May 25, 2022

Geithner’s Pump And Dump Scheme

Pump and Dump

According to the SEC website, a pump and dump scheme is one of the most common investment frauds and works as follows:

First, there’s the glowing press release about a company, usually on its  financial health or some new product or innovation.  Then, newsletters that purport to offer unbiased recommendations may suddenly tout the company as the latest “hot” stock.  Messages in chat rooms and bulletin board postings may urge you to buy the stock quickly or to sell before the price goes down. Or you may even hear the company mentioned by a radio or TV analyst.

Unsuspecting investors then purchase the stock in droves, pumping up the price. But when the fraudsters behind the scheme sell their shares at the peak and stop hyping the stock, the price plummets, and innocent investors lose their money.

If all of this sounds familiar it should, since we have probably just witnessed one of the biggest pump and dump schemes ever perpetrated at the expense of witless bank share investors.

Consider the scenario: The Pump

Early this year, the financial system is in a panic as banks announce ever greater losses and talk of nationalizing the banking system is rampant.  Public officials fear a full blown banking collapse if worried depositors start a run on the banks.  Public opposition to bank bailouts is intense.

To stop the growing banking panic, the Fed and Treasury announce that the major banks are too large to fail and will not be allowed to collapse.

An easy to pass “stress test” of the biggest banks is announced to prove to the public that the banking industry is sound.

After a cursory examination of the largest banks, they all pass and are told to raise additional capital just to be on the safe side.

Investors start to buy the bank stocks en masse causing many bank stock shares to double and triple in price.

Over $200 billion in new capital is obtained from investors eager to get in at depressed prices.

Treasury Secretary Geithner states that “this transparent, conservatively designed test should result in a more efficient, stronger banking system”.

Witless commentators at CNBC pile on with predictions that the banks will soon be earning billions in profits.

No less a luminary than Warren Buffet adds to the buying panic by stating that he would put his entire net worth into Wells Fargo.

Potentially catastrophic losses on derivatives, commercial real estate, mortgages, off balance sheet assets and credit cards are swept under the rug as frenzied investors pile into a sure thing.

The Dump

Now, however, Geithner’s brilliant scheme seems to be entering the “dump” phase where “prices plummet and innocent investors lose their money”.  Consider the recent price action in major bank stocks:

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Most of the bank stocks peaked during May and have already declined substantially or appear to be in a distribution phase.  Nervous investors are considering the latest horrendous employment numbers and increasing defaults in virtually every major loan category.   There’s no harm in jumping into a pump and dump scheme early on for some quick gains.  It just might now be the time to jump back out.

Disclosures:  None

Pay Back Time For Credit Card Companies

Card Company Practices Draw Heat                                                                                   Credit Cards

The credit card industry has drawn considerable attention in Washington.  It’s the kind of attention that the card industry did not want but probably deserves.   In an effort to reduce mounting credit losses, the credit card industry has increased interest rates and fees and reduced credit lines.   The backlash by consumers has resulted in the  House of Representatives passing the “Credit Card Holders’ Bill of Rights”, which will prohibit some of the more dubious  practices employed by credit card companies.

The new legislation will prohibit retroactive rate increases and the infamous double cycle billing, require 45 days advance notice of rate increases and require that a borrower be at least 18 years of age.

Prior to passage of the new legislation, lobbyists for the card industry were warning of the adverse impact that new legislation would have.

Congressional action may make credit-card debt less attractive to investors, said the American Bankers Association, the American Securitization Forum, the Financial Services Roundtable, the U.S. Chamber of Commerce and others, in a March 30 letter.

House legislation will “have a negative effect on lenders’ ability to offer reasonably priced credit,” said Kenneth Clayton, senior vice president for card policy at the Washington-based ABA, in a statement.

Card lending is unsecured, meaning the bank doesn’t have any collateral to claim when loans go bad. “The industry is taking massive losses on consumer credit across the board,” Kenneth Lewis, CEO of Bank of America, said on April 8. “Banks in the industry are just trying to protect those assets.”

Weak arguments such as these obviously did little to prevent the new legislation.  My advice to the card companies is – make your debt attractive to investors by restricting lending to people who have the ability to pay back their debts.  Sub prime lending of unsecured money to deadbeat customers regardless of rate will guarantee losses.  Responsible lending will allow you to offer “reasonably priced credit”.

Card Companies Victims of Their Own Tactics

The credit card companies have created their own disaster through reckless lending.  For years I have observed credit card companies extending ridiculously large credit lines to borrowers with minimal ability to service their debts.   It was common to see fixed income retirees or low income wage earners with credit card balances far in excess of their yearly income.   Many borrowers, living on the edge, cannot be blamed for accepting the “no questions asked” easy credit and payment terms pushed by the card companies.   The lenders are the ones responsible for ensuring sound lending.

The logical question is why would anyone lend money to people who in the end cannot pay you back?  The answer is that for decades the scheme worked and resulted in huge profits, as noted in Bloomberg.

Citigroup, Bank of America Corp. and the rest of the top seven U.S. card issuers together raked in more than $27 billion in operating profit from credit cards in 2007, according to Bloomberg data. Now they’re mostly earning customer outrage.

It became routine for borrowers to max out credit card debt and then pay it off through a mortgage refinance (using stated income of course) and then repeat the cycle.   This routine produced large profits for the credit card industry until housing went bust.   No surprise that suddenly maxed out and over leveraged customers started defaulting en mass on their credit cards.  Needless to say, the huge losses were quickly transferred onto the backs of taxpayers  via the magic of the TARP program.  Logically reckless borrowers walk away from their debts and reckless lenders get reimbursed for losses – does anyone see a problem here?

As delinquencies spiraled out of control, the card companies implemented new harsh policies to cut their losses. The problem that the card companies face  is that there is no way for them to accurately forecast who will default and who will pay, since they had previously approved cards without bothering to thoroughly verify the borrower’s financial profile – see Capital One’s Losing Strategy. Not knowing the card holder’s income or asset situation and facing huge losses, the credit card industry had no choice but to raise rates and fees for everyone.

The problem with this new “strategy” is that the borrowers willing to pay 18 to 25% interest rates are probably those most likely to default.  No one who has sufficient income and  spends prudently would be willing to owe card balances at ridiculously high interest rates.   Given these circumstances, the customers owing balances on their cards tend to be the highest risk borrowers, which necessitates  higher rates to offset higher losses.  Maybe the credit card guys should rethink their basic lending strategy?

Disclosure: No positions in companies mentioned