This Week’s Sign the Lunatics Are Running The Asylum

It’s official. Four big Wall Street banks pitched perfect games last quarter.

The trading departments of Bank of America, Goldman Sachs, JPMorgan Chase and Citigroup each finished the first quarter of this year having made money every single day. According to their SEC filings, their traders did not lose a single penny on a single day the whole quarter. For 61 days in a row. All four of them. Really.

Now I haven’t determined the actual probability of that occurring in a truly free market, but I’m going to guess that it’s indistinguishable from 0.0000. That is, there is zero chance these guys are really that good. (See TARP, 2008.)

But when you’re acting like some kind of emerging market oligopoly, screwing over your own clients and letting computers trade for you, apparently it is just that easy. And as I’ve said before, investors beware. These big banks are lousy businesses. They have no sustainable moats. After all, it wasn’t one bank but four of them that just threw perfect games.

There’s more in this article from the NY Times – although it inexplicably fails to raise the question, “How exactly did this occur?”

This gentleman’s quote pretty much summed it up:

“This is just, as we call it, milking the market and your captive client base.”

Exactly, dear sir. This has nothing to do with talent or being a steward of wealth.

Unbelievable, isn’t it?

Cale Smith

About Cale Smith

Portfolio Manager at Islamorada Investment Management.
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6 Responses to This Week’s Sign the Lunatics Are Running The Asylum

  1. Kirk Kinder says:

    They aren’t even banks. They are hedge funds who also have the ability to front run trades since they also do the trading for America. If you look at the Big 4 as far as banks, they are insolvent and losing money hand over fist. Their trading activity is the only thing keeping them alive. And, they only do it by knowing the answer in advance with HFT platforms frontrunning clients. No one gets every trade right.

    This just shows the corporatist nation we have become. The banks are in control and the politicians are doing nothing to alter this. Bring back Glass Steagall to separate depository banks from investment banks. If Goldman wants to operate as a hedge fund, that is fine. They shouldn’t have access to the Fed when they make mistakes. And, don’t get me started on the Fed. They are the main culprit behind this entire mess. The Fed under Greenspan eliminated Glass Steagall, and the gross mismanagement of the Fed Funds rate instigated the loose cash/bubble mentality.

    And, the best the guv can do is audit the Fed once? We need to audit them every year at a minimum. In reality, it should be banned.

    I am going to go to my happy place now to calm down. Think happy thoughts. Think happy thoughts. Blue birds sing with whiskey springs.

  2. PRICE MATTERS says:

    Cale,
    I am a fan of your blog and the spoke fund concept. I am in the process of researching how to launch my own in the not too distant future.

    While I understand the general public’s negative sentiment towards Investment Banks, I think there is a major disconnect between perception and reality with Goldman Sachs in particular. Buffett and Munger addressed the alleged “fraud” in Omaha and outlined how they did not believe anything was illegal. As Charlie Munger said in Omaha ” It’s Simple, This was a 3-2 decision by the SEC when they usually act unanimously. If I had been in the SEC I would have voted with the minority”

    I think you are missing a huge opportunity to buy GS at today’s price of $147.20 (6.6x 2009 EPS). By buying at this price you have a good margin of safety. It will take some time for the SEC case to play out and patience will be tested on this investment but I think the odds are good that you will wake up in 2 years and have north of a $200 stock.

    GS’ major clients are not pulling back on business what-so-ever and low Fed rates will continue for longer than people imagine.

    This is a golden opportunity in my book where the the stock is extremely unloved yet the business is fundamentally sound and getting to be more profitable. I could be wrong if the economy does not improve…but I love my downside protection at this level. (FYI- Not sure if you attended the Value Investing Congress but Berkowitz just took a massive position in Goldman)

    –Safe Investing

    FULL Disclosure: I have been buying GS over the past couple of weeks (Been painful so far but I am a long term value investor)

    • Cale Cale says:

      Appreciate the thoughts, and I certainly hope you do well on GS. At the top of the list of why I wouldn’t touch Goldman or any of the major banks is that I believe their moats are tremendously overestimated. An investment bank is just not a real good business to own in the long-term – at least to me. If you’re an employee, however, it’s fantastic. You will earn multiples of your own intrinsic value.

      BRKs investment in GS was a great deal – because of the terms, though, not because of the company invested in. While I’m happy to profit from it as a BRK shareholder, it’s continued success is still far from assured. I heard those same comments you mentioned in Omaha, but I think Buffett and Charlie threw up a straw man there, perhaps unintentionally – or perhaps because “to badmouth” might mean “to have called away.” In any case, Warren seemed to believe (as per the example he gave of picking munis from a list presented to Berkshire) that the fraud was because Goldman didn’t disclose Paulson’s role. It’s not fraud because of non-disclosure, though – it’s (alleged) fraud because Goldman said it was an independent third party who chose the CDO’s. It was not.

      I didn’t hear Buffett or Munger acknowledge that distinction between non-disclosure and, well, lying – which the SEC apparently believes to be a big difference. I agree. That ACA was run by gullible idiots is not the point. If an idiot buys a perfectly normal hair dryer from your store, takes it home, plugs it in, and then stands in the shower to dry his hair with it, that’s his problem. But if he buys that hair dryer after you’ve told him all the hair dryers in your store have been deemed relatively bath-tub safe by an independent expert in hair dryers…and then he goes and stands in the shower with it….well, the idiot’s problems are now your problems, too.

      And as much as I admire BRK, their track record in investing in i-banks is not great. See Salomon Brothers. The 3-2 vote Charlie mentioned was interesting but irrelevant – and I think it may be a mistake to presume it was the just merits of the case and not politics that explained the final vote.

      The fraud aside, to invest in the common right now basically assumes that the off-balance sheet asset that is Goldman’s brand will produce slightly better than average earnings power in the future. GS’ future earnings power is too hard for me to foresee right now – even if they do manage to retain their prop desks and/or avoid swap exchanges. Regulatory risk is both real and high. As a result, and given everything else, think I’d want an even bigger margin of safety to compensate.

      As far as Berkowitz’s stake…not familiar with his thesis, but in his own words, it seems fairly easy to kill the investment case for GS right now. Apparently he sees otherwise, though, and he does manage billions, while I am writing this in flip-flops, and have not tried to gauge the expectations inherent in the stock price right now. So, you both could do well in GS. But I suppose I’m happy to let others make a lot of money there in any case…

  3. Kirk Kinder says:

    The only thing I would add about many of the i banks is they could see some problems if the government ever wises up and re-enacts Glass-Steagall or something similar. I think Volker rule is a good start, but not enough teeth.

    If GS was pushed away from the Fed window, that will have an enormous impact on their borrowing costs. They would no longer see winning trades every day. Will this happen? I don’t know, but it should.

    Buffett and Munger are talking their book. If they are imparting life’s lessons on subjects that don’t affect BRK then I am all ears. When their cash is on the line, they aren’t as objective. Of course, that is human nature.

  4. PRICE MATTERS says:

    Thanks for the response. Completely understand your points of view and I respect them.
    This investment isn’t for everyone. It definitely has that “Ick!” factor that prevents most people from even considering investing in Goldman Sachs. That is partly the reason I am getting a great deal on their shares. I do believe they have a competitive advantage that has been exemplified over the past 140 years in investment banking. Many people take issue with employee compensation and I can understand why. However, the percent they are allocating to employee compensation seems to be falling recently which is a positive. I don’t mind them paying ridiculously high salaries if they can consistently generate 20% ROE.

    In terms of being shareholder friendly: If you invested in GS 5 years ago you are now sitting on a 40% return while the S&P is down about 5% or so in that time frame. Not too shabby in terms of out-performance!

    It is currently my largest holding in my fund….representing 10% of the portfolio.

    What I see is one of those rare situations where there is low risk & High uncertainty.

    Best of luck,

    Prem

  5. PRICE MATTERS says:

    Update on GS:

    With the SEC case behind them now and the penalty being much lower than many analyst thought ( I heard $1B plus numbers being thrown around–silly huh) I think GS can get back to business. Despite the run-up in the stock price to $156 I am still a buyer. I am keeping my $200 target over the next 2 years.

    -Safe Investing to ALL