The Emperor's New Balance Sheet

Posted: Jul 20, 2011 12:01 AM

The headline on CBS MarketWatch was dramatic: “Goldman Sachs hits a 52-week low.” 

In addition, Bank of America also hit a 52-week low. 

Why is this happening? 

I’ve heard all the excuses on television, from hosts to analysts and from executives to stock traders.  When I sifted through all the data myself, it seemed to me that the old tale of the Emperor’s New Clothes was more true than ever. 

The major banks have been protected by the Federal Reserve, the Treasury, and the White House since the credit crisis of 2008, and some would contend they’ve been protected a lot longer than that.  Excuses of a repeat Great Depression, financial armageddon, and return to normality have all been offered, and I find these explanations totally unconvincing. 

For quite a while, the markets only recognized the headlines when it came to these zombie banks.  Fostered by the media’s love affair with President Obama, the obviousness of the internal decay and corruption is either overlooked or simply ignored. 

From robot-signings to prop desk high frequency traders, it was only a question of time before true valuations started to take hold and were reflected in stock prices.  Being an old Wall Street veteran, I believe the truth of a company’s well being, or consequently a company’s ill-being, will ultimately be reflected in the stock’s valuation. 

It may take longer than we think because of the inevitable smokescreens, but it will always happen. 

The sad fact is that the media still buys the bogus numbers that financial companies continue to spew.  Most recently, the accounting trick du jour has been to move money from reserves to the active balance sheets and count those reserves as profits because some CFO has decided things have gotten so much better, and fewer reserves are required. 

While the media has bought this charade, it would appear investors have not.  For quite a while, Wall Street saw the investing public as the little boy who was given a crisp new $1 bill from his father.  Subsequently, the child trades the new $1 bill for two new shiny quarters, thinking that two was better than one. 

Further, the child then trades his two quarters for three dimes, then four nickels, and finally, five shiny new pennies.  Returning to his father, he exclaimed how proud he was in his trades, since five is more than one.  Compared to the recent questionable earnings reports churned out by the banks, the little boy’s trades look spectacular.       

Whether it’s the Emperor’s New Clothes or five pennies for a dollar, the current stock prices of Goldman Sachs and Bank of America may be just what they deserve. 

In fact, they may reflect overvaluation, not the opposite.         

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