A Look at the Market and the Debt Crisis

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Today I’m going to talk about the market and a Facebook update and then we'll look at “the debt crisis for dummies” briefing, also known as “a parable from Helga’s bar.” You’ll like both, I promise...

Now to the market: The main indices snapped back sharply on Monday and Tuesday didn't know what to do. This is typical behavior after a decent drop - we'll know more in the next few days, but if you were short you easily had enough time to bank decent first profits according to my trading plan.

Regarding the Facebook (FB) launch, I'll talk more about the stock price behavior in due course as it settles into its new listed environment.

My concern about FB as a company valued at c. $100 Billion, is that I really don't understand what it actually owns in terms of intellectual property. And without owning anything particularly proprietary, one day its prosperity could literally evaporate in a puff of smoke.

Over dramatic? Well, what if more corporates like GM decide not to advertise on Facebook? Or consider the impact of a News Corp style of scandal. With a non-privacy-invasive competitor waiting in the wings who's to say Facebook members wouldn't jump ship? It would only take a simple app to transfer your data over and then close your Facebook account. People are very fickle, and one bad move by FB could start a catastrophic migration.

I personally find it clunky, user-unfriendly, and cannot understand the current craze of people using it for their own public therapy!

In a nutshell, I don't understand what FB actually owns or produces, nor how it derives its sustainable income. This makes it a completely different proposition to Apple or Google, for example, and yet its PE multiples at IPO were vastly greater than those proven performers that actually do own and produce best-of-breed stuff. Furthermore I think FB could one day be very vulnerable to a mass exodus.

Dummies' Guide to the Debt Crisis

A good friend sent me this piece and I don't know whom to credit for it, but it's the clearest explanation I've heard regarding the debt crisis and the credit bottleneck that is stifling the world's economy.

Helga is the proprietor of a bar. She realizes that virtually all of her customers are unemployed alcoholics and, as such, can no longer afford to patronize her bar. To solve this problem she comes up with a new marketing plan that allows her customers to drink now, but pay later.

Helga keeps track of the drinks consumed on a ledger (thereby granting the customers' loans).

Word gets around about Helga's "drink now, pay later" marketing strategy and, as a result, increasing numbers of customers flood into Helga's bar. Soon she has the largest sales volume for any bar in town.

By providing her customers the freedom from immediate payment demands, Helga gets no resistance when, at regular intervals, she substantially increases her prices for wine and beer - the most consumed beverages.

Consequently, Helga's gross sales volumes and paper profits increase massively. A young and dynamic vice-president at the local bank recognizes that these customer debts constitute valuable future assets and increases Helga's borrowing limit. He sees no reason for any undue concern, since he has the debts of the unemployed alcoholics as collateral.

He is rewarded with a six-figure bonus.

At the bank's corporate headquarters, expert traders figure a way to make huge commissions, and transform these customer loans into DRINKBONDS. These "securities” are then bundled and traded on international securities markets.

Naive investors don't really understand that the securities being sold to them as "AA Secured Bonds" are really debts of unemployed alcoholics. Nevertheless, the bond prices continuously climb and the securities soon become the hottest-selling items for some of the nation's leading brokerage houses.

The traders all receive a six-figure bonus.

One day, even though the bond prices are still climbing, a risk manager at the original local bank decides that the time has come to demand payment on the debts incurred by the drinkers at Helga's bar. He so informs Helga. Helga then demands payment from her alcoholic patrons but, being unemployed alcoholics, they cannot pay back their drinking debts. Since Helga cannot fulfill her loan obligations she is forced into bankruptcy. The bar closes and Helga's 11 employees lose their jobs.

Overnight, DRINKBOND prices drop by 90%. The collapsed bond asset value destroys the bank's liquidity and prevents it from issuing new loans, thus freezing credit and economic activity in the community.

The suppliers of Helga's bar had granted her generous payment extensions and had invested their firms' pension funds in the BOND securities. They find they are now faced with having to write off her bad debt and with losing over 90% of the presumed value of the bonds. Her wine supplier also claims bankruptcy, closing the doors on a family business that had endured for three generations; her beer supplier is taken over by a competitor, who immediately closes the local plant and lays off 150 workers.

Fortunately though, the bank, the brokerage houses and their respective executives are saved and bailed out by a multi-billion-dollar, no-strings-attached cash infusion from the government.

They all receive six a figure bonus.

The funds required for this bailout are obtained by new taxes levied on employed, middle-class, non-drinkers who've never been in Helga's bar.

Now do you understand?

Remember, Plan your Trade and Trade your Plan!

Guy Cohen

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