As you’re reading this, I am nowhere near my computer. In fact, I’m not even in the office today. I spent the last three days increasing my “wealth.”

We all have different definitions of the word. Some of us give it a strictly monetary connotation. There is nothing wrong with that. In its most straight-forward definition, wealth is the abundance of money.

But if I can take the risk of getting touchy-feely for a minute or two, I’d like to take it a bit further. To me, wealth is the abundance of everything good in our lives.

If that truly is the case then move over Warren Buffett and Bill Gates, I am one wealthy guy. I bet you are too.

Like I said, I just spent the last three days with my beautiful, young bride and her equally stellar mother.

We spent the weekend at the beach. It’s Alaskan mother-in-law’s first trip to waters of the Atlantic. The opportunity to share my life-long passion with somebody that has never witnessed its majesty before is something I wouldn’t trade for even the hottest of stock tips.

But we had to cut our trip short. You see, in just a couple of hours, I’ll get the first snapshot of my largest investment yet (literally and figuratively). My wife is just ten weeks into what is going to be a lifetime love affair. She gets her first sonogram at five this afternoon.

Talk about wealth.

I could go on and on, but you don’t care. What you care about is your own wealth. There has never been a better time for an audit.

With soldiers killing soldiers, hedge fund managers stealing billions, a government that has lost its way and a country that appears to have dropped all moral responsibility, it is vital for folks like you and I to figure out how we value ourselves.

What is it that we want?

Health. Family. Stability. Food. Love. Life. Liberty. Happiness.

Of course, financial wealth plays a large role in all of those things. After all, if money is the root of all evil, isn’t the foliage of that is good?

As so many of us out here in the world of finance fight against Washington’s latest moves, it is important to set the issue of money aside. Too often, our political thoughts hinge on the question, “What’s this going to cost me?”

But what about all those other things?

How is healthcare reform going to affect my unborn child? How is a bigger government going to make it easier for me live a stable life? How are bonus caps going to make it easier for me to stay in love with my wife?

None of those things impact our real “wealth,” yet our government is hell bent on the idea that they are going to make all of our lives better.

Like I said last week. Vote ‘em all out. You’ll be wealthier for it.

Who’s back? Harry Dent, the self-styled “economic futurist,” who presumes to tell us about the great economic booms and busts that lie ahead.

How can he possibly know these things?

According to Dent, an analysis of the “highly predictable” nature of consumer spending based on demographic trends – increasing spending during child-rearing years, peak spending as the kids leave home and slower spending during late work and retirement – reveals what lies ahead for the economy and the stock market…

Harry Dent: Dow 44,000 & Other Flimsy Forecasts

Harry Dent is a man worth listening to. After all, he has a near perfect track record – as a contrary indicator…

For example:

• With less than auspicious timing, Dent brought out The Roaring 2000s Investor in 1999, confidently predicting that the Dow would hit 44,000 by 2008. With the luxury of hindsight, we now know he was off by 30,000 points or so.
• At the time, Dent also argued forcefully for NASDAQ stocks, predicting, “The technology revolution will favor Internet-oriented companies.” Within three years, the NASDAQ lost three quarters of its value and the leading index of Internet stocks plummeted 89%.

And Dent didn’t confine his market predictions to the U.S. He further forecast that Argentina would see “moderate growth until 2015 and then stronger growth into 2025.”

No, Argentina would suffer a currency collapse and financial crisis followed by rioting, social unrest and years of economic stagnation.

It’s obvious now just how wrong Dent was. But 10 years ago, plenty of brokers and investors agreed with him. He sold hundreds of thousands of books and raked in millions as an advisor to top Wall Street firms, including Morgan Stanley (NYSE: MS).

Harry Dent’s Next Bold Prediction: The Great Depression Ahead

Five years later, bloodied but unbroken, and using his same demographic trends theory, Dent published The Next Great Bubble Boom: How to Profit from the Greatest Boom in History: 2006-2010.

Well, no. That period encapsulated the biggest bust since the Great Depression. As for his revised forecast of Dow 40,000 in 2009, it looks like he’s off by 30,000 or so points again.

With a track record like this, you might imagine Mr. Dent would shy away from economic prognostication.

Yet he’s promoting a new book. And if you’re looking for a reason to be optimistic about the market, you’ll find it in his chosen title: The Great Depression Ahead.

Within weeks of the book’s publication, the Dow began a 48% ascent, one of the six biggest rallies in the last 100 years.

Look, I’m not entirely unsympathetic to Mr. Dent. Anyone in the investment prophecy business needs the skin of a rhino and a Ph.D. in humility. No one gets it right all the time.

Moreover, Mr. Dent has made hundreds of predictions in his long career, so I’m sure he can point to a few successes. (Of course, so can an orangutan heaving darts at the stock pages.)

It’s just that Dent has made millions in book sales and investment advisory fees peddling this mumbo-jumbo.

(Poor advice does have its consequences, however. His AIM Dent Demographic Trends fund severely underperformed the market and was quickly folded into another fund. His name was quietly dropped.)

Yet Mr. Dent is still out there, offering dubious investment advice based on faulty premises.

The truth, of course, is this…

Forget Harry Dent… Listen to This Advice Instead

While anyone can make a good call from time to time, no one can consistently predict the economy or the stock market.

If you don’t accept this – a fundamental investment tenet with great investors from Benjamin Graham and Warren Buffett, to Peter Lynch and John Templeton – your chances of long-term success are slim.

Yet Mr. Dent clings to his demographic theories and economic futurism. And that’s unfortunate.

Someone really ought to let him in on one of the great secrets of investing: Your only real mistakes are the ones you don’t learn from.

Good investing,

Alex

Source: Harry Dent: Bold Predictions of the Great Depression Ahead

Still, this is the fourth consecutive official drop in GDP — the longest U.S. economic losing streak since records began in 1947. The economy has contracted 3.8% since then, the deepest pullback since the Great Depression.

Paging through the fine print, there’s only one outlier — one segment of blockbuster growth while the rest of the economy muddles through, at best: federal government spending, up 11.4%.

“In some ways, the whole GDP discussion is irrelevant,” says Chris Mayer. “As investors, we care about markets, and not GDP growth. There is a great fallacy out there that if the economy does well, stocks should do well (or if the economy does poorly, stocks should do poorly). Hence, too many so-called investors waste an inordinate amount of time talking about recovery, or lack thereof.

“It’s possible that GDP does expand strongly. But investors could still lose. We have one glaring historical example: From 1964-1981, GDP grew 370%. And the sales of the Fortune 500 more than sextupled. Yet the Dow Jones industrial average went from 874 on Dec. 31, 1964, to 875 on Dec. 31, 1981.

“As Warren Buffett once wrote: ‘Now, I’m known as a long-term investor and a patient guy, but that is not my idea of a big move.’

“For investors, it is all about the price paid. The really relevant question is not one of whether or not the economic recovery is real. The question is are stocks cheap enough? To answer that, you have to look at stocks and compare them with the alternatives.

“My answer is some stocks are cheap and some are not. It is hard to generalize. In my view, investing is a craft of the specific. It is in the picking of the trees in which investing skills pay off the most, not in assessing the forest. There are, undoubtedly, specific stocks that will prove nice investments over the next few years. Finding them is what we are all about.”

Source: US GDP is Irrelevant

I was in Manhattan last week attending Grant’s Fall Investment Conference. The U.N. General Assembly is meeting there, and the streets were blocked off in places. The NYPD was out in full force. I heard one passerby complain about the inconvenience of it all to one police officer. He responded, “Don’t blame the NYPD, blame the General Assembly.”

With the General Assembly in Manhattan and the G-20 in Pittsburgh, government has taken over the headlines this week. It seems half the world is mostly preoccupied with telling the other half what to do. No doubt, bossiness is in a bull market.

At Grant’s conference, I heard presentations on gold, the dollar, oil, real estate and more by a slate of luminaries, including John Paulson. Paulson is one of the best hedge fund managers in the world. There were many others, including Grant himself, who has created something of a stir lately.

Jim Grant, the host and editor of Grant’s Interest Rate Observer, has turned bullish on the recovery. In a Wall Street Journal piece on Saturday, the great bear turned in his claws and picked up the horns of a bull.

In a phrase, Grant’s thesis runs this way: The sharper the decline, the stronger the rebound. For this, he finds ample evidence in the historical record. The economy bounced back strongly after each sharp contraction — such as those in 1893-94, 1907-08, 1920-21 and 1929-31.

In the current recession, GDP (a rough measure of economic activity) contracted nearly 4% from peak to trough, which is a sharp recession as these things go. So, Grant reasons, the rebound will follow the historical pattern.

Grant loves to challenge the consensus. And the consensus this time around is that the recovery will be weak. I loved the quote he pulled from economist A.C. Pigou: “The error of optimism dies in the crisis, but in dying it gives birth to an error of pessimism. This new error is born not an infant, but a giant.”

Grant makes an eloquent and thoughtful case, as he always does. He goes on to conclude in his editorial: “The world is positioned for disappointment. But in economic and financial matters, the world rarely gets what it expects. Pigou had humanity’s number.”

I hope Grant is right. It is an appealing case, but I don’t buy it. Too many of the problems of the prior boom remain unresolved. There is still too much leverage and debt in the system. And on a more basic level, business is not good across a spectrum of sectors. The contraction is still ongoing. I’m inclined to remember the old bearish refrain that things are never so bad that they can’t get worse.

It’s All About Markets

It’s true we’ve had a sharp contraction, but there is no rule that says we can’t contract more. A nearly 4% decline in GDP could turn into an 8% contraction when all is said and done. The move from 4% to 8% would be painful, indeed. Even then, we would be a far cry from the dark woods of the Great Depression.

In some ways, the whole discussion is irrelevant anyway. As investors, we care about markets, and not GDP growth. There is a great fallacy out there that if the economy does well, stocks should do well (or if the economy does poorly, stocks should do poorly). Hence, too many so-called investors waste an inordinate amount of time talking about recovery, or lack thereof.

It’s possible that Grant is right: GDP does expand strongly. But investors could still lose. We have one glaring historical example: From 1964-1981, GDP grew 370%. And the sales of the Fortune 500 more than sextupled. Yet the Dow Jones industrial average went from 874 on Dec. 31, 1964 to 875 on Dec. 31, 1981.

As Warren Buffett once wrote: “Now, I’m known as a long-term investor and a patient guy, but that is not my idea of a big move.”

For investors, it is all about the price paid. The really relevant question is not one of whether or not the economic recovery is real. The question is: are stocks cheap enough? To answer that, you have to look at stocks and compare them with the alternatives.

My answer is some stocks are cheap and some are not. It is hard to generalize. In my view, investing is a craft of the specific. It is in the picking of the trees in which investing skills pay off the most, not in assessing the forest. There are, undoubtedly, specific stocks that will prove nice investments over the next few years. Finding them is what we are all about.

Sincerely,
Chris Mayer

Source: Are the Bears Turning Bullish?

Always buy undervalued stocks and sell them when they’re overvalued. Or more commonly: “Buy low, sell high.” Of course, if you’ve invested for more than a week, you know this is easier said than done.

Undervalued (cheap) and overvalued (expensive) are such subjective measures when it comes to investing. Most times we end up guessing and most times we end up overpaying.

But today, let me show you one amazingly simple way to always buy stocks that are truly cheap…

Why America’s Most Successful Investors Buy “Low-Density” Stocks

All you have to do in order to invest like Warren Buffett, or any of America’s most successful investors – and rack up easy double-digit gains – is to buy what I call “low-density” stocks.

I define density like this: The value the market assigns to the cash that a company has in the bank.

• A high-density ratio: Means the market overvalues the cash.
• A low-density ratio: Means the market undervalues the cash.

The reason I focus on cash is straightforward: It’s the most tangible, liquid asset – and the easiest to value. After all, $1 is worth $1, so it’s easy to tell when you’re overpaying or getting a discount.

Let me use an example to make this concept crystal clear…

• Company XYZ trades for $1 per share and has $1 per share in cash (total cash divided by shares outstanding).
• To calculate the density ratio, we simply divide the price per share by the cash per share. In this case, the result is 1.

Here’s the thing, though: A one-to-one ratio is uncommon.

Most of the time, you’ll have to pay a premium for a company’s cash. Right now, for example, the density ratios for more than 480 companies in the S&P 500 are higher than 1, meaning you’ll pay more for these shares than they’re worth in cash.

But it’s even rarer to find a stock trading at a density ratio below 1.

Density Ratio Below 1 = Cheap Stock & Massive Gains

A density ratio below 1 means a stock could be worth $10 in cash, yet it trades for $7.50. Or it’s worth $1 and trades for 75 cents, etc.

And rest assured, whenever America’s best investors can buy $1 for 75 cents or less, they do. And you should, too. That’s because these discounts, understandably, don’t last for long.

Just take a look at Cynosure, Inc. (Nasdaq: CYNO). It traded at a density of roughly 0.70 for about a month this year. Once investors woke up to the bargain on offer, shares surged 138% higher.

There’s another low-density stock up for grabs at the moment, too…

Buy This “Low-Density” Stock Today

If you want to put my low-density strategy to work today, consider Trident Microsystems, Inc. (Nasdaq: TRID), which makes specialized semiconductors used in flat panel televisions.

• With zero debt, $2.87 per share in cash, and a market price of $1.90, it trades at a density ratio of 0.66.
• In other words, when you buy Trident, you’re buying $1 for 66 cents.

Incidentally, such a steep discount also makes Trident a prime takeover target. And with $2.21 billion in cash, Broadcom Corp. (Nasdaq: BRCM) could easily afford the $125 million market cap Trident.

But, even if Broadcom doesn’t pounce on the opportunity, history dictates that other investors will.

Based on its low-density ratio, Trident needs to rebound 51% to return to a density ratio of 1.

I recommend you capitalize on this truly cheap stock before it’s too late.

Good investing,

Louis Basenese

Source: How to Take the Guesswork Out of Valuing Stocks

Here is Warren Buffett’s view:

“Last fall, our financial system stood on the brink of a collapse that threatened a depression. The crisis required our government to display wisdom, courage and decisiveness. Fortunately, the Federal Reserve and key economic officials in both the Bush and Obama administrations responded more than ably to the need.

“They made mistakes, of course. How could it have been otherwise when supposedly indestructible pillars of our economic structure were tumbling all around them? A meltdown, though, was avoided, with a gusher of federal money playing an essential role in the rescue.

“The United States economy is now out of the emergency room and appears to be on a slow path to recovery.”

This is probably the view shared by most economists and most investors. It is not our view. From where we sit there is no recovery underway…and there never will be one. You can recover from a hangover. You can recover from a nasty divorce. You can even recover from an earthquake. But once a depression begins, you can only endure it. Get on with it. Get it over. And then, you can begin rebuilding again. You will never recover the economy you had before the crisis. You must find a new economic model.

A headline from yesterday: “Reluctant shoppers hold back recovery.”

That’s one way to put it. Shoppers don’t have any money. They need to cut back. Most likely, they will cut back until their savings rates reach 10% of disposable income. That will take $1 trillion out of consumer spending. The economy cannot possibly recover under those conditions; it can’t return to its same old, consumer-led, credit-fuelled self. Instead, it must go through a period of transition – in which output is depressed – until it finds a new personality, better suited to the new economic circumstances.

But Buffett is not worried about the depression. He’s worried about how the recovery is financed:

“.. enormous dosages of monetary medicine continue to be administered and, before long, we will need to deal with their side effects. For now, most of those effects are invisible and could indeed remain latent for a long time. Still, their threat may be as ominous as that posed by the financial crisis itself.”

Buffett does the maths. This year, the US deficit will total $1.8 trillion. Since 1920, the largest peacetime deficit was 6% of GDP. This is 13% of GDP. The magnitude of it alone should be cause for alarm. But there’s more. Where does this money come from? Even if you could direct 100% of the net US trade deficit (about $400 billion, the money that ends up in foreigners’ hands as a result of American spending) and 100% of American’s savings (estimated to be about $500 billion), you’d still be $900 billion short.

Desperate borrowers should expect to pay high rates of interest. A borrower who doesn’t need the money can shop for the best rates and hold out for a good deal. But when a person needs to borrow, he takes what the market gives him.

Yet, one of the most curious things about the financial world circa 2009 is the yield on the 10-year Treasury note. It has fallen to under 3.5%. Despite record borrowing by the feds, lenders content themselves with the lowest yields in nearly half a century. Go figure.

The market seems to be anticipating a depression. Why else would bond yields be so low? If the economy sours…and the stock market sinks…the safe yields on Treasury bonds will seem like a good alternative. But Buffett believes the Treasury yields are not as safe as they appear. That other $900 billion has to come from somewhere. And the feds can’t allow interest rates to rise significantly; that would undermine all their stimulus efforts. High real interest rates depress economic activity. So, what can the feds do?

“ Washington’s printing presses will need to work overtime,” says Buffett prophetically.

Of the two ways of financing the deficit, one is a flimflam; the other is robbery. In the great credit expansion consumers borrowed so they could buy things such as automobiles. Now, the feds borrow and bribe the voters with money to buy automobiles. No matter who does it, borrowing for consumption is merely taking from the future. Then, when the future comes…the account has to be settled. Result: no net gain. What was consumed in one year is not consumed in the next.

Of course, the feds don’t spend money the same way consumers did. Consumers wasted their money on frou-frou and watchamacallits of their own choosing. The government wastes money on different things – like turtle crossings and billion-dollar bailouts.

Not that we’re complaining about government spending. We’re just pointing out that it’s not the same as private spending. What makes goods good is that people choose them and buy them with their own money. They get what they’ve got coming. But the feds are spending other peoples’ money. If they get any goods at all it is practically an accident.

But what we’re talking about this morning is the dollar. According to Buffett, the dollar is in danger. He’s worried about the larceny, not the flim-flam. Printing up additional dollars robs savers. Each new dollar created to buy US debt makes each one already in existence – say, in a vault in the Bank of China – worth less than it was before. If that isn’t true, the whole body of economic thinking from Adam Smith to Irving Fisher is nothing but a fantasy. And the only way to protect the value of the dollars held by savers, theoretically, is to withdraw the stimulus money before inflation sends prices soaring.

Buffett is an optimistic fellow. He believes that responsible authorities will turn off their dollar-printing machines in order to protect the greenback. Here at the Daily Reckoning, we’re not so sure.

First, the depression is likely to be worse than people think. This will mask the effects of dollar printing. Plus, it will make the need for more dollars – more federal spending, more US debt – seem more urgent than ever. Instead of pulling the plug, they’ll turn up the speed.

Second, the feds are not really interested in the health of the real economy anyway. This is an insight which is obvious, but one that only came to us recently. When the feds put in place absurd policies to delay and restrain the inevitable correction, they are making things worse, generally, for everyone. But the politicians are responding to their constituents’ demands. One campaign donor wants to keep his business alive. Another wants to keep his job. Still another promises the feds high paying jobs on Wall Street, after their term in Washington is over. Millions of others — more than enough to turn an election – want free pills and mortgage subsidies and so forth. When the feds try to bailout the economy, they are only doing their jobs! They’re not going to stop doing their jobs – especially in a depression – just to protect foreign dollar-holders.

Source: Flim-Flam, Robbery and the Economics of Depression

Here are listed sales in the filing, courtesy of 24/7WallStreet.com:

· 7/20/09… 1,817,000 at $28.7269 average in open market sale.

· 7/21/09… 3,915,100 at $26.9188 average in open market sale.

· 7/22/09… 2,254,200 at $26.6425 average in open market sale.

What took Buffett so long to start selling Moody’s? We have no idea. Moody’s runs one of the biggest scams on Wall Street. It charges the companies whose securities it rates (just like Standard & Poor’s and Fitch also do).

So what do you think these ratings agencies did when presented with a whole load of junk mortgage-backed securities to rate? They assigned them investment grade status and pocketed the cash.

If these ratings agencies had instead acted honestly and responsibly (rather than pimping themselves out to the highest bidder) the whole subprime debacle and the ensuing credit crisis could have been avoided.

Buffett isn’t the only investment whizz who thinks Moody’s is heading for trouble. Hedge-fund legend David Einhorn of Greenlight Capital is selling Moody’s short.

Yesterday, Moody’s shares tumbled almost 4% on the news that the Buffett had began to unwind his position in the company. We’d like to see Moody’s go out of business. But that’s maybe wishful thinking. Make sure you don’t own any shares in Moody’s. And if you’re feeling speculative, consider going short Moody’s along with Einhorn.

One of the easiest ways of deciding what stocks you should own is by “standing on the shoulders of giants.” We’re no geniuses here at Notes. But at least we are smart enough to recognize it. And that’s why we track what people far smarter than us are doing with their money.

As of the end of the first quarter this year, this is how Warren Buffett’s holdings (via Berkshire Hathaway, his investment vehicle) looked like:

1. American Express Co. (NYSE:AXP) over 151.6 million shares, same as before.

2. Bank of America Corp. (NYSE:BAC) 5 million shares; same as last quarter.

3. Burlington Northern Santa Fe (NYSE:BNI) 76.77 million shares; HIGHER than 70.089 million shares of last quarter.

4. Carmax Inc. (NYSE:KMX) 12 million shares; LOWER than the 17.63 million and that is two straight quarters of declines.

5. Coca Cola (NYSE:KO) right at 200 million shares, still same as before.

6. Comcast (NASDAQ:CMCSA) 12 million shares, same as before.

7. Comdisco Holdings (NASDAQ:CDCO) roughly 1.5 million shares, same as before.

8. ConocoPhillips (NYSE:COP) is really lower than the 71.228 million shares reported as this has been used for cutting taxes, and we already know that the number is lower than what the filing says.

9. Constellation Energy Group (NYSE:CEG) was just updated this week so the number is actually about 12.4 million rather than what the filing shows as being 14.828 million shares.

10. Costco Wholesale (NASDAQ:COST) 5.254 million shares, same as before.

11. Eaton Corp. (NYSE:ETN) 3.2 million shares; looks like new holding but may have been missed before.

There’s a lot of talk these days about how Buffett has lost his touch. This may be so. But the guy remains the world’s most successful investor. If you have a medium- to long-term investment horizon, you could do a lot worse than consider following Buffett into some of these long positions. If you think you can outsmart the guy, go ahead. But we know who our money would be with…

Fenster: They treat me like a criminal. I’ll end up a criminal.
Hockney: You are a criminal.
Fenster: Why you gotta go and do that? I’m trying to make a point.
– The Usual Suspects (1994)

Ah, Goldman Sachs, how we despise thee. Let us count the ways.

First there is the matter of jaw-dropping compensation. As The New York Times reported last week:

Goldman posted the richest quarterly profit in its 140-year history and, to the envy of its rivals, announced that it had earmarked $11.4 billion so far this year to compensate its workers.

At that rate, Goldman employees could, on average, earn roughly $770,000 each this year – or nearly what they did at the height of the boom.

Senior Goldman executives and bankers would be paid considerably more…

The unofficial party line from Goldman is, “Don’t hate us because we’re smart.” (Or in the street vernacular, “Don’t hate the player, hate the game.”)

To get rich in a capitalist system you need three things – hard work, smarts and luck. America, rightly, bears little or no ill will when fortunes are made through the combination of these three. Take the Google guys, for example… or Warren Buffett… or any other number of big winners in our (quasi) free market system.

Heck, America even goes one better than that. In the United States, you can make ridiculous sums of money that no one even remotely thinks you deserve, and most folks won’t begrudge your good fortune.

If a ne’er do well CEO convinces his shareholders to pay him a bonus worth tens of millions for doing diddly-squat, that might be a shame… but it’s the shareholders’ money, free to be wasted as they wish.

Or if an athlete signs on to a professional sports team for tens of millions and then, say, gets into a nightclub shooting, wilts under pressure, or otherwise turns out to be a total flop, well… c’est la vie. A contract is a contract.

Point being, private financial exchanges are akin to what happens in the privacy of a home. The result may be weird or goofy or stupid or obscene, but as long as consenting adults are involved, the public doesn’t really care.

Where Goldman (and others) crossed the line is in the source of their gains…

Taxpayer Largesse

First, an interesting tidbit. Goldman’s take of $770,000 per employee is stunning enough. But as it turns out, Goldman may have actually used a subtle accounting trick to make that number smaller, so as to tone down some of the spotlight glare.

Various Wall Street sources have reported to Dealbook that “in a footnote to its financial results… Goldman said that for the first time it was including consultants and temporary staff in its overall employee figures. This had the result of increasing its official staffing levels by 2,000 jobs or so in both the first and second quarters.”

By spreading the haul over a bigger head count, you see, the gaudy top line number – average profit per employee – is reduced.

So by throwing in consultants and temps and, who knows, maybe even janitors and deli delivery boys, Goldman can practice its own peculiar brand of modesty in at least keeping the profit per head below a million bucks.

Again, the reason for gall is not because Goldman’s traders are “smart.” It is because this pound of flesh was extracted directly from taxpayer’s hides.

On one level the chain of events is simple:

• Goldman Sachs takes huge, multibillion-dollar taxpayer cash infusion from the government.
• Goldman uses these funds to make an absolute killing.
• Goldman says “Gee thanks!” and pays back the money with minimal (i.e. zero) penalty attached.

But actually it’s a lot murkier and uglier than that.

Thanks a Billion, Hank

To really get a bead on how stinky this whole situation is, consider why 2009 has proven so profitable for Goldman Sachs. Two reasons stand out. First, half its competition has been crippled or killed off. Second, AIG (a major Goldman Sachs counterparty) was specifically kept afloat.

If you’ll recall, the previous Treasury Secretary was Hank Paulson, a.k.a. “Hammerin’ Hank,” the ex-CEO of Goldman Sachs. (Paulson was recently back in the news defending his tough-guy leanings in the whole Bank of America/Merrill Lynch fiasco.)

Taipan Daily is not one to promote irresponsible conspiracy theories. But nor do we shy away from putting two and two together. So with that in mind, let’s look back at the dark days of September 2008.

During Paulson’s time at Treasury, there was no question who was top dog (in terms of the relationship between the Treasury and the Federal Reserve). Hammerin’ Hank was everywhere. Bernanke was a shrinking violet in comparison.

Now the uncomfortable questions…

On that fateful weekend in question when Lehman Brothers collapsed, who stood to benefit (in the long run) from the disappearance of a major Wall Street competitor? Goldman Sachs.

Coincidence? Maybe. But then note what happened just a few days later. Within 72 hours of Lehman Brothers’ collapse, Paulson announced that AIG would be saved… at an outrageous opening bid of $85 billion. (The taxpayer tab would eventually run much, much higher – and it’s still running.)

Again, using the old Latin phrase “cui bono” (Who benefits?) as our guide, one has to ask… who was one of the major beneficiaries, if not THE major beneficiary, in seeing AIG survive?

Goldman Sachs.

This is true because AIG played the role of busted bookie, having made tens of billions worth of dumb bets with other investment houses on the street. Normally when a gambling house folds, the gamblers waiting to be made whole are SOL – a technical acronym which means “out of luck.”

But when the gamblers are high rollers it’s a different story. In part, Paulson and Bernanke saved AIG, flooding it with tens of billions in taxpayer cash, so that those very same funds could be kicked right back out to other players on the street. In its death throes AIG served as a “beard”… a convenient one-stop money laundering shop, used by the Treasury and the Fed to avoid the political inconvenience of writing big checks out in the open.

As a result of AIG’s last-minute bailout, and the discreet transfer operation outlined above, Goldman walked away with a cool $13 billion or so… profits on AIG-backed contracts that would not have paid off had Hammerin’ Hank – the ex Goldman CEO – not saved the day.

Rotten Egg Insurance

There is yet another amusing question that must be asked. It would be a small miracle if Congress figures out the importance of this question, but who knows – they may eventually get around to it.

That question has to do with the morality, or even the legality, of buying rotten egg insurance on the very eggs one is selling.

Put it this way… suppose I set myself up in the fly-by-night homebuilding business. You decide to trust me, and soon move your family into a beautiful new 3,000 square foot home built by my construction firm.

In time you discover the home is a disaster. The drywall is rotted and mildewed… the electrical wiring is a fire hazard… the foundation is cracked… the generic insulation is asbestos-prone… a residential nightmare through and through.

Naturally you would want restitution on this disaster of a house. You might get some money back, but nowhere near enough. On top of that, the emotional anguish (and headache and hassle) could never be repaid.

So how would you feel if you later found out that, even as I sold you the house, I had acted with foresight by loading up on a certain type of disaster insurance… insurance that paid off specifically in the event of a construction-related loss? And what if, let’s further say, you found out that I made an absolute killing on the trade – making more from my side bet than I paid in restitution on our deal?

This is a fair summation of what Goldman Sachs did in relation to the whole toxic asset subprime debacle. It sold rotten eggs – or rotten houses if you like – and protected itself by taking out disaster insurance on the very garbage it was selling.

This is murky legal ground, of course. One can hardly blame an investment bank for looking out for itself. And making bearish bets in the market should hardly be illegal.

At the same time, this dramatic separation between “sell side” and “buy side” is very interesting. What to make of it when an organization that is shoveling toxic-related assets out the door as fast as it can – stuffing its clients like geese until their livers explode – is simultaneously making aggressive downside bets on the very same dreck?

It’s no big deal though… they were just being “smart”…

An Age-Old Pattern

There is yet more… plenty more. We could get into the front-running accusations tied to the stolen Goldman code, or the practices of certain players that look tantamount to stealing $15 billion-$25 billion a year directly from investors’ pockets, or the direct manipulation of certain markets… but that would be overkill. By now the point has hopefully been driven home.

The truth of the matter is that nearly all major banks – not just Goldman Sachs – have exploited their privileged position within the system for decades. Goldman is simply the biggest, most brazen example at this point in the cycle – and one of the few “smart” enough not to have blown itself up.

The crux of the problem is “regulatory capture,” in which the players in an industry amass so much power and influence that they successfully “capture” the watchdogs who are supposedly watching them.

Financial history has seen these episodes play out over and over again. One over-the-top example was the 1980s failure of Continental Illinois Bank and Trust Company – at one time the seventh largest bank in the United States.

When “Conti” finally failed, it was only after an extended comedy of errors, in which the bone-headed bankers running the show repeatedly told the Federal Reserve to shove off and mind its own business. Conti’s ship of fools was piloted by buffoonishly confident captains until the very day it ran aground.

And the Fed, far from being the all powerful regulator and stern disciplinarian it was supposed to be when it came to reining in the big money center banks, was instead cowed and stymied by Conti’s political clout and systemic importance. (Just as it is thoroughly cowed by the likes of Goldman Sachs and JPMorgan today…)

A Bonus Too Far

The reason this kind of thing matters is because now, finally, the big banks may have taken their greedy taxpayer rip-off game “a bonus too far.”

And again, it isn’t just Goldman Sachs. It isn’t even just the United States. In a recent piece titled “The devil’s punchbowl,” The Economist reports:

A new hiring frenzy in the City [London's financial district], with bonuses guaranteed for “only” the first year; investment-banking results for the second quarter likely to top those of the first; an innovative securitisation [sic] by Barclays to get bank loans off its balance sheet. The term “business as usual” normally delights tradesmen and their customers. Applied to the banks that plunged Britain into economic crisis, it strikes fear to the heart.

Surprisingly, there has been a steady drumbeat of public outrage over Goldman Sachs’ latest round of eye-popping profits (rather than the usual obliviousness). It is no longer quite “business as usual” for the most connected player on Wall Street.

The American taxpayer is slowly waking up to the true source of such profits, and the free market travesty such ill-gotten gains represent. If anything, these fat cats are more socialist than capitalist in their smoky back-room domination of a secretive, incestuous, oligarch-infested state.

But with that said, your humble editor doubts it will be outrage alone that derails the big bank gravy train. Politicians love a bit of theater in front of the cameras to please the folks back home, but most of the time it winds down to nothing.

No, what would really wreck the gravy train would be another global banking crisis… a sort of “financial supernova 2.0″ with as much destructive power as the first one (if not more).

And we could see it too… more on that to come.

Source: A Bonus Too Far (Bankers on Borrowed Time)

Now trading at $90,560, Berkshire Hathaway class A shares (NYSE: BRK.A) have plunged 60% from their 2007 peak of $149,000. According to Barron’s:

In the past decade, the stock has traded for an average of 1.6 to 1.7 times book value, a measure of shareholder equity per share. The current price-to-book ratio is near the low reached in early 2000, when Berkshire’s stock bottomed at about $40,000.

The turmoil in the financial markets has seriously dented confidence in Berkshire. And some would say with good reason. In March, Berkshire made a loss of about $5 billion on long-term put options on equity indexes – just as share prices were beginning to take off again. And the company has also suffered losses on stakes in  ConocoPhillips and American Express.

But as we’ve been at pains to stress here at Notes, the markets are topsy-turvy right now. And the recent rally has favored what Mr Market has seen as “offensive” stocks (read junk stocks: low quality, debt laden and consumer sensitive) over so-called “defensive” stocks such as Berkshire – those with strong cash positions and low debt levels.

Berkshire class A shares could top $110,000 in the next year, according to Barron’s. This would put them at roughly 1.4 times Barron’s estimate of book value in 12 months time: $80,000 a share. Even better values are Berkshire’s class B shares (NYSE: BRK.B):

Berkshire’s class B shares (BRK-B), worth 1/30th of the A shares, fetch about $2,750 each. The B shares look like a better buy than the A shares, because they sell at a 3% discount to their theoretical value. But the discount has persisted for some time, and could continue, as the B shares can’t be converted into A shares.

Rahm Emanuel is right about one thing: this crisis is an opportunity. Buying Berkshire shares now could be one of the best value plays in a generation.

In 1930, Graham was 36 years old, a near millionaire who had already enjoyed a lot of success in markets up to that point. So when he met with a successful, retired 93-year-old businessman named John Dix, Graham was full of “smug self-confidence,” as he would admit in his memoir. Graham found Dix “surprisingly alert” as Dix peppered him with all kinds of questions. Then Dix asked him how much money Graham owed to banks. Dix didn’t like what he heard.

That’s because Graham used a lot of debt in his investment fund to finance stock purchases. When Dix heard this, he then offered him a grave warning with “the greatest earnestness.”

Dix said:

Mr. Graham, I want you to do something of the greatest importance to yourself. Get on the train to New York tomorrow; go to your office, sell out your securities; pay off your debts, and return the capital to your partners. I wouldn’t be able to sleep one moment at night if I were in your position in these times, and you shouldn’t be able to sleep either. I’m much older than you, with lots more experience, and you’d better take my advice.

Graham, of course, didn’t take his advice. He even writes in his memoir that he “thanked the old man, a bit condescendingly, no doubt.”

Of course, Dix was right, and the worst was yet to come. “I have often wondered what my life would have been like it if I had followed his advice,” Graham muses. Graham suffered mightily in 1930, his worst year ever.

After 1930, he did unwind the debt he held in his account and he did much better thereafter in what was a mercilessly difficult market. Given that Graham’s partnership had 44% of its assets financed by debt going into 1930, just pacing the market would have wiped him out. Irving Kahn, another great old investor and student of Graham’s, wrote of Graham’s ordeal in the 1930s: “Keeping the fund alive was a great achievement. The small losses of 1931 and 1932 were especially impressive.”

Graham’s big mistake was using too much debt. That’s why Dix told him he shouldn’t be able to sleep at night. Dix appreciated just how dangerous all that leverage was. The inspiration in Graham’s tale, though, is that he fought his way back and went on to earn good returns in the market in later years.

The lesson he learned is a lesson that we have to learn in every cycle, it seems. Fast-forward to today’s calamity and enormous debts once again pose a great danger, despite the market’s recovery.

After the crash of 2008, the market hit bottom on March 9, 2009, when the S&P 500 closed at 676.53. As I write, the market is up nearly 37% from those lows – and a similar view seems to be taking hold that the worst is behind us, just as it did in early 1930. When the market recovered in early 1930, the failure of Creditanstalt, a big bank at the time, sent it lower.

Banking troubles plagued the market for the rest of the year. Today, there is still an enormous amount of debt out there and certainly more bank failures to come.

One of the best pieces I’ve read about our financial crisis recently was “The Death of Kings: Notes From a Meltdown” by Nick Paumgarten in The New Yorker. It is certainly the best written. (It appeared in May and is worth tracking down.)

Paumgarten talks to a lot of interesting people in his efforts to understand the nature of the crisis. One of my favorites is a man named Colin Negrych, “part market philosopher, part screen savant – a nexus of market intelligence.” Negrych advises some of the most respected investors in the world, who prize his secrecy and distinctive advice. He’s made billions for them, and skimmed off some for himself, too. Negrych seemed to sum up the whole thing rather well:

“There seems to be an unwritten rule that this can’t happen. So much effort is put into sustaining the stock market and home prices. This whole culture has been set up to see stocks and homes as annual riskless investments. They most assuredly are not. Banks are going under because they are undercapitalized… The problem is too much debt… Debt is the story.”

In Negrych’s view, Wall Street churns out believable, but wrong, arguments for why these increasing levels of debt are sustainable. All the financial engineering “fills the gap between people’s desires and their wherewithal.”

So this is the problem. It’s why I’m particularly averse to debt these days. To do well in this market, we’ll need to raise the bar for what is cheap and what is in excellent financial condition.

It’s also why I think it’s especially important that investors stick with cash-rich, debt-light, tangible assets – rich in water rights, oil, natural gas, potash mines, gold mines and the like. We like assets that are inherently useful, even needed – like oil rigs, hydropower assets and methanol plants. Things hard to build, difficult to replace and costly to substitute.

Talented owner-operators with a track record help too.

After all, Graham did quite well in asset-rich names, even in the 1930s, once he kicked the debt habit. As Negrych said, “Debt is the story.” And it will be for some time yet.

Source: Ahead to the Past