The Treasury's Pump and Dump Scheme for Bank Stocks

Pump and Dump

According to the SEC website, a pump and dump scheme is one of the most common investment frauds and works as follows:

First, there’s the glowing press release about a company, usually on its financial health or some new product or innovation. Then, newsletters that purport to offer unbiased recommendations may suddenly tout the company as the latest “hot” stock. Messages in chat rooms and bulletin board postings may urge you to buy the stock quickly or to sell before the price goes down. Or you may even hear the company mentioned by a radio or TV analyst.

Unsuspecting investors then purchase the stock in droves, pumping up the price. But when the fraudsters behind the scheme sell their shares at the peak and stop hyping the stock, the price plummets, and innocent investors lose their money.

If all of this sounds familiar it should, since we have probably just witnessed one of the biggest pump and dump schemes ever perpetrated at the expense of witless bank share investors.

Consider the scenario: The Pump

Early this year, the financial system is in a panic as banks announce ever greater losses and talk of nationalizing the banking system is rampant. Public officials fear a full blown banking collapse if worried depositors start a run on the banks. Public opposition to bank bailouts is intense.

To stop the growing banking panic, the Fed and Treasury announce that the major banks are too large to fail and will not be allowed to collapse. An easy to pass “stress test” of the biggest banks is announced to prove to the public that the banking industry is sound.

After a cursory examination of the largest banks, they all pass and are told to raise additional capital just to be on the safe side. Investors start to buy the bank stocks en masse causing many bank stock shares to double and triple in price. Over $200 billion in new capital is obtained from investors eager to get in at depressed prices.

Treasury Secretary Geithner states that “this transparent, conservatively designed test should result in a more efficient, stronger banking system.” Witless commentators at CNBC pile on with predictions that the banks will soon be earning billions in profits. No less a luminary than Warren Buffett adds to the buying panic by stating that he would put his entire net worth into Wells Fargo (WFC).

Potentially catastrophic losses on derivatives, commercial real estate, mortgages, off balance sheet assets and credit cards are swept under the rug as frenzied investors pile into a sure thing.

The Dump

Now, however, Geithner’s brilliant scheme seems to be entering the “dump” phase where “prices plummet and innocent investors lose their money.” Consider the recent price action in major bank stocks:

Most of the bank stocks peaked during May and have already declined substantially or appear to be in a distribution phase. Nervous investors are considering the latest horrendous employment numbers and increasing defaults in virtually every major loan category. There’s no harm in jumping into a pump and dump scheme early on for some quick gains. It just might now be the time to jump back out.

Disclosure: No Positions

Comments

[apppro:]

I'm sick & tired of all you 'let it all fails' & 'new normals' preaching to everyone about what is wrong.
Where were you all to question how we allowed 'The Shorting of America' to proceed with such abandonment that it brought down our entire system over 4 weekends.

Just go away already and let the rest of us to pick up the pieces to a disaster people like you enabled to happen.

Jul 09 06:56 AM

[CautiousInv...:]

The author and I are on the same page so to speak.

I would, though, like to add two comments. First, the change in accounting rules allowed banks to blow through estimated earnings in the first quarter. Beyond reducing losses through relaxation of M2M, some of the accounting profits are arcane and in some instances stem from fluctuating bond prices. In toto, though, the changes served their purpose and investors flocked like lemmings to part with money and invest in these citadels of finance.

Secondly, and with respect to too big to fail, I know that failure of a large financial firm could have unknown and unfavorable ripple effects throughout global financial markets which could be sufficiently ominous that no one wants to experiment with a big failure. And maybe TBTF stops here but I, in a conspiratorial epiphany, started thinking about ulterior motives. Maybe the administration and Treasury want big banks around for a more sinister purpose: purchase of Treasury debt.

Historically, they have accounted for precious little but that is not to say things could not change. And with bulging deficits and the avalanche of debt to be thrown at global markets, its not impossible that a deal was struck under which "I will save you if you save me".

Jul 09 07:50 AM

[Jeff Nielson:]

Excellent observations - with the evidence for the author's claim being RECORD levels of INSIDER-selling during this "rally".

Yes, truly a text-book case in "pump and dump".

It's only too bad that Bill didn't throw in a few paragraphs about the FOREIGN investors who pumped yet MORE billions into these fraud-factories - after suffering HUGE losses over the last couple of years (from doing exactly the same, foolish thing).

As the old saying goes, "fool me once, shame on you..."

Jul 09 01:35 PM

[mrxg4:]

Buffet never said he'd put his entire net worth in Wells Fargo, period. He said he'd be willing to do that when the common for Wells was at $9.

You're implying Buffet is continuing to pump Wells, when in reality what he said was a whole lot different. And the market seems to agree with him, at least for the time being...

Jul 09 06:48 PM

[untiringeagle:]

"By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens...There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."---John Maynard Keynes


On Jul 09 06:56 AM apppro wrote:

> I'm sick & tired of all you 'let it all fails' & 'new normals'
> preaching to everyone about what is wrong.
> Where were you all to question how we allowed 'The Shorting of America'
> to proceed with such abandonment that it brought down our entire
> system over 4 weekends.
>
> Just go away already and let the rest of us to pick up the pieces
> to a disaster people like you enabled to happen.

Jul 10 01:31 PM

[RiskAverseA...:]

"After a cursory examination of the largest banks, they all pass and are told to raise additional capital just to be on the safe side. Investors start to buy the bank stocks en masse causing many bank stock shares to double and triple in price. Over $200 billion in new capital is obtained from investors eager to get in at depressed prices."

Following the 1929 crash, those enterprises with nothing to lose (because everything was at risk of being lost) pooled their resources to do pretty much the same thing. Whether "investors" are responsible for the effects mentioned in the above quoted paragraph is entirely debatable. However, per more recent "distribution" of bank stocks, even here it probably is a misnomer calling bank stock buyers "investors." More like saps. And their king is Cramer.

Jul 11 11:55 PM

[Perry B:]

Good article good comments. I am on the box about AIG trading at $13.0 When in fact it is only worth .50 after the split. How can this junk stock continue to trade? Also there are a lot of secret deals going on in banking as mentioned in alpha articles on BOA. Mentioning secret negotiations on replacing boards. What rights do shareholders have these days, if boards can be replaced in secret meetings?

Jul 16 12:21 PM