Small Cap Stocks

Goldman’s annual report had this interesting quote:

“Goldman Sachs is grateful for the indispensible role governments played and we recognize that our firm and our shareholders benefitted from it,” Blankfein and Cohn wrote. “It is impossible to know what would have happened to the financial system absent concerted government action around the world.”

Here’s what would have happened absent concerted government action: Absolutely nothing, as long as you didn’t work for Goldman Sachs!

People would have woken up the next morning, and gone to work, assuming they were in jobs that actually produced something for the economy. They would have gotten paid for their work and then gone home. No a big deal. Any capital scarcity issues for payment of wages could be easily addressed by the government, as can be amply demonstrated by the paradoxical government actions to ensure obscene bonuses for anyone working at bankrupt financial institutions, while shutting off capital from the rest of the population. And, in the worst case scenario, for the unemployed, the government could have easily immediately instituted a major job program to get people back to work (Yes, having people working, as opposed to being unemployed, should be the goal of any government).

Pretty much the only real issue in the economy would have been for those people employed in speculation and gambling in the financial markets. But those people are already mostly wealthy, at least on a relative basis, and could have withstood the initial shock, as many had. The Market would have recovered in due time, as it always does, when people with some money and some brains moved back into solid investments, recognizing that since human beings still were alive an economy still existed, and money could be made. Other firms would have quickly sprouted up to fill any voids in the financial sector.

There never could have been a second depression as the fear mongerers would have you believe, since our entire financial system is now set up to prevent a second great depression, i.e. deposit insurance, welfare, unemployment insurance, fiat money system, no “barbaric” gold standard, ability of massive government intervention in the real economy etc. There is enough of a back stop from the government already existing and easily deployed in our economy, that massive government intervention is completely unnecessary to prevent the failure of financial gambling institutions, especially those whose activities are clearly fraudulent.

For awhile now, I’ve been wondering what the logical basis was for our current barbaric employer-based healthcare system, under which if you don’t work for a company, you can’t get affordable insurance. No other industrialized country has such a ludicrous type of system, presumably because it is the right of every individual in civilized society to be able to get the healthcare that they need, irregardless of who they work for or what kind of work they do. Can you only get auto insurance if you work for a big company? How about life insurance?

In truth, there really is no logical basis for an employer-based healthcare system. Apparently, the system is a relic of history, as described in this article: Is Employer-Based Health Insurance Worth Saving? from the NY Times, which I just came across online.

The author explains:

“Our employment-based system was not the product of a carefully designed health policy. It was a byproduct of evading wage controls during World War II. At the time it was thought that, as the nation’s drafted military personnel risked their limbs and life on foreign battlefields at low, tightly controlled pay, those who stayed behind should have their wages controlled as well.

But with the wink of the eye with which Congress routinely puts loopholes into the tax laws or regulations it imposes, the wage controls imposed in World War II did not extend to fringe benefits. And thus, employer-paid fringe benefits, including employment-based health insurance, were born. “

So Is Employer-Based Health Insurance Worth Saving? As a self-employed person, I’m of course biased, but I can think of few other aspects of US society that are as reprehensible as linking healthcare to employment and unfortunately Obama’s plan does little to nothing to actually improve upon this situation. Even from an economic perspective, a healthier society will obviously produce a better economy, so wouldn’t it be prudent for the government to invest as much as possible to ensure quality healthcare for every citizen irregardless of where they work? The payback for a healthier society would be enormous. Imagine if the government took $5 trillion, and instead of investing it in worthless Wall Street securities that have no social benefit, put the money into reforming healthcare.

One of Schopenhauer’s key contributions to philosophy was his belief in the primacy of the Will. In Schopenhauer’s world, the Will proceeds the Intellect/Thought. Schopenhauer’s insight into the primacy of the Will, was of course, a major advance in thought, which I believe greatly influenced Freud’s development of the theory of the unconscious.

The main thrust of thinkers, like Schopenhauer and Freud, is that our conscious thoughts and our rational minds are really only after thoughts. Essentially, most of the time, our conscious mind, or what we think is rational, is merely a set of rationalizations for irrational activities of the Will (I leave out mathematics and science from the discussion here because the rationality of mathematics/science is an incredibly complex issue).

The application of Schopenhauer’s Primacy of the Will, which I believe to be true, to financial markets is quite straightforward. I believe that, in general, the valuation justifications brought forward to explain or predict financial market prices, like stocks, are merely rationalizations, i.e. they are after-thoughts. Complex financial valuations, e.g. EV/EBITDA, are simply a way to rationalize the previous purchase of securities, and there is no way that intellectual valuations can ever serve as the foundation for a purchase, or sale. Incidentally, the secondary nature of valuations is precisely why “Value Investing” is just as unjustified as “Technical Trading.” Both are modern day “snake oil” investment theories, despite the Buffett Halo (as I’m sure most realize, Buffett doesn’t really make his money from value investing, though he ingeniously, as any smart businessman would, seeks to convince others that he does).

The above of course begs the question: If valuation is not the primary driver of financial market prices, than what is? What is the “Financial Will” that proceeds the “Financial Rationalization”? And if one cannot use valuation to justify buys or sells, then what can you use?

These are very difficult questions to answer, and quite frankly I don’t profess to know the answers just yet. In fact, I’ve recently become completely convinced of the “after-thought” nature of valuation.

In future posts, I plan to offer some of the solutions I’ve come up with for the above problems, and hopefully show how they can be used to make money in financial markets.

This past month I’ve been re-reading Schopenhauer’s later works and to my surprise many of his ideas can be applied, by analogy, to modern day financial markets. His dialogue on religion, particularly struck me because of how similar the positive arguments for religion were in his time, to the current arguments in favor of big finance. It almost seems to me that finance has stolen the limelight from religion, and in the process usurped all the intellectually erroneous arguments for religion in support of modern day financial myths.

One specific example is the use by modern finance of the pragmatic approach to religion. It suffices to frame the pragmatic view of religion simply as follows: Religious pragmatism basically believes that without religion there would be no morality and society would collapse. This ethical view of the foundation religion, while false, is still held by many religious people, which is why moral transgressions by deeply religious people often times seems so shocking (they wouldn’t be, of course, if people understood that religion and ethics are two entirely separate spheres of human activity).

Stepping back from religion, I think most of us are now quite familiar with the pragmatic approach to finance, which is simply that if without high finance, i.e. the creation of and speculation in “imaginary” securities, we could not have a well-functioning economy and society. This argument, of course, laid the foundation for the ludicrous multi-trillion dollar bailout of large financial companies during the financial crisis.

Of course, numerous modern day counterexamples can be given to the “Save finance or else!” meme (in fact I believe that the counter examples, prove exactly the opposite: No bail out and less finance equals a stronger economy and society). However, I think that showing the intellectual errors of this meme is perhaps a better way to go.

For that we’ll need to go quickly back to religion. The basic reason why religion cannot be supported by ethics, i.e. one needs religion to keep society ethical, is because to merely discuss the issue presupposes a definition of ethics. For instance, to even debate whether God is good or evil, assumes some definition of good and evil. One could, of course write an entire book on this concept, but it suffices to say that religion and ethics are clearly two separate intellectual spheres. Quite simply, people, and by extension society, could be ethical without religion, because ethical concepts already exist without religion. Religion may of course, provide other benefits to an individual or society, which are beyond the scope of this post, but ethics is surely not one of them.

The same line of reasoning can be applied to the “save finance or else” argument. The basic error, of course, is that nearly all aspects of finance presuppose an economy, so that the collapse of finance cannot possibly lead to a dissolution of our economy or our society. Interestingly, while ethics can exist without religion, and vice versa, it should be clear that most finance cannot exist without an economy. This is because without an economy, there would be nothing to finance. For example, if there were no such thing as houses, there could have been no mortgage market or subprime mortgage meltdown. If there were no loans to real businesses, there could be no CDS market. Even more simply, if there was no economy, there would be no need for a means of exchange, and absolutely no need for money or finance.

At this point, I should mention that I believe quite strongly that Wall Street invents worthless securities on a daily basis, so that in essence one does not need an economy for certain aspects of modern day financial markets. One simply needs a “market maker”, and a belief that the securities have some value. But this position also implies, perhaps even more strongly, that the downfall of finance would have no effect on the real economy, because many financial instruments have absolutely nothing to do with the economy in the first place. How can their collapse, therefore, have any effect on the economy?

Based on the above, I think it should be clear that our economy and society provide the basis for finance and not vice versa. And even when a real economy is missing, Wall Street can simply invent a tradeable financial instrument based on nothing other than as a reference to the instrument itself. Taken together, it is obvious that the economy would do perfectly fine without the large financial institutions and high finance. Of course, given the current structure of society, certain economic relationships would cease to exist with the downfall of big finance, however, these economic relationships could be easily, and quickly, replaced, if needed, by a different set of social and economic principles.

All in all, it should be clear that the claim that society cannot function without finance, is merely an empty threat, used by the priests of high finance to enrich themselves at the expense of others in society. Doesn’t this sound familiar to the way religion was used for centuries?