This blog post originally appeared on RealMoney Silver on Sept. 22 at 7:59 a.m. EDT.
With so many crosscurrents, it is hard to have a conviction regarding the short-term trends in the equity market, but it is easy to have an economic view. It is only with the benefit of hindsight that we will know whether Thursday's market lows will hold. At some point after the initial thrust higher from the new
ban on short selling and our government's $700 billion rescue package, hedge fund and mutual fund redemptions and an uncertain profit picture could lead to an absence of buying power and a vulnerable equity market.
I feel safe in saying that the market has limited upside.
The frequency of the recent bailouts --
American International Group
-- and the scale of the policy initiatives needed to plug up a seized credit market underscore the fragility of the world's financial system, which has gone
over the last decade.
It will take years, not months, for the world's economies and financial system to adjust and normalize to more reasonable levels of risk taking.
There will be more casualties.
Last month, I made an
, entitled "This Blame Game Is Short on Logic." And on Thursday, in "Blame the Blamers," I further
why the blame being thrust upon the short sellers of financial stocks is misplaced.
Today, I direct my energies toward exposing the true culprit -- namely, the Wall Street firms and their executives.
The current nightmare has exposed the players on Wall Street, who, in their packaging, slicing and dicing of mortgage products, have proven themselves to be scarier and more destructive than a serial killer in a slasher flick.
The words of a mentor of mine ring out loud: As he recently said in an interview, the way to riches on Wall Street is being a part of that community, not by investing in Wall Street shares.
Aggressive use of leverage, the risks associated with short-term funding (and long-term lending) of brokerage balance sheets and the subpar level of secular profitability (return on assets) on Wall Street have combined to expose an over-rated industry whose engineers -- namely, a small cabal of the firms' traders and executives -- bear full responsibility for the credit fiasco and it's economic ramifications.
It was an accident waiting to happen.
- Wall Street firms take uncommon risk in producing normal returns for their shareholders.In the process of leveraging up, the financial benefits were bestowed upon a privileged few, but the systemic risks were passed on to the many.Let me frame the math: A broker/dealer index that includes Bear Stearns, Goldman Sachs (GS) , Merrill Lynch (MER) and Paine Webber demonstrates that the average return on equity for the industry has averaged 15.9% over the last 23 years. (Return on equity peaked in 2006 to 2007 at about 26% and, taking out the last year, troughed at about 5% in 1990 to 1991). During the same period, leverage has ranged from about 30x to approximately 15x, depending on where the industry is in the cycle.In other words, Wall Street's return on average assets has averaged roughly 1% over several profit cycles! I don't use leverage in my partnership, but I am certain if I returned only the 1% that Wall Street has achieved on average, I would have very few (if any) investors left.
- A "heads I win, tails I win" compensation culture on Wall Street extracts capital and necessitates continued high degrees of leverage and its attendant risk.Over the past decade, Wall Street's compensation was no longer calculated on multiple years of contribution/performance but rather became a short-term (meritocracy) calculation based on a one-year profit and loss statement. The extraordinary compensation at hedge funds, private equity and in the investment and commercial banks became a "heads I win, tails I win" proposition as a star system emerged that was based on contributions calculated within reduced time frames rather than an assessment of the value-added contributions over lengthy periods of time (subject to high water marks and claw backs).Importantly, outsized annual compensation packages were typically not retained but rather were allowed to exit Wall Street every year -- in part, helping to explain the appreciation in home prices between 1995 and 2005 on the East and West Coasts and the willingness to take risks.
Wall Street has sold out America.
Fortunately, for the U.S. economy, Wall Street will never be the same until these lessons learned above are forgotten.
Doug Kass writes daily for
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At the time of publication, Kass and/or his funds were short Fannie Mae and Freddie Mac, although holdings can change at any time.
Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Short Offshore Fund, Ltd.