The stock market has been posting gains the past few days.

After two very tough months to start 2009, what could go wrong?

Plenty, especially if you are focused on just the Dow Jones Industrial Average.

The Dow Jones has many financial-related companies, like Citibank, JP Morgan, Bank of America, American Express and quasi-financial stocks like General Electric and Caterpillar Tractor, which perform extensive lending and financing.

Remember, the financial stocks have led the charge the last two weeks, after Citibank's CEO circulated a memo to employees announcing the bank did well in January and February.  But two months do not make a full quarter, and the banks have posted significant losses in the previous quarter, as mentioned before.

In fact, JP Morgan CEO James Dimon mentioned on Friday, March 27, 2009 that March is shaping up to be a difficult month.  And financial stocks promptly swooned, bringing the rest of the market along with them.

What else could go wrong?

On Tuesday, March 31, we will finally hear the final revised 4th Quarter GDP numbers.  Remember, one month after each quarter, we get preliminary GDP numbers.  Then one month later, we get revised GDP numbers.

Then, at the end of the following month — which is also the end of the NEXT quarter — we receive the final revised GDP number.

The market took a beating on each of the previous two GDP announcements at the end of January and also February 2009.  If the number on Tuesday is revised downward, watch out.

We also will receive preliminary 1st quarter GDP numbers (1st quarter 2009) one month from now, at the end of April, 2009.  Fasten your seat belts.

Every time I see headlines about future budget deficits, I keep telling myself "that is a weather forecast!"  Most folks read the headline, perhaps scan the first paragraph, proceed to get bummed out and turn on the NCAA Tournament.

Just drill down into this a bit.  The forecast is for a $9 trillion deficit to amass between now and the next ten years.  Ten years!

Ten years ago, we were all worrying about Y2K.  Remember?

Buried in the next-to-last paragraph was this little golden nugget.  Read this whopper:  "Long-term deficit predictions have proven notoriously fickle — George W. Bush inherited flawed projections of a 10-year, $5.6 trillion surplus and instead produced record deficits — and if the economy outperforms CBO's expectations, the deficits could prove significantly smaller."

There is so much ink spilled every day in the financial media that is essentially nothing more than predictions, or a public relations spot for something else.  Unfortunately many of the PR and predictions become headlines.  Our decisions can be swayed by too many headlines that are merely predictions or opinions.  I've come to the conclusion everything written by the financial media has an agenda attached to it.  Or said another way, everything written by the financial media is intended to make you do precisely the wrong thing.

I cannot help but laugh when I see some "expert" interviewed about the stock market, and the excuses/reasons given why markets went up or down that day.  "The market is worried about inflation."  Later the same week "deflationary fears rattled the market."   Look, the market is not that smart — or that "forward-looking."

Don't get hung up on the Dow Jones.  The Dow Jones may not be a "relevant" yardstick for you to use.  After all, it's only 30 stocks…and you might not own ANY of them.  And avoid predictions and projections.  It's just a waste of time.

Have you seen the ads that Charles Schwab has been running on TV?
You probably have seen them.  They sound like real people, but they're actually cartoon/colorized images.

These may be the best ads for financial services ever created.  Here's why:

You're probably not aware of this, but in the financial services industry, firms and advisors are strictly prohibited from running testimonials of any sort. Think about it… how powerful would an ad be if some firm could get a few of their clients on TV and have them say: "You know, at so-and-so brokerage firm, they told all of us to get out of the stock market last summer!"

Too bad we can't do that.

I would love nothing better than to have one client after another — in print, audio or video — in their actual voices — splattered all over my website.

See, I can expend tons and tons of hot air (or spill a lot of ink) telling you how great I am.  But it becomes much more believable when you see an image of someone who looks like you, or someone who looks like someone you know, or who talks like you, or has the same problems as you, and is seeking a similar solution as you.

Which is why referrals are the strongest kind of recommendation/testimonial I can get.  You told your "story" in person to someone else, and told it in such a compelling way that it moved the other person to pick up the phone and say "I want that too!"   I sincerely appreciate the countless referrals I have received from you.  It tells me you appreciate the work I am doing for you, and also tells me you care enough to refer your friends and co-workers.  How terrific is that?

Testimonials are great — they are real people telling you real things that are important, or, at least matter to them.  Maybe their advisor or brokerage firm didn't get them out of the market, but perhaps they provide a valuable service, like — "he clearly explained everything to me like no one else had ever done before…" or even something like "he's the first advisor I've worked with who actually returns phone calls!"

Can you believe we are not even permitted to run testimonials saying "we were happy just to get a phone call back, that's never happened before!"?

By the way, if you happen to spot a financial advisor or brokerage firm with testimonials on their website, run!

This is why brokerage firms usually resort to running only "branding" advertisements.  Not that there's anything wrong with branding advertisements, in fact, they're usually very effective over time.  It's easier for them to say "we are bullish on America" (what precisely does that mean?), than to get their lawyers to approve an ad that says "well, my broker did not steal my money and basically did an okay job."

This is precisely why these ads from Charles Schwab are excellent.  They are not real people — they're illustrated images of real people.  Their voices are real, their situations are real — the woman on the street, the guy standing over the barbecue, the older couple.  People you and I could know very well.

More than that — Schwab really captures the essence of what's going on.  You know, that conversation going on in the back of your mind.  These stories they tell are dead-on, bull's-eye perfect.  I can tell you that every single one of these analogies they use in their commercials, I have also heard from new clients over the last few months.  Schwab has nailed it.

These are real people that really need help.

Of course, the next time you are with a friend or co-worker, listen.  Listen hard to what they are saying.  The main theme I have heard lately borders somewhere between worry and hopelessness, which is a terrible neighborhood.   The situation today is NOT hopeless, and worry never got anyone, anywhere.  Do THEM a favor, send them over to me.

One of top questions I've heard (over and over) lately has been:

What about buying Citibank down here?

As little as two weeks ago, the financial services giant was trading at one dollar (in fact it dipped briefly to 97 cents).

So?   How can we miss, right?

Well, I can think of few reasons why this may not be such a hot deal.   But before we get to that, did you ever read the first post I wrote about Citibank?  It was back in November 2007.

First, "word on the street" is the uptick rule may be reinstated.

If you were relentlessly selling short Citibank, the announcement of the return of the uptick rule ought to be enough to get you to cover your short (buy back the stock you sold short).   And while it's impossible to tell, it's my guess we saw a lot of short covering this week.

Next, the CEO of Citibank, Vikram Pandit, circulated an internal memo to employees that stated Citi actually made a profit in January and February.  That's good, right?

Maybe.

After all, the same company managed to lose $28 billion in the previous quarter.  Twenty-eight-billion-dollars!  How can a company manage (mis-manage?) to do that — in just a 3-month period?  Mark-to-market had much to do with the write-downs they took in the previous quarter.  And that rule is still in place, it has not been suspended.  So, the company may still lose money for the entire quarter.  Yikes.

What else? There are millions of new shares coming onto the market.  Citibank is converting many of their preferreds into common stock.  This dilutes the value of common shares already in the market.

Anything else? Well, yes, maybe the worst of all.  The company announced they are contemplating a reverse stock split.  A study completed in 2008 showed companies that did reverse splits found these reverse splits underperformed the market by 50% (on a risk-adjusted basis) during the three-year period after the action. “Reverse stock splits are a strong indicator the company is going to be a significant underperformer during the near future,” says Jim Rosenfeld, co-author of the study and an associate professor of finance at Emory University’s Goizueta Business School in Atlanta.

Many companies consider pulling a reverse stock split to avoid getting delisted.  But many wind up taking that path eventually anyway.  Can you imagine Citibank getting delisted from the New York Stock Exchange?

I am not a big fan of Comedy Central or Jon Stewart, I've watched the show a few times.  But on Thursday March 13, 2009 Stewart interviewed Jim Cramer on his show.  And for the first time (at least that I can remember), someone actually tried to hold Cramer responsible for some of the advice he has given, and also for the fact that CNBC has "morphed" into an entertainment channel.  The thrust of the conversation was more toward exposing CNBC (and to some extent Cramer) as shills for Wall Street and no investigative work is done on that channel.

Bravo.  It is truly an excellent piece to watch and encourage you to do so now.

I expect Yahoo and Hulu will chop up this video shortly. So, don't delay, see this video as soon as possible.  It's nearly 20 minutes, so take some time and watch this, it will be worth it.  Here is the link: http://tv.yahoo.com/blog/stewart-vs-cramer-winner-take-all–183

Stewart said "CNBC could be this great financial tool…especially for people who believe there are two financial markets…the people who are told to invest in 401ks and just leave it there…invest for the long term…don't worry about it."  And the other market — that occurs in a back room.  Where giant piles of money are going in and out…" "But you go on TV and pretend (that market) isn't happening."

By the way, if you have not checked out Hulu (http://www.hulu.com) you really should.  Full-length TV shows (and even some movies) are shown online.  Free.  Since they have no business plan to make money, I don't expect them to be around very long.  But worth a look.

How mark to the market accounting helped kill Wall Street

Mark-to-market accounting is what's used in your brokerage account — your margin account at a Wall Street firm.  To understand mark to market accounting, let's look at what happens in a retail brokerage account that trades on margin:

Suppose you invest $80,000 in cash in a brokerage account.  You sign up for margin capability.  Before you place a trade in your account, you have the ability to buy up to $160,000 worth of securities with only $80,000.  You will pay margin interest on any outstanding balances, and your "margin maintenance" is recalculated every night – based on the gain or loss in value of the securities in the account.  This is how a margin account works.

Using the above illustration, you have 50% equity in the account, and have an outstanding margin (or debit) balance of $80,000.

Suppose the value of the assets in the account drop from $160,000 to $145,000.  You now have 45% equity in your account.  You still have buying power and seem to be in no imminent danger of a margin call.  Remember, you still owe $80,000.  If you were to close the account now, you would sell the assets for $145,000.  The margin debit balance of $80,000 would be paid (margin interest would also be included).  The securities dropped almost 10% in value (from $160,000 down to $145,000) but you lost nearly twice that percentage, because you leveraged the trade.  You would be left with the remainder… approximately $65,000.

But suppose the value of the assets in the account dropped from $160,000 to $100,000.  You now have 20% equity in your account.  Remember, you still owe $80,000.  At this stage, you have no more "buying power."   This means you cannot take money from the account, nor can you buy any additional investments.  In fact, at 20% equity you have a "margin call" and your broker would be contacting you requiring you to deposit more money (or other securities) to boost the equity in the account.

Margin works wonderfully when the assets in your account are rising in value.  But margin will wipe you out when the assets in your account are falling in value.

The assets in the account are repriced every single night in a margin account.  And the equity is calculated every day and the amount needed for "margin maintenance" is also calculated every day.  And when your account gets upside down, you have a margin call, and it needs to be rectified right away.

Margin accounts are calculated using mark to the market accounting.

Banks (and brokerage firms) that own mortgage backed securities have been required — since November 2007 — to use mark to market accounting on these securities.  Coincidentally, this was just around the time these mortgage securities started dropping precipitously in value.  2007 saw many mortgage firms get wiped out, and brokerage firms and banks holding these assets started realizing the volatility of these assets.

Remember banks and brokerage firms were required to employ mark to market accounting beginning in November 2007 for mortgage backed securities.  As real estate values collapsed, and foreclosures began to rise, banks and brokerage firms no longer wanted to hold the securities as investments on their books.  It is no wonder then, that six months later (March 2008) that one of the biggest holders of mortgage backed securities — Bear Stearns — was caught in a massive credit squeeze.  The assets that they regularly borrowed against were no longer "borrow-able."

Bear Stearns — which had traded at well over $100 per share months before, agreed to sell themselves to J.P. Morgan Chase for two dollars per share.  This figure was ultimately increased to $10 per share.

By mid– 2008, Merrill Lynch had decided to unload a $31 billion pool of mortgage backed securities that they owned, and essentially announced they would take the best offer.  These mortgage backed securities had been held on the books (it's estimated) at $.80 on the dollar.  This pool was sold for $.22 on the dollar in July, only after Merrill Lynch agreed to subsidize part of the losses that might be incurred by the buyer.

These are anecdotes and examples using vast over-simplification and are being used to illustrate how mark-to-market accounting works.
While not directly connected, mark to market accounting required that other banks and brokers investing in similar type investments market their own similar assets down to similar levels.  Thus, the entire mortgage backed market froze. Trades were no longer taking place, because every time a trade would take place, it would require the values of similar securities to be repriced everywhere.  These securities could no longer find a value and could not be borrowed against, hampering most lending capabilities at these firms.

If you haven't been able to make heads or tails of the credit crisis, read this.

Thursday, March 12, 2009 is the day the House Securities Subcommittee will hold a hearing on mark-to-market.  The chairman of the committee, Paul Kanjorski (from Pennsylvania) seems to agree with us — mark to market standards have proven "problematic" for banks.

Mark to market (also known as fair value rules) has been only one of the contributing factors in the recent credit crunch.

Many mortgage and bond-related assets, many of which had been AAA rated previously, have been experiencing a mandatory write down in value, because of these accounting rules.  Many of these assets needed to be "re-priced" nearly every day.  This is how Citibank could lose $28 billion in the last quarter.  Think about that number.  A quarter is only 90 days long — and not all of them are business days.  And yet, for a bank (or any business) to lose $28 billion is hard to conceive.  That's over $300 million lost on a daily basis during the quarter.

How can that be?

Mark to market accounting rules required that banks write down the value of assets on their books — nearly every day.  Even though these assets were not bought and sold (they couldn't be sold — the trading market for asset backed securities has been frozen for nearly a year), they still needed to be marked down.

What I expect we will hear from these hearings on Thursday is something along the lines of "there should be an exemption from a need to repriced these assets on a daily basis since there is no liquid market for these securities presently."  I also expect we will hear a proposal to improve the situation these banks are facing.  It would not be a big surprise to hear testimony proposing "mark to the model" instead of "mark to market."

Mark To A Model

"Mark-to-a-model" is a proposal that has been gaining speed.  Many have argued it is not realistic to carry these securities at the full face value of the underlying security, nor is it realistic to carry these securities at zero value either (like now).  What might be a better — temporary — solution is a financial "model" that can gauge the average holding period of the securities, the average duration of the portfolio and a model of the credit composition of the portfolio.  At least with a model, minimal (floor) values can be placed on the securities.

What would be the result of a change in mark-to-market, or instituting mark-to-a-model?

The first benefit would be a drastic increase in the book value in market value of the securities on hand at banks.  No one is trying to game the system.  By re-inflating the value of many securities on hand at banks, this will automatically raise the capital ratios at these banks.

So what?

Raising the capital ratios at these banks removes the need for bailout money.

You may have read recently that banks are "hoarding cash."

Why would the banks hoard cash — especially when lending is needed to restart the economy?

Well, the banks have been required to maintain certain capital ratios, or be declared insolvent and run the risk of being taken over by the government, or closed.  So, although the banks have received capital injections, with the purpose of lending, the same banks have been "hamstrung" because they need to maintain a certain amount of cash on their books to meet capital ratios.

These capital ratios will be met if they suspend mark to market accounting, at least on a temporary basis.

It may also help to re-ignite trading in these asset backed securities.  This helps improve liquidity and lending capabilities.  Put another way, you cannot borrow against securities that don't have a liquid market and do not trade.  While the "marginability" of these securities is severely hampered, just re-establishing a market for these securities is a step in the right direction.

Let's hope they don't screw it up.

Mark to Market is a topic I have written about previously.

You can read about them here. I don't like changing the rules of the game in mid-stream, but something drastic needs to be done.  A terrific opinion piece was written in the Wall Street Journal recently by Peter Wallison.  If you click on his name, you can see his very impressive resume.  Graduate of Harvard Law, adviser to Nelson Rockefeller, adviser to President Reagan, General Counsel to the US Treasury, Wallison has the credentials.

The Obama Administration has still not come up with a plan to remove troubled assets from the balance sheets at banks.  Therefore, their solution appears to be "semi-nationalization," as evidenced recently when the US Government and Citigroup agreed to convert the preferred shares held by the government into common shares.  The US Government will soon own approximately 36% of Citigroup, which is about as aclose as you can get to nationalizing a bank without coming right out and saying it.

Wallison asks a very important question as the thesis of his article.  Accounting rules are very important, and should not be bent.  This situation appears exceptional, but that does not mean there will be other exceptions in the future.  It is a dangerous precedent.  What most commentators and other media are missing is this important twist.  Wallison writes:

What happens, then, when there is virtually no market for these assets — as has been true for at least a year? In that case, accounting rules require the banks use whatever market indicators are available.

What will this imply for other banks that are in trouble, or soon fall into trouble?  How endless is the money supply?

I agree with Wallison's approach…nationalizing the banks is a terrible solution.  Revisiting mark to the market needs to become a priority.  And Wallison writes:

…Both taxpayers and banks could come out well — and so would our economy — if the government were to buy the assets at their "net realizable value," which is based on an assessment of their current cash flows, discounted by their expected credit losses over time.

Take a look at the article here (printed in the Wall Street Journal February 25, 2009).  Additionally, suspending mark to market can effectively replace another cash infusion from the Government.  It is worthy of consideration.

Warren Buffett writes an annual letter to the shareholders of Berkshire Hathaway each year.  If you've never read them, you really ought to.  They are priceless gems.  Not a laugh a minute, but an interesting observation on what's happening.

This year's version is about 22 pages and he comments on Mark to the Market, derivatives, Bear Stearns and some of the other problems we've been exposed to the past year, thanks to our friends on Broad and Wall Streets.  The whole piece is worth your time if you care aout the markets, but I'd pay particular attention to pages 15-18.

I also found Buffett's "prediction" about the possible bubble in the Treasury market to be very interesting.  You should too.

You can find it here: http://www.berkshirehathaway.com/letters/2008ltr.pdf

Throwing good money after bad into these banks is not the answer.

Now, I don't like changing the rules in the middle of the game.  But I still believe the almost-immediate fix for this entire mess is suspending "mark to the market" regulations.

Read this statement from news sources today: Citigroup declined to comment on talks with the government, but in an email said its capital base is very strong, despite $28.5 billion of losses in the last five quarters.

How could Citigroup lose $28 billion — and say they are very strong?
Believe it or not, it is TRUE.

They HAVE to book these losses due to "mark to the market."  This is really important!  When a competitor has to mark down the value of bonds, mark-to-the-market means you must do the same thing on your books…whether you sell or not!

OK, true, these same banks made profits hand-over-fist when real estate was going up and they leveraged like crazy off it.  So, if you run your business that way, it's going to be painful…no…near suicidal…when things are bad.

And that's precisely whats happening now.

Now, a capitalist society says the weak will be extinguished.  OK.

So weak auto stocks should be wiped out.

Weak homebuilders have to go.

Weak retailers, see ya.

But banks provide the grease for the entire economy.  They should NOT be bailed out with cash.

Suspend mark-to-the-market.   Now.

There have been several articles written recently regarding stockbrokers and retention bonuses.

If you are outside the industry you may not know when brokerage firms are merged or acquired, the brokers (the salesforce) are sometimes awarded bonuses merely for staying.  The reason behind the bonus is the broker/salesperson may face a drop-off in business, the bonus may help smooth the transition period.

Often times, the retention bonus requires a broker to stay at the firm for a long period of time.  That's usually good for his or her business, showing they are stable while the sign outside the building may be changing.

Larger producers may get these retention bonuses, while lower-end producers may see a significantly smaller bonus, or perhaps nothing. Some of these deals, in my opinion, carry staggering, eye-popping numbers.

This has been getting attention lately because many of these same firms that planned retention bonuses also received TARP money from the government. 

It's hard to justify (in my opinion) handing out retention bonuses as a worthwhile use of taxpayer bailout money.

Others apparently agree.

On February 20, 2009, it was reported Wells Fargo has decided NOT to pay retention bonuses to the Wachovia brokers they recently acquired.  “With the environment we're in, with all the attention we're under — all the firms are under — and with clients down 20%, 30% and 40 % … a [retention] bonus didn't seem to be the appropriate approach,” said Wachovia Securities spokesman Tony Mattera.  You can read more about it here.

And also here.

Also, on February 11, 2009, retention bonuses were also picked up by the Huffington Post (and other news outlets).  In that article, it discusses how some brokers were informed "There will be a retention award.  Please do not call it a bonus" The Huffington Post article also contains an audio clip from the conference call for Smith Barney and Morgan Stanley.

The article also cites some comments describing the retention bonuses/awards as a "gratuitous expense" and even quotes a former chief economist at the U.S. International Trade Commission as saying "They are putting lipstick on a pig," said Peter Morici, a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission. "Very often, retention bonuses are paid to undeserving executives who helped drive their enterprises into the ground…"

You can read the entire article (along with the audio portion) here.

And also here.

What is left in the governments bag of tricks to get the banks back on track?  One topic that I wrote about — 5 months ago — has popped up this past week with more and more frequency.  We are finally starting to hear more and more chatter about relaxing "Mark to the market" regulations.

What is mark to the market?

Suppose a house on your street went into foreclosure.  Previously, that home — and every other home on the street had a value of $600,000.  But the foreclosed property went through a sheriff's sale and was sold for $250,000.  Does it mean every home on the street must suffer the same price cut?  Events like this can "dent" prices up and down the street.  But following market to the market regulations, every home on that street would now be worth $250,000.

Is that fair, or even realistic?

This is what banks and brokerage firms have been dealing with.  It's absolutely glorious when prices are moving up.  But it is a nasty, vicious, life threatening downward spiral when prices are going down.  Let me explain:

In summer of 2008, Merrill Lynch desperately wanted to get out of a large investment ($31 billion) of mortgage backed securities.  Merrill, and many other brokerage firms were still carrying these bonds on their books at approximately $.80 on the dollar (80% of the face amount).  They received an offer of $.22 on the dollar, only a fraction of what they were carrying them on their books.  When Merrill completed the sale, all other similar investments — at Merrill Lynch and every other firm — had to be marked down to those kind of levels.

Here's where bad news gets worse. Most banks and brokerage firms were choking on debt like this.  After all, Standard & Poor's and Moody's had rated these mortgage backed securities as high-quality investments.  This allowed banks and brokerage firms to hold these investments instead of treasury bonds (which had much lower interest rates), and these high credit ratings also gave them the opportunity to borrow against them. The benefit to the banks was easy to see.  But everyone else benefited too: somewhat higher rates were paid on CD's and bonds, loans were available to many, and mortgages were created at lower rates.  We all drank from the well.  Some more than others.

Here's where worse news becomes a catastrophe. Many banks and brokerage firms were leveraged 30:1 or 40:1.  Meaning, if the value of these bonds dropped by 5%, they had a serious problem.  This is why they started creating, buying and selling these additional "bets" or "side contracts" known as credit default swaps.   Most of these mortgage backed investments had already been marked down to about 80%.  But the bar was brought down to 22 with that Merrill deal.  Yikes.

I am completely against bailing out incompetent management.  Wall Street and the banks have taken some really dumb risks and made terrible decisions.  Indeed, some of these executives need to be shot.  But the problem is that the banks provide "the grease" that keeps the economy moving.  So something needs to be done.  Mark to the market needs to be modified.  Yes, it means changing the rules in the middle of the game, which really isn't fair.

There's more (much more), but that's enough for now.

Brokers and TARP Money

Looks like others are starting to learn the story.  Your individual stock broker — getting TARP money — is just plain wrong.    And the size of these retention bonuses is extreme.

But believe it.  It is happening right now.  Merrill brokers are getting their TARP money right now.

What's even more outlandish is the fact that industry executives (who created the very concept of paying these retention bonuses) refuse to call them bonuses.  In the Investment News article (link is below), a spokesman for Morgan Stanley states these are "not bonuses."

Let's clear this up, since many folks outside the business don't seem to understand how these retention bonuses work.

In exchange for the TARP money (retention bonus), the broker signs an agreement to stay at the firm for a period of time (several years).  This money is also structured as a "forgivable loan" or "forgivable note."  What this means is, if the length of the deal is 5 years, then 20% (one-fifth) of the loan is written off (forgiven).  So every year, the stockbroker in this example would have "phantom income" for each of the five years of his deal.  So the stockbroker would have to make allowances to cover his income taxes.

But the money is real.  Very real.

Think this is a small group of stockbrokers?  Think again.  Brokers generating less than $500,000 are being shown the door at many large firms, or seeing their payouts chopped.

Stockbrokers are being handed money to sit at their desks.  TARP money.

Your money.  Completely wrong.

Here is the link to the article in Investment News.

When I was in college, I loved listening to a local college radio station (WFUV, Fordham) that had a sports-talk show on Sunday nights.  The show featured something new: phone calls from listeners!  This was more than 25 years ago, before WFAN in New York, ESPN Radio and all the other sports outlets we have today.

Incidentally, one of the announcers was an annoying student at Fordham, Michael Kay.  Kay continues his annoyance today as the obviously homer-voice of the New York Yanke$$.

One day, I got into a conversation with my father about something mentioned on the show.  He asked "where did you hear that?"  I told him about the radio show.

He replied, "So, they are experts?"

That one line really stuck with me…especially as a communications student.  Shortly after, I changed majors to business and focused on economics, later getting my MBA in Finance.  But our conversation continued.

“Tom, the job of the media is to sell.  They sell advertising.  Not a bad profession.  You can make a lot of money.  But the media has no obligation to look out for YOUR best interests…or even tell you the truth.  They want to sell ads.  So what do you think they are going to say?  And they can (and often do) twist a story to get a different perspective.  Be skeptical."

With that piece as background, let's look at the top headlines Saturday morning over at CBS Marketwatch:

Freddie Mac to ask for an additional $30 billion

Gosh, that sounds awful, doesn't it?
But wait…Freddie already was granted a $100 billion line, but only used $13.8 billion.  They are tapping a line that is already established.  Non-story.

Capital One results suggest gloomy 2009

The unreported part: Capital One also said they don't see a bottomless pit of losses.  Guess CBS Marketwatch missed that.  Or maybe that’s just not a sexy headline today.  The spin continues: “In the last three months of this year alone, Cap One lost a staggering $1.42 billion.”  Sounds bad, right?

But wait: that number includes $1 billion it set aside to deal with expected losses.  They are making provisions for losses that may — or may NOT — happen this year.  I'm not recommending buying this stock whatsoever, but that sounds like pro-active management to me.

Californa-based 1st Centennial Bank Fails

And your point is…?  Look, when banks fail (that is, when banks fail after 1933), they are taken over by the FDIC or sold in a pre-arranged marriage (through the FDIC) to another bank.  In the last real-estate driven recession (18 years ago), 800 banks failed.  Banks are going to fail in recessions.  But accounts don't get wiped out anymore because of this.  They pull down the signs on Friday and re-open on Monday.

AFLAC assures investors it does NOT need additional capital, but S&P downgrades anyway.

What is S&P saying?  Are they saying management is lying?  Or does S&P just knows AFLAC's business better than AFLAC?  After all, S&P re-affirmed positive ratings on banks and brokers throughout 2007 and much of 2008 — all the way down the drain!

And from a few days ago:

Microsoft cutting 5000 jobs.

Microsoft announced they were cutting 5000 jobs — over the next 18 months.  And while 5000 "jobs" were being cut, the actual number of employees being let go — again — over 18 months, is expected to be 2000.  Many people will be re-trained and re-assigned.

Look, sites like CBS Marketwatch, Yahoo Finance, magazines like Business Week and channels like CNBC are designed to do two things: generate enough shock value to attract attention and then find a way to keep you glued to them.

This is a waste of your time, and straps you into the emotional roller coaster.  Why do you want to do that?

Remember this:  Everything said and written in the media on Wall Street is written or said to make you do the wrong thing.

I had a longtime client (and friend) call me yesterday.  She told me one of the "experts on TV" said the market could drop another 20% from here.  And she was scared, worried, and nervous.

Wouldn't you be?

I reminded her — that's just one guy's opinion.  If you met a guy named "Mr. CBS Marketwatch" in the line at the grocery store, you wouldn't believe half of the nonsense he was spitting out.  You'd just nod politely, and pray that he bags his prunes and oatmeal and gets out of your way.

Look, there's a reason I use these point and figure charts.  For the first fifteen years of my career, I was burned relying on “expert opinions.”   What do you say to a client after you relied on the “experts” and lost money for them?  There's a lot of brokers wondering exactly that lately.  They instruct brokers to tell clients "you have look at the long term picture."

That’s nonsense.  And it’s the path to losing money.

I use these charts because there is no “opinion” built into the chart.  They only show price changes.  And from price changes, you can see trends.  And — unlike other types of charts — point and figure charts are not subject to interpretation.  It is what it is.  Charts either trend up, trend down, or stay in place.  No opinion.  Just facts.

And, a funny thing I’ve noticed, time and time again: Point and figure charts often start to move down (meaning, prices are falling) WAY before bad news arrives.  And these charts often start moving up (reflecting rising prices) well before the good news is announced.

Keep that in mind as you read this again: Everything said and written in the media on Wall Street is written or said to make you do the wrong thing.

Don’t ever forget that.

This may be enlightening.   Guess what?  In some cases,

Your Stockbroker is Getting TARP Money.

Not just the brokerage firm, YOUR stockbroker himself or herself is getting TARP money.

Last week, Citigroup announced a deal to sell Smith Barney to Morgan Stanley.  In my opinion, a very dumb decision, but hey, they are panicking over at the big Citi.

Besides your money, the true "assets" at a brokerage firm are the salesforce (the brokers).  They like to be called "financial consultants" not "the salesforce."  OK, whatever.  They sell, sell, sell and generate the revenues.

When brokerage firms are sold, the acquiring company doesn't want the "assets" to leave, so the salesforce (financial consultants) are paid a "retention bonus" to stay with the new merged company.  And it's often a factor of their trailing twelve months commissions (and often 100% of that number, but sometimes more).  It is usually paid upfront, with a "forgivable note" if they stay with the firm a certain length of time.

So, which retail brokers are getting retention bonuses?

Merrill Lynch brokers get bonuses RIGHT NOW as the salesforce was just sold to Bank of America.
Smith Barney brokers will be getting bonuses as the salesforce was just sold to Morgan Stanley.
Morgan Stanley brokers will be getting retention bonuses as well.
Wachovia brokers are getting retention bonuses as the salesforce was just sold to Wells Fargo.
Even American Express is getting TARP money.

Citigroup received a BOATLOAD of TARP money…$45 billion.
Bank of America also just received $20 billion in TARP money this week (and are paying the retention bonuses to Merrill brokers next week).
In fact, Morgan Stanley has lined up to receive TARP money, as did Wachovia, Wells Fargo, you name it.

Here are some numbers to think about:  According to sources, Merrill Lynch brokers generated $12 billion in commissions over the previous 12 months.  If the average retention bonus is 50%,  Merrill Lynch brokers would be getting $6 billion dollars in TARP money.

But the average retention bonus looks to be at LEAST 100%, not 50%.  Some brokers will be getting significantly MORE than 100% of their trailing 12 months gross commissions in bonuses.

This is SHAMEFUL.  And WRONG.  And should be stopped.

And, according to some, the retention deal is likely to be 80% in cash and 20% in stock.  That's billions in taxpayer TARP money (your money) being handed over to stockbrokers.  Now I am certain that these firms will flatly deny, and will say "no TARP money was used in retention bonuses."  But banks and brokerage firms are not specifically showing where TARP money is being spent.  It is all commingled in one giant vat of free money.

Your money.

In fact, Bank of America, apparently could not complete the deal to buy Merrill unless they received TARP money.

Oh, one more thing about these retention deals…the average "payout" for brokers differs from firm to firm.  But the average payout falls somewhere between 30% and 40%.  Suppose your broker sells you an annuity or mutual fund.  You invest $50,000, and suppose they get 4% (which you may not see).  The gross commission would be $2000.  Depending on their payout, the broker receives between $600 and $800 (or 30% to 40%).

Well, as part of these retention deals, many higher producers will receive 60% payout on commissions over the next twelve months.  So there is an additional incentive to generate more transactions.

Lucky you!

In this podcast, Tom Mullooly discusses several reasons why

Citibank would consider selling Smith Barney, to their competitor, Morgan Stanley.

There are several reasons why Citibank may be considering this transaction, including:

• Citibank simply needs the money

• Volume is down, and projected to stay down in stocks and products

• Margins are down

• The new product pipeline has dried up

• Liabilities are increasing (including legal expenses and the cost of severance)

And finally, Tom discusses the "secret sauce" retail brokerages have employed for years, that may now be going away.

On Friday afternoon, January 9, 2009 Citibank announced that they were in talks with Morgan Stanley to discuss a possible sale of their Smith Barney brokerage unit to their competitor, Morgan Stanley.

What would a combined Morgan Stanley — Smith Barney firm look like?

A combined Morgan Stanley — Smith Barney sales force would total approximately 18,000 — before any cuts were made.  And I would expect many of the overlapping branches to be closed.

From the street level, there are many towns and cities across the United States where as Smith Barney branch sits directly across the street from a Morgan Stanley branch.  On a local level, there would be tremendous consolidation — and elimination.  It would be very clear to the lower end producer at both firms, that their days are numbered.

There simply wouldn't be any room for the bottom 20% of the combined sales force any longer.

Why would Citibank be considering such a drastic move?  There are several reasons:

Citibank needs the cash. After receiving $45 billion in a capital infusion from the federal government, Citibank is now exploring every single possible way to raise money.  Clearly, they feel this franchise (Smith Barney) still carries a valuable price tag, but there has to be some doubt, collectively among Citibank board members that perhaps the future value of Smith Barney may not be as great as it is today.

Margins are down. This should not be a shock for most people: sometimes, buying 100 shares of stock at a retail brokerage firm can cost you between $50 and $100 in commission.  You can buy the same stock through a discount broker for $15 or less.  Additionally, the commission you are charged at a full service brokerage firm is often not shared with the broker.  In recent years, brokerage firms began policies that stopped paying brokers for transactions generating less then $25, soon it became "less then $50", then it became "less than $75."  The individual broker was getting squeezed out of his own business — his own firm would pocket the commission on small trades.  25 years ago, a brokers were often paid 50% of the transaction.  Meaning, if a client generated $1000 in commissions, the payout to the broker was $500.  While some of the highest revenue-generating brokers receive a 40% payout, more and more brokers are finding themselves receiving a payout somewhere between 25% and 30% of the gross commission.  This is pre-tax.

Volume is down. It's no secret trading volume in stocks and bonds is down in the last 12 months.  Apparently, Citibank must feel this volume will not be returning anytime soon.  It's also important to note that not only is trading volume down, but product volume is also down.  When a brokerage firm creates new products, their sales force raises the money for it — from the individual investors (their clients).  A mutual fund rollout, a new bond sale, a managed futures fund, synthetic preferred stocks and hybrid investments are all examples of new products brokerage firms have rolled out in recent years.  If you've been in the market a long time you may also recall that brokerage firms also were involved in the underwriting of investments like variable annuities, limited partnerships and tax shelters.  These new product creations always carried significant profit margins for the brokerage firms that created them.  That market has now dried up.

The new product pipeline has shut down. May 1, 1975 was the day commissions were deregulated on Wall Street.  Discount firms like Charles Schwab took advantage of these unregulated prices and began offering "discount brokerage."  The difference between a full service brokerage firm and a discount firm was in research, products, advice and initial public offerings (IPOs).  One by one, all of these distinctions have become blurred.  There is no more proprietary research — minutes after a research opinion has been disseminated by a Wall Street firm, it's freely available on Yahoo, and many other websites on the Internet.  One advantage full service brokerage firms offered in recent years was access to initial public offerings (IPOs).  Perhaps Citibank feels this market is now also disappearing.  It appears that way at the moment.

Liabilities are likely increasing. As is the case with any downturn in the market, complaints may be on the rise — with legal costs to follow.  Legal and settlement costs can be a tremendous drag to earnings in the future.  Perhaps this is something Citibank wants to simply avoid.

No more "secret sauce." There is another area that may have eroded significantly over the past year, causing Citibank to reconsider whether they wish to remain in this business.  It's an area of retail brokerage that many never discuss.  But one branch manager explained it to me as "the secret sauce" retail brokerages have employed for years.  If you ever walked into a local branch of a full service brokerage firm, you have probably thought "hey, this is pretty swanky!  I wonder who pays for all of this?" This particular branch manager was talking about margin interest and interest on free credit balances.  For the first 12 years I was a broker, I had no idea of the components that make up a profit and loss statement of a retail office of a brokerage firm.  Like many others, I simply thought the biggest producers were the people that carry the profitability of the branch.  This is not necessarily true.  The biggest "profit center" for most retail branches is not an employee — in fact, it's not even a member of the sales force.  As it was explained to me, margin interest and interest earned on free credit balances works 24 hours a day, seven days a week, 365 days a year.  And interest charged on margin accounts, and the interest earned on free credit balances (that is, money that has been credited, but not yet swept into a money market account) can amount to nearly 50% of the profits in a retail branch.  Retail brokerage firms like debit balances in margin accounts!  Perhaps Citibank realize is that fewer people are buying and selling stocks, fewer people are carrying margin balances and investors in general are much more careful today about how (and where) their money is invested.

Is the SIPC responsible for helping Madoff clients?

The Securities Investor Protection Corporation (also known as SIPC) maintains a special reserve fund — authorized by Congress — to help investors who had accounts and brokerage firms that failed.

Technically, when a brokerage firm fails, and owes customers cash and securities that are missing from customer accounts, SIPC usually gets involved.  Keep in mind: Bernard Madoff's securities firm did not fail.  His investment advisory practice turned out to be a fraud.

SIPC does not work like the FDIC.  Protection for investment fraud does not exist in the United States.  And since SIPC has a reserve of just over $1 billion, there is simply no way it would be able to compensate all victims in the event of loss due to investment fraud.  The focus of SIPC is very narrow… SIPC was created to help restore funds to investors dealing with bankrupt and otherwise financially troubled brokerage firms.  Not fraud.

I'm not a lawyer and don't pretend to give legal advice.  But it seems to me that if some of the money was restored to the investors who were wiped out through Madoff, then that *could* prevent them from taking a catastrophic loss against their taxes.  As I've noted in another post, taking a catastrophic loss against income might actually be more valuable for some individuals.  But only after consulting with a tax advisor will they know the right answer.

On a related note: the clients who lost money were (technically) clients of Madoff's investment advisory firm — not the brokerage firm.  That point is somewhat confusing.  Keep in mind that Madoff ran a brokerage firm (which was a member of SIPC) — and also ran an investment advisory firm (which was not a member of SIPC).  It seems a bit of a reach to claim that investors lost money through Madoff's brokerage firm.

You can read more about SIPC at their website.
You can read about the SIPC and Bernard Madoff here.

The federal, state and local governments are co–losers with Madoff investors.

Lots of questions are starting to surface regarding Bernard Madoff, and the scam that he's been running — apparently, for years.

I'm starting to read questions like "not charging an advisory fee, only working for the commissions…isn't that a conflict of interest?" Of course it is — and no investment advisor would ever (or should ever) work under terms like that.

Another question that's being asked is "when did this actually stop being an investment program and start becoming a Ponzi scheme?" Until all the details are in, I think people need to assume this has been a Ponzi scheme…all along… from the very beginning.

One more question being asked (which I addressed earlier) is "how can one person run a scheme like this — on this magnitude, and for this length of time — without anyone else being involved, or aware of it?" Of course.  We should all be skeptical.

Another red flag (and how could so many smart people miss this one?): how was it that no dividends were ever reported?  Sometimes you wind up holding a stock through the dividend — by accident!  And not one dividend was reported…ever? The topic I raised on several blog posts elsewhere, took a different slant from the "shock and surprise" many commenters posted.  My point was this: it's probably a safe assumption that people paid ordinary income and capital gains on fictitious transactions — in many cases, for years.  We're talking about a tremendous amount of taxes being recouped by investors who can file amended returns.

Taking that concept one step further: let's assume that everything was fictitious — the statements, the trades, the returns — everything.  What we're really looking at is not losses, but… theft.

I've heard that theft losses can be written off entirely against your income.  I'm not an accountant, and don't give tax advice.  Let's put this in perspective: if you lose money in the stock market, you "net" your gains and losses and can take a maximum of $3000 capital loss each year.  The remainder gets carried forward into the future, until it is completely used up.

However, if you lost $1 million, due to theft, you can write off the entire $1 million as a loss against your income.  And if that wipes out your entire net income for the current year, you can go back the last three years and amend those tax returns — and then carry the remainder forward — until is used up.

Will investors be made whole?  No.  No chance.

Under this scenario, the federal, state and local governments are the co–losers with Madoff investors.  And who will make up the deficit caused by this?

You got it.