Survival Investing: How to Prosper Amid Thieving Banks and Corrupt Governmentsby John R. Talbott
Most individuals and institutions hold the preponderance of their investments in common stocks, corporate bonds, mutual funds, index funds, muni bonds, money markets, bank CDs, and Treasury securities. But these conventional investments will not do well in a world dominated by corrupt, debt-laden governments and thieving bankers, brokers and middlemen. Finance guru
Most individuals and institutions hold the preponderance of their investments in common stocks, corporate bonds, mutual funds, index funds, muni bonds, money markets, bank CDs, and Treasury securities. But these conventional investments will not do well in a world dominated by corrupt, debt-laden governments and thieving bankers, brokers and middlemen. Finance guru John R. Talbott, prescient predictor of the financial crisis and the housing market crash, offers a new paradigm for the coming economic reality. He shows how the recent housing collapse and global economic crisis left governments of the world with enormous annual operating deficits at a time when the banking system continues to struggle with bad debts and requires additional government guarantees and bailouts. Add the fact that growth is constrained because the first wave of the baby boom is hitting 65 and consumers are still loaded with unsustainable levels of debt, and you have a recipe for an economic catastrophe. In this uncertain atmosphere, Talbott offers clear strategies on what you can do to protect your investments and your family.
Among the global dynamics covered are:
*the low-wage threat of China and India
*the legitimacy of gold investing
*the false security of diversification
*the risks of sovereign debt
. . . and why most economists are missing the boat.
“A nonconformist approach to finance and investing that should appeal to politically minded contrarians.” Kirkus Reviews
“This slim but shrewd discussion of money and politics--and the deleterious effect the latter has on the former--is a provocative study of the dangers of impending runaway inflation.” Publishers Weekly
“Finance is based on trust. But what do you do if you cannot trust financiers? Talbott, who has long been an acute observer of what's wrong with our financial system, proposes provocative answers.” Daron Acemoglu, Professor of Economics, MIT and co-author of Why Nations Fail
“You need not embrace John's political bombast, but you ignore his financial prescriptions at your peril. For over a decade, he has made consistently prescient observations about future developments that were ignored by the vast majority of establishment analysts and pundits...until they happened. John is a brilliant unconventional thinker. His concept, introduced in this book, of measuring investment returns in terms of ounces of gold instead of units of paper currency could revolutionize investment practice much as Einstein's general relativity revolutionized cosmology.” Peter Fahey, Retired Partner, Goldman, Sachs & Co.
“In this highly readable, brutally honest, and genuine book, Talbott identifies the key problem our society and economic system face - corporations, especially banks, have way too much political power and cannot be trusted with investors' money as governments, regulators, and even academics betray their responsibilities to the public. Talbott calls it like he sees it.” Anat Admati, Professor of Finance and Economics, Stanford Graduate School of Business
“John Talbott, a Wall Street insider, blows a deafening whistle in this no-holds-bar description of financial corruption and government malfeasance. His grave warnings about Wall Street and Pennsylvania Avenue come with strong advice about how to protect ourselves from the next terrible economic storm -- Uncle Sam's going broke. Survival Investing will put your hair on end, but also let you sleep at night. It's a must read.” Laurence Kotlikoff, Professor of Economics, Boston University and co-author of The Clash of Generations
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How to Prosper Amid Thieving Banks and Corrupt Governments
By John R. Talbott
St. Martin's PressCopyright © 2012 John R. Talbott
All rights reserved.
A DAY AT THE RACES
My family has lived in Kentucky for more than 230 years. On my mother's side, Colonel John Steele was rewarded for his brave fighting in the Revolutionary War with a land grant on the Kentucky River. More senior officers were given land in the more desirable Virginia, and Steele found himself surrounded by woods and Indians on the Kentucky frontier.
Nearly two and a half centuries later, I found myself retracing Steele's steps as I cut my way through the Kentucky forest in an attempt to find the stone house that he built. While I never located the house, I did find a cemetery with tombstones for his daughters. This land remains essentially rugged today, and it is incredible to me that someone back then could build not only a stone house in the middle of the forest but a three-mile road to get to it and survive by shooting whatever he needed for dinner.
Kentucky, of course, is famous for four things. My parents' hometowns of Bardstown and Lawrenceburg are famous for Kentucky bourbon. Although other states may disagree, Kentucky claims some of the most beautiful women in the world. And until recently, Kentucky was famed for its rich tobacco. Now, taxes on tobacco and government payments to tobacco farmers to plant other crops have forced tobacco farmers in Kentucky to find other sources of income. Always industrious, Kentucky farmers have turned to an even bigger cash crop, marijuana.
But Kentucky probably is most famous for its fast horses. No one is quite sure why Kentucky's horses are so fast; usually the bluegrass and the limestone water get the credit. Most likely the initial breeding stock was superior, and breeders benefit from this great start even today. Much of the speed and endurance of thoroughbred racehorses rests in their breeding.
Because this book is about investing in corrupt and crooked markets, you might suppose that I'm going to tell you that I believe horse racing is a rigged game. I am sure individual races are rigged at some small tracks across the country, and certain jockeys and trainers are corrupt. But that is not my experience from watching horse races at Churchill Downs, Keeneland, Saratoga, Belmont, Santa Anita, Hollywood Park, and Del Mar. Far from it. In fact, horse races are a wonderful introduction for anyone studying how markets are supposed to operate.
Academic papers have been written on the market efficiency of horse-racing tracks and markets. Market efficiency basically says that all publicly available information relative to how a security, or a horse for that matter, should be valued has already been incorporated in its price so it is very difficult to use public information to beat the market. For horse racing, this means that the posted odds of winning at race time reflect the best publicly available information on the probability that each horse might win.
When I was younger, I did my own small research project. I wanted to see whether the exacta payoffs for a particular race at Churchill Downs were properly priced. An exacta is nothing more than accurately predicting the horses that will come in first and second. To win you need to do both. So the odds posted just before the start of a race for each possible exacta combination should reflect the odds that any two horses will come in first and second. This is not that difficult to check, except that for a 12-horse race there are 12 times 11, or 132 different combinations of exactas that might occur. Thus, before each race, the television screen in the clubhouse shows 132 exacta prices. Also, while the odds that a horse will come in first are easily calculated from the win pool, it is a little more difficult to calculate the odds that a horse will come in second because the place pool is a bet that a horse will come in either first or second.
Therefore, the informed bettor must examine the placepool odds to figure out the probability that a horse will come in first or second, then subtract the odds that the horse will come in first to arrive at the odds of its coming in second. If I then take this probability and multiply it by the probability that another horse will place first, I should arrive at the odds reflected in the exacta pool for that combination of horses. Simply put, the probability of one horse's winning multiplied by the probability that a second horse will place second should equal the payoff on the exacta.
So I did this calculation. I did it for a ten-horse race. So I had to do 90 calculations for 90 different exacta prices. Amazingly, the exacta prices that I determined were fair, based on the odds of the horses coming in first or second, almost exactly reflected the exacta odds that Churchill Downs was giving on its television screens before the race. There was a very small margin of error — say, 2 to 5 percent. To arrive at the correct probabilities, of course, I had to subtract the margin taken by Churchill Downs, which was 18.5 percent for win-and-place bets and 25 percent for exacta bets.
As a young investment banker just starting his career on Wall Street, I found this all a little incredible. Here was a small race of relatively unknown horses on a weekday at a half-filled track in Kentucky. Determining the correct payouts for exacta bets required more than 90 calculations of various odds — and this was just one race. Yet somebody somewhere in those stands was doing exactly those calculations and arriving at almost exactly the right odds for each exacta bet. I thought this was a wonderful demonstration of market efficiency. It made me wonder why anyone would bother trying to beat the stock market, which is a large, sophisticated, and well-financed market dominated by professionals, when this small horserace market in Kentucky was nearly perfectly efficient.
This idea — that markets are efficient, that it is impossible to beat the market, that the market incorporates all the best available information — is something that I was taught in business school. It doesn't mean that some people can't get lucky and generate returns in excess of the market return in the short run. But, on average, across all investors, it should be difficult to generate abnormal returns.
If the stock market is truly efficient, it also means there shouldn't be wild and unpredictable swings in market prices. While nothing explicitly prohibits volatility, if markets are perfectly efficient, dramatic swings in price must mean that new information is arriving in the marketplace. This is because efficient markets presume that a stock price already incorporates all publicly available historical information. Therefore, any big, instantaneous change in the value of a company must be the result of dramatic new information about its growth prospects or profitability.
But that certainly doesn't seem to be the case in today's market. Today's market for houses, bank shares, European debt, and virtually everything else seems enormously volatile. It's hard to imagine that there is enough new information constantly arriving to justify these market swings. But there is another explanation.
It may just be that our sophisticated and large financial markets are not as free of corruption as my little horse track in Kentucky. If markets are corrupt, then the theory of efficient markets flies out the window. There is no reason to believe that corrupt markets should be efficient or that the prices should reflect all available information. Heck, prices in a corrupt market may reflect inside information or swing wildly based on someone's manipulating the price of an individual stock. In reality efficient markets presume a level of honest dealing that I have come to believe no longer exists in our largest financial markets. Hence, the subject of this book is how individual investors can best weather a market that has become corrupted by insiders, special interests, and governments.
For a quick illustration, let's see what happens to my little horse track in Kentucky when corruption enters the picture. If we can see how corruption can destroy the fair game that is horse racing in Kentucky, we can begin to understand how corruption threatens to destroy not only our largest capital markets but the entire global economy.
So imagine you're no longer at Churchill Downs, a reputable track in Kentucky, but at another track in town, the nefarious (and fictional) Devil's Park. You and the family have decided to take a portion of your life's savings and head out to Devil's Park for an afternoon of racing. Before you leave home, you turn on the television and watch a prognosticator pick his favorite horses for the day. Little do you know that this prognosticator's station receives its funding from its biggest corporate sponsor, Devil's Park. Of course, because this prognosticator is effectively controlled by Devil's Park, he strongly encourages you to bet more than you can afford on every race at the track that day. This prognosticator never saw a horse he didn't like. (Much as CNBC and its banking sponsors have never seen a stock they didn't like.)
When you arrive at the racetrack, you are greeted by four men selling tip sheets. They swear if only you had been there yesterday, you would have won a tremendous amount of money betting on their picks. On close examination, you see that their picks from yesterday, while mildly successful, involved wagering more money than they actually made. Of course, you never find out that these tip-sheet prognosticators in the parking lot of Devil's Park are paid and controlled by the management of Devil's Park. (Just like the rating agencies on Wall Street were controlled and paid by the big banks.)
You settle into your seat at Devil's Park for the first race and look up at the tote board to see the latest odds for each horse in the race. How are you supposed to know that a trainer on the back side with inside information about how well his horse is going to run is getting ready to dump an enormous bet on his horse just before the first race, dramatically influencing those odds? (Much as some hedge fund managers do.) There is no way you can compete with such inside information. But, thinking that it is all a fair game, you go to the ticket windows and buy a $50 win ticket on a horse called Fat Chance.
The whole idea of parimutuel betting at racetracks is that all bets are pooled, and after the track takes out some small percentage for itself, the winner receives the remainder of the pool. But what if the track were taking a greater percentage — instead of 18.5 percent, as much as 30 percent of each pool? (Just like investment banks that were charging larger commissions and bigger bid-ask spreads than reported.) Bankers on Wall Street have tried to do just this through numerous means, including churning and burning clients' accounts to maximize commissions, as well as paying soft commissions to clients who direct trades their way. Today, Wall Street bankers favor exotic derivatives and mortgage securities because they are traded over the counter, off the exchange, and it is difficult to calculate how much the bank is keeping for itself.
Or what if, rather than printing just the 100 tickets that were bought on Fat Chance to win, the track printed an additional 30 win tickets and kept them for itself? (Not unlike the Federal Reserve, which supposedly controls the supply of money yet prints additional currency for its needs.) These extra winning tickets would dilute your winnings if Fat Chance did come through, yet they would never show up as part of the official winning-ticket count. It is an old scam made famous in the movie The Producers, when Max Bialy stock sells more than 100 percent equity interest in a theater production titled Springtime for Hitler, in the hope that the production would be a disaster and none of the equity investors would demand their money back. Unfortunately for Max, Springtime for Hitler becomes an enormous hit, and his scam is uncovered because he has no money to pay all his investors.
You finally settle in your seat to watch the race, and the horses are off. All seems to be going well, and you know that if a jockey tries to throw the race near the finish line, everyone at Devil's Park will see it. But as you watch the horses on the backstretch through your binoculars, you see an unusual phenomenon. The jockeys on the three favorites in the race are pulling on the reins, forcing their mounts way to the back of the field. As the horses turn for home, the secondtier horses have such a large lead that even when the favorites are allowed to run, they have no chance of catching the field. None of the three favorites finishes in the top three, so the one-dollar trifecta — a bet naming the top three finishers in order — pays more than $16,000. You ask yourself what idiot would have made a trifecta bet that did not include any of the three favorites. But then you notice the jockeys on the three favorites are slapping high fives and laughing as they leave the racetrack. This is a classic example of market manipulation. Investors, as well as bettors at a racetrack, expect other participants to act independently, especially insiders such as the jockeys in a horse race. To the extent that some people are colluding to prevent horses from running or stocks from appreciating, they can steal enormous amounts of money from the unsuspecting public.
Let's say somehow you get lucky and Fat Chance wins the race. You go to the betting windows to collect, but you are told that, because of unforeseen circumstances, Devil's Park Racetrack is no longer solvent and cannot pay off your bet. You tear up your winning ticket in frustration. Then on the ride home, you find out that even though Devil's Park is insolvent (like our biggest banks), it is being bailed out by the federal government and has paid off all the biggest winners that day, ignoring the smaller bettors. The racetrack survived, its biggest creditors survived (like the commercial banks' creditors), but small bettors (homeowners and consumers) got the shaft.
Irate, you sit down and write a letter to your member of Congress to complain about the funny business at Devil's Park. In reply you receive a form letter from your representative, but that is all. As it turns out, Devil's Park has been paying your member of Congress $2 million a year to cover his campaign expenses. You contact the racing commission (as any investor might contact the Securities and Exchange Commission or the Justice Department) to file a complaint against Devil's Park, but the current chair of the racing commission discourages you from doing so. You learn that the racing commission chair was once the chief financial officer of Devil's Park, and the in-house counsel for the racing commission has announced he is going to work for Devil's Park's principal law firm.
While Devil's Park, thankfully, is not a real place, the abuses I have suggested are unfortunately real in our capital markets. I will go into much more detail about how these abuses and corruptions have been allowed to occur. More important, I will examine how investors can protect themselves and their investments from the debilitating effects of corruption.CHAPTER 2
CORRUPTION IN THE BANKS
The basic premise of this book is that global banks and world governments have been corrupted and are lying, cheating, and stealing from people. Many of you likely believe this by now, yet you continue to make traditional investments that will perform poorly in this corrupted and troubled environment.
The big question is, if the banks are so corrupt, why haven't senior bankers and banking executives been arrested? The answer is fourfold.
First, they write the rules. It is difficult to violate a law if you are the person writing the laws. We all learned in civics class (at least, those of us old enough to have taken a civics class) that Congress writes the rules and legislation in our country, but in a lobbyist-dominated environment, where the financial industry is the biggest lobbyist by far, this is no longer true. Much of the reason for this financial crisis is that bank lobbyists were successful in removing from the books important legislation that had been constraining their behavior since the Great Depression. The most famous of these is the Glass-Steagall Act, which prohibited banks from both taking deposits and conducting principal investing and investment-banking activities.
But other laws were also weakened or removed. There was a proposal in 2000 that the derivatives business, specifically the credit default swap (CDS) market, not be regulated. And in 2004, Hank Paulson, as CEO of Goldman Sachs (two years later he became US Treasury secretary), was instrumental in making sure that capital requirements for banks were loosened so that banks could leverage themselves up with debt tremendously.
Excerpted from Survival Investing by John R. Talbott. Copyright © 2012 John R. Talbott. Excerpted by permission of St. Martin's Press.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.
Meet the Author
John R. Talbott is a former investment banker, economics guru, and bestselling author with global book sales approaching 200,000. He has established himself as a predictor of major economic events over the last two decades, including the dot.com technology stock collapse, the overheated national housing market, and the global mortgage crisis. Talbott has had articles published in The Wall Street Journal, the Financial Times, The Boston Globe, the San Francisco Chronicle, the International Herald Tribune, The New Republic, the Los Angeles Times, and Salon.com and is a regular contributor to The Huffington Post. He has appeared as a financial expert on television for CNN, CBS, Fox News, CNBC, Fox Business News, CSPAN, and MSNBC as well as on hundreds of radio programs. Talbott was previously a visiting scholar at UCLA's Anderson School of Management as well as a top Goldman Sachs investment banker.
John R. Talbott is a bestselling author and a visiting scholar at UCLA’s Anderson School of Management. He formerly serves as an investment banker for Goldman Sachs. His book The Coming Crash in the Housing Market was an Amazon.com and Business Week bestseller that accurately predicted the financial and management problems that developed at Fannie Mae and Freddie Mac, our largest mortgage providers.
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