A modern version of TV commercial: "Goldman Sachs. They make money the easy way. They stick it to the investors"

Posted by Shyam Moondra

In 1986, the late actor John Houseman made a TV commercial for the investment bank, Smith Barney, which instantly became a classic. In that commercial, Houseman delivered the famous lines: "Smith Barney. They make money the old-fashioned way. They EARN it." The modern version of that commercial would be "Goldman Sachs. They make money the easy way. They stick it to the investors."

In the last ten years, the financial sector, and for that matter the entire U.S. economy, has increasingly become more speculative in nature than at any other time in history. The days are gone when stocks, bonds, commodities, and currencies would be the primary vehicles for investment. Now, the companies and individual investors can bet on all sorts of derivatives, sports events, political elections, movie box-office receipts, etc. Not only that, they can also buy the so-called credit default swaps as an insurance to protect against losses on their bets. Even individual investors are now more apt to trade in options, sell short, and engage in day trading based on short-term speculation rather than invest based on sound long-term fundamentals.

America, as a society, is increasingly becoming greedy and turning more and more to gambling. The investor's greed made it possible for Bernard Madoff to pull-off his Ponzi scheme that cost billions of dollars to the investors. Greed made corporate CEOs to fake short-term profits by sacrificing the long-term interests of their companies and walked away with millions of dollars in stock options. Gambling has made it possible for many financial giants with assets of hundreds of billions of dollars, such as Goldman Sachs, to make lots of money quickly by manipulating markets and deceiving investors, thanks to the SEC staff that were too busy watching porno websites on their office computers. But, as we all know, gambling is never a sure thing. So it has also produced dramatic falls such as Enron, Lehman Brothers, Bear Sterns, and General Motors. Excessive risk taking culminated into the crisis that brought financial ruins to millions of families and state governments, and it led to the unprecedented high levels of federal budget deficit and national debt.

Now that we have seen the catastrophe caused by the financial meltdown, the key question is could it happen again. Alan Greenspan, the former Fed Reserve chairman, said that unless a way can be found to change human nature about greed, another crisis is inevitable. As is evident from the SEC suit brought against Goldman Sachs, there is a pervasive mindset in the corporate world that they can do what they please to make money with very little regard to ethics and playing by the rule. The financial reforms proposed by President Barack Obama are a necessary first step but we also need aggressive enforcement by the SEC, CFTC, and FDIC, to minimize the chances of another financial crisis. When criminals sense that the police is not cruising the streets, they would tend to commit crimes. If the enforcement agencies were doing their jobs and the companies were fearful that they would be caught doing the wrong things and there would be consequences, may be we could have avoided some of the wrongdoings that have become so widespread in the financial sector.

Another problem in the financial markets is manipulation by the big players. Companies like Goldman Sachs with assets close to a trillion dollars have enormous financial resources that they can marshal to make the markets move in a certain way. When some stocks move sharply or are pinned down at a certain price level near the options expiry date, it's quite obvious that they are being manipulated. The big players often combine short selling, options trading, and the issuance of research reports at strategic moments to move stocks in the desired direction. They call it strategizing but it fits the definition of manipulation. The SEC knows what is happening, but so far they have been too lax in enforcing the laws.

Reforming the derivative market is critical to controlling excessive risk taking, as are the reforms in how compensation is structured for the executives and professionals. We need to go back to a reward system that encourages long-term accomplishments rather than artificially manufactured short-term profits.

It's clear that we need to strengthen regulations and enforcement of the financial sector. However, we need to do it in such a way so that we do not stifle legitimate innovations. In parallel, the corporate world must also show increased sense of responsibility and accountability for the greater good. They must go back to the culture of ethics and integrity that served us so well for generations.

Republican opposition to financial reforms is a major blunder

Posted by Shyam Moondra

Republicans are being urged by the Senate Minority Leader Mitch McConnell to oppose the financial industry regulations as proposed by the Obama administration, just as they opposed the health care bill. McConnell says he wants the new regulations to prevent any future financial crisis but his tactics suggest that he is out to kill any new regulations of the Wall Street. His motive is suspicious given that he and other Republicans have been showered with handsome campaign contributions by the banks and hedge funds. He believes that by playing this double game, Republicans will be well positioned in the upcoming mid-term elections in November. He is dead wrong, just as he was on the health care legislation. The people have nothing but contempt for banks because of their greed and any-thing-goes attitude. Recent polls show that as many as 90% of the people view the financial sector negatively. They vehemently opposed the $700 billion government bailout funded with taxpayer's money at a time when individual citizens were losing their homes and jobs. It's a political mistake to take the side of the Wall Street against the Main Street in an environment where the hate for the banks is so deep rooted in the minds of the people.

McConnell wants a blanket statement put in the new financial reform bill saying that the government would never again bailout the financial sector. When it comes to governing, you never say never and limit your options in case of national emergency. In 1971, bailout was instrumental in saving Lockheed, which is a thriving defense contractor today. In 1975, the federal government bailed out New York City that saved jobs and saved the city from chaos that would have ensued if the city were allowed to go bankrupt. Last year, if the federal government hadn't bailed out the large banks, we would have had depression with unemployment running as high as 25%. Therefore, rather than saying that bailout should never be an option, we should focus more on preventing the circumstances that could lead to the need for bailouts.

The essential elements of any reform for the financial sector must include:
· De-linking the risk taking and excessive compensation.
· Higher capital ratio requirements for the banks and close monitoring of these ratios. No more 20:1 leverage that some banks have had immediately prior to the collapse of the credit markets.
· Restrictions on proprietary trading by banks, as proposed by Paul Volcker. Banks should not be allowed to own or finance hedge funds.
· Close monitoring of trading in innovative derivative products that today is normally done off exchanges without any regulations.
· Increased enforcement of the laws against market manipulation by banks and hedge funds. More powers should be granted to SEC, FDIC, and CFTC.
· A strong mechanism to protect the consumers from predatory practices of the banks.

The financial crisis, which led to the economic meltdown throughout the world, is a global phenomenon. Unless financial reforms are implemented worldwide, a repeat of the financial calamity is inevitable, given the interconnectedness and interdependence of the financial institutions around the world. If the U.S. implements the proposed reforms but other industrialized countries do not, then the U.S. banks will be put at a disadvantage vis-à-vis major banks of other countries in a fiercely competitive global arena. President Obama needs to provide more leadership in making sure that financial reforms are implemented universally and not just in the U.S.

The Republican election strategy of frustrating any financial reforms is unlikely to sit well with the voters, given their intense dislike for the financial institutions. The people in fact want serious reforms and restrictions on how the banks make money and treat their customers. McConnell made a mistake on the health care bill and now he is about to make the same mistake on financial reforms. The best strategy for the Republicans would be to replace their current leaders in the Congress and at the RNC.

Pessimists continue to misjudge the stock market - next stop 12,000

Posted by Shyam Moondra

I predicted five months ago that DJIA was headed to 11,000 (The Moondra Post, October 31, 2009) and last Friday it did just that. Last month, I predicted that DJIA would hit 12,000 this summer (The Moondra Post, March 17, 2010) and, in spite of the dire predictions of many pessimists, I think we are headed to that level soon and even to 13,000 by early next year. The pessimism of many bears is based on miscalculations. Their arguments and my rebuttal are as follows:
· The market has gone up over 69% since March of 2009 when the market bottomed out at 6,500. While 69% appreciation may seem excessive, it should be pointed out that the market sunk to 6,500 because of the fear that financial crisis might force some big commercial banks to declare bankruptcy which never happened. In that sense, the market now is simply correcting the miscalculation that many made. At least half of the appreciation, say 35%, shouldn't even be called appreciation; it was just a reversal of the fear driven decline that in retrospect was unjustified. Even at 11,000, the stocks are hardly overpriced, given that the forward PE of 15 is quite modest. The market analysts are predicting that corporate profits this year would grow 50% compared to last year.
· The unemployment continues to be very high and thus consumers would be reluctant to spend freely in the foreseeable future. Since consumers drive the two-third of the U.S. economy, the pessimists argue that the market is running ahead of itself. While it's true that unemployment will improve only gradually, the consumers have done a remarkable job in managing their finances during this recession. They have saved more than usual and reduced their debt. That means they are not going to wait until employment has fully recovered before they start spending again. The increasing auto sales in recent months are a testament to the renewed confidence of the consumers in the sustainability of the economic recovery that appears to be gaining strength.

The pessimists neglect to take into account some very powerful forces that could unleash the growth in the coming months.
· Corporations have done a remarkable job in managing their cost-structure by staying lean-and-mean. They not only reduced the payroll aggressively, but also cut the inventory levels to the lowest level not seen for decades. Even a small pick up in demand could significantly increase their profit margins. Also, corporations have $1.5 trillion cash on their balance sheets, which is unprecedented. This cash could fuel capital investments in the coming months and years.
· The inflation expectation continues to be low because the capacity utilization is very low. The Federal Reserve Board has indicated that they would keep interest rates low for an extended period. These trends would fuel the economic growth.

Higher corporate earnings, low inflation, and low interest rates have always put the stocks on fire and this time it wouldn't be any different. The market has the potential to surpass 12,000 on the DJIA this summer and set the stage for a move to 13,000 by early next year. When market goes over 11,400 or so, which could happen as early as this week, some profit taking would be inevitable (given the market would then be up by 1,600 points from the last bottom of 9,800). But that small correction, of the order of 500-600 points, should be considered as a buying opportunity for the long-term. I wouldn't be surprised if the market set a new record high by the end of President Obama's first term in office.

Republicans should fear Obama's luck and accomplishments

Posted by Shyam Moondra

Republicans are in complete disarray. They have followed a policy of "No" on cooperating with Democrats on major issues such as health care and financial regulations, but their negative policy approach has backfired. Rather than gaining popular support, the Republicans have actually lost ground. The scandalous behavior of the staff at RNC, where they went partying at strip joints and charged their RNC expense accounts, has made things worse for the party. Republicans, who take pride in family values, look like hypocrites. Campaign donors feel betrayed and that has negatively affected the in-flow of campaign contributions. Republicans also have no front-runner, who could challenge President Obama in 2012. The lack of leadership and focus within the Republican Party has splintered the party and driven many Republicans to join the ranks of the Tea Party. This division will siphon off the votes and further weaken the Republican Party. All of these Republican problems are mainly due to the absence of strong leaders in the Congress and at the RNC. It's time they replace Senate Minority Leader McConnell, House Minority Leader Boehner, and RNC Chairman Steele. Republicans also need to adopt a policy of constructive engagement and focus on solving people's problems rather than be seen as obstructionist.

Republicans have been counting on Obama's failure on major issues, but so far luck has not favored them. Obama is in fact on a roll. He got health care reform done, something that many presidents before him tried and failed to do. Obama also got TARP approved (a program initiated by President Bush), which did stabilize the banking system, in spite of the fact that American people were not in favor of using tax-payer's money to save the rouge banks. Obama got $700 bi stimulus program passed by Congress in spite of the strong Republican opposition. By most accounts, the stimulus program has worked in stopping the economic slide (cover story of Business Week, April 19, 2010). Obama successfully concluded a new SALT treaty with Russia. Some of Obama's other accomplishments include:
· Reformed the student loan program.
· Financial reforms are on their way to becoming a law.
· His aggressive Afghanistan policy is working with the Taliban and Al Qaeda on the run.
· Iraq exit strategy seems to be on track following the recent successful elections there.
· Got the first Hispanic Supreme Court justice, Sandra Sotomayor, confirmed by the Congress. Now that Justice Stevens is retiring, Obama has an opportunity to appoint another woman on the Supreme Court.
· Proposed a plan for offshore drilling, strongly favored by the Republicans. He has also provided billions of dollars in research grants for the development of alternative energy technologies.
· Initiated the work on completely reshaping the tax code by eliminating the loopholes that many rich individuals and corporations use to escape from paying their fair share of taxes. The Board led by Paul Volcker will issue recommendations by the end of the year.
· Reversed Bush's ban on stem cell research.
· Made it easier for women to sue for job discrimination.
· Extended health care to millions of children.
· Extended the National Service program.
· Set aside huge tracts of wilderness for federal protection.
· Proposed a nationwide super-speed train system.
· Provided strong leadership at the U.N. climate change conference in formulating a consensus.
· He took a small step towards Cuba by allowing family visits and remittances of money from the U.S. to Cuba. Cuba is a small and impoverished country and it is no threat to the U.S. Obama must take further steps such as dropping the trade embargo leading up to establishing full diplomatic relationship with Cuba.
· Obama gave the orders to shoot the Somali pirates and free the American hostage, dispelling many Republicans' fear that Obama is weak and he lacks resolve to deal with the evil people in the world.
· He seems to be succeeding in getting a consensus on imposing a new round of sanctions on Iran on the nuclear weapon issue. As a result of Obama's tough stance, North Korea is inching towards resuming the six-party talks on nuclear disarmament.
· Obama is showing strong leadership on the issue of eradication of nuclear weapons throughout the world by organizing a conference in Washington, DC which is expected to be attended by the heads of state of 46 countries.
· Obama has been successful in improving the image of the United States around the world, especially in the Islamic countries.

President Obama, who was initially aloof from the bill writing process, has begun to show leadership and has racked up an impressive long list of accomplishments in spite of Republican's total lack of support in a short period of just one year. The American people reward hard work and accomplishments. Even though some people may have reservations about his approach to health care reforms, but they are also mindful that we needed to take the first step on the health care issue. Republicans are miscalculating that their non-cooperation will somehow win them votes. At the end of the day, the people would want their problems solved, so it's very unlikely that they would reward those who are doing nothing. It's time Republicans stop praying for Obama's bad luck and start contributing constructively to solve nation's problems.