get out of this.

Jablonski: Well, it was good talking to you. [read: Me give up watching TV network news and opinion shows?  No way.]

Whalen: Thank you.

Jablonski: Chris Whalen of Institutional Risk Analytics.

Is It Different This Time?

Justin here. The late Sir John Templeton (pictured here, right, 30 years ago with Jonathan) is known for saying that the four most expensive words in the investing language are "this time it's different."

[Jonathan was fortunate enough to work for Sir John. You can read more about their relationship in our last commentary, here]

Earlier this week, I came across a presentation by Weston Wellington with Dimensional Fund Advisors, called "Is It Different This Time?" He reviews our nation's past and, in particular, the media's reaction during those time. He does a great job of bringing some perspective to a volatile time.

So what's in it for you? It is guaranteed to lower your blood pressure 20 points for every viewing.

It's well worth your next 15 minutes (or if you're really pressed, skip ahead to the "TIME 1970" slide and watch from there.)

The long and short is this:  Life is rarely as bad (or as good) as it seems. Try your best to be patient, calm and rational.

"Well, I'm just a bill . . .

. . . just a lonely old bill, and I'm sittin' here on capital hill. But now I'm off to the Senate where they sit and debate: adding a surtax to millionaires, an extension to unemployment pay, tax breaks for businesses and renewable energy, increasing FDIC insurance and adding a $1,000 tax credit for less affluent homeowners."

Justin here. I know that doesn't quite carry the same tune as the original Schoolhouse Rocks song, but this is a lot more complex than just "school buses must stop at railroad crossings" (no offense Bill).