Of Pitchforks and Torches

For those that follow the socionomic principle that social mood is causal, rather than consequential of social action (personified by the buying and selling of stock, willingness to take credit risk, consumer time preferences, etc), some of this weeks headlines should be of interest.

It is often found that financial crises and the uncovering of fraud tend to often coincide. This does not mean, however, that the fraud in question is some shocking revelation, only discovered by the work of a heroic detective. To the contrary. More often than not, the specific fraud was well known for years, even decades, before it became an issue of public outrage. So it is not necessarily the precise nature of whatever fraud has been exposed that is of concern to us. Rather it is the social reaction to it that provides clues to the overall state of social mood, and therefore to potential repercussions this may have for the financial markets.

Social mood was ambiguous to fraud in our financial markets in recent decades. Even the high-profile cases we are all familiar with (Enron, WorldCom, Barings Bank, etc) were mere blips on the radar. The stock market barely reacted. People didn't really care. And unless they were holders of those particular companies' stock, most people's net worth was higher 6 months later. Unemployment was low, wages were rising and they could obtain a mortgage by fogging a mirror. They felt better off. So why complain?

Such is not the case today. Even with a 45% rally in the stock market off the March lows, the average person is still invariably worse off than they were six months ago. And much worse off than they were a year ago. Those who are lucky enough to still have a job see their wages falling or overtime being slashed. Their home's market value is still falling. And the only saving grace of last year - falling mortgage rates and gasoline prices - are now rising again. They are being squeezed at both ends.

So it is only natural that closer scrutiny is paid to those who can be blamed for their plight.

Ron Paul's Federal Reserve Transparency act (HR 1207) appears to be one such manifestation of the common anger. Of course, the Federal Reserve's meddling in the economy is nothing new. Dr. Paul has been warning of its interventionist economic policies since the early 70s. Entire economic schools of thought have railed against the Fed since its inception in 1913, arguing that their interventionism magnifies the business cycle, rather than smoothes it. So why is it that now, all of a sudden this bill has obtained 213 cosponsors stretching across both parties? Democratic Party skepticism of central banking is showing its first signs of life since the days of Grover Cleveland. There was no organized public outrage against the Fed after the Dot.com collapse, nor after the S&L crisis. So what has changed? Only the social willingness to go after those who can be blamed for causing the bubble.

Another revelation we have learned of is that former CEO of subprime lender Countrywide Financial, Angelo Mozilo is being charged with fraud by the SEC for insider trading and failure to disclose pertinent information to shareholders. Mozilo sold $139 million worth of stock in 2006 and 2007 while it was obvious that the subprime business model was kaput. Nevertheless, Mozilo and Countrywide continued using company profits for share buybacks - the same stock he was selling. Again, this is hardly surprising. Share buyback announcements were almost a daily occurrence in early 2007 and many of the buybacks coincided with executive exercise of stock options or outright dumping of shares. This was pointed out on numerous occasions by many market analysts and shareholder advocacy groups. Yet the cries fell on deaf ears. Until now. A pertinent snip from a MarketWatch article dated June 5th reads that the defense lawyer "...also accused the SEC of bringing the case in response to political pressure to repair its reputation, which has taken hits from the agency's failure to detect the Bernard Madoff fraud." (emphasis added)

Political motives for covering one's own tracks will likely prove to be fuel for the insatiable fire of public rage. Inquiries and fraud charges like these will in turn reveal more fraud and negligence by regulators. In the last week we have learned that another Countrywide executive, John McMurray tried to blow the whistle on the company's potential systemic risk at a conference hosted by the Federal Reserve Bank of Chicago in 2006. He was promptly ignored.

On April 15th, however, we received perhaps our most telling bit of evidence on the state of social mood. More than a million Americans participated in tax day TEA (Taxed Enough Already) Parties, expressing various grievances they have with their government's handling of the credit crisis. The second round of these events will be held on July 4th and are being organized in over 1100 US cities. Will the calls for political action add to the positive feedback cycle of seeking out scapegoats which upon new revelations further intensify public anger, calling for more inquiries, etc...?

It is more than a slight possibility that the countertrend wave of investor optimism persists for longer than most bears are able to stand, while social pessimism builds in the background. But my suspicion is that as the summer wears on, social mood will prove too much for the stock market to handle, and opportunistic traders will take their profits at the first sniff of a turnaround.


Disclaimer: The content on this site is provided as general information only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The ideas expressed on this site are solely the opinions of the author(s) and do not necessarily represent the opinions of sponsors or firms affiliated with the author(s). The author may or may not have a position in any company or advertiser referenced above. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult your investment adviser before making any investment decisions.