The Lamb is cynical by nature.  He is a paid-up subscriber to the axioms “If it sounds too good to be true, it probably is,” and “Where there’s smoke, there’s arson.”

Recently, a friend of The Lamb, Adam (name changed to protect the imprudent), told him about a new website called OneSeason.com.  Adam is a willing, though very suspicious, participant in the OneSeason market.  Essentially, this site allows “investors” to buy and sell shares in their favorite players and teams from the world of sports.  There are both primary and secondary markets.

In the primary market, OneSeason conducts initial public offerings (IPOs) of shares for both teams and players (with a price set at $5 per share) via an allocation algorithm.  These shares are then traded in the secondary market, splitting if/when the price reaches $20 per share.  The company makes money by charging commissions of 5% on IPOs and 1% on secondary trades.  Presumably, fixed and variable costs are de minimus. 

Now for the fun part.  Unlike traditional shares of company stock which entitle the holder to a fractional ownership of that company’s net profits, holders of OneSeason shares simply own the bragging rights to a given player or team.  Unfortunately, bragging rights, much like gold and vacant land, are not positive carry investments.  Then again, land and gold are both tangible assets and offer at least the potential of capital appreciation.

Of course, OneSeason shares can go up in value.  An investor simply has to find someone to pay a higher price than he paid — the so-called “greater fool theory.”  The Lamb certainly feels that OneSeason participants are entitled to purchase shares as they wish – (The Lamb’s Rule #5 — “You pay your money, you take your choice.”)  However, he feels that OneSeason has essentially created a somewhat mitigated pyramid scheme.  This “venture” differs only slightly from the early 20th century Ponzi Scheme. 

Charles Ponzi's Mugshot

The product (service?) OneSeason sells has no intrinsic value save for the aforementioned bragging rights of player/team cyber-ownership.  This may be a good time for potential OneSeason participants to repeat to themselves The Lamb’s Rule #2 — “Know and understand what you own.”

One may ask how this is any different from owning a baseball card or even a work of art.  The difference is that in owning one of these two types of positional goods, an investor has possession of a tangible item, and more importantly, one which is of finite supply– 

Pablo Picasso is not going to be composing many more paintings, and the American Tobacco Company threw away the mold for the T206 Honus Wagner baseball card nearly a century ago.

As amazing as it seems to The Lamb that this market exists, more incredible still is that it has actually spawned websites for OneSeason investors (again, the term “investors” is used extremely loosely here) to exchange opinions and information about share prices of players and teams, much like websites devoted to fantasy football/baseball enthusiasts.  Sites like OneSeasonNation.com and OneSeasonTrader.com garner far more hits than does your editor’s humble corner of the blogosphere.

Trade shares at OneSeason.com if you wish.  But keep The Lamb’s Rule #4 (An asset is only worth what someone else is ready, willing, and able to pay for it) safely in the front of your mind. 

Right now, Adam is wishing he had remembered it…

One of The Lamb’s favorite movies is Trading Places with Dan Aykroyd and Eddie Murphy. In one scene, Aykroyd’s character, the haughty Louis Winthorpe III, is desperately trying to obtain money by selling his fancy watch to the only buyer around — a pawnbroker, played in a great cameo role by Bo Diddley:

Pawnbroker: I’ll give you fifty bucks for it.
Louis Winthorpe III: Fifty bucks? No, no, no. This is a Rouchefoucauld. The finest water-resistant watch in the world. Singularly unique, sculptured in design, hand-crafted in Switzerland and water resistant to three atmospheres. This is the sports watch of the ’80s. Six thousand, nine hundred and fifty five dollars retail!
Pawnbroker: You got a receipt?
Louis Winthorpe III: It tells time simultaneously in Monte Carlo, Beverly Hills, London, Paris, Rome and Gstaad.
Pawnbroker: In Philadelphia, it’s worth 50 bucks.

This scene is exemplary of The Lamb’s Rule #4: an asset is only worth what someone else is ready, willing, and able to pay for it. While it is fine to boast that an asset is “singularly unique” and “sculptured in design,” the best bid was $50 dollars, so Aykroyd’s watch was worth $50.

(Sidebar: if you haven’t seen Trading Places, (1) Aykroyd sold the watch to the pawnbroker for the proffered $50; and (2) You should proceed immediately to your nearest church/temple/mosque for a full confession).

Many of us have heard the bobbleheads on CNBC and elsewhere prattle on recently about the lack of pricing transparency in certain asset classes. They’ve placed part of the blame for the economic carnage currently engulfing America’s financial institutions on the opaqueness of credit default swaps and other assets that don’t actively trade on exchanges.

But now, these same critics are supporting proposals to allow firms to inflate the marks-to-market of many of these same assets to levels above their true current market levels. They state that forcing firms to mark their positions at what they consider “fire-sale” prices (what others might call “current market” prices) is the root cause of the problem, not the fact that these assets have simply decreased in value.

They assert that suspending mark-to-market pricing, also known as fair-value accounting, will alleviate pressure on these firms who now find themselves with assets on their books which they bought voluntarily and whose values have since declined.

Fortunately, the SEC and the Financial Accounting Standards Board (FASB) are trying to hold the line against this lunacy. From the above Bloomberg.com article:

JP Morgan Chase analyst Dane Mott: “Blaming fair-value accounting for the credit crisis is a lot like going to a doctor for a diagnosis and then blaming him for telling you that you are sick.”

Invesco’s Diane Garnick adds, “Suspending the mark-to-market prices is the most irresponsible thing to do. Accounting does not make corporate earnings or balance sheets more volatile. Accounting just increases the transparency of volatility in earnings.”

To grasp the gravity of the risk of suspending/eliminating fair-value accounting, look at the enormous volume of assets that firms had on their books as of August 15, 2008, which they listed as so-called Level 3 assets, or those in which values may be based on management’s expectations of what they will (may?) eventually be worth:

[Click on each graph for a clearer view]

(Graphs via econompicdata.blogspot.com)

Notice that the seven firms taken over by Uncle Sam (or nationalized, or bailed out, or forced into a merger, etc.) — Freddie Mac, Fannie Mae, Merrill Lynch, AIG, Lehman Brothers, Wachovia, and Indy Mac — had nearly half a trillion dollars worth of Level 3 assets as of August 15, 2008!

Notice also that five of the seven firms with the highest amount of Level 3 assets as a percentage of equity as of this same date (Freddie Mac, Indy Mac, Merrill Lynch, Fannie Mae, and Lehman Brothers) have since been “Uncle Sam’d.”  Freddie’s Level 3 assets were ten times more than its equity and Indy Mac’s Level 3s represented nearly 100% of its total assets!

Against this backdrop, do we really want to allow firms to value such a large amount of assets at something other than current realizable market values? Is inflating these values really going to give the public a better understanding of these firms’ true financial conditions?

No one is saying that firms shouldn’t be allowed to raise the prices of assets on their books if/when buyers emerge at higher levels. But until that happens, firms should only value their assets at what Bo Diddley or anyone else is ready, willing and able to pay for them.

Though the fat lady has yet to sing, The Lamb can hear her warming up her vocal chords in the backrooms of Congress.  Treasury Secretary Paulson is on the verge of getting his way and being allocated up to $700 billion dollars with which to purchase assets that no one else seems to want.

The proposed Troubled Asset Relief Program (TARP) struggling its way through Congress likely will have several parts.  Yet, the guts of the plan boil down to this:  you, The Lamb, and every other taxpayer will become the proud owners of some $700 billion of assets which the current owners no longer want.  Actually, that’s not quite accurate.  We may shell out $700 billion, but it is highly unlikely that we will receive assets worth anywhere near that amount.

Let’s, for a moment, give Mr. Paulson (and Federal Reserve Chairman Ben Bernanke) the benefit of the doubt.  They argue that in addition to steps already taken to bail out, insure, shore up (or whatever other term they want to use) the country’s most critical financial institutions, taxpayers must now help more of these companies rid themselves of so-called TAs (troubled assets).  The rationale, it goes, is that these TAs are impairing companies’ balance sheets and restricting their ability to lend money to other companies and to Joe and Jill Taxpayer in the form of credit lines, mortgages, car and student loans, etc., thus crippling the economy.  Therefore, the only way to get the economy back on its feet is to remove these TAs from Corporate America’s collective balance sheet, or at the very least, to provide insurance for them, which is a distinction without a difference.

OK, fine.  The Lamb might not like or agree with this, but he can live with it.  What infuriates The Lamb is that we are going to be asked to pay above-market prices (via insurance or outright purchase) for these TA’s, a clear violation of The Lamb’s Rule #4– “An asset is only worth what someone else is ready, willing, and able to pay for it.”  The Treasury appears “ready” and “able” to overpay for these TA’s, but The Lamb will certainly not be going along “willingly.” 

And as any economics professor will tell you, when the price paid for an asset is greater than the market price, there will be a surplus supplied by sellers.  Think about it– if there was someone willing to pay 125 cents for a dollar bill, how many dollar bill sellers would there be?

Via CNBC.com:

Ben S. Bernanke, the chairman of the Federal Reserve, told Congress on Tuesday that the government should avoid paying a fire-sale price, and pay what he called the “hold-to-maturity price,” or the price that investors would bid if they expected to keep the bond till it was paid off.

The government would buy the troubled investments with the intention of eventually selling them back to the market when prices recover.

What the esteemed Fed Chairman calls a “fire-sale” price, The Lamb calls the market price.  Call it whatever you want, but The Lamb doesn’t feel like paying 125 cents for a dollar bill, and then having to try to turn around and resell it for 125 cents or more to some other sucker.

And “selling them back to the market when prices recover?”  The Lamb doesn’t want to be too annoying, but what if prices don’t recover?  What happens then?  What happens after we’ve paid 125 cents for all the dollar bills in sight on the advice of Helicopter Ben and then aren’t able to resell them to the next guy? 

To whom will we turn for our 7 trillion dimes?  Maybe to these guys:

The Lamb is often in the minority on his views of things.  That is one of the reasons for the title of this blog site.  Ben Franklin’s quote serves as a warning against tyranny of the majority.  The system of “majority rules” is sometimes wholly unfair to the minority and can have terrible unintended consequences.  The recent limits imposed by the SEC on short-selling, in The Lamb’s opinion, are an overreaction to this past weekend’s bankruptcy of Lehman Brothers, the trials and tribulations of AIG, and the shotgun marriage between Merrill Lynch and Bank of America. 
 
Short selling has always had a certain ignominy attached to it.  Some have said that it is at the very least unethical, if not illegal.  While The Lamb certainly agrees that naked short selling (selling a company’s shares without replacing them by settlement date) should be banned, the shorting of any security and the corresponding repurchase agreement (repo) market with which it is joined at the hip, is an integral part of a smooth functioning capital markets system.  Banning short selling is market manipulation in its purest form– it interferes with a willing buyer’s ability to purchase from a willing seller.  Not only that, the buyer suffers from fewer sellers.  If he wants to buy, he will have to pay a higher price as there are fewer players competing to sell him the asset.  Simply, short sellers add liquidity.  Banning legitimate short sellers, or long buyers for that matter, decreases liquidity and forces both to settle for a worse price.
 
Many have also argued that the Uptick Rule should be reinstated.  The Lamb has always been against this rule.  While this rule may slow price declines, this is not necessarily a good thing.  Securities should find their “correct” price as quickly as possible.  Referring to The Lamb’s Rule #4:  An asset is only worth what someone is ready, willing, and able to pay for it.  Are Uptick Rule proponents also in favor of a Downtick Rule for purchases?  Probably not. 
 
Let’s take this a step further.  Let’s say that you are a market maker for options.  An investor wants you to sell him a put option so that he can protect his portfolio from a market decline.  You both agree on a price for the option.  To delta-hedge your position, you as the market maker would have to short-sell the option’s underlying security.  But wait a minute– the SEC has decided that you aren’t allowed to short sell.  So what do you do?  Well, to compensate you for taking the extra risk of not being able to properly hedge your position, you naturally charge the investor a higher price for his protection, making him worse off and you with greater risk.
 
The Lamb sees this as gross market inefficiency: