Because We're Here

By Tim Price | October 30, 2008 | 2:37 PM | 0 Comments

Lieutenant Gonville Bromhead: “Was it like this for you ? I mean, how did you feel the first time ?”

Lieutenant John Chard: “How do you feel ?”

Lieutenant Gonville Bromhead: “I feel afraid and there’s something more. I feel ashamed. There. You asked me and I told you. How was it your first time ?”

Lieutenant John Chard: “Do you think I could stand this butcher’s yard more than once ?”

- From the screenplay to ‘Zulu’ by John Prebble and Cy Endfield.

Notwithstanding Ben Bernanke’s apparently extensive study of the Great Crash and the Depression, no amount of reading about such a huge market dislocation could possibly have prepared the most apt student for the Crash of 2008. And Ben Bernanke isn’t directly managing other people’s money, so much as helping (amongst other things) to divert billions of taxpayers’ cash toward the evidently deserving banksters on Wall Street.

First observation. Trying to draw meaningful medium term investment conclusions in response to short term market movements has now moved from the realms of camp surrealism to outright farce. As Macro Man points out, two days in October were among the worst days for the Dow Jones Industrial Average ever: 15.10.2008, down 8.2% and 9.10.2008, down 7.6%. But look on the bright side, two days in October were also among the best days for the Dow Jones Industrial Average ever: 13.10.2008, up 10.5%, and 28.10.2008, up 10.3%. Forget those plans to break the bank in Monte Carlo; just watch the value of the world’s largest capitalised companies if you really want to see where the action is.

On which note, let’s not forget the circus freak show that Volkswagen stock has become. As the price charts show, a blue chip component of the German Dax Index is convulsing like a penny stock charged with 58 million volts. Doubtless the German laughing stock exchange will maintain that VW market makers were only obeying orders.

The VW corner is not without precedent. John Brooks, in ‘Once in Golconda’ (John Wiley & Sons) charts the course of Allan Ryan and the infamous 1920 bear raid on his investment, the Stutz Motor Car Company of America:

“At first, Ryan lost ground. So great was the short-selling pressure that, despite his efforts, by early March the price of Stutz had dropped back to near 100. But then the tide turned decisively. By the morning of March 24 Stutz was up to 245; that day it shot up to 282, and a week later had skyrocketed to 391. In the course of the startling rise, practically all Stutz stockholders except Ryan, his firm, and members of his family decided to take their profits, and sold their stock – which was snapped up in every case by Ryan; meanwhile, the opportunity to get an inflated price for Stutz appealed more and more to the short sellers, whose number and activity increased, and Ryan bought their offerings, too. Toward the end of the month, the stock that they were selling to Ryan had first to be borrowed from him, since there was no longer anyone else who had any. Confident that he was winning, he gladly went on lending and then buying it, and the wild, uncontrolled rise to 391 on March signalled his victory. The short sellers, it was clear, had disastrously underestimated his strength; they were overpowered, and their remaining choices were to buy back the stock they owed him, at his price, thereby incurring huge losses, or, alternatively, to face professional ruin and perhaps a prison term for breach of contract. Ryan, who was feeling much better by this time, had engineered in Stutz what Wall Street calls a corner.”

Unfortunately for the triumphant Ryan, he reckoned without the ability of members of the New York Stock Exchange to look out for their own.

“In the light of this situation, certain events of March 31 appear odd indeed. Ryan was in a position to know who most of the short sellers were, since in recent days it was he and he alone who had loaned the stock; he knew, then, that most of them, like him, were members of the Stock Exchange, and some of them, unlike him, members of its key committees.. Ryan was summoned to appear before the Exchange’s Business Conduct Committee to explain the gyrations of Stutz. He might have thrown the question back at certain of his interrogators, whom he knew to be among the short sellers; instead, he explained to the committee that the scarcity of Stutz stock had apparently been brought about by the fact that he and his family now owned it all – and even, because of clerical confusion, had contracts for a few more shares than actually existed. He then named the terms on which he would settle with the short sellers, still diplomatically omitting to mention that some of them were seated in front of him. He would, he said, sell them all the shares they needed to fulfil their contracts at $750 per share.”

To cut a long and inglorious story short, the Governing Committee of the Stock Exchange immediately decided to suspend all dealings in Stutz for an indefinite period. A Stock Exchange spokesman, when reminded by a reporter that no rule of the Exchange appeared to allow such behaviour, replied that “The Stock Exchange can do anything.” The Exchange also refused to accept Ryan’s resignation as a member, subsequently found him guilty of “conduct inconsistent with just and equitable principles of trade”, and forced him into bankruptcy. Thankfully such venal and cynically self-interested behaviour on the part of the authorities and brokerage firms would, of course, be inconceivable today.

Irrespective of the high jinks surrounding the suspension of financial short selling across major exchanges, hedge funds are in any case fighting their Waterloo. While the very best managers will tend to thrive under even the most extreme conditions (i.e. now), a significant proportion of the industry will inevitably get carried out on stretchers, in part because they were never much more than hubristic potheads leveraging beta. In any event, the investment environment for the next 12 months will have the following attributes: simplicity, liquidity, transparency. The phrase “stocks, bonds and cash” would be an appropriate if somewhat simplistic shorthand.

“Why is it us ? Why us ?” asks Private Thomas Cole in Cy Endfield’s ‘Zulu’ – the shattering cinematic account of a historic massacre of British - and Zulu - warriors. Shocked investors may well feel like asking the same question. One answer is that we are all in the dubiously fortunate position of having lived through the greatest bubble in property valuation and credit creation, and now the greatest asset deflation, in history - whether we wanted the experience or not. Colour Sergeant Bourne’s reply is a little more philosophical:

“Because we’re here, lad. Nobody else. Just us.”