The Great Evaporation: When Buy and Hold became Hold and Cry

It’s no secret that virtually every investor has felt the pain of plummeting 401K’s, IRA’s, college funds, and other investment accounts. Human nature dictated that “If I hold on a little longer, it will come back; I’ll be made whole again.” The idea of selling stocks and booking huge losses is in direct contradiction to long-term investment philosophy, in which bull and bear markets are customary and expected. However, this has not been a run-of-the-mill bear market. It became and still is the “Great Evaporation”, where vast amounts of American wealth disappeared. I remember hearing market ‘experts’ and analysts discuss the downturn around January 2008 when the DJIA was around 12,000 (at that point it was down more than 2,000 points off its high). Some speculated that the sub-prime mortgage crisis was nearly over and things were already getting better; some predicted a market rebound was imminent followed by ascension to levels never seen before. And why not? The Fed had been steadily growing the money supply and injecting liquidity into the credit markets, which was viewed as proactive and positive. There was widespread feeling that the downturn was a much needed market correction from an artificial high. Some said it was healthy. There was a sense of security. Unfortunately, it was a false sense of security.

Bear Stearns, the country's fifth-largest investment bank in 2008, was founded in 1923. It had reached a peak price of $171.52 in January 2007. In March of last year, it was sold for just $2 a share, down 93% from its closing price just 2 days earlier. This was just 2 months after experts predicted a new market high. Thousands of employees and investors lost everything.

After the Bear Stearns collapse, for some, the point of no return had been reached. The possibility of being made whole again became a dream. In the coming months, the stock market gave up more ground, with the DJIA fluctuating in the 10,000 – 11,000 range. Although this was a far cry from the highs of October 2007, to many, the market appeared to be stabilizing, and investors were hoping that the worst had passed. Few knew what lay ahead. The sub-prime debacle ballooned into a full-fledged housing crisis, and bank failures accelerated. Wall Street suffered huge losses, and unemployment began its climb. Once mighty companies who traded as blue chips were now beginning to look about as valuable as corn chips.

Things looked so bleak that in October 2008, before TARP was passed, there were dire warnings and predictions in Washington of catastrophe if Congress did not act. Congressman Brad Sherman of California told the House in a speech in early October: "Many of us were told in private conversations that if we voted against this bill on Monday that the sky would fall, the market would drop two or three thousand points the first day, another couple of thousand the second day, and a few members were even told that there would be martial law in America if we voted no."

According to Senator James Inhofe of Oklahoma, Henry Paulson painted a very dark picture.

“He said, ‘This is going to be far worse than the Great Depression in the ’30s,’” Inhofe said. “And all these things – he was very descriptive of exactly what would happen if we didn’t buy out these toxic assets which he abandoned the day after he got the money.”
A month and a half later, Paulson completely changed course on his bailout plan. Instead of buying up toxic assets as he originally put forth, he announced the Treasury would instead inject capital directly into banks. How was this change possible? Was Paulson lying when he terrified Congress, or merely incredibly incompetent? Which is worse? Either way, he should be held to account for being the protagonist in The Great Evaporation.

In early October 2008, the DJIA was still in the 10,000 range, and unemployment was about 6%. SINCE THEN there has been an ADDITIONAL 25% evaporation of people’s 401K’s, etc., and a 2% jump in unemployment from 6% to 8%, which translates into approximately 2.6 million MORE jobs lost, all in the past 22 weeks. Does anyone feel like we’re better off now than pre-TARP, or that we’ve turned some sort of corner?

Now we stand at market levels last seen in 1997. As we digest day to day news, the stock market will enjoy bear market rallies as it searches for a bottom. However, in order to break the back of the bear, the market must acquire and maintain a 30% increase over current levels. This is simply not realistic in the near term. But, Barack Obama says not to worry about the stock market, it’s just a tracking poll. Try explaining that to a 75 year old retiree on a fixed income who has lost 60% of his life savings, Barack.

There are too many negatives, especially in the U.S. Future indications of labor trends point to continuing job losses, perhaps into the double-digits. Capex spending (buildings, machinery) is down nearly 30%. Companies would be buying today if they expected prices to go up in the future; they’re putting off buying. What does that tell you? Credit markets are still largely stagnant. Housing is still searching for a bottom. Manufacturing production and demand are both down. Income is down. Taxes are being increased. At some point, money velocity will cause inflation pressure. I hate to be a doomsayer or even a pessimist; but I’m glad to be a realist. Please understand that I am proud to be one of many self-proclaimed non-experts; Lord knows we don’t deserve to be mentioned in the same sentence as pros like Henry Paulson or other Wall Street wizards, and Capitol Hill Intelligentsia.

People are celebrating over an announcement by Citi that they were cash-positive in the first 2 months of 2009, even though this was before write-downs. Citi stock skyrocketed 50%. If it keeps moving up, you may be even able to buy a cup of coffee with a Citi share soon. Have people forgotten that in November, we the taxpayers gave Citi $27 billion on top of $25 billion just weeks before? Citi also announced coming layoffs of 75,000 employees. Massive layoffs, huge taxpayer funded cash injections, penny-stock status, and we’re supposed to be impressed that, a few months later, Citi has more cash on hand than expected? Ah, but in return, Citi gave the government preferred equity with an 8 percent dividend. Will that dividend be re-paid to us, the taxpayers? Don’t hold your breath. Memo to the Citi CEO: Shutup and put together consecutive quarters of profitability, then announce how wonderful you are.

Oh, and Barney Frank will finally be holding a House Financial Services Committee meeting to discuss mark-to market rules. I know I feel invigorated.

Well, here are my layperson’s recommendations to the Charlatan, the Banking Queen; and Paulson the Great Evaporator. Note: These should have been implemented last year, but hey, better late than never. Also, none involve borrowing money we do not have, or increasing taxes.

1.
If you don’t want to repeal mark-to-market; (so called fair-value accounting) rules, please see your way clear to at least modify the rules so that banks are not forced to value assets at pennies on the dollar when they are clearly worth more; this will help all sorts of things like capital margins, credit ratings, lending, profits, and job growth.

2.
Reduce payroll tax so that everyone WHO EARNS income keeps more of it, rather than mailing out ‘stimulus checks’ which are no more than welfare payments to those who already pay no tax.

3.
Capital Gains
Reducing or eliminating capital gains tax will free up money to invest in economy-growing activities. Just look at Singapore and China.

4.
Corporate Tax
Reducing the Corporate Tax rate will also free up investment capital, and attract new businesses that would otherwise organize in other countries.

5.
Avoid buy American or other protectionist legislation. Anything gained in higher tariffs and in buying less from other countries will more than be wiped out when they do the same to us.

6.
Modify Sarbanes – Oxley legislation. It has not had its desired effect. It has not prevented any bankruptcies, and has placed a huge financial burden on the backs of companies, especially those who desire to go public. Even Senator Oxley who co-wrote the bill said "Frankly, I would have written it differently, and he would have written it differently," he added, referring to the bill. "But it was not normal times."

I think one of the greatest losses of Sarbanes – Oxley is, how do we know that the next drug and disease researcher or even the next Google was not regulated out of existence before it even had a chance because of additional costs imposed on them by overly constrictive legislation that, while however well intentioned, offered little to no benefit in return?

Bloated and intrusive government should never tread where competent private sector producers live and work. Where is Reagan when we need him? Healthy business is where economies get revived, and where the bleeding is stopped. Big government is where healthy businesses and strong economies get crippled.

Also, since Henry Paulson worked so hard and accomplished so much, I think he should take vacation. Hell, he’s earned it. A hunting trip with Dick Cheney would be nice, Mr. Paulson, don’t you think? Why don’t you ring him up?