The stock markets have been acting reasonably well in view of a very sobering outlook for the American economy.

General Motors struck a deal with the United Auto Workers after a two-day strike in September wherein for $51 billion the company shifted the health-care obligations for retirees to a union-run trust fund. It took Chrysler only a six hour strike to come to agreement with the UAW on virtually the same terms.

The Federal Reserve, fearing a rout in the housing industry as a result of the credit squeeze that was engineered by greedy Wall Street bankers, brokers, lawyers, rating agencies and their clients, unanimously agreed to a one-half percent decrease in its interest rate. The markets loved the Fed’s move, but we think the jury is still out.

And the icing on the cake is that on October 10th Tiffany opened a store on Wall Street. We don’t know if this represents the beginning of the end or the end of a protracted beginning for the stock markets.

During the last few months the stock and bond markets have moved with remarkable volatility — some days the major indices would be up or down close to 3% for the day.

Global markets react instantaneously in all their glory resulting in magnificent gains or magnificent losses while the U.S. markets are less of a dominating force when the rapidly growing European and Asian markets are put in perspective. And just as extraordinary amounts of money chased higher yields in subprime mortgages, structured finance, et cetera, et cetera leading to the world wide Credit Crisis and a run on a London Bank (that had to be bailed out by the Bank of England), money today is chasing stocks in Shanghai, Russia and Brazil.

The Financial Times claimed the “Credit squeeze costs banks $18bn” as its headline in its October 6th issue. “Merrill Lynch takes $5bn writedown – Washington Mutual sees profits fall 75%. The toll of big bank losses from the credit squeeze topped $18bn yesterday after Merrill Lynch and Washington Mutual revealed heavy damage inflicted by financial market turmoil….These announcements followed writedowns from Citigroup, UBS, Deutsche Bank and others. Most of the markdowns stem from falls in the value of leveraged loans that banks have committed to provide (for private equity transactions – our insertion) and mortgage-related securities as a result of the credit squeeze.”

We have to admit that we would not have been surprised to see these companies’ stocks sell off on this news. But we would have been wrong, for the short term anyway. After the announcements, Mother Merrill’s stock gained 2.5% while WaMu’s (Washington Mutual’s) shares gained 2.2%.

As the kids would say, “Go Figure.

The reasoning was that the markets determined the worst is now behind these companies. We are not quite as sure as many of the banks, brokerage firms and hedge funds are holding investments at this moment that they cannot value. There are no viable markets for a great deal of the paper these firms hold so they make “assumptions” as to what their assets may be worth.

In every report to every one of our clients their portfolio valuation is “Marked to Market.” That simply means that every security is valued as to its last sale as of the date of the report.

This is not the case with, to name only a few, structured finance and CDOs (collateralized debt obligations) that are complex instruments owning pools of debt that are sliced into tranches having, in many cases, credit ratings that range from “junk” to AAA within the same investment.

The owners of these investments “Mark the investments to Model.” We think they are often “Marked to Myth” as their value cannot be calculated. A small problem is that there is perhaps upward of a trillion dollars of this paper issued and outstanding, although nobody knows the exact amount. The investments were sold to investors — hedge funds, retirement funds, offshore banks, you name it — who wanted higher yields (returns) on their money.

An example of valuations, or lack thereof, appeared in the October 9th Wall Street Journal in an article titled “Pricing Tactics of Hedge Funds under Spotlight.” “Valuation of infrequently traded securities first sprang to public view as an issue this spring when two Bear Stearns Cos. Hedge funds blew up. One of the funds initially reported a 6.5% loss for April. A few weeks later, investors learned that the fund was actually down about 20% for that month. The fund told investors that the change was because of downward revisions in the price estimates it received for hard-to-value securities.” We believe these two Bear Stearns funds had about $9 billion in loans.

On August 30th the Financial Times had a front page article titled: “Liquidity crisis in debt market could spark $43bn (Billion) ‘firesales.’”


We would have serious reservations about having the people mentioned above manage our money if these are just a few examples of how they manage their own.

To repeat: It really is much better to have someone working in your best interests as opposed to his or her best interests! But then you have always known that.

John W. Hamilton
October 17, 2007