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Accounting Gimmicks, Goodfellas and Greece

I’ll never forget the old Abbott and Costello episode when Costello found a stack of money wrapped in a rubber band, excitedly threw the money in the air and said “look, its rubber!” The joke was that rubber had been rationed during World War II, as was coffee, shoes, meat and over 20 other consumer goods. The discussion of our national debt has taken on a life of its own, but at some point Americans will embrace the necessary sacrifices, maximize the largest economy in the world and pass stories of our triumph over hardship to the younger generations. I’m not suggesting that we’re out of the woods yet, but that the American public has finally figured out that we’re lost and will do whatever it takes to find a way home.

Greece, on the other hand, may not be so fortunate. If you’ve ever seen a mafia movie where they muscle their way into a neighborhood restaurant, buy a ton of fire insurance and then burn the place down, consider what happened in Greece. Many large banks lent U.S. dollars to Greece in 2001 when their debt was manageable and agreed to be repaid in Euros so it could be classified as a currency trade, as opposed to debt. They apparently disguised the debt so the European Union would think Greece was below the 3% annual debt to GDP threshold, essentially making it possible for a debt ridden country to legally circumvent safeguards against the instability of the EU with sophisticated financing techniques. The banks made a second profit on the same transaction by selling those securities back to private Greek institutions, purchased insurance against the default of Greek bonds and thus bet that the house of cards would collapse and Greek debt would go up in smoke.

 It turns out that Greece may not be the only country influenced by the mathematical maneuvers of large investment banks. On Friday April 16th, the Securities and Exchange Commission charged Goldman Sachs with civil fraud, alleging that top client John Paulson was allowed to handpick the residential mortgages used as collateral for a portfolio of bonds that Goldman Sachs later sold to outside investors, which in turn provided Paulson with an opportunity to bet that those same mortgages would default. Truth be told, the investment contained no actual mortgages, only bets on the performance of the mortgages, known as credit default swaps. The regulators must prove that Goldman Sachs misled investors and that the investors would have walked away from the deal had they known all of the details. Goldman Sachs profited from its mortgage business as the housing bubble was inflating and then again when the bubble burst - they’re no easy target.

These circumstances should make any investor wonder if the game is rigged. Wall Street used to raise money to capitalize industries that created jobs and innovations; today they resemble yet another legal casino that plays both ends of each transaction. If powerful institutional investors would impact the credibility of a European nation and, as alleged, intentionally deceive their own investors to make money, what profitable endeavor would they label as too egregious to pursue? What’s off limits? Banks recently purchased $5.7 billion of the total $34 billion auctioned in 10-year notes and 30-year bonds, providing demand that many analysts didn’t think existed. A failure to raise sufficient assets at future auctions could facilitate a crisis in confidence at a time of intense government borrowing and impact the value of the dollar. John Paulson, who has reportedly invested 10% of his $30 billion under management, would be the richest man in the world if gold hit $5,000 an ounce. Nobody knows what happens when patriotism gets in the way of profit, but one should feel queasy if they can’t spot the pigeon at the other end of the poker table.

The problems in Greece and the 2008 housing crisis are the best things that could have happened to the United States, offering a valuable glimpse at what’s in store for fiscally irresponsible nations and unregulated financial markets. The U.S. national debt as a percent of GDP is eerily comparable to that of Greece and will lead this country down a similar path unless our government takes responsible measures to reduce spending and increase revenue. Markets have become increasingly complicated and warrant refurbished regulatory oversight that doesn’t restrict innocuous business practices. The discussion of politics, however, is considered to be so impolite that citizens are more familiar with the private life of Tiger Woods than the components of important pieces legislation. We have long tolerated fat cats with hands out slicing logic in portions small enough for the voting public to consume, but as the rapper Mos Def would say, we’re too busy surviving to argue about Darwin, darling.

The cost of bankrupt ideas and uninformed constituents is rising and the treasury can no longer afford it. America’s most daunting impediment to economic growth is our government’s inability to structure reasonable sacrifices, incorporate legal safeguards against market manipulation and allow dynamic industries to flourish unencumbered by poll numbers. Individuals can’t reduce government waste, moderate the influence of lobbyists, regulate the finance industry or shape legislation; instead we rely on those elected into office. While Wall Street bet on the demise of Greece’s sovereign debt and the overheated housing market, investors who are fully committed to the stock market put all of their chips on our elected officials in Washington. We’ve all made any number of improbable bets in our day, but who would risk their life’s savings on such a shabby a record of achievement? One’s political beliefs are of no consequence these days; it’s the results we’re after. The world economy is poised for growth once these questions are resolved; the trick is to get to that bridge so you can cross it.




Disclosure: Long 58,098 shares of (NYSEARCA:GLD) in client accounts, personally own $120,803 (MUTF:OPGSX)