Mom and Pop Got Cheated
- Details
- Published on Tuesday, 21 August 2012 11:53
- Written by Bill Bonner, Founder and President, Agora Inc.
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The market is rigged against the little guy. It is only a matter of time until mom and pop figure it out.
We're in those lazy, hazy days of summer... with little action in the markets.
Not many of the players seem to want to play.
For example, Goldman Sachs' chief U.S. equity man says it's time to get out of stocks before they fall off the "fiscal cliff."
From CNBC:
[David] Kostin vehemently defends his year-end S&P 500 target of 1,250, despite the benchmark's recent rise to above 1,400. The strategist still sees a 12% drop ahead, believing that Congress will fail to address the fiscal cliff before the election, and maybe even before the end of the year...
The worst-case scenario this year is that a lame duck Congress does absolutely nothing after the election -- not even kick the can down the road by voting in a short extension of the tax breaks and spending plans. Under that scenario, 2013 GDP would actually contract, according to Goldman Sachs economists.
The big banks are taking no chances, either. They're keeping their money in Treasuries. Here's Bloomberg on that story:
The gap between U.S. bank deposits and loans is growing at the fastest pace in two years, providing lenders with more funds to buy bonds and temper the biggest sell-off in Treasuries since 2010.
As deposits increased 3.3%, to $8.88 trillion, in the two months ended July 31, business lending rose 0.7%, to $7.11 trillion, Federal Reserve data show. The record gap of $1.77 trillion has expanded 15% since May, the biggest similar-period gain since July 2010. Banks have already bought $136.4 billion in Treasury and government agency debt this year, more than double the $62.6 billion in all of 2011, pushing their holdings to an all-time high of $1.84 trillion.
Faced with a slowing U.S. economy, unemployment above 8% for more than three years and regulations forcing them to hold more and higher-quality assets, banks are lending at below pre-recession levels. The bond purchases help explain why even after rising this month, Treasury 10-year note rates are about half the 3.5% median forecast of 43 economists in a Bloomberg survey a year ago...
While the gap has narrowed to $1.75 trillion as of Aug. 8 as lending of $7.12 trillion trailed $8.87 trillion in deposits, the gap is more than 17 times the $100 billion average in the decade before credit markets seized up, Fed data show.
What's going on?
Is it the heat or too much sun? The pros are turning against stocks. The little guys too.
The typical investor has lost a lot of money in stocks over the last 15 years. First, he was whacked by the dot-com debacle. Sure, the dot-coms were obvious money losers. Serious investors stayed away. But the Nasdaq was flying high in the late 1990s, and the little guys thought they were going to make a fortune.
Then came the bubble in finance and housing. Houses were a no-brainer. The companies that built them might as well have been printing dollar bills. So the mom-and-pop stock market geniuses piled in... and got whacked again.
But that wasn't the end of it. In 2009, Buffett told them to get back into stocks. That turned out to be good advice. The stock market recovered... even if the economy didn't. And then along came Facebook. Now was the chance of a lifetime, they reasoned. Everybody was on the Facebook... billions of people. Everyone used it.
We never have understood the appeal. Facebook seems like an electronic form of shooting the breeze... gabbing... gossiping. A waste of time, in other words. But people who had never been interested in stocks before were quoted in the newspapers saying they wanted to buy shares "for their grandchildren" or to "finance their retirement." It was madness. Facebook will probably be out of business long before the grandchildren grow up or retirement comes.
But cometh the historical drama... cometh the clowns to play the key roles. Investors bought Facebook shares at $40 and more. Now they've got shares worth $20.
When Facebook went public, we guessed that it might be the signal event that finally turned the public against stocks. Maybe we were right. Volume is down. Stocks -- measured by the Dow -- are back to where they were in the late 1990s. But the typical investor has done much, much worse. He's traded in and out... run up fees and commissions... made the wrong choices and lost a lot of money. And now the Facebook IPO -- a public and well-documented transaction -- has allowed the little guys to peek behind the curtain and see how Wall Street really works.
Which brings up a question: What made them ever think they could make money in stocks in the first place?
It's not hard to figure out why Wall Street would want retail business. That's how it makes money: charging fees, commissions and taking advantage of spreads. Like a casino, the financial industry makes money on transactions. The more transactions...the higher the prices... the harder it is to get a reservation at Masa or Per Se or any of the other super-expensive restaurants in New York.
No surprises there. But why would the little guys think they could give money to Wall Street insiders... and get back even more? Won't Wall Street always try to make the most money it can... like a casino... by allowing retail customers to make just enough to keep them coming back -- until all their money is gone? Do they think the Wall Street pros are saints? Or just stupid?
In theory, Wall Street takes the savings of investors and "allocates" them to industries that need capital. Thus, the retail investor participates in the growth of the business in which he invests and the economy in which he owns shares. Wall Street earns a reasonable fee for putting businesses together with the money they need.
Let's say a business needs $1 million. Wall Street could put Mom and Pop into the stock -- taking as much as, say, $200,000 (fully loaded... including all of the SEC and other costs imposed on the company itself).
Or it could fund the $1 million from its own resources... or put its own money into Treasuries, as it is doing now. How does it decide what to do? Just like anyone else: It will always try to maximize its own returns. So if it anticipates a greater return on investment by buying the stock itself, rather than selling it to customers, it will do so.
Likewise, the company will go with the best deal too. If it needs to raise money, it will first give the good deals to friends, family and useful insiders. If it can borrow money cheaper than it can raise equity from Mom and Pop, it will borrow.
So Mom and Pop will always get the short end of the stick. They will get invited only into businesses that neither banks nor Wall Street want to finance. And only when the anticipated rate of return -- to the investor -- will be lower than what the company would have had to pay for borrowed funds.
The little guy never had any business in the stock market. Finally, he may be figuring it out.
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