The Price Is Light: Gaming With Lehman

| About: Lehman Brothers (LEH)
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There is a famous American game show, The Price is Right, during which contestants attempt to guess the correct price of a certain item. The winning contestant guesses closest to the true price. A somewhat similar game is occurring with the stock market’s financial companies. However, rather than observing a familiar item and guessing the price based on a few simple known variables, many complicated and obscured variables affect the true value of financial companies.

Let’s attempt to play a simulated version of this game with the headlining stock Lehman Brothers Holdings Inc. (LEH). A little over a year ago, LEH was trading near $80 a share. The company was coming off a multiyear bull run and was profiting from investments related to the strong real estate market, the roaring global boom, and tons of private equity deals and IPOs. The market looked at LEH’s financials and imagined every investment providing superior returns, the global boom spiking without fail, and the deal flow continuing ad infinitum. Although none of those projections were connected to reality, they were included in the stock price nonetheless.

So, in our simulation we are now staring at a share of LEH trading at $80 in 2007. We are bright-eyed and having idealistic fantasies like parents do while staring at their newborn babe. LEH is our little darling. LEH can do no wrong. LEH is genius! We are guessing that the price of LEH is “right” at $80 - for sure.

While we are staring at our simulated computer screen enjoying the beautiful ascension of our darling, simulated LEH employees are making trades, signing contracts and checks for more projects, and marketing their services to prospective clients. As all the aforementioned booms started losing momentum, the quality of the then-current deals began to erode. Long trades in real estate-related securities started to sour. Deal flow came to a screeching halt. But all the while, LEH bulls kept demanding shares because they were living in a deluded intellectual world where LEH was invincible.

Last summer a handful of people snapped out of their daydream. So, LEH shares started to slide. Despite the mounting evidence that the boom had peaked, LEH management and their well-paid PR machine told the public, “Although you can’t see behind our veil, trust us that things are just fine.” And since most analysts, fund managers, and individual investors are too far removed from the company’s reality, they drank the Kool-Aid and guessed that the price for LEH was “cheap.”

This is the point when most people are simply investing based on the inertia of the market (e.g., “buy the dips”). Although any reasonably discerning person could find plenty of data to support that major problems were manifesting in the economy (if you are lazy read Barry Ritholtz’s brilliant blog The Big Picture), the inertia bots piled back into shares and kept them stable until February of this year. At that point, reality was harder to conceal and the protectors of the veil (e.g., CEO, PR team, Federal Reserve, National Association of Realtors, etc.) were forced to concede a host of problems. Thus, the next wave of sellers dumped their LEH shares.

Despite the concessions and selling, the protectors of the veil followed all their negative revelations with positive rhetoric and spin. They are, after all, trying to prevent us from accurately repricing the market all at once - because that’s what we call a “crash.” So, once again plenty of inertia bots started buying shares. As a result, we had a little rally from the middle of March until the middle of May. At that point, more of reality was revealed, and the next wave of selling began.


At this point, we are in the present moment: Monday, July 14, 2008. LEH has taken a hard beating down to $12.40. The mainstream media is finally reporting that LEH owns ghost towns and has an enormous amount of possibly valueless illiquid assets on their books. However, despite all the negative data about LEH’s reality, there are still people who continue to buy. And, despite those who continue to buy, the reality behind LEH’s veil has still not been fully disclosed - not to mention the economy is getting worse.

This same issue is true for the market as a whole. Although companies have revealed some things about the cancers growing on balance sheets, they haven’t revealed everything. And we definitely don’t know how much worse that cancer will be as the economy continues to slow. But, like contestants who know results of a reality show that was filmed but not yet aired, those who can see behind the veil are very well aware that share prices are not yet based on reality.

Legendary investor Benjamin Graham said, “In the short run the market is a voting machine, but in the long run it is a weighing machine.” So, we will continue this classic Bear Market game where insiders are forced to give us nuggets of reality and prices reduce another leg based on weight. Then protectors of the veil will find a statistic or two and claim things are bottoming, and we will have another bounce based on votes. Maybe LEH execs will even consider going public to end the slaughter? But until we know everything and get to stare at the naked skinny horror behind the veil, LEH and the market will continue to be inaccurately priced as a heftier load. Therefore, I recommend staying out of this volatile market unless you are an incredibly skilled trader. As the maxim goes, “When in doubt, stay out.”