Monday, July 02, 2007

This Week's Theme: The Shifting Sands of Lies

An Economy and a Stock Market Built on Lies

What can you say about an economy and a stock market which depends totally and completely on the sustaining power of outright, blatant lies?

Lest you think I overstate the case, please read BusinessWeek's surprisingly candid feature, Mutually Assured Mayhem Wall Street is on edge, scrambling to buck up Bear Stearns and avert a domino-effect debacle.

Allow me to summarize: the entire credit/lending bubble which has long powered the housing, bond and stock markets is in danger of collapsing--unless the lies are maintained.

What is the lie? It's simple: what CDOs and mortgage-backed securities are actually worth. You read a lot about "mark to market" now, and all this means is that for a security which doesn't trade on the open market, any value can be claimed by the owner. Once the security is actually put on the sales block, however, a market value is quickly identified. All similar securities can then be "marked to market" i.e. assigned a true market value rather than a made-up value-- also known as a lie.

The analog might be a collection of baseball cards of varying quality and rarity--much like an MBS or CDO based on hundreds or thousands of mortgages of varying risk, interest and quality. The owner of the baseball cards can claim a value of $1 million, until such time as the collection goes up for auction. Then, experts pore over each constituent part and calculate a reasonable valuation based on similar products which have been traded.

The market value will also depend heavily on the market sentiment at the time of auction; collections which might have sold for $100,000 in a risk-averse, tight-money environment could be worth a lot more in a loose-money, euphoric environment. The reverse is also true.

Lest you think I overstate the losses, please read this report from Bloomberg: Bear Stearns Rivals Reject Fund Bailout in LTCM Redux:

Bear Stearns may dissolve the second fund after more than $600 million of investors' money dwindled to less than $200 million.
That, my friends, is a 2/3 loss.

In a desperate attempt to save themselves, other firms are piling lies on top of lies. For instance; Lehman Brothers analyst says Bear Stearns loan does not threaten earnings. Oh, really? You can suck a $400 million loss on one fund and rescue another fund with a $3 billion capital infusion, yet your earnings are unimpaired? Call the Vatican, a miracle has occurred!

Then there's a third layer of lies from the ratings agencies. To continue our baseball card analogy, the ratings companies (Moodys, Fitch, etc.) have examined your collection of cards and warrent that your cards are in excellent condition and the ballplayers' signatures are authentic, backing up your valuation estimate of $1 million.

But when the collection comes up for auction, it's quickly noted that many cards are in poor shape and the signatures suspect. In other words, the ratings agency lied about the quality and value of your card collection.

The grim blade of reality, e.g. the market at auction, is threatening to slash valuations based on lies. You might think a does of reality would be healthy for an economy and a stock market, but you'd be wrong--the halls of power are ringing with panic at the thought that the actual market value of this tottering mountain of rapidly depreciating, risk-laden debt will be revealed.

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Is this fear that the lies will be torn aside defensible on any ground? The answer is resoundingly yes, on the basis of greed. Should the mountain of debt be repriced to reality (marked to market), and re-rated to its actual risk, the mighty dominoes will fall: the bankers who packaged the CDOs, the lenders who originated the mortgages, and a stock market totally dependent on the torrent of cheap, easy money needed to fund private equity buy-outs and corporate buy-backs.

Are you proud of a nation whose entire financial structure is terrified of the truth? I am ashamed of this panicked fear of truth, and of the craven greed which powers the desire to maintain the lies at any price and at any cost to the nation. Unfortunately, there is no shame on Wall Street, nor any ethics except "never give a sucker an even break."

If you reckon this a rant, then please explain to me how shamelessly stacking lies on lies to keep a rotten, corrupt edifice from falling over of its own weight is "good business," "ethical business," and "good for America."

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