Jim Rogers: Commodities Are The Next Cisco's

He says commodities bull market will end the same way as the tech bubble. In other words, there's still a long way to go.

Jim Rogers: I'm Long Commodities And Short Nasdaq Stocks

"If the economy gets better I am going to make money in commodities.  If it doesn't get better, I am going to make money in commodities because they are going to print huge amounts of money."

Jim Rogers

EXEL: The Next Killer Stock?

The only reason I won't put EXEL on my "Next Killer Stock" list (which currently comprises 6 stocks) is because the company is still in developmental stage and is unprofitable, but it has huge future potential.

Here is a video testimonial of drug XL184, Exelixis' main drug.

Chart Of The Week: GPL

Silver is hot these days.

Jesse Livermore: Don't Sell Stocks In A Bull Market

I did precisely the wrong thing. The cotton showed me a loss and I kept it. The wheat showed me a profit and I sold it out. Of all the speculative blunders there are few greater than trying to average a losing game. Always sell what shows you a loss and keep what shows you a profit.

In Fullerton’s there were the usual crowd. All grades! Well, there was one old chap who was not like the others. To begin with, he was a much older man. Another thing was that he never volunteered advice and never bragged of his winnings. He was a great hand for listening very attentively to the others. He did not seem very keen to get tips that is, he never asked the talkers what they’d heard or what they knew. But when somebody gave him one he always thanked the tipster very politely. Sometimes he thanked the tipster again when the tip turned out O.K. But if it went wrong he never whined, so that nobody could tell whether he followed it or let it slide by. It was a legend of the office that the old jigger was rich and could swing quite a line. But he wasn’t donating much to the firm in the way of commissions; at least not that anyone could see. His name was Partridge, but they nicknamed him Old Turkey behind his back, because he was so thick-chested and had a habit of strutting about the various rooms, with the point of his chin resting on his breast.

The customers, who were all eager to be shoved and forced into doing things so as to lay the blame for failure on others, used to go to old Partridge and tell him what some friend of a friend of an insider had advised them to do in a certain stock. They would tell him what they had not done with the tip so he would tell them what they ought to do. But whether the tip they had was to buy or to sell, the old chap’s answer was always the same. The customer would finish the tale of his perplexity and then ask: “What do you think I ought to do?” Old Turkey would cock his head to one side, contemplate his fellow customer with a fatherly smile, and finally he would say very impressively, “You know, it’s a bull market!”

Time and again I heard him say, “Well, this is a bull market, you know!” as though he were giving to you a priceless talisman wrapped up in a million-dollar accident insurance policy. And of course I did not get his meaning. One day a fellow named Elmer Harwood rushed into the office, wrote out an order and gave it to the clerk. Then he rushed over to where Mr. Partridge was listening politely to John Fanning’s story of the time he overheard Keene give an order to one of his brokers and all that John made was a measly three points on a hundred shares and of course the stock had to go up twenty-four points in three days right after John sold out. It was at least the fourth time that John had told him that tale of woe, but Old Turkey was smiling as sympathetically as if it was the first time he heard it. Well, Elmer made for the old man and, without a word of apology to John Fanning, told Old Turkey, “Mr. Partridge, I have just sold my Climax Motors. My people say the market is entitled to a reaction and that I’ll be able to buy it back cheaper. So you’d better do likewise. That is, if you’ve still got yours.”

Elmer looked suspiciously at the man to whom he had given the original tip to buy. The amateur, or gratuitous, tipster always thinks he owns the receiver of his tip body and soul, even before he knows how the tip is going to turn out. “Yes, Mr. Harwood, I still have it. Of course!” said Turkey gratefully. It was nice of
Elmer to think of the old chap. “Well, now is the time to take your profit and get in again on the next dip,” said Elmer, as if he had just made out the deposit slip for the old man. Failing to perceive enthusiastic gratitude in the beneficiary’s face Elmer went on: “I have just sold every share I owned!”

From his voice and manner you would have conservatively estimated it at ten thousand
shares. But Mr. Partridge shook his head regretfully and whined, “No! No! I can’t do
that!”

“What?” yelled Elmer.

“I simply can’t!” said Mr. Partridge. He was in great trouble.

“Didn’t I give you the tip to buy it?”

“You did, Mr. Harwood, and I am very grateful to you. Indeed, I am, sir. But
“Hold on! Let me talk! And didn’t that stock go op seven points in ten days? Didn’t it?”

“It did, and I am much obliged to you, my dear boy. But I couldn’t think of selling that stock.”

“You couldn’t?” asked Elmer, beginning to look doubtful himself. It is a habit with most tip givers to be tip takers.

“No, I couldn’t.”

“Why not?” And Elmer drew nearer.

“Why, this is a bull market!” The old fellow said it as though he had given a long and detailed explanation.

“That’s all right,” said Elmer, looking angry because of his disappointment. “I know this is a bull market as well as you do. But you’d better slip them that stock of yours and buy it back on the reaction. You might as well reduce the cost to yourself.”

“My dear boy,” said old Partridge, in great distress “my dear boy, if I sold that stock now I’d lose my position; and then where would I be?”

Elmer Harwood threw up his hands, shook his head and walked over to me to get sympathy: “Can you beat it?” he asked me in a stage whisper. “I ask you!”

I didn’t say anything. So he went on: “I give him a tip on Climax Motors. He buys five hundred shares. He’s got seven points’ profit and I advise him to get out and buy ‘em back on the reaction that’s overdue even now. And what does he say when I tell him? He says that if he sells he’ll lose his job. What do you know about that?”

“I beg your pardon, Mr. Harwood; I didn’t say I’d lose my job,” cut in old Turkey. “I said I’d lose my position. And when you are as old as I am and you’ve been through as many booms and panics as I have, you’ll know that to lose your position is something nobody can afford; not even John D. Rockefeller. I hope the stock reacts and that you will be able to repurchase your line at a substantial concession, sir. But I myself can only trade in accordance with the experience of many years. I paid a high price for it and I don’t feel like throwing away a second tuition fee. But I am as much obliged to you as if I had the money in the bank. It’s a bull market, you know.” And he strutted away, leaving Elmer dazed.

What old Mr. Partridge said did not mean much to me until I began to think about my own numerous failures to make as much money as I ought to when I was so right on the general market. The more I studied the more I realized how wise that old chap was. He had evidently suffered from the same defect in his young days and knew his own human weaknesses. He would not lay himself open to a temptation that experience had taught him was hard to resist and had always proved expensive to him, as it was to me. I think it was a long step forward in my trading education when I realized at last that when old Mr. Partridge kept on telling the other customers, “Well, you know this is a bull market!” he really meant to tell them that the big money was not in the individual fluctuations but in the main movements that is, not in reading the tape but in sizing up the entire market and its trend.

And right here let me say one thing: After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting.  Got that? My sitting tight! It is no trick at all to be right on the market. You always find lots of early bulls in bull markets and early bears in bear markets. I’ve known many men who were right at exactly the right time, and began buying or selling stocks when prices were at the very level which should show the greatest profit. And their experience invariably matched mine that is, they made no real money out of it. Men who can both be right and sit tight are uncommon. I found it one of the hardest things to learn. But it is only after a stock operator has firmly grasped this that he can make big money. It is literally true that millions come easier to a trader after he knows how to trade than hundreds did in the days of his ignorance. The reason is that a man may see straight and clearly and yet become impatient or doubtful when the market takes its time about doing as he figured it must do. That is why so many men in Wall Street, who are not at all in the sucker class, not even in the third grade, nevertheless lose money. The market does not beat them. They beat themselves, because though they have brains they cannot sit tight. Old Turkey was dead right in doing and saying what he did. He had not only the courage of his convictions but the intelligent patience to sit tight.

Jesse Livermore

Marc Faber: Time To Sell Stocks

"The US stock market has now doubled from its low. In other words, there are only three occasions in the last hundred years when the stock market in the US doubled within two years.

One such occasion was in 1934, coming off a very deeply oversold condition in 1932 and the other one was in 1937. After 1937 and 1934, the 12 months return were both negative.

I would be a little bit careful here to just buy the US because investor sentiment is very positive. The volume has been relatively sluggish and the market is extremely overbought by any statistical model.

My view is that the US market will eventually join the emerging markets on the downside because if you take a bearish view about emerging economies, you cannot be too optimistic about the US because for many US corporations, 50 percent or more of their profits come from emerging economies."

Marc Faber, CNBC

Marc Faber: I Think We Are All Doomed

"I think we are all doomed. I think what will happen is that we are in the midst of a kind of a crack-up boom that is not sustainable, that eventually the economy will deteriorate, that there will be more money-printing, and then you have inflation, and a poor economy, an extreme form of stagflation, and, eventually, in that situation, countries go to war, and, as a whole, derivatives, the market, and everything will collapse, and like a computer when it crashes, you will have to reboot it.

For the investor, the question is: How do I navigate through this complete disaster that is going to unfold? And I think if you look at different asset classes – real estate, equities, bonds, cash, precious metals – I suppose that you have to be diversified. I think real estate in the U.S. may go down another 10% or so, or even 15%, but I am always telling people, if you can buy the piece of land or the house you like, what do you actually care if it does down another 10%? If everything I bought in my life had only gone down 10-15%, I would be very rich, because a lot of things became worthless, especially loans to friends, and bonds, and so forth.

Look at the history, for example, of Germany, for the last 100 years. They had World War I. They had the hyper-inflation in World War II. The bond-holders got wiped out three times. If you owned Siemens, and you still own Siemens today, it was not a fantastic investment, but at least you still have something. You were not wiped out. I think that in equities you will be better off because you have an ownership in a company, than by being the lenders to companies, and the lenders, especially, to governments."

Marc Faber

Jim Rogers: Here's What I'm Bullish On Now

"Firstly, I have started looking at shorting US government bonds. I think they are turning into a real bubble because of this situation in the Middle East. People are flooding into US government bonds, which is a mistake. I have bought a small tractor company in Japan today because they are starting to infuse huge amounts of money in Japan trying to solve their agricultural problems. I am bullish on agriculture, I am bullish on all commodities."

Jim Rogers

Jim Rogers: Crude Oil Is Headed To $150-$500

"Certainly, it can go to USD 150 per barrel over the next decade. I have no idea what will happen this year. If Libya calms down and everybody else does, it will go down for a while. If the UK goes bankrupt or some sudden surprise happens, everything will go down. But crude oils is going to go over USD 150 per barrel, it is going to go to a couple of 100's in the next decade."

Jim Rogers

Warren Buffett: Berkshire Hathaway Profit Up 43% And We're Eyeing Acquisitions

“Our elephant gun has been reloaded and my trigger finger is itchy."

Warren Buffett

Are You Going "All-In" On Gold And Silver, Yet?

One of the surest signs of a top (and possibly THE top) is when people go "all in" on an asset class, as many precious metals lovers have done.

The reason I believe precious metals are holding up here is because the big boys have not completely sneaked out of the backdoor yet. But perhaps they may have already done so. New speculators coming in on these thin markets can help prop the prices up a little longer.

I recommend using some prudent asset allocation at this time. Certainly don't stay all-in.

As with everything else, when nobody can properly value an asset class that has been rising spectacularly (combined with people going all-in), you know the end is near. Even George Soros doesn't know how to value gold; he's just in for the "bubble" ride, as he puts it.

An inability to value an asset class may be a positive thing for precious metals investors because they don't have to put a P/E on these things. All they have to do is talk inflation and money printing, and you can talk these things for a very long time. At least during the internet bubble people could see P/E's of 200-500 so they can sell if they didn't believe in the valuation.

As inflation protection, dividend-paying stocks, not gold or silver, are still one of the best ways for long term inflation fighting. Many people made a lot of money by buying beaten down dividend payers during the recent bear market.

The equities market is doing well and will continue to do well. By the way, we may not have inflation, but rather an increase in demand of all commodities due to China and India wanting to be like us. Gold and silver are commodities too and they are thinly traded (like many other commodities) so it doesn't require a lot of money to get them moving.

Be careful out there.

Equities Vs. Precious Metals

The reversal in the precious metals (gold and silver) yesterday indicates a top may be in for the sector. Today was probably a bull trap -- an oversold bounce. Of course, in some super bull markets yesterday's action could be a nonevent and the bull continues. But in light of the unstoppable bull market in equities, it is likely the top in precious metals is near. Sure, maybe precious metals moves with equities market to SPX 1500, but there is only so far that precious metals and equities can move higher together. As the stock market continues its bull market, precious metals will collapse or trade sideways. After all, gold and silver are investments based on fear and thin markets and not much else.  I think next month's employment numbers are going to be surprisingly good. Investors are more positive these days and are re-entering the market, albeit slowly. Even with SPX at 1300, most people have not bought into the equities rally of the last two years. As surely as day and night, they will come back. I'm confident equities is where people ought to be invested.

Marc Faber: The Endgame Is Near

“The only true currencies that exist today are gold, silver, platinum, and palladium. This crackup boom will end very badly, but before it ends badly, we’ll have money printing, very high inflation, and when everything fails, the US will go to war. They’re already in war, but they’ll increase it.”

Marc Faber

George Soros On Green Energy

“Developing alternative sources of energy and achieving greater energy efficiency is both a significant global investment opportunity and an environmental imperative.”

George Soros

Warren Buffett On Discipline

"The chains of habit are too light to be felt until they are too heavy to be broken."

Warren Buffett

Chart Of The Week - TGT

What To Do Now?

The selling is merely a buying opportunity.  Traders are once again over-reacting to the Middle East headlines as they are very inclined to react with a repulsive force to any negativity after getting their psyche destroyed back in 2008.  The Libya uprising is not going to spread to Saudi Arabia.

So here's what to do now:

Paul Tudor Jones: Crude, Stocks And Bonds Are Related

"Currency, crude, stocks, and bonds; they're all interrelated. The whole world is simply a big flow chart for capital." 

Paul Tudor Jones

Warren Buffett: You'll Find The Brains In Israel

Jim Rogers On Libya

"Of course it can get worse. It can turn into a civil war which can rage for a long time. I doubt it will, given the state of the world. But now we are having more and more social unrest, certainly we are going to have a lot of social unrest. The price of food is going up. When food prices go up, people get agitated and they look for someone to blame."

Jim Rogers

Paul Tudor Jones: Don't Play Earnings

"I don't risk significant amounts of money in front of key reports, since that is gambling, not trading."

Paul Tudor Jones

Chart Of The Week - CY

John Paulson: My Top 20 Stocks

John Paulson's top 20 holdings:

SeekingAlpha

A Day Made Of Glass, By Corning

Buy The Morning Dip

The indicis are getting hit hard by strife in the Middle East. The only thing to do is to buy the dip.

Going All In On Silver And Gold?

I see many bears (or people who are just bearish on our economy and the fed money printing) are putting 100% of their portfolio in gold and silver stocks and ETFs.

First of all, that's bad asset allocation no matter how you look at it or how confident you are on the investment. Secondly, if things are as gruesome as the bears say, gold and silver could get confiscated at any time.

Just a government announcement could easily drop GLD and SLV over 50-80% overnite, in my opinion.

Be careful out there.

Jim Rogers: Long Dollar, Long Silver, Short The Fed

Ad: Your Kids Will Beat You

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And your 15-year-old kids, they can probably beat you in this stock market game with a little bit of study and with my manual.  To them, it will be like playing video games.  Most investors reading my blog are in the age range of 33-60.  You guys, like me, are dinosaurs.

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It's about how a few simple, logical, powerful ideas can make a massive difference in your stock market trading and investing.

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---Beanie

David Einhorn -- 17th Annual Graham & Dodd Breakfast

Heilbrunn Center for Graham & Dodd Investing
17th Annual Graham & Dodd Breakfast
David Einhorn’s Prepared Remarks
October 19, 2007

What strikes me the most about the recent credit market crisis is how fast the world is trying to go hack to business as usual. In my view, the crisis wasn’t an accident. We didn’t get unlucky. The crisis came because there have been a lot of bad practices and a lot of bad ideas. Securitization is a mediocre idea. Re-securitization of already securitized assets into a CDO is a bad idea. Re-securitization of CDOs into CDO-squared is a really bad idea. So is funding a pool of long-term illiquid assets with very short-term funding in the so called asset backed commercial paper market. And as I will get to in a moment, it is a horrendous idea to delegate most of the responsibility for assessing credit risk to a group of credit rating agencies paid for by the issuers rather than the buyers of bonds.

This crisis came for exactly the right reason. There is a big flaw in the structure of our credit markets. The bad structure induced lenders to take imprudent risks and make imprudent loans, which, of course led to losses. What is unique about this crisis compared to others is that the losses are in illiquid, opaque structures scattered around the world. Why should anyone be surprised? We got what we deserved.

Last Saturday’s Wall Street Journal reported that the big fear that the US Treasury Department is working to avoid is, “the danger that dozens of huge bank-affiliated funds will be forced to unload billions of dollars in mortgage-backed securities and other assets, driving down their prices in a fire sale. That could force big write-offs by banks, brokerages and hedge funds that own similar investments and would have to mark them down to the new, lower market prices.” So the fear is that the new prices are actually disclosed. This is the “don’t ask-don’t tell” method of security valuation.

In my view, the credit issues aren’t just about subprime. Subprime is what the media says. Subprime is what parts of our financial establishment say. Subprime is about them — those people and the people who made foolish loans to them. The word “Subprime” is pejorative. Subprime is not about us, for we are not subprime. How convenient to be able to pass the blame.

There has been much talk from politicians and pundits about predatory lending –that is making loans at high rates to people who couldn’t reasonably be expected to pay them back. They are right, that is a bad practice, but that is not what’s shaking the markets. At issue today is that lenders of all sorts have lent too much money and did not demand enough interest to compensate them for the risks they took. There has been a colossal undercharging for credit across the board.

I believe the poor lending standards and the low cost of credit in subprime extend throughout the credit markets into all areas of residential real estate, commercial real estate and the corporate lending markets.

Let’s start with the U.S. housing market. In addition to under-priced subprime loans, we have home equity loans to prime borrowers. We now see that when house prices fall — and they are falling — from a creditor’s perspective, a second lien is not much better than a credit card receivable, though the interest received is much less. Structures backed by Alt-A loans with no documentation are performing just as poorly as subprime structures, due to the lower amount of over collateralization embedded in those deals.

In commercial real estate, we read a few weeks ago about Macklowe, who purchased several buildings from Blackstone with a one-year bridge financing supporting a capital structure that was designed to be negative cash flow for the first five years. Last year Met Life sold Stuyvesant Village to an investor group for about thirty-five times free cash flow. Why were the buyers willing to pay so much? Because lenders were willing to lend over thirty times cash flow at low rates. While this was a large deal, it was by no means exceptional. These are loans based on the borrowers’ ability to refinance rather than the borrowers’ ability to repay. This is no different from 2-year ARMs in the residential market, except we haven’t yet reached the loss period when the music stops.

The same has been true in corporate lending. Very low debt spreads and weak lending terms have fueled the leveraged buyout boom. With lower interest rates, a private equity owner can service more debt. More debt means winning more deals at higher prices. Blackstone has said that the benefits of the favorable debt financing have been passed on to the sellers of companies.

Many of the loans were “covenant-lite” loans, where practically the only thing that could cause a default would be a missed payment. Some loans were “PIK-toggle” giving lenders the option of deferring payments. Put these together, and it becomes almost impossible to default quickly. The lenders actually convinced themselves this was a good thing — no early defaults mean a good bonus. I believe the “covenant-lite” and “PIK toggle” terms are quite parallel to the now criticized “no-doc” and “pay-option” terms that everyone agrees were ill conceived in the residential market.

In all of these areas, lenders have taken on too much risk for too little compensation. There is not enough spread to absorb any material up tick in losses. The only difference between these areas and subprime residential is that we haven’t seen the losses yet. Why have so many borrowers of all sorts been so undercharged for risk? The short answer is “securitization” or more broadly “structured finance.” Advocates of securitization say it disperses risk. However, it does so by separating the loan originator from the eventual outcome of the loan. The originator gets a fee up front. The risk is held somewhere down the line in an alphabet soup of structured vehicles called CDOs, CMBS or CLO — not to mention CDO2, SIVs, SIV-lites et cetera.

Why would anyone blindly lend to an opaque structure full of loans or pieces of pools of loans that they didn’t underwrite or even evaluate? Because the structures come with credit ratings from Standard & Poor’s, Moody’s and Fitch. Have the rating agencies developed an expertise in analyzing these structures? Perhaps, but more pertinent, they are the only ones who can evaluate them, because they are the only ones with the detailed information about the structures. The underwriters give the rating agencies much more information than is contained in the prospectus. In their evaluation of corporate credits, rating agencies are exempt from regulation FD. This means that they can receive confidential information not available to other market participants. This is kind of like a confessional where the priest delivers a public opinion on the extent of your virtues or sins — and your spouse has to guess what a AAA or BBB means about your fidelity.

In the recent crisis, the rating agencies say they shouldn’t be held accountable for their opinions because they are, with apologies to my wife, nothing more than journalists engaged in free speech. What would it be called if you paid a leading publication to do a story on you and you could pull it before press, if it were unflattering. Funny, that is not free speech but is ‘for-profit speech.’ According to the rating agency party line, if people disagree, they are free to ignore the ratings. However, a credit rating is not an ordinary opinion. It is a “special” opinion — an insider opinion, because it is based on a different information set. I can’t replicate a rating analysis, because I am not privy to the information. Therefore, I am not on equal footing to be able to decide whether I agree or disagree with a rating agency. Since they know more than I do, the presumption has to be to agree. The rating agencies are structurally set up to have “insider opinions.” They just don’t want legal liability for having issued conflicted and flawed insider opinions.

Incidentally, this lack of information has made it harder for the market to find a clearing price for distressed pieces of structured deals. Without enough information in the market — other than a credit rating — it is hard for informed buyers and sellers to know what to do, once the credit rating comes into doubt. One clear improvement to the current structure of the debt markets would be to insist that all information shared with rating agencies be shared with the whole market; the rating agencies should lose their exemption from Regulation FD. When Regulation FD was implemented many worried that if equity analysts didn’t have special access, the stock markets would become less stable. That hasn’t proved out. The credit markets should take the same step. More information broadly disseminated makes for a more efficient market.

lf you read Moody’s investor presentation you will see that the reason to buy Moody’s stock is to participate in the growth of structured finance. Moody’s business is to support that growth and Moody’s shareholders depend on this. This conflict has caused a great deal of ratings grade inflation in structured finance.

Consider municipal bonds. According to S&P’s long-term data the 10 year default rate on an A rated municipal bond is 1%; while a corporate bond’s default rate is 1 .8%; and a CDO’s is 2.7%. An A rated muni has the same chance of default as a AA/AA- rated corporate and a AA+ rated CDO. When municipal bonds default the expected recovery rate is 90% compared to 50% on corporates and CDOs.

This isn’t an accident. About a decade ago, Moody’s said, “No matter what types of instruments the ratings apply to, no matter where the issuer resides, and no matter what the currency or market in which the security is issued, Moody’s ratings are intended to have the same relative meanings in terms of expected credit loss.”

Without much fanfare the rating agencies abandoned this practice of AAA meaning AAA and BBB meaning BBB. Instead for each type of bond, they use a different rating scale with different so-called “idealized default rates” for each rating. The idealized default rate for a municipal bond at a given rating is less than the idealized default rate for a corporate bond, which is less than the idealized default rate for an asset backed security which is less than the idealized default rate for a CDO.

As an example of the lack of soundness in this system, Nomura securities pointed out that hypothetically, if you took a AA+ rated asset backed security and repackaged it all by itself and called the repackaged instrument a CDO, it becomes AAA, because the CDO has a higher idealized default rate than the asset backed security. When a municipal bond is put into a CDO, for modeling purposes the rating agencies ascribe a higher rating to the muni to adjust for the fact that the muni is under-rated in the first place.

Maybe everyone knows this, but it was news to me, when I learned it a few weeks ago. I might not be the only one who didn’t know. Is it a coincidence that rating agencies charge more to rate bonds in the more lenient categories?

Moody’s recently wrote a report saying that if States were evaluated on the corporate scale, 49 of them would be rated AAA Moody’s noted the 10-year cumulative default rate for all investment grade Moody’s-rated municipal bonds, including bonds one notch above junk, is about half the rate for AAA rated corporate bonds.

If municipal bonds are much safer than their ratings imply, it means that all kinds of states, cities and towns — effectively taxpayers of all sorts — are systemically overcharged for borrowing. The municipal bond market is $2.5 trillion. If the average municipality pays twenty basis points more for its interest because the bonds are under-rated, this scheme is costing taxpayers $5 billion per year.

The misrating of municipal bonds directly benefits the friends of the rating agencies on Wall Street, the banks who underwrite the deals. A lower rating — means bigger underwriting fees. Or alternatively, the excess cost can be shared with another great friend — I mean very large customer — of the rating agencies — the municipal bond insurers who effectively rebate some of the “overcharge” to the municipalities in exchange for a share of the savings through a scheme called “bond insurance.” The municipalities purchase bond insurance to enhance their credits to the AAA level. Of course, since they are in fact, AAA to begin with, the insurance provides no true benefit.

I assure you that a quick peek at the balance sheets of any of these so-called AAA rated bond insurers will tell you that they are not likely to be there to pay more than a fraction of the claims they have insured in an environment where there are wide-scale defaults in the municipal bond sector.

But I digress. Is it proper to have the same ratings mean different things in different classes? Probably not. For many bond buyers the statutory requirements are determined by the credit rating. If a bond is rated investment grade, then it is eligible for purchase. No distinction is made for buying the “good” A rated bonds versus the “bad” ones. The bad A- rated bonds don’t come with special warning labels. They tend to find themselves in the portfolios of the least sophisticated ratings-driven portfolios like pension funds. Wall Street has designed a number of lucrative strategies for itself and its clients to take advantage of these discrepancies through so-called “ratings arbitrage.”

To take a big problem and make it bigger, the new BASEL II standards for international banks that we are about to implement in the US, tie the regulatory capital requirements to the credit ratings. I don’t believe these standards give distinction to the good A rated paper versus the bad. This should broaden ratings arbitrage opportunities at the potential expense of distorting the regulatory calculations designed to ensure the safety and soundness of our banking system.

Coming back to the grade inflation in structured finance — in my opinion, the rating agencies are not in a position to blow the whistle, even if they wanted to because the conflict of interest is too great. In July, Moody’s publicly complained that by tightening its rating standards it had lost share in CMBS transactions. According to Moody’s managing director Tad Philipp, “It is those deals which we seek to differentiate through higher credit enhancement that we are least likely to be asked to rate.” He explained, “I guess this is sort of like no good deed goes unpunished.” Moody’s stock fell 2% that day.

The various entities that enable structured finance direct so much business to the rating agencies that the agencies can’t risk alienating them. If Pocatello, Idaho doesn’t like its rating, it has no leverage with Fitch. Wall Street is a different story.

On August 3, Standard & Poor’s revised Bear Stearns’ long-term credit outlook to negative from stable. This made a ton of sense. Three of Bear Stearns best businesses:

Mortgages, Hedge Funds and Prime Brokerage have all been severely impacted by the recent crisis. Bear was having trouble funding itself; its clients were fleeing and it was stuck with a highly levered balance sheet full of questionable assets like junior pieces of securitizations and variable interest entities and unsold inventory of mortgages, mortgage backed securities and asset backed securities. Also, it faces litigation over its hedge fund debacle. This very modest action created such a ruckus that Bear Stearns immediately put out a press release and held a conference call. The S&P analyst came out on TV that afternoon to do damage control saying “the market reaction today is overplayed.”

Rating agencies say hedge funds cause systemic risk. Funny, I think rating agencies are facilitating an even bigger systemic risk. It can be hard to value certain securities in times of distress. The latest hedge fund getting bad press is Ellington management, a large participant in the mortgage business. A couple of weeks ago, it suspended redemptions from its funds because it could not determine the value of its assets. Apparently they own what I’d call 20/90 bonds. 20-bid and 90-offered. While Ellington made negative headlines for doing the right thing, acknowledging it is unfair to let people in or out in such circumstance, does anyone believe that the large mortgage players like Bear Stearns and Lehman Brothers don’t also have large portfolios of 20/90 bonds? When they reported their quarterly results, investors marveled at their risk controls. However, Lehman moved about $9 billion of mortgage securities into a special classification called Level 3 under FASB 157, which gives them more valuation discretion. Both Lehman and Bear claimed their Level 3 portfolios actually had gains in the quarter, so it looks like they put the 20/90 bonds closer to 90 or perhaps even 95. This appears to be a classic example of a hedge fund being vilified for doing the right thing, while others are cheered for doing the opposite.

The rating agencies have lost the ability to impose discipline on the balance sheet of the broker-dealers and the financial guarantee companies — the enablers of structured finance that bring so much business to the rating agencies. This creates an enormous systemic risk, as these entities are able to maintain access to cheap credit while overextending themselves beyond prudence. One day, taxpayers may have to pay, should the government determine than an over-levered leader is too big to fail at the point it reaches the cusp of doing just that.

As the rating agencies have lost control, these companies have expanded their on and off balance sheet leverage over time with no apparent negative impact on their ratings. My friend, Bill Ackman, showed me MBIA’s balance sheet from 1990 which actually looked like a AAA balance sheet. Today’s balance sheet looks, well… different from that. Equity was 46% of assets in 1990 compared to only about 16% of assets today. Yet, it is still triple A.

The rating agencies offer branded products. Their best brand is AAA. People buy AAA because they don’t want credit risk. There was a big fuss over Enron. Enron was BBB. BBB rated entities default from time to time. AAA ratings don’t — or at least they didn’t. Now, we are set for an unprecedented spate of originally AAA rated bond defaults. In my judgment, the effects of grade inflation will eventually ruin the brand values of the rating agencies.

In August, Morgan Stanley wrote a report that estimated Ambac, a bond guarantor, could suffer $5 billion of losses from its subprime exposure in its stressed loss analysis. The report said “if Ambac were to take a $5 billion charge, we do not see how it could possibly raise enough equity to remain a going concern. A loss of this magnitude would erode 75% of its $6.7 billion in qualified statutory capital.”

One would think that even the reasonable possibility that Ambac could suffer that fate would be enough for the credit-rating agencies to downgrade Ambac. After all, it has a AAA rating — the gold standard. Nothing could be more creditworthy than AAA. Will the rating agencies at least put Ambac on “credit watch?” I believe the conflicts of interest mean they can’t and they won’t. Morgan Stanley agrees. Its conclusion about Ambac was the cynical, but practical one — it rates Ambac “Overweight.”

In early September, a senior Moody’s executive confirmed this suspicion at a small private dinner sponsored by one of the brokerage firms. He said, “Moody’s would never lower the credit ratings of a financial guarantor, because that would put the guarantors out of business.”

It is plain that the States and Cities and Towns in this country are triple A credits without triple A ratings and the financial guarantee companies have triple A ratings without being triple A credits.

When ratings agencies are more concerned about the effects of the rating actions than on the accuracy of the ratings, they become part of the Wall Street “confidence” machine and surrender their ability to fulfill their statutory role in objectively analyzing credit.

One would think that the lesson here would be to get rid of the bad practices. We should be asking ourselves what role, if any, should there be for credit rating agencies? If there is a role, should the rating agencies lose their exemption to Reg FD so that outsiders can truly do their own credit analyses on equal footing, when they don’t trust the rating agencies? To the extent that we are going to have credit ratings, shouldn’t all credits be evaluated on a single scale? And should ratings agencies be paid by the users of the ratings, rather than by the issuers?

Some have questioned whether we would lose the benefit of public ratings and doubted there would be enough business for the rating agencies, if we eliminated the issuer pays system. First, I believe we could mandate the public disclosure of ratings and allow the agencies to profit by selling the more detailed research to subscribers. There are existing firms like Egan-Jones selling credit analysis on this model; however, such a change would likely have an impact on the profitability of the rating agencies. For example, Moody’s has an operating profit of 54% of sales. This ranks it 5th in the entire S&P 500. It is able to have these margins because of the current system. If you change the system, the margins will fall. Certainly, the rating agencies will fight very hard on this issue and try to scare people.

However, there is a very big gap between 54% margins and not having rating agencies. If they lost the issuer pays structure, they would hardly say “Oh well, let’s go home, then.” They would have to adapt and they would persist in business. The margins would be less, but the capital markets would be much better served.

A couple months ago, I thought CDO’s would go into the bad financial ideas Hall of Fame next to portfolio insurance, which exacerbated the crash in 1987. Today, I am not so sure.

Certainly the buyers of bonds, the losers in the current arrangement will have a say in some of this. But the Wall Street machine is a loud one, the credit rating agencies are entrenched and the current powers in Washington don’t want to see anyone lose money on their watch.

What doesn’t surprise me is that many holders of the bad paper are in no rush to mark them down to fair value and that Washington is willing to aid their efforts to sweep the problems under the rug. It is very important to many banks and broker-dealers that ‘we maintain a “Don’t ask — Don’t tell” policy of price discovery for troubled debt instruments.

I have watched valuation treatment by public companies in a smaller, but telling way for the last several years. In May 2002, 1 was invited to make a speech at the Ira Sohn research conference to benefit the Tomorrows Children’s Fund to support the children’s cancer center in Hackensack. It was the first time I was invited to give a public speech. I was asked to speak about an idea. I picked, what I thought to be the best and most interesting idea in my portfolio at the time, which was to sell short Allied Capital. The gist of my speech was that Allied Capital had swept its own bad loans from the 1999-2002 corporate credit crisis under the rug and refused to mark them down to fair value. I believed it mismarked its portfolio.

By the time I gave my speech about Allied Capital, it was late in the afternoon. The market had closed for trading. The next day, Allied’s stock was unable to open when the market did. There were too many sell orders for the New York Stock Exchange specialist to balance them on time. When the shares did trade, they opened down 20%. But the steep decline that day was nothing compared to the plunge I was about to take, spending years uncovering what I view as a fathomless fraud.

As some of you may know, this is an ongoing saga. Allied fought back hard. Over time, I discovered Allied’s wrongdoing was much deeper than I initially imagined and extended as far as bilking U.S. taxpayers out of tens, if not, hundreds of millions of dollars by underwriting fraudulent government backed loans through its Business Loan Express subsidiary.

I believe the media, Wall Street analysts, the board of directors, the accountants, the SEC, prosecutors and other government agencies have completely fallen down on their jobs to police Allied’s management. For the purpose of today’s talk, let’s just assume that I was right…that Allied did have improper accounting and then went out of bounds in an intimidating shoot the messenger campaign to silence and smear its critics and distract folks from its own misconduct by among other things screaming market manipulation and even hiring private investigators to illegally steal the telephone records and gosh knows what else about its critics.

Instead of investigating my allegations of Allied’s improper accounting, regulators first decided to investigate Allied’s claims that my speech was an attempt to manipulate the market.

As Allied persists in its misbehavior without consequence — in fact, its shares have since recovered from the initial fall after my speech — it raises the question: if someone commits fraud, but no one has yet lost money and the regulators decide to ignore it, was it really fraud? The authorities are good at “cleaning up” fraud after the money’s gone. After a blow-up, with investors’ capital already lost, they know just what to do. If the blow-up is big enough, like Enron, they form a special “task-force” and pursue criminal cases against the insiders.

The authorities really don’t know what to do about fraud when they discover it in progress. The Arthur Andersen prosecution, which put the audit firm out of business for bungling Enron, cost a lot of innocent people their jobs. The government doesn’t want that to happen again. It seems that the regulatory thinking, espoused by SEC Chairman Christopher Cox is that shareholders should not he punished for corporate fraud, because he believes they are the victims in the first place. Why punish the victims a second time? This thinking may be politically expedient in the short term, but creates a classic “moral hazard.” If regulators insulate shareholders from the penalties of investing in corrupt companies, then investors have no incentive to demand honest behavior or avoid investing in dishonest companies.

The truth is that investors in corporate securities are risk takers making investments of risk capital. One risk is fraud. The best way to encourage fraud avoidance is to make the penalties for fraud sufficiently high. If investors believe that companies making false and misleading statements will be punished, they will be more sensitive to what is said. Their money is at stake.

Passing laws like Sarbanes-Oxley helps honest companies create better controls. It does nothing to stop top-down corporate fraud, unless it is enforced. For our markets to work effectively, participants need to follow the rules and when they stray, there need to be serious consequences. If Sarbanes-Oxley is to be effective and taken seriously, the SEC can’t let behavior like Allied’s pass without prosecution.

To tell the whole story would take me far more than the time we have together this morning. In fact, it would take a book. It is a story worth telling. So much so, I have written a book on the whole experience. It is called “Fooling Some of the People All of the Time” and will hit the bookstores next spring. Before going on to questions, I thought I would read you an excerpt from the book so you can get a flavor as to what you might find at Barnes & Noble next year.

Steve Cohen On The Current Stock Market

As for the current market he described it as “grinding every day.” But “underneath stocks are exploding, and everything I’m seeing today looks bullish,” he said. “I’m not going to get negative just for the sake of being negative.” He added that it was a strong January and while there’s the potential for dislocation over summer when QE2 ends but that this is shaping up to be “a typically classic year” for the market.

Dealbook

Warren Buffett: I Was Lucky

Resurgence Of Ethanol?

Ethanol and lithium batteries are the only two types of clean auto fuel that is available today.

David Einhorn owns BIOF.

Wayne Huizenga: Ceos Confident Of Recovery, I'm Excited About The Next 12 Months

“For most business men and woman, they’re out there trying to make it happen on their own. They’re not worried about Washington.”

Albert Einstein On Complexity

"Any intelligent fool can make things bigger and more complex... It takes a touch of genius - and a lot of courage to move in the opposite direction."

Albert Einstein

Paul Tudor Jones: My Current Top 5 Stocks

S&P 500 Spyders (SPY)

iShares MSCI Emerging Markets Index (EEM)

Citigroup (C)

GAIN Capital Holdings (GCAP)

AT&T (T)

Warren Buffett On Investing Focus

"Dumb investors focus on the glass of milk. Smart investors focus on the cow."

Warren Buffett

Albert Einstein: Mathematics Is Not A Certainty

"As far as the laws of mathematics refer to reality, they are not certain, and as far as they are certain, they do not refer to reality."

Albert Einstein

David Einhorn On St. Joe

"There is a considerable gap between timberland and conservation values that support a single-digit share valuation for St. Joe and the current public market valuation that implies that undeveloped rural land in the Florida Panhandle is worth more than Iowa farmland. The land values don’t justify the stock price. We do not believe cutting some executive compensation expenses or installing a new management team would bridge that gap."

David Einhorn

Bulls Are Back: SPX 2,800 By 2013

So, I'm not the only crazy guy when I said the Dow will hit 36,000 by the end of this decade.  This market is very much like 1995.

Ed Seykota's Trading Song

Warren Buffett: Your Heroes Say A Lot About You

"If you can tell me who your heroes are, I can tell you how you're going to turn out in life."

Warren Buffett

Steve Cohen: Always Be Charting

"Any time I get into a position I’ll look at the chart first. I always default to the chart. It is critical for entry points.”

Steve Cohen

Steve Cohen: 3 Mistakes That Can Kill You

“Leverage, concentration and illiquidity are the three things that can kill you.”

Steve Cohen

Maybe Next Time He'll Think Before He Trades

David Einhorn Recent Stock Buys And Sells

Bought:

BP -  $145 million
Sprint Nextel - $250 million
Potash - $60 million
MDC Holdings - $2 million
Capitol Fed - $1.2 million

Sold:

Xerox - $130 million
Ralcorp Holdings - $110 million
Foster Wheeler - $100 million
CIT Group - $80 million

Businessinsider

Steve Cohen: Watch Your Losers

“I spend most the day watching my losers because if those are being managed correctly the winners take care of themselves."

Steve Cohen

Warren Buffett Earns Presidential Medal Of Freedom

Steve Cohen: My Top 3 Stock Picks

Williams Companies (WMB)

Plains Exploration (PXP)

Green Mountain Coffee Roasters (GMCR)

Steve Cohen

Paul Tudor Jones: Don't Rationalize

"I see the younger generation hampered by the need to understand and rationalize why something should go up or down. Usually, by the time that becomes self-evident, the move is already over."

Paul Tudor Jones

Victor Sperandeo: You Won't Make It In Trading If You Don't Admit To Being Wrong

"Assume that you're a brilliant student who graduates from Harvard summa cum laude. You get a job with a top investment house, and within one year, they hand you a $5 million portfolio to manage. What would you believe about yourself? Most likely, you would assume that you're very bright and do everything right. Now, assume you find yourself in a situation where the market is going against your position. What is your reaction likely to be? "I'm right." Why? Because everything you've done in life is right. You'll tend to place your IQ above the market action.

To be a successful trader, you have to be able to admit mistakes. In trading, however, the person who can easily admit to being wrong is the one who walks away a winner. Besides trading, there is probably no other profession where you have to admit when you're wrong."

Victor Sperandeo

Jeremy Grantham: Never Fight The Fed

"Never fight the Fed about market prices or underestimate its global reach. The U.K. stock market has been more responsive to the U.S.’s Year 3 stimulus than the U.S. market has itself. It shows Britain in its true colors: half a hedge fund and half the 51st state.  How humiliating!"

Jeremy Grantham

Benjamin Graham: Your Biggest Enemy?

"The investor's chief problem--and even his worst enemy--is likely to be him self."

Benjamin Graham

John Kenneth Galbraith: It's Hard Changing One's Mind

"Faced with the choice between changing one's mind and proving there is no need to do so, almost everyone gets busy on the proof."

John Kenneth Galbraith

Albert Einstein On Wisdom

"Wisdom is not a product of schooling but of the lifelong attempt to acquire it."

Albert Einstein

Jack Schwager: A Key Characteristic Of All Great Traders

“Every single great trader that I met, found a methodology that fit their personality.”

Jack Schwager

Jack Schwager: Winning Methods of the Market Wizards

Paul Tudor Jones: Everything Happens For A Reason

Paul Tudor Jones - Failure Speech June 2009

Jesse Livermore: How To Know If Your Trade Is Right

"Experience has proved to me that real money made in speculating has been in commitments in a stock or commodity showing a profit right from the start."

Jesse Livermore

Bruce Berkowitz On AIG And JOE

Ken Fisher: 2011 - A Pause For Breath

Stocks soared in 2010. Expect less in 2011.

The bull isn't over, but returns will be modest - frustrating both strong bulls and bears. Also, expect wide performance dispersion among categories and leadership changes. I call it the year of the "alpha-bet".

In any year, stocks can do one of four things - rise a lot, rise a little, fall a little, or fall a lot. Up-a-little is most likely for 2011, down-a-little next most likely and up-a-lot third - least likely is down-a-lot.

Why? 2011 is this bull's third year - starting in March. Third years are often modestly positive or mildly negative, sometimes very strong, but not terrible. Average returns for a third year are just 3.66% (in US stocks, for which we have vaster historic data). Strip out the down years, and the average of positive third years is 10.8%. Not bad, but still not huge. After a couple of strong years, 2011 will be more like 1960, 1977, 1994 and 2005 - pauses that refresh before the bull market's next big up-leg.

Stocks surging out of 2010's correction helped improve sentiment.

Now, there are too many optimists for "up a lot" to be likely. Too many über-bears too! But little in between - giving us a bifurcated, barbell sentiment display that's rare but not unprecedented. These strongly opposed forces almost offset each other - like a volatile sideways tug-of-war. I call the market The Great Humiliator - it wants to humiliate as many people as possible, for as much money as possible for as long as possible. It's exceptional at it. Now the best way to do that - annoy both bulls and bears - is to have stocks be flattish this year.

Ken Fisher