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BEING STREET SMART 

by Sy Harding

YOU and I ARE GOING TO BUY THE TOXIC WASTE? September 19, 2008.  

Will they never learn? Financial firms get greedy. Regulators make rules. Congress passes laws. Markets hand back unintended consequences. Over, and over, and over again.

What is going on now is not new.

Two hundred years ago Thomas Jefferson said, “I believe that banking institutions are more dangerous to our liberties than standing armies.”

One hundred years ago Henry Ford said, “It is well the people of the nation do not understand our banking and monetary system, for if they did I believe there would be a revolution tomorrow morning.”

Over the years, and as a result of previous financial debacles, a few laws and regulations were passed that actually worked to some degree, to restrain the cycles of excessive bankers’ greed and subsequent national suffering.

Shockingly, in recent years the most important of those were dismantled by Congress and regulators, bowing again to the pressures of their friends on Wall Street and in the financial community, and the nation is now paying the price – again.

When investigations into the 1929 crash revealed the unsavory actions of financial firms leading up to and during that ugly panic, the Glass-Stegal Act was passed (in 1934). It separated banks from brokerage businesses, commercial banks from investment banking, savings banks from commercial banks, and so on.

That impenetrable wall between financial institutions and the types of products they could offer served the nation well for 64 years.

However, as the economy and stock markets powered into high gear in the 1990s, envy between the separated areas of the financial system began to grow. Banks and insurance companies wanted to be brokerage firms and mutual fund companies. Brokerage firms wanted to be banks. They all wanted to sell leveraged investments, make risky investments themselves, be involved in real estate, and issue lucrative credit-cards.

So in 1999, Congress repealed the Glass-Stegal Act, repealed it just as the next investment bubble it had been designed to prevent was forming. Great timing? Well, yeah, for financial institutions that went crazy enticing investors into the market. For investors and the financial health of the nation, not so much. The 2000-2002 bear market, the worst since 1929, took place.

We can also look back to the late 1980s when the dramatic collapse of Savings & Loan institutions (S&Ls) also threatened a meltdown of the entire financial system.

S&Ls were deregulated in the early 1980s. By the mid-1980s they were loaning more money in overpriced real estate than they could cover in the event of falling prices. The collapse came in the late 1980s, resulting in more than 1,000 S&L’s going under, while in the banking sector more banks failed than at any time since the Great Depression. The government formed the Resolution Trust Corporation (RTC), which took over a total of 745 banks that were either closed or forced to merge with healthy banks. The intervention did avert a financial system meltdown, but just barely. The cost to taxpayers has never been accurately measured, estimates ranging from $150 billion to $800 billion.

The Securities Act of 1934 also included the so-called ‘Uptick Rule’. It said a ‘short-seller’ could not relentlessly sell a stock short when it was declining. Each short sale had to wait until there was at least one trade at a price higher than the previous trade, an ‘uptick’. Great idea. It worked quite well for all those years from 1934 until 2007.

But last year, July, 2007, the SEC quietly agreed with a request from the NYSE to abolish the uptick rule. That protection for investors also disappeared.

Since then, even when a stock or the market is already declining sharply, traders can jump in with short sales and just keep pounding it lower. That produces extreme oversold conditions, so the rally back up to whatever is to be its normal level for the day or week also takes a big move. Voila. Extreme up and down volatility that whipsaws investors, but produces great profit for professional traders and program-trading firms.

And then we have had the abolishment of most of the ‘circuit breakers’. After the 1987 crash regulators instituted ‘circuit-breakers’, also known as ‘curbs’. They were designed to prevent the program-trading firms (the largest banks and brokerage firms trading for their own accounts) from relentlessly driving a declining market down even further with their massive computerized sell-programs, as they had in the 1987 crash. For instance, if the NYSE Composite moved 200 points or more from its previous day’s close, trading restrictions were placed on program-trading firms. The curb came into play fairly often, with financial TV shows letting viewers know when “curbs are in”.

That rule was quietly scrapped November 2 of last year, just after the market entered its current bear market. The NYSE said it had not been effective in curbing market volatility.

Try telling that to investors being whipsawed by the extreme day to day volatility since.

Now, to solve the current financial debacle, caused primarily by their abolishment of previous regulations, Congress and the Fed are going to create another government owned corporation, and use taxpayer money to buy the troubled debt of financial institutions? That debt is the toxic waste on their balance sheets financial firms have been trying without success to unload on each other, or on foreign wealth funds, hedge funds, private equity groups, anyone sucker enough to bite. But no one would.

So now the government will step much further into what is supposedly a free market system, form a corporation, and buy that toxic waste with taxpayer money (and additional debt for future generations), the goal being to free financial institutions to return to their ‘normal’ activities. Meanwhile, new rules today that you cannot sell short the stocks of banks and brokerage firms if you think their stocks are overvalued.

Let’s see now. They profited big-time from their fraudulent activities. Tax-payers are losing their homes as a result. Investors are suffering another bear market. Regulators are now going to have us (tax-payers) buy the toxic waste they produced. The value of their stock will be held up artificially. And their balance sheets will be clean so they can go back to their ‘normal’ operations.

They are so good to us.

Sy Harding is President of Asset Management Research Corp., and publisher of the financial website www.StreetSmartReport.com, and the free blog www.SyHardingblog.com. He also authored the timely 1999 book Riding the Bear - How to Prosper in the Coming Bear Market, and 2007's Beating the Market the Easy Way - Seasonal Strategies that Double the Market!

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