It's Times Like These When Money Returns To Its Rightful Owners

Posted by jeff

Wed Aug 26th, 2009 09:13 PM

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"It's Times Like These When Money Returns To Its Rightful Owners": So said a banking executive from a conservative Midwest bank I heard speak recently. I'll admit it: I'm a lover of poetry and I even used to write some myself. No worries - I'll spare you. But there is something so poetic to me about the statement above and how emblematic it should be of our capitalist system. I have often commented that it's not the smartest guys/gals who make the most money, it's the guys/gals with the biggest cohones. This has apparently now been scientifically proven in a University of Chicago study reported on recently by Bloomberg News. My understanding is that newly appointed French pay Czar Michel Camdessus, who like the Chicagoans is a devout free markets disciple, is considering allowing French bank traders to keep their bonus payout ratios if they will just submit to castration.....dust off those guillotines.

But seriously, while those who are the most ardent risk takers often amass large sums of money, it is those who shepherd their capital wisely who keep wealth.....and pay the least taxes. It is the times of mean reversion when the cavalier surrender their ill-gotten gains to their more reticent skinflint cousins. There is a cleansing effect that goes along with this redistribution of wealth. The burning down of over-growth makes room for new green shoots that have room to grow. Profit margins in entire industries rise, because competition is thinned. But it is thinned by the exit of those who produced little or no economic value with the capital they controlled and their revenue is re-allocated to those who are much more productive with their capital. This brings our entire economy forward, and while there are times when grand experiments....like using sock puppets to sell goods online.....are merited, so too are there times that the excesses need to be wrung out.



Unfortunately, I don't think my wise midwestern banker friend is right that now is the time when money will return to its rightful owners. In fact, everywhere I look I see barriers being erected to prevent this from happening. The government has bailed out the banking system and is subsidizing purchases of the toxic assets that do trade.....a precious few after more than six months into the effort to re-liquify the system. The stock market rally that has been engineered is allowing capital raising by a much wider group than the truly worthy. I could not have put it any more eloquently than this quote from today's Wall Street Journal article about why REITs will inherit the earth in the commercial real estate space.

"Everyone was predicting a have-and-have-not scenario, and that didn't play out at all," says Debra Cafaro, chief executive of health-care REIT Ventas Inc. "What happened was indiscriminate access to capital, which has buoyed the whole sector."

While the chart to the left clearly shows that overall REITs were much better stewards of capital, collectively being net sellers at the top of commercial real estate, versus other players who were net buyers, many were not good stewards of capital. This has apparently been overlooked in the recent capital raising orgy.

This is merely a microcosm of the world in general, where for various reasons the wheat is only being separated from the chafe during times of extreme distress, other than that sloppy stewardship of capital is being rewarded as markets fail to differentiate the good from the bad. I believe that this is due to an incredible shift to short-term thinking which has pervaded our society, as I discussed in my piece "Trading Mentality: The 8th Deadly Sin."



The chart to the left which I lifted from a Seeking Alpha article entitled Stock Return Dispersion and the VIX Forecast Alpha Dispersion demonstrates that differentiation in stock performance is highly correlated with volatility. What it does not explicitly say, that savvy Urban Digs readers know, is that volatility is more often than not associated with declining stock markets. So it is in bad markets that good is segregated from the bad. This is a trend that I believe is increasing to the increasing dominance of hedge funds, which are by nature trend chasers, due to their need to generate short-term performance, and particularly by the growth of statistical arbitrage strategies which buy laggards and sell leaders in a group such that the stocks are pushed back into their historical correlations, when they get out of whack. (I am sure that one of our physics PhD readers can correct my misrepresentation of statistical arbitrage, but while I am misrepresenting I should mention that this strategy is so crowded that it apparently now needs the help of front-running - flash trading - to keep producing returns.) Since stock markets historically go up much more often than they go down, historically stocks have lower full cycle return dispersions than bear market return dispersions. It's a self-reinforcing trend. Unfortunately, it is not in the interest of our capitalist system, where stocks are not just pieces of paper or mathematical ciphers; they represent businesses that either add efficiency to our economy or don't and are supposed to be winners or losers based on these trends. We have collectively created an environment where as long as you don't go under you win....and by the way, we have very little tolerance for anybody big going under. It's Trump world. We have created it. Can we undo it, or has the system gotten so far out of our control that we are doomed to be Japan without even really trying to be?