posted on July 21, 2010 09:42
Last year, The Sentinel Economic and Financial Newsletter discussed the our social cycle model and the components affecting our economy. We stated the following, “The prevailing wisdom implies that our financial markets are suffering from a temporary setback that we can work our way out of through the application of money. The reality is something quite different. The present condition is a multi-generational bear market of historic proportions.”
We introduced the concept of the Fallen Heroes, which were people who were formerly in the pantheon of their respective fields that fell into disfavor. General Motors (GM) fit the category of a Fallen Hero. At one point, GM was the largest auto producer in the world. What was good for GM was good for the country it was said. We will not attempt to analyze what went “wrong” with GM but rather state foreboding events that preceded their demise.
In 2001, GM pension funds began a period of chronic underfunding. A pension not sufficiently funded places strain on earnings. Later in 2004, as the financial mania pushed forward in consumer goods and housing, GM was obtaining 87% of its profits from its financing arm, GMAC. This is incredible considering that a car company was making substantially more money from finance than from selling vehicles! In later years, GM joined the parade, offering employee pricing and other discounts for previously hot-selling vehicles. GM fell to the point that it was at the mercy of Government for loans (with non-existent money) and had its CEO dismissed by Government.
Another Fallen Hero was Jim Cramer, the CNBC stock market maven. Comedy Central’s Jon Stewart barbequed Mr. Cramer for failing to call out the speculative excesses of Wall Street. The dressing-down of Mr. Cramer was inconceivable just a couple of years ago when his flashy, loud persona made him “must see” television. Beyond Mr. Cramer, Stewart took CNBC to task for cheerleading Wall St. and failing in their duty to educate viewers on what was driving momentum in the stock market. The stock market rally from March 2009 to May 2010 has temporarily buoyed the popularity of Mr. Cramer. At the bottom of the bear market, financial shows starring the likes of Mr. Cramer will have few viewers.
A fallen institutional Hero was IndyMac bank. The lending institution that failed in July 2008 was intimately involved in the creation of low quality loans eventually sold off to the secondary market. Despite evidence that such low quality loans originated with this bank, regulating agencies apparently disregarded these events. Rating agencies (also fallen institutional Heroes) that should have been vigilant over the types of loans made by financial institutions fell asleep at the wheel. Such negligence was typical of other ratings agencies who may have recommended certain stocks right before they tanked.
Beyond Bernard Madoff (the Father of all Fallen Heroes) and other high profile Ponzi schemes, here are some other lower profile examples:
- Jan 2009 – four defendants from Florida were charged with running a $1B Ponzi scheme
- Jan 2009 – Heber Springs, AR man charged with defrauding investors of tens of millions between 1996 and 2008
- Feb 2009 – grand jury indicted three men with operating a $65M Ponzi scheme in Seattle
- Feb 2009 – a Minnesota man charged with defrauding 519 people nationwide of $30M out of a company known as Joshua Tree Group
- Mar 2009 – a Folsom, CA man was charged in a Ponzi scheme that bilked 150 investors of $40M, many of whom he met at his church.
The FBI web site was the source of these cases. There were many more beyond these. The cases provide an interesting geographical cross-section. Fraud was not strictly a Wall St. phenomenon. From coast-to-coast, these frauds existed and in the latter case, religious piety was no exception. The breadth of the fraud was indicative of the end of the previous social cycle where the public suspended disbelief in the hopes of achieving fabulous wealth. It was easy to discard critical investment analysis. The public witnessed athletes, actors/actresses, media stars, and perhaps their own acquaintances becoming wealthier and wanted a piece of that large American apple pie. Since much of the wealth being acquired was on the back of debt, the wealth was illusory. While the wealth was illusory, the debt is very real.