John Paulson Says Double-Digit Inflation is Coming

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.   

As average U.S. gas prices head toward $4.00 a gallon, billionaire hedge fund operator John Paulson recently told a standing room only crowd at New York’s University Club that double-digit inflation is about to rear its ugly head. Paulson assumes that the Fed will continue to engage in its inflation-creating behavior.

John Paulson is famous for making a killing on shorting subprime bonds before their collapse. Most of Wall Street was bullish at the time and Fed Chair Ben Bernanke famously declared that he didn't see subprime mortgages causing any problem. The market completely fell apart weeks after Bernanke spoke.

The Paulson Bernanke dynamic is now back in play with predictions of inflation. Bernanke doesn't see it now and doesn't anticipate it. In an interview with ABC News done around the same time that Paulson gave his talk, Bernanke stated "We haven't quite yet got to the point where we can be completely confident that we're on a track to full recovery," and he continued that the central bank would take no options off the table to further stimulate the economy.  The interviewer didn't ask Bernanke the obvious question of whether or not the need for further Fed stimulus after four years indicates that the previous efforts have been a failure.

Paulson's presumption that the Fed will continue to feed inflation forces is completely supported by Bernanke's actions and statements. The Fed Chair further blamed rising oil and U.S. gasoline prices on geopolitical tensions. Prior to the mid-2000s though, geopolitical tensions only raised the price of oil to $40 a barrel. This time it's well over $100 a barrel. Money printing accounts for the price difference, but you'll never hear that from the Fed's money-printer-in-chief. And this is to expected. No government in inflation's 2000 year history has ever taken full responsibility for causing it.

Governments also have a history of finagling with the inflation numbers as well. This seems to be a universal practice once some form of indexation takes place (adjusting prices for inflation). The U.S. introduced indexation for social security and tax brackets in the 1970s. Starting it the 1980s, a number of statistical "improvements" were introduced in how the inflation rate was calculated. Interestingly, all of these "improvements" lowered the reported rate.

When it comes to inflation predictions, investors have a choice between John Paulson, who has made billions from his knowledge of how markets works, and Ben Bernanke, who has repeatedly shown he is oblivious to their dangers (remember how he let Lehman Brothers go under and this almost led to the complete collapse of the global financial system?). If you are betting on Bernanke, you are betting against history repeating itself. Money-printing has always led to massive inflation in the past. Apparently, John Paulson knows this.


Disclosure: None


Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Nova Gold, the Gold Market and the Euro

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


Canadian gold miner NovaGold Resources (NG) raised around $100 million on Tuesday, March 9th after selling 18.2 million shares of common stock at $5.50 each. Despite the dilution from this sale and another scheduled sale of 13.6 million shares for $5.51 on March 11th, the stock rallied 9%, closing at $6.88. Together the two sales will increase the outstanding shares of NovaGold by 17%.

The purchasers of Tuesday's stock offering were funds managed by Paulson & Co. Thursday's sales will be to George Soros' Quantum Fund. Both are renowned investors, bullish on gold, and bearish on the euro. The average investor would have trouble realizing that Soros is bullish on gold because of mainstream media reports misrepresenting his outlook. The press reported that Soros stated the gold was in the ultimate bubble, instead of would be in the ultimate bubble because of governments engaging in excess spending and  money printing globally. Bubbles are where investors make the most money, as long as they can control their greed and sell around the top. Successful investors understand this. Unsuccessful investors like to blame the market, instead of how they interact with the market.

The bullishness of Paulson and Soros is even more interesting because of their funds large bets against the euro. The price of gold and the value of the euro tend to move together. The crisis in Greece caused a sharp drop in the euro and is still holding it down. Gold sold down with the euro, although traditionally gold has been a safe haven during crisis periods. It didn't hold up during Credit Crisis selling in the fall of 2008 either, although it closed up on the year. Gold is currently in a sideways trading pattern and the big January and February buying season in China and India is over. Gold prices tend to be weak in the spring because of lower retail demand for the metal. The technical patterns on the chart indicate its price is trendless at the moment.

Ultimately, the value of NovaGold is dependent on the price of gold. NovaGold is sitting on some very huge untapped mineral deposits of gold, silver and copper. For those who think the price of gold will rise sharply in the future, these deposits are like money in the bank that is paying a very high interest rate. Apparently Paulson and Soros are of this opinion based on their actions. In the short-term, NG stock may be highly volatile however. Sharp up and down moves are common. There is also strong long-term resistance around the 7.00 level that was established in 2004, 2005, 2007, and 2008. Yesterday was the third time in recent months that the stock approached this key price. Breaking and staying above it will be a technically significant event.

Investors should remember that gold is in a long-term (secular) bull market that began in 2001. This doesn't mean that prices go up everyday. There will be pauses and dips. You make your money by buying on the dips.


Disclosure: Have held positions in Novagold and gold several times

NEXT: The Economy's House of Cards

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Manipulation Fails, Gold Rallies Back

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our Video Related to this Blog:

The old tricks of the authorities to game the gold market and support the U.S. dollar are no longer working. The IMF gold sale, used at least half a dozen times in the last two years, barely dented the price of gold yesterday and gold is rallying nicely this morning and trying to push above its high from last week. The U.S. dollar is dropping and is at 76.05 at the moment. If it drops below 76.00, it could fall all the way to 71.50 this fall. The inability of the dollar to rally during the Fed meeting this time is a sign of extreme weakness and an indication that the usual behind the scenes manipulation supporting the dollar is no longer working.

While the U.S. mass-media repeatedly publishes stories about there being no inflation, there can't be any inflation and even if there is inflation, it won't show up for years, gold is telling a different story. Just yesterday this quote could be found in the Wall Street Journal, "Still observers say many buyers believe inflation will remain low for years to come." The financial press is filled with similar remarks on a daily basis. Insiders don't believe this for moment, which is why gold is hitting record highs. These stories are meant to keep the public uninformed about what is really going on in the economy and financial system.

The source of inflation is the U.S. government's huge deficits and the need to continually print new money to cover them. This is constantly covered up by mainstream press reporting as well. Just this morning a story from a major online service about the huge bond auctions this week had the following quote, "Solid demand at auctions of different maturities this summer suggest today's two-year sale should be fairly well received." Media coverage has been filled with stories citing solid demand for U.S. treasuries in the last many months. Just where is this solid demand coming from?

In the second quarter, the U.S. Fed directly bought 48% of the new treasuries sold. It is quite likely that it 'influenced' the purchases of much of the rest. One mainstream financial paper stated U.S. households increased their holdings of treasuries by 2.5 times during 2009 so far (and this wasn't a comedy piece). The statistics that includes household holdings of treasuries also include hedge fund purchases however. Hedge funds are much more likely to have purchased massive amounts of treasuries, but somehow this logical conclusion couldn't be reached, perhaps because it would lead right back to the Fed. The large U.S. banks, all of whom have connections to the Fed, have also increased their purchases of treasuries significantly. There have also been reports from alternative Internet sources about how the Fed has been faking foreign purchases of treasuries by funneling them through off-shore money havens.

Whatever the actual percentage of new treasury purchases by the Fed is, and you can assume that it is well above 48%, it is all being done with printed money... lots of printed money. There has been no case in history of massive money printing by a government that didn't subsequently result in a lot of inflation. I have yet to see this mentioned in mainstream media coverage. It looks like the truth will soon be told by gold and the U.S. dollar. Gold is on the verge of a massive breakout and the U.S. dollar on the verge of a massive breakdown. The next few weeks could be quite interesting.

NEXT: Fed Decision Today; Dollar, Bonds and Gold

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Changes in Wall Street Firms that Led to the Credit Crisis

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Today's Guest Blogger: Dennis Mack, New York Investing meetup member, graduate of Harvard Law '69 and Fulbright scholar.


It is my belief that one of the major factors that has led to the current Wall Street collapse is the loss of internal self-regulation by the financial institutions once they became public companies. When I started practicing law on Wall Street, brokerage firms and investment banks were partnerships. The senior partners (often depicted in movies as miserly, backward thinking and overly demanding) were reluctant to take excessive risks because it was their personal capital that was at stake and the capital of their business partners and, perhaps, family members. When the brokerage firms and the investment banks sold shares to the public, we as a society lost the connection between risk-takers and risk-absorbers. The traders and bankers took on risks, but it was other people's money (the public shareholders) that actually suffered the losses. The traders and bankers were richly rewarded for short term results, but there was always a one-in-ten chance that their bets would result in a wipe-out - not of the traders and bankers but of their shareholders. The traders and bankers could just move to new firms.

In the old days, traders and bankers did not move to new firms. They became part of the firm and would not dream of leaving it. They married into the firm - literally sometimes by marrying the daughter of a partner. That may seem stifling but it also meant that the partners and those traders and bankers knew that their success was tied to the success of the firm. Now, there is a great disconnect. Traders and bankers can make their reputation at a financial institution and demand more or they will walk. Compensation committees award the higher bonuses because it does not come out of their own pockets. When there is a problem (uncovered by management) or an insufficiently generous bonus, the trader/banker could move on to another institution or even set up his own shop and practice his craft. His track record at the old shop would draw in money at 2% and 20%. In an up market with cheap borrowed money from China, they were able to magnify small returns into large returns and demand their big bite. No matter that leverage is a two edged sword that would eventually decimate the client's portfolio while still giving the manager his 2%.

In 1969, when I was assigned the task of organizing my first hedge fund in Panama/Bermuda, I was flabbergasted by the fee structure. I peppered the client with questions about whether people would actually pay such a fee when there was no clawback in later years after the fund would decline. They explained to me that a hedge fund was designed to create positive returns in both up and down markets and therefore the risk I perceived was negligible. They also said that if an investment manager had to give credit for past losses, he would have no incentive to service the fund after the loss and might even leave the management company to get a new start elsewhere. Besides, they argued, it would be unfair for new money coming into the fund to get a free ride up - not having to pay a 20% fee on the gains that they would enjoy.

The extraordinary rise in executive compensation in other corporations is a whole other story, but there are at least two connections. First, there was the rise of finance in business schools. This sent the best students into finance or consulting. It also meant that corporations were valued less on the products that they could turn out for a profit than the profits that could be augmented by adroit maneuvering among the tax, accounting and financial rules. People who could massage the results for the best appearance rose through the ranks. To retain them, you had to pay them like financial managers. Second, in pre-WWII America, individuals and family trusts owned corporations. Insurance companies invested in bonds and mortgages. Mutual funds were tiny. Pension plans were not funded. Individuals and family trusts bought and held. Trading on the stock exchanges was very, very low. There were concentrations of individual money that controlled corporations. Investors with large shareholdings voted their shares as if it were meaningful. They had a long term commitment to the company. Today, most shares are held by financial institutions. Many of them are traders and not investors. Some vote to support their trading strategy - not for the welfare of the company and its shareholders. Some are even able to rent the votes of real shareholders in order to produce a result that will allow them to profit personally. There is a disconnect between shares and corporate decision making.

We learned in law school that shareholders own the corporation and elect the directors to run it on their behalf. Today, management presents to the atomistic community of shareholders a slate of their golf buddies to direct the company pretty much at the behest of the management. Management takes the risks and are paid large bonuses whether they succeed or not while an ever-changing body of shareholders pass their holdings from chump to chump until the music stops in Chapter 11 or 7.

How do we change that? Do we want to require brokerage companies and investment banking houses to return to private partnerships when they have to compete with foreign behemoths? Do we want to impose upon financial institutions fiduciary duties in voting? Should only the very wealthy invest in stock and be incentivized to hold on to it for the long term (e.g., 5 years or longer)? We must start talking about some very fundamental changes, but we must see it within the competition of a global marketplace for financial and management expertise. I wonder whether US regulation alone can resolve our problems.

NEXT: New York Investing meetup members in the Videosphere

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Excess Liquidity to Solve Excess Liquidity Problem

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our Video Related to this Blog:

Almost everyone expects the U.S. Fed to lower interest rates by 50 basis points to 50 basis points today. Soon we will find out what will happen when there are no more rate cuts left as I asked rhetorically long ago in one of the New York Investing meetup's You Tube videos. We do know what has happened in the past because of excess liquidity with one bubble inflated after another because of fed policy. Each bubble leaves a trail of victims, many of whom should have known better. The list for the Madoff scandal keeps growing and the similarity to suspended belief that made Enron possible should be noted. While there were a few lone voices saying the emperor had no clothes, the top Wall Street players supported both and questioning from the media just didn't exist.

Hedge funds were one of the many beneficiaries of U.S. government easy money in the 1990s and 2000s. In 1990, there were only 610 of them in the U.S, by the end of 2006, there 9462. Assets under management went from $38.9 billion in 1990 to $1.9 trillion in June of 2008, when according to Bloomberg they peaked. As of November 24th (long before the Madoff scandal) U.S hedge funds returns were down 22% on the year - some protection from the Bear Market! A number of hedge funds themselves invested with Madoff and their clients were generally charged 20% of profits and a one and half percent maintenance fee to get them in on the biggest Ponzi scheme in American history. Just another of example of Wall Street being filled with people who know other people, but know little about investing.

While hedge funds still remain beyond the reach of the average investor (and in many cases this is fortunate), the other big beneficiary of the credit bubble, mutual funds, are also suffering. In the six months between May and October, U.S. mutual funds had a decline of $2.5 trillion in assets. Much, but not all of this, was the result of the declining stock market. Money seems to be flowing into money market funds which hit a record $3.7 trillion last week and have hit records highs for the last 11 consecutive weeks. There also seems to be some shift of funds toward ETFs. Despite the declining market, ETF assets have grown by $104 billion in the first nine months of 2008. Perhaps the American public is slowly realizing that the mutual fund industry is obsolete and does little except take a slice of their investing money in exchange for lower than average market returns?

The New York Investing meetup continually points out that there is no free lunch and much of our investing predictions are based on this simple premise which is why they are so accurate. Don't think we don't get a lot of flack because of this because we do. Most people want to believe in the too good to be true premise (and the Madoff scandal makes it clear that the rich and well-connected are just as susceptible to this as everyone else) and the U.S. government through its interest rate policy, the Treasury through its bailouts and the mass media that refuses to question, all keep the illusion going. Most people of course also don't make money with their investments either. Instead they wind up eating the free lunch and invariably go hungry later on.

NEXT:

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Indecent Exposure: Madoff Caught Swimming Naked

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our Video Related to this Blog:

Warren Buffett's famous remark that you only know who's swimming naked when the tide goes out is particularly relevant at the moment with the ultimate Wall Street insider Bernard Madoff accused of operating a $50 billion Ponzi scheme (with an additional $17 billion just 'missing'). The hear no evil, see no evil SEC gets no credit for unmasking this multi-decade fraud, with Madoff confessing to his sons as his scheme fell apart and they in turn notifying the FBI. There are even reports of in-the-know Wall Streeters having invested with Madoff knowing his operation was fraudulent, but they had assumed that it was based on an insider trading scam - it being common knowledge on the Street that the SEC rarely investigates citizens above suspicion (one SEC employee was recently fired for trying to open just such a case) for this behavior.

Madoff is the former chairman of the Nasdaq and the founder of Bernard L. Madoff Investment Securities, a closely-held market-making firm that has operated since 1960. He also ran a hedge fund, which is the source of the supposed $50 billion in fraudulent losses (sustained during the time that former Fed chair Alan Greenspan repeatedly said there was no need to regulate hedge funds). Madoff's hedge fund business didn't register with the SEC until September 2006. What took it so long to do so is a good question. An even better question is, did they investigate the hedge fund since that date and if so why couldn't they uncover the largest fraud in American financial history? Madoff's Investment Securities is also market maker on Nasdaq and huge amounts of funds pass through that operation. Are those funds safe or have some of them been pilfered too?

Investors in Madoff's hedge fund are a who's who of big money people, banks and other hedge funds who should have known better. These include banks Santander, Royal Bank of Scotland, BNP Paribas, HSBC, Nomura and hedge funds Man Group, Tremont Capital Management and Fairfield Greenwich Group. Some big names that have surfaced so far as Madoff investors are Philadelphia Eagles owner Norman Braman, New York Mets owner Fred Wilpon and J. Ezra Merkin, the chairman of GMAC Financial Services (49% owned by looking for a government bailout GM). A number of charities also entrusted their money to Madoff, Senator Frank Lautenberg's family charitable trust among them, and at least one has already closed down as a result.

The revelations of the Madoff fraud are somewhat reminiscent of Richard Whitney scandal during the Great Depression. Whitney was the president of the New York stock exchange from 1930 to 1935 and was also a citizen above suspicion just like Madoff. He was assumed to be a brilliant financier, but this image was also false. He turned to embezzlement to cover up his mounting business losses and to maintain his extravagant lifestyle. The authorities eventually caught up with him, although it didn't take nearly as long as it has with Madoff, and he wound up in Sing Sing. Revelations of financial misdeeds indeed became commonplace in the 1930s as the economy fell apart and you should assume that this will be the happening once again.

NEXT: Excess Liquidity to Solve Excess Liquidity Problem

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

T & A and the GS-20 Summit

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our Video Related to this Blog:

Last Wednesday Treasury Secretary Paulson announced the T&A would be taken out of TARP (the Wall Street bailout bill passed in early October). The raison d'etre given by the Bush administration to congress for passing TARP was that only by purchasing troubled assets on bank balance sheets could banks be freed up to lend again and get the economy going. After the legislation was passed, congressional leadership from both parties announced with great fanfare how they were saving the American economy with this program. The ink was barely dry on the bill however, before Paulson announced that preferred stock was going to be purchased in troubled financial institutions instead. While the first $250 billion will still be earmarked for that purpose, Paulson has now decided that the remaining funds should be used to support financial markets that supply credit for credit card debt, auto loans and student loans. Of course next week, there might be a better way to save the American economy and the six week old program could be changed even again. If all this looks like no one in Washington has the slightest idea what they are doing, it's because they don't.

This is not to say that the new ideas for TARP are not an improvement on the original provisions of the bill which were essentially a form of welfare for Wall Street. Unlike welfare for the poor though, welfare for the rich comes with fewer limitations. While TARP has a provision for 'restriction' of bonuses, it doesn't eliminate them, nor does it force companies that can't continue to exist without government support to pay their executives salaries that top government officials would get. Nevertheless, over the weekend seven top Goldman Sachs (Paulson's old firm) managers graciously renounced their bonuses for 2008. Why they would have been getting bonuses when the company's stock has fallen 70% in the last twelve months is not exactly clear. CEO Lloyd Blankfein received a Wall Street record $68 million bonus last year when he was making the decisions that lead to this year's disastrous performance.

Like everything else in the contemporary economy, lack of effective ideas for handling the credit crisis is global as well. The GS-20 meeting of world leaders this weekend in Washington produced mostly a commitment to free trade and further monetary and fiscal stimulus (in other words governments throughout the world are going to print more paper money which will be backed by nothing other than their leaders hot air). British PM Gordon Brown, who decided to sell half of Britain's gold at the bottom of the market in 1999 and has presided over a worse subprime crisis than in the U.S., led the charge for increased stimulus measures. Other ideas bandied about included multinational supervision for global banks, more oversight for credit rating agencies and regulation for hedge funds. These useful suggestions didn't get much beyond the bandying stage however. Essentially anything concrete was put off until the next meeting in April. The do-nothing summit was immediately declared a success by President Bush.

Shortly thereafter, Japan announced a second quarter of negative GDP confirming it was in recession as the euro zone did last Friday. Since this was not exactly surprising news, Asian markets were little changed overnight, even despite the drop in the U.S. on Friday. The out of the blue rally in American markets last Thursday faded almost as quickly as it arriveed with the Dow down 3.8% and the Nasdaq down 5.0%. Technically speaking this was another crash day on the Nasdaq, but as I have said many times, no one pays attention anymore to just a 5% or 6% drop - and that includes world leaders.

NEXT: Trojan Horse of Earnings Surprises

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

From Bailout to Bailout - The Prelude to Bear Stearns Collapse

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our video on the material in this post is 'The Bear Stearns Bailout'. It can be found at: http://www.youtube.com/watch?v=G8Mn67rNCFQ

The New York Investing meetup first mentioned in August 2007 that Bear Stearns was likely to fail. Two of Bear's hedge funds had gone under in late July and this helped t0 precipitate a sell off in the U.S. stock market by bringing media attention to the subprime crisis. Even though the subprime crisis had begun by at least December 2006 with the sudden failure of mid-sized mortgage lending company, the financial media failed to recognize its importance until the forced closure of the Bear Stearns funds. The precarious state of Bear Stearns finances that this failure indicated was in turn also missed by the U.S media. As usual, the media took its cues from Wall Street, which remained bullish on Bear Stearns right up to the very end (as was the case for Enron and a number of other major corporate failures).

Furthermore, the September 20, 2007 earnings report indicated everything was fine. Despite the failure of the two hedge funds, Bear Stearns claimed to have earned $1.16 a share. A write off of only $200 million (an insignificant amount for a Wall Street firm) was taken as a charge for closing the funds. Another $700 million of mortgage assets were also written down, also not that great an amount. In the earnings conference call, the CFO stated that he “expect[ed] a return to more favorable conditions next year”, stressed the underlying business was sound, and market dislocations tended to run a quarter or two. The only thing he was correct about was that the market dislocations would only last two more quarters - although he certainly didn't imply that this would be because Bear Stearns would no longer exist after that time.

While the September earnings report was reassuring, Bear Stearns December 20th earnings report was an indication of serious and possibly fatal problems. Suddenly, the company lost $6.90 a share, the first loss in its history (Bear was even profitable in every quarter during the Great Depression). Wall Street analysts were expecting a loss of only $1.79 a share, missing the actual loss by over $5.00 a share. The loss included only $1.9 billion of write downs in subprime mortgage exposure. Despite the indication that analysts had completely missed the extent of Bear Stearns problems, the stock actually went up after the earnings report, instead of sharply falling as it should have. The CEO subsequently 'resigned' - something that usually only takes place when a company is in trouble.

By December 2007, Bear Stearns was hardly unique in suffering losses because of the ever expanding credit crisis. The Federal Reserve attempted to address these system wide problems by creating its first new lending facility, the TAF (term auction facility), which gave it an additional conduit for its money pumping operations. In January 2008, reacting to the further deterioration in the financial system, the Fed cut its funds rate by an additional 1.25%. Bear Stearns, however, could not benefit directly from any of these moves since it was not a commercial bank and was therefore not allowed to borrow money from the Fed, so its situation continued to deteriorate.

Nevertheless, even as late as early March 2008, neither Wall Street, nor the media were ringing any alarm bells that Bear Stearns was about to implode. No Wall Street analyst had a sell recommendation on Bear Stearns stock even though it was about to lose almost all of its value. It apparently didn't bother them that the balance sheet indicated 33 times leverage, an amount that can only be described as enormous and which was greater than any other broker dealer or commercial bank. While the public facade that everything was fine was being maintained by Wall Street, rumors were circulating behind the scenes that Bear Stearns might go under. The big players were quietly getting their money out in what was basically a secret run on the bank.

NEXT: Bailout to Bailout - The Collapse and Rescue of Bear Stearns

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

The New York Investing meetup predicts the subprime disaster in July 2007

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.


While Federal Reserve chairman Ben Bernanke was making repeated announcements that the subprime problem was contained and wouldn't have far reaching effects, the New York Investing meetup had other thoughts.

In his now famous June 5, 2007 speech to the International Monetary Conference, Bernanke stated, "... at this point, the troubles in the subprime sector seem unlikely to seriously spill over to the broader economy or financial system." The New York Investing meetup, which doesn't automatically accept any pronouncements from Washington or Wall Street, quickly came to
the opposite conclusion. Cyberspace was filling up with stories of rapidly rising foreclosures, dropping housing prices, faltering hedge funds, and problems in the debt market. In the July 11, 2007 meeting, the New York Investing meetup warned its membership that the subprime crisis was about to explode and would cause serious damage to the stock market. In less than two weeks, the accuracy of the New York Investing meetup's take on the subprime crises was vindicated. The stock market would fall until mid-August.

Daryl Montgomery

Next: The New York Investing meetup predicts a crash of bear market in August 2007

For more information about the New York Investing meetup, please go to:
http://investing.meetup.com/21