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  O'Connor
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Past Commentaries

Current Commentary, Review and Outlook
June 30, 2009

Wanted: A Man For All Seasons

Any illusions of respectability that used to attach to a suit and a tie, to a title with responsibilities, to a huge salary and the accoutrements of wealth and power, have pretty much evaporated. It is profoundly sad to see principle and morality so casually displaced by mendacity and greed. For too many, riches are preferable to reality, and it's such an easy preference to make. For too many the truth is a damned nuisance, but in the end it's all there is. I used to advise stockbroker trainees against churning client accounts to generate commissions: "You have to be affluent enough to be ethical." How rich does one have to be before honesty is affordable?

Ken Lewis, CEO of Bank of America, has testified in a deposition to the New York attorney general that he was forced to accept a merger with Merrill Lynch on the orders of Treasury Secretary Hank Paulson, who reportedly threatened to fire Lewis and his board of directors, and Ben Bernanke, the Chairman of the Federal Reserve. So rather than resign his $12 million-a-year post and stand up for his shareholders to whom he has a fiduciary obligation, Lewis did the easier, more pragmatic thing: go along and get along. He accepted the merger with Merrill's toxic losses, thus paying off Merrill's shareholders and principals with the equity of his Bank of America shareholders. How pathetic and sad to see someone so big reduced so small. Bounced from Chairman by the shareholders, including me and my proxies, he has no future as the CEO either. Hold your sympathy, his retirement plan is well endowed.

If Lewis's statements are true, they cast a devastating light on the credibility of the offices of the Treasury and the Fed. The problem continues to plague the markets: who can you trust? In the specific case of Merrill and Bank of America you have to believe they have a serious marketing problem with depositors, investors and shareholders who may have fundamental confidence and anger issues with B of A's red, white and blue, and Merrill's bull.

Too Big To Fail

What an absurd solution it is to take one institution that is "too big to fail" and merge it with another, thus creating an even bigger Leviathan. Too many institutions too big to fail have proven themselves too big to succeed.

Yet we hear it so often that it becomes axiomatic. It is a gross canard. There are legal mechanisms for preventing corporations from getting "too big" in the first place. Gathering dust are the Clayton Act and the Robinson-Patman Act. These amendments to the original Sherman Antitrust Act forbid mergers or acquisitions that substantially reduce commercial competition.

How much additional oil has been produced by the mergers of Chevron with Texaco or Exxon with Mobil? And the answer is "none." And how much price competition was eliminated by the consolidated oligopoly that is the oil industry? Or the paper industry? How much cheaper or better is satellite radio now that the only two participants in the industry have been allowed to merge?

In the financial industry these consolidations are revealing deeper problems for which there can be no effective solutions fairly provided by the same politicians who created them. In the April 28th Wall Street Journal, Dennis K. Berman sagely concludes that the Lewis deposition reveals a perhaps irreconcilable difference in the regulation of banks and securities markets. "Securities laws are relentless in their demands for disclosure. Banking regulation relentlessly keeps it secret." How can anyone be confident in the sitting congressmen who are restructuring financial regulations? The concentration of power is troublesome.

Many of the people who have permitted and in many cases encouraged the financial fiasco possess sterling pedigrees. They are among the best and brightest from the finest academic institutions. Was it all just a "big mistake?" Was it truly a problem with "the system" or the fault of "capitalism?"

Shortly after the collapse of Communism the first democratically-elected president of Czechoslovakia, Vaclav Havel said, "We live in a morally contaminated environment. We fell morally ill because we became used to saying something different than what we thought. We learned not to believe in anything, to ignore each other, to care only about ourselves.If we realize this hope will return to our hearts." And as then Joseph Ratzinger wrote in 1985, "The market rules function only when a moral consensus exists and sustains them." (Quotes from Carl Anderson writing in The Wanderer, June 25, 2009)

The problem is a failure of personal moral responsibility. "The problem with socialism," said Bill Buckley, "is socialism. The problem with capitalism is capitalists."

The record of Paul Volker's character and intelligence is beyond reproach. One hopes his influence remains. The changes he seeks are to: 1) limit the size of banks; 2) separate deposit-taking from trading at financial institutions; and 3) force all derivatives trading onto public exchanges. (Bloomberg.com, 6/28/09) Sounds like a return to sanity: restrain bigness and create competition and diversification in the banking community; keep intermediation and disintermediation, deposits and equities, lending and owning, apart from each other; and enforce full transparency of derivatives by publicly trading them in the light of day.

Sooner or later problems get solved. After all, when there's no solution, there's no problem and humanity has been investing and trading since before the Phoenicians.

The Markets

Harvard President Drew Faust on Bloomberg television 6/10/09: "The Harvard endowment will recognize a 30% drop over the last twelve months." It is going to be a long, slow slog to recovery. There is a generational change in psychology to which we must be sympathetic. Investment decisions are based as much on the attractiveness to the larger market as ourselves. It's not much good to like stocks that nobody else does. The result is a portfolio of orphans.

Stock screens are revealing significant growth in the number of companies priced below book value, a condition I've rarely seen since the 1980's. In fact valuations are much improved across the board. Whereas the largest cap companies have yielded the greatest disappointments we are screening far more small and mid caps.

Money market funds cannot yield much when the Fed has a target rate of 0 to .25% for Fed Funds. We improve portfolio yields by staggering very short term, high quality, corporate paper in periods of 4, 6, 9, 12 and 18 month maturities.

R.I.P. Stockbrokers

Like ice that was delivered in big blocks by men in trucks, or coal that was dumped down a chute into the cellar, time and technology have changed and stock brokerage is dying. The function of a stockbroker has been reduced to bringing assets into the firm, to "manage" the relationship. It's expensive, redundant, and obsolete. The system offends fiduciary responsibility and the prudent man rule. The existing generation of "stockbrokers" is being squeezed out of business, replaced by financial advisors and financial planners whose market is much more specific, which is to say, smaller than the general public served by stockbrokers in the past.

There is a consensus building of inflation fear and higher interest rates in the near future, resulting from the unprecedented liquidity pumped into the system by the Fed. The Monetary Base, which is currency in circulation, has risen from $830 billion to $1.720 trillion in the last year through June 24. I don't doubt that the value of the dollar and our standard of living will be diminished, but I am not so sure about radically higher interest rates in the near future. In any case, there is absolutely nothing to be gained by the speculation. The system will respond to changes in rates.

The need for systematic money management has perhaps never been greater.

Best regards,

Dennis M. O’Connor