THE OPPORTUNITIES ARE ENORMOUS...BUT THE GAME IS COMPLEX

PART ONE:
Back in the day brokerage firms were owned by partners. If the firm lost money, the partners were personally liable. Commission charges to buy and sell stocks and bonds were extremely high but no one forced anyone to buy and sell stocks and pay those fees. When I was originally a broker at E.F. Hutton and Company and I wanted to get a quote on a stock, I walked up to the front of the room, stood in a long line, picked up the phone and was able to request one quote and only one. I then had to find my way back to the desk through the throngs of other brokers, I would give my customer the quote which really wasn't current anymore, I would write out the order on what was called a trade ticket, I would put it in a vacuum tube, it would travel a long distance and about an hour later I would know if we bought the stock or not. Times have changed.

Somewheres along the line the powers that be decided that fixed and high commission rates were not the way to grow a hearty participation in American Capitalism among the people. Rates were then lowered, then lowered, then lowered, and then lowered. It also came to pass that "money management for a fee" began its monumental growth. We now can trade billions of shares a day explained by the cult of the necessity for a liquid market. The liquidity is well out of balance with the actual need and has turned stocks into the semblance of a gambling casino with all the rules and regulations of such activity very much in place within our markets. Research is superficial and shoddy at best, but thinking, fortunately, keeps evolving through higher and higher levels.

About the same time,Donaldson, Lufkin and Jenrette found a way to pierce the wall of the New York Stock Exchange prohibition requiring all member firms to be private. The cry became "the road to growth requires public capital and we as partners can no longer foresee having enough capital to sustain significant growth". The members of the exchange tried to maintain their historical rules of private companies but the opportunity for making the existing partners wealthy men controlled the outcome. So the door was opened and privately owned firms were able to create great wealth for their owners by selling shares in their privately owned companies. There is no question that I personally benefited from this "time in history". The combination of much lower commissions and the loss of the future money management asset growth, made the traditional brokerage business a heck of lot less profitable, even with the ancillary interest income.

PART TWO:
In order to understand where I'm going with this you will have to allow me to tell you a quick story. My wife Sally and I, during the Internet bubble, were invited to attend a presentation by one of the best asset management firms in the world. This firm had scrupulously avoided investing their clients money in the overpriced dot.com companies. Unfortunately, it's performance had lagged its peers that had invested in those companies and the firm lost thirty percent of its assets under management, solely because they were thought to be an old dowdy company. At the meeting we attended, we were immediately introduced to the new Internet guru of this wonderful asset management firm. We were told he had appreciated money at an annual rate of 500% in the last year and now was the time for all the money that had left their firm to return and they would do all they could to compete with their new investment guru. Only a few "special clients", like us, would be "invited" into this "fantastic investment opportunity". In other words, at the very peak, the rate of asset loss to this money management firm and the enormous emotional pressure they felt was so great, they could not stop themselves from attempting to participate in the craziness. The Internet boom went bust a few months after this presentation, the young money manager was fired, all the money was lost, over $200 million dollars, and quite successfully, this money management firm continues to deliver a steady investment product.

Now we return to the public nature of brokerage firms and banks. As I have said in prior blogs, the recent financial crisis was all started by the government when it decided that housing had to be made more easily available to more and more people. My parents bought their first house for $4,000, then they bought a second house for $11,000, several years later it sold for $42,000 and no one at that time, many years ago, foresaw housing prices going up and up and up. There was absolutely no clear cut series of reasons to forecast that one should not liquidate their home because the prices would keep going up and up and up, even though homes were the ultimate symbol of success and the savings and capital base of most of our people.

PART THREE:
Presidents Reagan, Eisenhower, Clinton, Bush, Nixon, Carter, let alone President Roosevelt, used the rhetoric of home ownership as a lever to attract votes. To try to explain what happened when the housing prices broke is as impossible as trying to determine what the true value is of almost anything.

Just to make this even a little clearer, if a bank received depository inflows from a poorer area and did not lend that money out to the people that wanted home loans in those areas it was called redlining or discrimination, it wasn't called determining if the potential homeowner was likely to pay the loan or not. It didn't matter to the mortgage lenders at that time because the new theory was the prices of the homes would go up anyhow, they always had. So wherever you went to get a mortgage loan, it had to be given to you at terms that were better than the terms up the block, because if my bank didn't give you the loan, then another would. Guess what would happen if I didn't give you the loan? The earnings of my bank, or institution or brokerage firm would slow down relative to my competitors, the shares of my company would not rise as much as my competitors and I would be criticized for not participating in what was obviously going to "go up forever". In other words, I had to get into the Internet boom or I would lose my assets under management and go out of business, and I had to give bank loans to virtually anyone or my shares would go down and I'd lose my job, since after all if the country allowed this, who was I (CEO of any Bank) to stand alone against the crowd. In so many respects corporate and investment decisions are nourished by a short term mentality.

I remember an investment manager yelling a the CEO of Fannie Mae, "you idiot, make more loans, I own your shares, you work for me".

This is what really happened, all else is sand on the beach.

Sorry for the length of this. Have a great weekend.