Monday, November 24, 2008

Greed Killed Investing

CNBC's Rick Santori said the big money boys did their part to create the rotating crisis of confidence in storied financial firms. Big banks and Wall Street firms took turns buying credit "insurance" (credit default swaps) in a weak kneed firm. Subsequently, they shorted the stock. This practice is akin to secretly buying insurance on your neighbor's house and burning it to the ground.

Instead of prosecuting the likes of CitiGroup, Morgan Stanley and Goldman Sachs, Uncle Sam opened up the Treasury vault. Hank Paulson repeatedly puts tens of $ billions of taxpayer money into the pirating entities.

Greed overran the system. Firms jettisoned quality in pursuit of extrinsic motivators. Commissions/fees encouraged realtors to sell homes, mortgage writers to accept almost any applicant with little information, and rating agencies to give investment pigs triple A ratings. Executive incentive compensation encouraged excess leveraging and the packaging/selling of investment junk via derivatives and securitizations.

Derivatives are financial bets on a future event. Credit derivatives were intended to provide peace of mind to a firm's bondholders, only CDS buyers don't have to hold the bond. Accounting rules enabled companies to keep most of their derivative obligations "off balance sheet." This makes it difficult for a shareholder to get an accurate financial picture of the publicly traded company.

The "mark to market" accounting rule was intended to improve financial statement accuracy. It arose in a time of rapidly rising asset values. It required companies to value their financial assets at market value. Financial firms wanted it in a time of rising assets. They could borrow more, keeping the same high relative leverage. The accounting change turned into a razor when assets declined.

Our elected leaders look to stop "mark to market" accounting. They do so to save our imploding financial system. While it may work, Wall Street and big banks killed investing. Balance sheets can longer be trusted.

It takes a long time to build and grow a market. Poor quality can kill it overnight. Ask Johnson & Johnson about their poisoned Tylenol crisis. Imagine if everyone in the acetaminophen retail chain behaved similar to America's storied financial firms. The pain killer would be off the shelf.

J&J did the right thing. Their product is still for sale.