My Take on the Credit Crisis…And Its Application to Trading.
The magnitude and complexity of the issues currently facing our global capital markets is unprecedented. Comparisons are being made to 1929, but I think that misses the mark because of the intricate and far-reaching financial relationships between public and private institutions across the globe.Simply put, this isn’t just a case of some bad market bets made by a big hedge fund run by a bunch of Nobel laureates. It’s much more than that. It runs deeper than that — by billions (if not trillions) of dollars!
If you really want a non-partisan grasp of the things that led to this, try reading this article in the Financial Times. The author holds Alan Greenspan largely accountable. Certainly Greenspan–despite his recent and consistent attempts to revise statements made during the glory years–was a key player in what has certainly damaged our financial markets forever. Frankly, the extent of the damage remains unknown because there is no assurance that the current “fixes” being proposed by the folks who are now holding the bag will be anything more than a longer fuse on a bomb that they are now packing with more explosive. Might work…might not.
It seems to me that the actions taken by Paulson, Bernanke, et al., have a great chance of making the best (a relative term, to be sure) of the worst situation I’ve seen in my life. Reducing risk through decreases in leverage — a good thing, since those who were so highly leveraged have provided irrefutable evidence that their degree of competence was woefully inadequate relative to their degree of financial firepower. You can dispute this if you want, and rationalize that all these Wall Street brainiacs just got themselves into a bad situation. But such a conclusion flies in the face of the the facts. These (expletive deleted) raped the financial landscape in ways that directly impact the global economy and created what I believe amounts to a national security problem with a breathtaking combination of greed, arrogance, hubris, and more than a modicum of bullshit.
Let’s face it — the only folks who are certain that the wide-ranging and unprecedented steps being taken by the government will actually work are lying to you. They are doing the best that they can…but the linchpin in the current approach is regaining the confidence of the investor; of the consumer, and of the banks! If the consumer doesn’t buy the story, the consumer doesn’t buy. And if the banks decide to hoard the cash rather than loan it out — the banks don’t lend and the borrower can’t borrow. And, of course, that old saying that we should “never underestimate the power of the American consumer” really means that we should “never underestimate the blind willingness of the American consumer to borrow funds to finance a lifestyle that they are unable to afford rather than to save for retirement.”
Be that as it may, we do need a major uptick in consumer confidence to right the ship. And when things are so skewed that no simple or short-term approach will work, the best chance to get the consumer on board is to include a healthy heaping of B.S. on top of the best plans they can come up with. That’s what’s happening now. Paulsen, Bernanke, et al., are doing the best that they can, but their success depends on hoodwinking the public into believing in their solution, even though it is far from certain that the solution will right the ship…and right it quickly.
But the genesis of our current situation goes much deeper than the hubris of Greenspan or the greed of bankers. Instead, this is a tale of intellectual laziness and greed on the part of our politicians, lobbyists, regulators and common citizens.
Few things in life are free, and riskless prosperity is a myth. It was always a myth, despite the indulgent and self-promoting speeches by our former Fed Chairman who continually bragged about the new complex derivatives that essentially allowed lenders to lay off their risk and create a never-ending stream of cheap money for all who wanted it. It sounded great and there was ample reason to buy into this. In fact, there was every reason but one to accept what Greenspan was saying as gospel. The one fly in the ointment was that it just wasn’t true. Getting rich requires taking risk. Take risk out of the equation, and the opportunity for wealth dries up. Greenspan was hawking prosperity without risk. And man, was he popular for doing so! We had the “briefcase indicator” on CNBC when the guy walked across the street. The markets would pause when he was giving a speech. The entire financial world revolved around Planet Greenspan.
But it’s not the guy’s fault as much as it is the fault of the special interest groups, politicians, bankers, mortgage brokers, and borrowers in search of quick bucks and lots of votes and PAC money. The list of accomplices is long. The list contains both honest folks and criminals alike.
It’s enticing to blame the crooks. Let’s just blame the predatory lenders who sold borrowers bad loans.
Well, that doesn’t work. There are crooks everywhere and there are ample laws on the books prohibiting unlawful lending practices. Those who broke the law will get their comeuppance.
But placing the blame on crooks, while appealing to the intellectually lazy, is silly, pointless and unhelpful. Why? Because the crooks that made out in the years that led up to where we are now were just exploiting the situation. That’s what crooks do! They exploit opportunity. No exploitable opportunity, no crime.
Want to avoid having your car stolen. Then don’t leave it unlocked in an unsavory part of town with the engine running while you stroll down the street looking for a pack of smokes!
Remember Willie Sutton, the famous bank robber from the 1930’s? When asked why he robbed banks, he said, “Because that’s where the money is!” He also carried a gun. Why? “Because you can’t rob a bank on charm and personality.”
Well, with so much dumb money flowing into an industry flooded with unsophisticated and poorly capitalized (read: “broke”) borrowers, Willie Sutton could have left his gun at home. All that was needed over these past several years was charm and personality. If you were a likeable person who could build trust on the strength of your personality, then you had a job in the loan business.
But forget the lenders. What about the borrowers? If you bought real estate that you could not afford for the sole purpose of flipping it for a profit, then one of two things happened. Either you made money on the deal [Congratulations on a great trade], or you are upside down. And if you’re upside down, you may be facing foreclosure or at least a long holding period. In that case, you deserve what you get. Period. This is a free country, my friend.
You make your own choices and reap the profits or losses that flow from those choices.
The Trading Connection
There are a several takeaways from this that we can all learn as traders.
- The Problem with Leverage: If you buy low and sell high, you’re a winner. If you use more leverage, then you make even more money. But if you buy high and sell low, you lose money. And if you use more leverage than you can handle, then you’re out of the game. That’s trading…and that’s life!
- Logic Applied to Information Ferrets Out The Risk: Read as much as you can about the issues that impact your financial decisions. Then apply your own logic. If something seems too good to be true, it probably is. There is no such thing as a sure thing…as a riskless trade. If it seems riskless, you don’t understand the risk.
- Watch How Stocks React to Information Flow: Stocks of homebuilders began rolling over in mid-2005. The ultimate depth of the real estate crisis was not known at that time (though guys like Doug Kass had certainly been warning of the impending fiasco during the boom years. Few listened.). Once you see the high fliers starting to roll over despite the drumbeat of good news, take a cue from the price action. You don’t make much money reporting the news. But you can make a lot of money trading the reaction to the news. Lazy traders believe the news and base their trades on the news. Good traders absorb the news, and base their trades on whether stocks are believing the news.
- Be True to Learning and Profits Will Come. Trading is hard and you’ve got to take on risk to succeed. This is a skill game. While there is an aspect of luck in every facet of life, basing a trade on whether you feel lucky is to disrespect your future prosperity. The real estate conundrum is no different — folks put all their eggs in a bunch of overpriced baskets. The problem is that there are plenty of empty baskets now. Your trading behavior should be geared towards improving your future prospects, not towards the instant gratification derived from “being in the game!” Every trade offers an opportunity to learn. Improvement requires learning. If you don’t learn from your prior trades, you’re just going to repeat your mistakes. And since the odds are typically with the House, you’ll ultimately lose your money. Focus on building a future as a successful trader and you’ll become a successful trader. Focus on finding the sure thing and you’ll pop every bubble that comes along. The only “sure thing” is that there is no sure thing.
Final Point
I receive a lot of feedback from our members. Some of it revolves around money that has been made because of trading ideas shared by some of the great traders in the Community Forum, or around losses that have been avoided or minimized due to the discipline that has become a cornerstone of this community. But the most rewarding feedback I receive doesn’t concern winning or losing because I know that stuff is transient and cyclical. We’ll all have profits and losses throughout our trading career. That’s cyclical. The most rewarding feedback I receive is when I hear how much a member is learning from the association with the Stock Market Mentor.
Unlike profits and losses, learning doesn’t have to be cyclical. Learning can be the trend that never ends.
Let’s strive to continue learning. And as for the credit crisis that’s getting so much attention. Let’s learn all we can from it so that we can avoid falling prey to the next financial fiasco.
And trust me — there is another one right down the road. How do I know that? Because everyone is always looking for a quick buck. And there is no such thing as a quick buck.
—Dan
Free Chart Strategy Session Tutorials