Tom A's Stock Picks

Garden Party II

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This post extends an allegorical tale I started in March, the first five paragraphs date from then:

Here we are, guests at a Stock-picker's party. At a country estate, on the carefully landscaped grounds of a newly built mansion, we are enjoying a pleasant gathering, chatting with old friends, sipping a drink, munching on various delicacies, strolling through the spacious formal gardens. I forget who our host is, it doesn't really matter, there's plenty of good food and a truly wonderful spirit of companionship and camaraderie among all concerned. Day Traders, Active Traders, Swing Traders, Investors, Speculators, Brokers, Analysts, Gurus and Guru wannabees - everybody is having a good time.

Suddenly a cloud comes over the sun, the day grows noticeably darker, and we hear a whispered rumor: "unwelcome guests, uninvited, they are crashing the party." The first to appear is Risk, perhaps you have seen him on TV lately, bleary-eyed and with a sallow complexion, he keeps sneaking around, insinuating himself into the conversation, slyly sabotaging all the arrangements. He saunters over to the punchbowl and surreptitiously spikes it from a small flask he carries in his pocket. Soon his cousin Volatility arrives, built and dressed like a professional wrestler, he drains the bowl in one long swallow and then starts picking fights and tipping over the tables, smashing glassware, hurling plates and saucers at everyone.

Then comes Call, not the pleasant fellow who always hangs around with Put, but Dr. Margin Call. When Margin calls, people listen - they have no choice. With a rueful grimace he informs his victims of the precarious state of their financial health, and prescribes his remedies - purging and bleeding. The last unwelcome guest is Loss, mournful and lugubrious, like an undertaker come to lay to rest our fondest hopes of quick profit, not to mention our legitimate aspirations to financial security.

Can't we do anything about this? Where is our host, surely he can have this riffraff evicted - he can call the authorities and restore order. We will send them back to where they came from and continue with our party, none the worse for the temporary interruption. Alas, our host is the renowned architect of financial disaster, Professor Leverage. A gifted man, incredibly inventive, but he sometimes overreaches himself. Some even question his sanity. Our unwelcome guests are his offspring, and he is powerless to make them leave. As we look on in horror, his mansion, in reality nothing more than an elaborate house of cards, collapses in a cloud of smoke, which billows upward and eclipses the sun...a flock of financial vultures circles overhead...

But wait! Isn't that a helicopter I hear? Perhaps Ben will come to the rescue.

Note from the author: this is where I dropped the narrative in March 2008. Now I will resume the tale.

The sun shone for a minute or two, a helicopter hovered aloft, baskets of greenbacks showered down on the guests, and the party picked up where it left off.

But then terrible, horrible, ghastly misfortunes started to strike various guests. Bear Stearns turned pale, pirouetted, and fell. The coroner appeared, as if out of nowhere, Dr. Paulson pronounced him dead of natural causes, and promptly sold the corpse to J.P. Morgan. Then Freddie and Fannie turned pale and started making weird gurgling noises. Paulson's diagnosis was grim - terminal capital inadequacy. He called in Lockhart, who reversed his previous finding of good health. Fannie and Freddie were both bled and purged of 80% of their shareholder interest, then resuscitated with the promise of a transfusion.

Somewhere in there the Lehman Brothers were attacked by mysterious forces and fell to the ground. Paulson's diagnosis, instant triage, "not too big to fail, let them bleed to death, moral hazard must be prevented, at all costs."

Goldman Sachs and Morgan Stanley started to look weak and woozy, but they hustled over to Dr. Paulson who examined them briefly and declared they needed nothing more than a change of climate. He wrote them out a prescription - move to commercial bank-land, the asset valuations are better there. Warren Buffett very generously donated some of the precious green blood to strengthen Goldman.

Soon a gasp of horror went up from the guests. "They're here, the executioners, the agency executioners!" A squad of stooped, monk-like figures appeared, hooded and cowled, toting AK-47s, the dread minions of S&P and Moody's sprayed an indiscriminate fusillade of downgrades at anyone and everyone, before picking out their special victims: Ambac, MBIA, and American International. Lining them up, they opened a devastating fire of multi-notch downgrades. MBIA and Ambac flinched but stayed on their feet. AIG started bleeding profusely, gushing and hemorrhaging green blood, he fell, gravely wounded. Dr. Paulson appeared: the diagnosis, terminal lack of capital, the prognosis, grim. The cure: a liberal purging and bleeding, 80% of shareholder interest, followed by a prompt resuscitation with a transfusion of government backed promises. A crowd of onlookers screamed in protest: "moral hazard, moral hazard, you'll teach all shareholders to expect a bailout." The shareholder muttered among themselves, complaining their board gave them the run-around.

Moody's executioners paused to reload with new assumptions and projections, more deadly than before. MBIA stood there stoically, "I've got a bullet proof vest." I looked, and sure enough, there it was, direct from AAAcme Manufacturing Company. "I am not dependent on capital markets," intoned MBIA, "go ahead and shoot me." Ambac called on his congressman - "please don't let them shoot me, I can't stand the loss of any more blood. The cavalry is on their way, please make them wait, five minutes, ten minutes, I beg of you. By the way, if you made insurance part of the solution I could do some wonderful things."

Then the Mighty WaMu fell, a pernicious run of deposit withdrawals had weakened him. OTS pronounced the diagnosis, death of natural causes, and then FDIC ripped his heart out and handed it to JPM as a trophy. The crowd watched in utter amazement, shocked and awed by the spectacle.

Finally Professor Leverage appeared, accompanied by his friend, George. Calling for silence, George proposed a solution: "Rebuild Professor Leverage's mansion," he said, "restore it as it stood before, and the party can go on." Paulson and Bernanke outlined the plan: using a 700 billion lever, and applying immense forces at certain strategic points, they claimed they could raise the mansion in a matter of days. Some doubted the need for that much leverage, suggesting lesser sums, as little as a niggardly 150 billion. "That won't do it," wheedled Paulson," we need a big bundle of bucks to raise this sucker back up." The onlookers debated furiously: some thought a policy of insurance on the mansion would be a better solution. Others thought depriving offending CEOs of their golden parachutes would be a an improvement, guys like Willumstad and Freeman, prime offenders. Or more purging and bleeding of shareholders, 80% is too little. The debate raged on as darkness fell.

At the outskirts of the crowd, a superannuated bean-counter watched in wonder. "Maybe if they can prop that thing back up again, even for five minutes, it would be a good time to leave the party."