The Big Nasty D (eflation) Word Is Here Sept 22, 2015
Doug
Wakefield
Nomi
Prins latest book, All
the Presidents Bankers, allows the reader a glimpse into the comments
and actions of those sitting at the highest levels of finance on Wall Street
since the open of the 20th century. As I look at where America and
the world markets stand today, coming off the top of the 29th
financial bubble in history, I believe that a quick examination of two Wall
Street bankers from two past market tops is a worthy place to start.
The
first individual was Albert Wiggin, President of one of the Big Six Banks in
America at the time, Chase National Bank. Wiggins’ start in banking was most
certainly a rise to the top at an early age. In 1892, at age 24 he was married;
became the assistant cashier to the Third National Bank of Boston at age 26; at
age 31 became the vice president of the New York National Park Bank, and by age
36, was the youngest vice president ever of the powerful Chase National Bank.
He
has known in American history for stepping in to save the American financial
system during the collapse of US markets in the Crash of 1929.
“On
Black Thursday of the Wall Street Crash of 1929, Albert Wiggin joined with
other senior Wall Street bankers in an attempt to save the collapsing stock
market. On behalf of Chase National Bank, Wiggin, along with other bankers,
committed substantial funds for an investment pool.” [Wikipedia, Albert H.
Wiggin]
The
Wikipedia post on Wiggins then attest to the fact that prior to the Crash of
1929, Wiggin’s shorted 42,000 shares of his own bank, netting him a tidy
sum of $4 million. According to the US Inflation Calculator, based
on the devaluation of the US dollar between 1929 and 2015, this would be equal
to a sum of $55.7 million today.
Prins
takes us even deeper into Wiggins’ actions in 1929.
“During
the bull market, he had organized investment pools that bet on shares of Chase
Securities and Chase National Bank to inflate their values. He also cut some of
his friends in on the action, and made sure that everyone borrowed from Chase
to pay for their holdings. His family extracted $8 million of loans from Chase,
even though they could have afforded to buy stock without loans. They used
those loans to purchase more stock to inflate its values further.”[pg 103 of 524 in Kindle Edition]
As
Wiggins certainly showed by his own actions with his personal money, he clearly
understood that timing was extremely valuable, when you are lending to
speculators and sitting atop a boom before the bust.
“Wiggin
knew he was covered no matter what happened. Shortly before the Crash, he
shorted shares in his own bank by borrowing shares from various brokers at
prices he anticipated would fall, at which time he would buy the shares in the
market at lower prices and return them to the brokers, making money on the
difference. When the Dow stood at 359 on September 23, 1929 (the market had
topped out twenty days earlier at 381), he placed what would be a hugely
profitable bet that Chase’s stock would fall…..” [ibid]
And
thus Wiggins made over $10 million from using $200 million of his depositors’
money to speculate as Chase stock was inflating, and then made $4 million
personally by shorting his own bank’s stock when it rapidly deflated during the
crash that October.
Even
though Wiggin’s presented ways to reduce taxes and tariffs as a means to
stimulate the economy in the bank’s 1931 annual report (assisted by the bank’s
economist Dr. Benjamin Anderson), policies that would go unheeded at the time;
his personal actions of promoting his own stock at the detriment of his
depositors and his own family while profiting personally from the blow off into
the top, as well as profiting by short selling his own bank’s stock during the
Crash, should be a reminder to us all of the deceptive side of the history of
markets.
Ethics,
honesty, and transparency are usually overlooked when the public is pleased
with their investment returns. I mean hey, who wants to stop the party when the
state is providing the punch bowl of cheap credit…even if this is what was
taking place in the 1920s before the Crash of ‘29. And long term consequences?
I know, they are always out there in the future….or are they?
From 1929 to 2007
While
the events of 1929 was way before my time, and my father was only 4 at the
time, I have many stories connected to the top in 2007, having released my
research paper, Riders
on The Storm: Short Selling in Contrary Winds in January 2006. So when
Prins wrote of 2007, this was my history and yours as well.
Prins
discussion of events in 2007 reveal why an understanding of what we are NOT learning
from history becomes even more critical at market tops than what we have
recently experienced from the deluge of cheap credit.
“There were massive problems plaguing Wall Street. Yet in
a July 9, 2007, Financial Times interview, Prince (CEO
of Citigroup) talked up Citigroup’s strength. Reminiscent of Charles
Mitchell (President of National City Bank,
which later became Citibank in 1976) nearly eighty years earlier, he
said, “When the music stops, in terms of liquidity, things will get
complicated. But as long as the music stops, you’ve got to get up and dance.
We’re still dancing”[405 of 524 in Kindle
Edition]
Well, it wasn’t but a few
months later that the music stopped. Prins points out the on November 4, 2007,
there was an emergency board meeting because of various rising losses in
Citigroup’s positions, Prince resigned. He stated at the time, “Given the size
and nature of the recent losses in our mortgage-backed securities business, the
only honorable course for me to take as chief executive officer is to step
down.”
When he resigned in 2007,
his salary and bonuses from the previous 4 years totaled $53.1 million, and to
assist him during this transition phase, a $99 million golden parachute. [Ibid,
pg 406]
When the music stopped in
2008, massive losses continued to mount.
For the millions of
investors in buy and never sell strategies today who look at the values on
their statements today, trusting that the Federal Reserve will always cut rates and always flood the system with more cheap debt as though this were some sacred
rite of passage for the American investor, I can only say two words. Wake up!
Lessons for 2015 from
1929 and 2007
Prince made the comment
in the summer of 2007, “When the music stops, in terms of liquidity, things
will get complicated.” He should have said, “When the music stops, in terms of
liquidity, investors are going to lose big.”
Every investor expects
that there will be plenty of liquidity, or in laymen’s terms, plenty of buyers
for their investment or plenty of cash to exit into when they get ready to cash
out a portion of their investments and go spend the money. Yet, the problem
Prince certainly must have known about in July 2007 was the collapse of two
Bear Stearns hedge funds in June, wiping out $1.8 billion of investors’
capital. Before the public would see headlines celebrating the Dow’s close
above 14,000 for the first time on July 19th, trouble with liquidity
had already started.
[Chart pulled from March
6, 2015 issue of The
Investor’s Mind: The Great Liquidity Ruse]
Now we leap to this
spring. How much longer can the public expect interest rates to fall when
looking back at where we have already come since Volcker was the Chairman of
the Fed in the early 80s, and US Treasury yields reached their highest in
American history?
Right now, in the short
term, this decision may come down to the choice of holding assets in markets
that hit their highest levels ever this spring or summer, or in holding US
Treasuries, the largest bond market in the world and still today considered as
only 1 of 3 assets ranked as Tier 1, the safest level, by the BIS.
We know today that
Prince’s comments in 2007 about a lack of liquidity making things complicating
was a prescient warning. So why not look for comments on liquidity from another
banking powerhouse?
We turn now to the annual
shareholders report of JP Morgan bank that was released this spring. While the
mainstream idea of, “They print money, market goes up” has brought about the
misleading idea that the Federal Reserve can always print more debt and stocks
will always start climbing again, nothing could be more polar opposite from the
truth and the lessons on financial bubbles.
QEI, II, and III have
closed since the 2008 crisis, and yet we find that we have LESS liquidity today
than in 2007. Notice I said less liquidity, not less debt or Treasuries that
represent that debt.
Consider Morgan’s
description of the extreme importance of having enough liquidity across the
system:
“Liquidity in the marketplace is of value to both issuers
or securities and investors in securities. Liquidity can be even more important
in a stressed time because investors need to sell quickly, and without
liquidity, prices can gap, fear can grow and illiquidity can quickly spread –
even in supposedly the most liquid markets.”
[pg 31 in stockholders report]
The report goes on to
explain to its stockholders, and frankly, anyone seeking to learn what has
taken place since 2008, that the inventories of the market markers for US
Treasuries has declined to $1.7 trillion in 10 year Treasuries today from its
peak of $2.7 trillion in 2007. During the same period, with the flood of debt
being created to inflate lending for speculation on higher and higher asset
values, the US Treasury market globally has grown to $12.5 trillion from $4.4
trillion.
The more debt that was
created, the more big banks, sovereign wealth funds, and large investors were
buying up US Treasuries, even directly from the US Treasury. This was taking
place while market makers, or dealers in our capital markets, were watching
their supplies shrink.
Why did these big
institutions and central banks stash away even more than the amount of US
Treasuries created since 2008? Did big money understand that this was merely
another boom that would eventually lead to a painful bust one more time? Were
they preparing for the time when cash would be hard to find, and buyers panic
not to get in, but to get out of “all time high” markets?
The other lesson that
investors need to learn very quickly is the one Albert Wiggins leaves us with
today. When you tell your clients and family to go out and borrow $8 million to
bet on your stock going higher, that borrowed money is mostly coming from
margin loans. Works great on the way up but becomes deflating collateral
against a constant debt on the way down. Since margin loans are backed by
securities that can change value quickly, the lender can literally demand
overnight you start shrinking your asset position to meet certain ratios of
asset/debt as prices start falling across an investment or market.
[Chart
from Lance Roberts of STA Wealth Management in NYSE Margin Debt Declines Again,
Sept 17, 2015]
As Lance Roberts recent
chart above makes clear, the massive amount of debt from QE allowed the massive
growth of margin loans underneath stock prices.
So
as we look at the history unfolding in front of us, may we return to the
history behind us, and learn from it as fast as we can. Now the lessons from
history become more than some dry academic subject, but the deflationary
realities of bear markets of the past.
Cheap credit fueled
bubbles seduce the public that investing is easy, especially if the state, ie the
central bank, is constantly touting that it will do whatever it takes to stop
the deflating of the every bubble its cheap credit polices have inflated!
“Why
such a big difference in the response to the initial sharp drop in Chinese
equity prices in June and the subsequent shocks?… The initial equity drop
was probably largely seen as a natural, to some extent intended,
market-specific correction from blatantly overstretched valuations.”[Underlined text my own, Comments by Claudia Borio,
Head of the Monetary and Economics Department at the Bank of International
Settlements, at the media briefing
to the release of the Sept 2015 Quarterly Review on Sept 13th]
"So
the Fed kept filling up the punch bowl [referring to the period between 2002 and 2005]. And as
opposed to going into inflation of goods prices, it went into an inflation of
asset prices.
That's inflation in the same way, but its not
called inflation. So if the stock market goes up we don't say, 'Oh my god,
there has been inflation', or if housing prices double we don't say 'oh my god,
there has been this enormous inflation', we say, 'How much richer we are!' But
the problem is that we are not richer, it is simply an illusion of
richness." Dave Colander -
Professor of Economics at Middlebury College (minute 59:00)
Be a Contrarian, Remember Your History
The
big shift from longs to shorts and shorts to longs is underway around the
globe, as every major equity market is now under its 200-day moving average,
and the global deflationary slowdown sets in. Don’t be mislead by hope in the
“unlimited OZ”. Trade on the lessons from history.
Click here to start the next
six months reading the newsletters, reports, and group emails as the bust
phase grows stronger.
On a Personal Note
Check out Living2024. It is my personal blog. I wanted to have a place to write stories about where this entire drama seems to be taking us all. Check out my latest post, Please “Assist” My Investments.
Doug
Wakefield
President
Best Minds Inc. a Registered Investment
Advisor
1104
Indian Ridge
Denton,
Texas 76205
Phone
- (940) 591 - 3000
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