Thursday, March 18, 2010

Bubbles

I've been thinking about financial bubbles...

the latest Lehman revelations were a complete non-surprise. I obviously didn't know that they were using repurchase agreements to exaggerate their assets. But I knew the accounting was wonky. The accounting is ALWAYS wonky in these things. You can't believe anything a company says about its balance sheet, because while they're probably telling you the (rough) truth, they don't HAVE to tell you the truth, because they pay the auditor, you don't. Ernst and Young signed off on those reports. They were incompetent, negligent or lying. And they made a ton of cash off of Lehman they wouldn't have made if their audit had been accurate.

Remember Enron? How did they get away with it? Arthur Andersen assured us that Enron had a profitable company based on a legitimate business model. They ran the same scam for Worldcom. Deloitte Touche covered for Adelphia. KPMG shelled out $125 mil to Rite Aid shareholders, although they maintain they did nothing wrong. Price Waterhouse insists that they're above board, despite a $225 mil. payout to outraged Tyco investors.

Alexis de Tocqueville said it well, "...each man is haunted by the fear of sinking to a lower social level and by a restless urge to better his condition. And since money had become the sole criterion of a man's social status, but has also acquired an extreme mobility, that is to say it changes hands incessantly, raising or lowering the prestige of individuals and families - everybody is feverishly intent on making money or, if already rich, on keeping his wealth intact. Love of gain, a fondness for business careers, the desire to get rich at all costs, a craving for material comfort and easy living quickly become ruling passions..."

He meant under a despot. Draw your own conclusions about the nature of American Government since the advent of the National Security Presidency.

Machiavelli regarded a kleptocratic financial elite as the final proof of a society's corruption and imminent demise, but I can't find my copy of Discourses on Livy to provide you with a good quote. It may have been a mistake to shelf the paperbacks in a double row. Quadruple, really. They're stacked.

My view is this; the financial system is rigged. That doesn't mean one cannot make money in it. One can make money in a rigged game, for a while. But you are gambling with people who are incented to cheat you, and whose career success demonstrates their willingness to do so. The earnings claimed by the corporations you invest in are almost certainly exaggerated, and may in rare cases be completely fictitious. And the people charged with verifying the claims of the corporation make more money if they enable any deceit.

Incidentally, history provides some guidance for dealing with these rapacious parasites. After the South Sea Bubble burst, the fortunes of the company's directors were confiscated and the proceeds distributed to victims of the fraud.