Streetwise

Lauren Rudd

Sunday, July 18, 2010

There Is A Kindergarten in the Middle

“There is an old joke that Wall Street has a river at one end and a grave yard at the other. Yet, this is strikingly incomplete. It omits the kindergarten in the middle.”

                                                                                                                                                                        Fred Schwed, Jr.

That quote comes from Fred Schwed’s book “Where Are the Customer’s Yachts,” published in 1940 and updated in 1955. Many years later, Barron’s, that bastion of financial wisdom, had a sudden epiphany and subsequently penned the profound thought that successful brokers all seem to have nice cars but only a few investors do.

As an illustration of how little progress Wall Street has made with regard to the clarity and accuracy of its seemingly never ending torrent of investment advice, allow me to first paraphrase a quote from that hallowed purveyor of financial reporting, The Wall Street Journal, as found in Schwed’s book.

“During the slow rise from the April lows, the action of the market was regarded in the nature of a technical recovery, with little thought of the imminence of dynamic action. Resistance, as expected, was encountered just below 140 for the Dow; but after a one-day decline, volume dwindled and the market presently appears to be in somewhat of a consolidation.”

And here is an email I received not long ago.

“The key is in what has happened is the inverse correlation of the USD to the SPX. In the last 20 years, the dollar and the S&P have had wildly fluctuating correlations, from which you'd be hard pressed to draw any conclusions. That correlation has oscillated between -1 and 1, quite rapidly. By the way, that applies even to commodities and the dollar, which may surprise people. And that points to something that has not happened before.”

Yes, Wall Street has played fast and loose with the English language and the investing public. Yet, there are antidotes for exaggeration, ignorance, and even misinformation. It is when the Street’s behavior morphs into a more fraudulent domain designed to deliberately mislead investors and regulators alike that a line must be drawn in the sand.

Consider the latest example of possible misfeasance, one that I find especially disheartening because I have spoken highly of the bank in the past. Bank of America officially confirmed that it "mistakenly" used Repo 105-type transactions on $10.7 billion in assets, which it had misclassified as sales rather than borrowings in the period between 2007 and 2009.

As Bloomberg News reported, the bank used the excuse that a $10+ billion fraud is simply a rounding error. The bank said the inaccuracies are not material and “don’t stem from any intentional misstatement of the Bank’s financial statements and was not related to any fraud or deliberate error.”

If you are hazy on Repo 105-type transactions, they were infamously used by Lehman Bros. A repo is a repurchase agreement whereby securities are used as collateral for a short-term loan with the transaction to be reversed on a specified future date. In the case of Lehman the repo was entered into just prior to the end of the quarter and booked as a securities sale, thereby showing less debt and more cash on the books. As soon as the new quarter began the transaction was reversed.

A repo is in no way illegal or even improper, on the contrary. However, failing to disclose the action and booking it as a sale are more than “inadvertent errors,” they could easily pass for fraud.

Why is it that we continually let Wall Street take advantage of us, even when we should know better? Kermit Long answered the question well when he told the story of the two men who were walking along a crowded sidewalk. Suddenly one exclaimed, listen to the lovely sound of that cricket. The other commented he heard nothing. Furthermore, he asked his companion, how was it possible to detect the sound of a cricket amid the din of the city?