Good Reading -- March 2011

(Let me know if you are going to Omaha for the Berkshire meeting on April 30th. A few of the people on this list are going and I will likely try to organize something.) --------------------------- Quoted This is several weeks old now, but I forgot it last month and it's still applicable.

"Bonds suck, equities are overvalued, cash yields zero.” -- James Montier, January 18, 2011

Facts and Figures

1. All the gold in the world would make a cube measuring 67 feet on a side and valued (~ March 1, 2011 spot) at $7 trillion. That same $7 trillion would buy you two-thirds of every publicly traded business in the U.S. Or you could buy every acre of U.S. farmland plus all of Exxon Mobil, Apple, GE, Microsoft, Google, IBM, Chevron, Wal-Mart and P&G, and still have $2.75 trillion left to spare. (Figures derived from CNBC interview with Warren Buffett on March 2, 2011.)

2. If the government calculated CPI as it did in 1990, the inflation rate wouldn't be the currently published 1.5% but 4.5%; using 1980 methodologies, 8.5%. (Figures courtesy of 2010 Baupost letter to partners.)

Links

1. Recordings of the FCIC interviews with Warren Buffett, Michael Burry, and Jim Chanos. Kind of amazing/scary to hear how naive, uninformed and dim the interviewers were, but still interesting to hear the actual testimony. These were some of the better ones, but the full list is here.

2. "SEC Head Admits Misstep in Madoff Ethics Issue" -- after completely botching the "investigation" for a decade, now we find out about a glaring conflict of interest in the post-mortem. Shocker. But don't worry! The SEC is totally on this whole fraud thing now. I would think this article is from The Onion if I didn't know better.

WASHINGTON (Dow Jones)--The U.S. Securities and Exchange Commission is scrutinizing hedge funds that consistently offer above-market returns amid concern about whether outsized returns are a result of malfeasance, but budget constraints could hamper the agency. "We're now doing things like canvassing all hedge funds for aberrational performance," SEC enforcement director Robert Khuzami told a House Financial Services subcommittee on Thursday. He said the focus was on "anybody who is beating market indexes by 3% and doing it on a steady basis." The scrutiny is one example of how the SEC says it is aiming to use more sophisticated approaches to rooting out wrongdoing following scandals like the one perpetrated by Bernard Madoff. But it is also an example of how the agency, facing government-wide budget constraints, says it is struggling to keep up."We are more and more faced with the need to understand and identify wrongdoing in products and markets, transactions and practices that are increasingly complex or fast-paced or both," Khuzami said. "For those reasons our resource needs are most acute in the areas of IT, data access and analysis, human expertise and paraprofessional and administrative support."

Attached

1. "Howard Marks Presentation to UCLA Student Investment Fund" -- summary notes courtesy of the excellent blog The Inoculated Investor.

2. "The Madoff Tapes" -- a comprehensive look at one of the greatest financial crimes in history, with some new commentary from Madoff himself. Focuses more on the human/family side than the actual fraud and the legitimate business, which I don't think the author actually understands. But still worth a read.

3. "Playboy Interview: Steven Jobs" -- an absolutely incredible interview from 1985. It's long, but make time for this one. I'm definitely not a tech guy or an Apple geek, but this is really impressive. His range and depth of knowledge of business issues is jaw-dropping. And this was at age 29, after dropping out of college and lacking any formal business "training," but having already spent a decade at Apple. His prescience and insight as it pertains to the computer industry, history and broader society is equally impressive. And throw in his technical/design genius...wow.

• a few months after giving this interview, Jobs was forced out of Apple in an internal power-struggle (he went on to start Pixar and NeXT, among other things, before returning more than a decade later)

• AAPL's booming and the share price is loco now, but back in the mid-80s the company saw revenue growth go from 75% p.a. to zero in three years...earnings were solid but margins shrank (and were much lower than today's). IBM was coming on strong, and AAPL stock got cut in half between '84 and '85. I couldn't find full financials, but it doesn't look like the stock ever went much below 15x trailing earnings...I can't imagine buying the stock even then, especially having read this only to see Jobs then get forced out of the company...

• Even after Jobs came back in '96/'97, and the company posted big writedowns and net losses, there was never a chance to really buy the stock cheap...I can't find any meaningful time in which it traded below TBV; had you bottom-ticked it in early of 1997, you could have bought the company for under 1.25x, and at a split-adjusted price of $4, that would have compounded at almost 37% p.a. to today's (3-11-11) price of $345

1. "The Seven Immutable Laws of Investing" -- especially good and timely material from James Montier. Yes, most of it is a rehash of tried-and-true value investing concepts, but that's the point. Make this a priority.

Copied Below

1. "Abrams Capital on investment strategy" -- an old, somewhat poorly written article about David Abrams, but thankfully it's short and it still has some very worthwhile nuggets.

2. "What Vikram Pandit Knew and When He Knew It" -- this month's edition of "Auditors and Disclosure are a Complete Joke."

3. Excerpts from Baupost annual letter -- it's always worthwhile to pay close attention to anything Seth Klarman has to say, and this is unusually good stuff even for him. Make this a priority. (I have a copy of the full letter, which is much longer but still excellent. Please email me for a copy -- not to be posted/published elsewhere.)

4. "The Young and the Perceptive" -- interesting article, although it glosses over the fact that there were many, many (non-teenagers) who actually did read the documents closely and find countless mistakes/frauds/mispricings/problems across the entire spectrum of the financial world.

5. "PIK Bonds Stage Comeback as 'Danger' Ignored" -- everything old is new again...and that didn't take long. Also seeing renewed activity in CLOs, CBOs/synthetic junk bonds, covenant-lite loans, dividend recaps and LBOs, etc. At least there can't be any argument about the Fed's monetary policy having revitalized the rampant speculation in capital markets that was so prevalent in the middle of last decade.

6. "Why Isn't Wall Street in Jail" -- this article in Rolling Stone from Matt Taibi (of Goldman Sachs is a "vampire squid" fame) has some serious flaws: the language is coarse and inflammatory and declaims the author's credibility; it's not clear that the author really has even a journalist's grasp of the subject; it's very one-sided; the rant on class politics and immigration/deportation would be best left for another time. However, it does make some excellent points, with which I totally agree, that aren't getting a lot of airplay elsewhere:

• the SEC's massive incompetence is undermining American markets and the economy

• the SEC's problems stretch beyond incompetence to a more troubling level -- the incestuous relationship between the regulators and the industry supposedly being regulated (the inherent talent-pull of the corporate firms notwithstanding)

• it is shocking that there have been no meaningful prosecutions/convictions

• civil settlements against executives are not punishment -- not only are the dollar amounts immaterial and/or incommensurate with the alleged crime; shareholders and/or D&O insurance cover the costs, not the executives personally

• the detail and quality of disclosure generally, and at financial firms specifically, is an embarrassment to capitalism

• Dick Fuld, Erin Callan and others at Lehman absolutely lied to investors and failed to disclose basic, material facts

• Repo 105, which applies to other firms as well, is an absolute sham

• AIG's disclosure was at least as lacking (collateral posting, rating triggers, asset substitutions, et al. all went undisclosed) but, in my opinion, lacks the blatant lies so evident in the Lehman case

Abrams Capital on investment strategy

By Georgina Russell, WG'07

Published: Sunday, January 22, 2006

Thoughtful, reflective, and self-aware. In a time when the public seems to be in a frenzy over the hyperactive Jim Cramer (host of CNBC's Mad Money), one might not think of these as adjectives typically used to describe a professional stock picker. David Abrams, however, is in fact, all that and then some.

David Abrams recently visited campus as part of the Wharton Investment Management Club's Speaker Series. Abrams runs Abrams Capital, an investment partnership he founded in 1999 that now has $2.5 billion of assets under management. Prior to founding Abrams Capital, Abrams spent ten years at the Baupost Group, à la Seth Klarman. Since inception, Abrams Capital has achieved compounded returns to limited partners in excess of 20%.

David Abrams will tell you that studying Shakespeare and being able to distinguish cheap art from the expensive can help you to be a better investor. He will speak to you of insights and intellectualism. And he is - no wonder - a man who tries to "leave a fair amount of time everyday to read and think." Abrams is clearly and refreshingly different. He attended Penn as an undergrad, but while many of his peers were studying discounted cash flows and the efficient market hypothesis at Wharton, Abrams was working towards a degree from the College of Arts and Sciences at Penn, where literature and a deep understanding human behavior were more de rigueur.

Great Companies, Great Management While not prone to it, Abrams occasionally engages in business speak, saying things like, "I look for Great Companies with Great Management." While this statement is neither a novel idea - as Warren Buffett puts it: "Good jockeys will do well on good horses, but not on broken down nags" - nor indicative of Abrams' talent, his method for finding these investments is. So how does he do it?

"Start with the numbers," Abrams says. If the management team isn't generating good numbers, than at least one of these two prerequisites is lacking. Beyond that, Abrams' dissection of a management team begins with an office visit. "We visit their offices. Going to someone's home tells you a lot about the person, and so does a mahogany paneled CEO office with a private bathroom." With Abrams on the premises, it doesn't end there, as he takes it all in, asking, "do they have cheap art or expensive art on the walls?"

At this point, you may be pondering, as I did, Which is worse? Cheap art questions "why bother?" and expensive art begs "why aren't you paying a dividend with that excess capital?" Clarifying, Abrams quickly followed his hypothetical question with, "not to say that one is better than the other."

Interestingly, Refco, a firm that recently collapsed amidst fraud allegations, owns a collection of contemporary photography a collector would envy - it includes works by Cindy Sherman, Richard Prince and Rineke Dijkstra among others. The collection has even inspired a book, available on Amazon, "Subjective Realities: The Refco Collection of Contemporary Photography."

As for what's motivating these art purchases, perhaps Shakespeare can help explain. "To read King Lear or Macbeth can be useful for investing." Continuing on the Shakespearean note, Abrams went on to refer to James Stewart's recent book Disneywar, in which Michael Eisner is made to resemble the main character of many a Shakespearean tragedy - he answers not to his "subjects," who in modern corporate America would be his shareholders, but to his own ego. This is why Abrams looks for what he terms "owner-operated businesses," businesses where the CEO's compensation is largely stock based. If the CEO is compensated in lockstep with his shareholders, the pain and pleasure of each party is one.

Art and business sometimes collide however. On the Saturday following the 1987 crash, Abrams recalls he was deeply distracted. So much so that when his phone rang that morning, even after recognizing the voice of a lady friend on the other end, it was not until she told him so, that he realized he had stood her up that morning - for a first date and at an art gallery. This woman is now his wife and the mother of his two children.

Diversification and Concentration, Insights and Intellect But back to shareholder value. Abrams holds a concentrated portfolio. As he puts it, "we believe in diversification for risk reducing, but we don't want to diversify ourselves into ignorance. If we can do three smart things a year and nothing dumb, we will be very successful. If we can do five, that's a home run."

He sits on the board of three of his investments. When asked if doing so restricts the fund's ability to exit, Abrams replies, "yes, of course, but there are positives to it. When you have more knowledge, which you do as a member of the board, you have better insights. So the trick is, pick investments where you are likely to have insights that will make you more bullish, and in these situations, sitting on the board becomes beneficial."

If David Abrams has insider knowledge of anything, it's managing a concentrated portfolio, and his resulting insight is as memorable as it is invaluable. Many funds with assets under management equivalent to Abrams Capital own many more positions. Abrams gives us this to reflect on, "with a profession such as investing, people see the 'doing' as the buying and selling. It is difficult to come home from work, and answer your spouse's question, 'what did you do today?' with 'well, I read a lot, and I talked a little.' If you're not buying or selling, you may feel you aren't doing anything."

One Man's Garbage is Another Man's Gold One might say that Abrams is Buffett-esque in his approach - holding a concentrated portfolio, taking a controlling position in many of his investments, and looking for owner-operated businesses. Given this, it is no surprise that Abrams believes the single most valuable thing you can do as an aspiring investor is to read Berkshire Hathaway's annual reports cover to cover going back as far as you can. (For those of you for whom this may seem a daunting task, I recommend starting with "The Essays of Warren Buffet: Lessons For Corporate America," a book compiled by Lawrence Cunningham, also available on Amazon.)

Yet, despite the similarities in approach between these two investors, one of Abrams largest holdings, USA Mobility (USMO) is unlikely to ever appear in Buffett's portfolio. USMO is in the pager business - we kid you not - pagers, as in beepers, the devices popularized by rappers and doctors alike in the 1980's. As you might expect, paging is a declining business. However, there seems to be a stable, core user base - people whose work focuses around emergency services. Pagers, operating via satellite signals, are more reliable than cellular phones, especially in the wake of disasters like Hurricane Katrina. Thus, despite revenue declines, USA Mobility anticipates a steadying of income, and its "fallen angel" status has left it undervalued in the marketplace.

As Abrams puts it, "Wall Street tends to hate, hate, hate businesses that are shrinking and Warren Buffet says they're cigar butts. That's okay - cigar butts - give them to me. I'll take 'em."

+------------------------------------------------------------------------------+ What Vikram Pandit Knew, and When He Knew It: Jonathan Weil 2011-02-24 00:00:00.11 GMT Commentary by Jonathan Weil Feb. 24 (Bloomberg) -- On Feb. 14, 2008, the Office of the Comptroller of the Currency sent a seven-page letter to Citigroup Inc.’s chief executive, Vikram Pandit, summarizing the results of a special supervisory review its bank examiners had recently concluded. The gist of the regulator’s findings: Citigroup’s internal controls were a mess. So were its valuation methods for subprime mortgage bonds, which had spawned record losses at the bank. Among other things, “weaknesses were noted with model documentation, validation and control group oversight,” the letter said. The main valuation model Citigroup was using “is not in a controlled environment.” In other words, the model wasn’t reliable. Here’s where the timeline gets curious. Eight days later, on Feb. 22, Citigroup filed its annual report to shareholders, in which it said “management believes that, as of Dec. 31, 2007, the company’s internal control over financial reporting is effective.” Pandit certified the report personally, including the part about Citigroup’s internal controls. So did Citigroup’s chief financial officer at the time, Gary Crittenden. The annual report also included a Feb. 22 letter from KPMG LLP, Citigroup’s outside auditor, vouching for the effectiveness of the company’s financial-reporting controls. Nowhere did Citigroup or KPMG mention any of the problems cited by the OCC. KPMG, which earned $88.1 million in fees from Citigroup for 2007, should have been aware of them, too. The lead partner on KPMG’s Citigroup audit, William O’Mara, was listed on the “cc” line of the OCC’s Feb. 14 letter. Unanswered Questions So, what did Citigroup and KPMG know, and when did they know it? Those are questions the Financial Crisis Inquiry Commission should have answered, but didn’t. The OCC’s letter to Pandit was one of hundreds of newly released documents the FCIC posted to its website before it closed shop this month. As far as I can tell, there’s no indication the commission asked anyone at Citigroup or KPMG to explain how they justified their assurances about Citigroup’s internal controls in the face of the OCC’s criticisms. KPMG’s name doesn’t even appear anywhere in the FCIC’s 545-page report. The key players aren’t talking now, either. Pandit, Crittenden and O’Mara didn’t return phone calls. A KPMG spokesman, George Ledwith, declined to comment, as did an OCC spokesman, Kevin Mukri. A Citigroup spokeswoman, Shannon Bell, declined to discuss the OCC’s findings, though in an e-mail she said the certifications by Pandit and Crittenden were “entirely appropriate.” Subprime Fallout The OCC began its special review after Citigroup on Nov. 4, 2007, disclosed that the value of its subprime-related assets had fallen by anywhere from $8 billion to $11 billion since Sept. 30, which the bank blamed on downgrades by credit-rating companies that “occurred after the end of the third quarter.” As I wrote in a column at the time, the idea that all these losses occurred after September 2007 wasn’t credible. Merrill Lynch & Co. had already written down its own subprime-related holdings by $8.4 billion during the third quarter, while Citigroup’s writedowns as of Sept. 30 had been small by comparison. Now we have further confirmation. In a Jan. 17, 2008, internal memo to John Lyons, the examiner in charge of the OCC’s review, two OCC staff members, Michael Sullivan and Ron Frake, put it simply: “Model control processes did not work.” Broken Models Citigroup’s valuation model for collateralized debt obligations, they said, “was built in a short time and largely circumvented typical control policies and procedures. Developers were not aware of their responsibilities under corporate policies, having typically built trader tools rather than official valuation models. Control groups did not enforce them at the time and are now firmly on the sidelines.” About the only kind comment the OCC staff had for Citigroup’s valuation method was that it “is broadly within the range of current market practice.” That was hardly a compliment, considering the whole financial world was blowing up. One big problem they found was that Citigroup was using a sketchy discounted cash flow model to value its CDOs, rather than using the value of the collateral as a starting point. The Feb. 14 letter to Pandit, signed by Lyons, echoed those conclusions. It said “several months after the first use of the DCF model there are several deficiencies that need to be addressed.” Additionally, “over-reliance was placed on credit rating agency ratings without considering the appropriateness of these ratings to specific products or the true risk of the underlying collateral.” Skewed Balance Sheet Yet somehow KPMG and Citigroup’s management decided they didn’t need to mention any of those weaknesses or deficiencies. Maybe in their minds it was all just a difference of opinion. Whatever their rationale, nine months later Citigroup had taken a $45 billion taxpayer bailout, still sporting a balance sheet that made it seem healthy. “As I look at the deficiencies cited in the letter, taken as a whole, it appears that Citigroup had a material weakness with respect to valuing these financial instruments,” said Ed Ketz, an accounting professor at Pennsylvania State University, who reviewed the OCC’s letter to Pandit at my request. “It just is overwhelming by the time you get to the end of it.” One company that did get a cautionary note from its auditor that same quarter was American International Group Inc. In February 2008, PricewaterhouseCoopers LLP warned of a material weakness related to AIG’s valuations for credit-default swaps. So at least investors were told AIG’s numbers might be off. That turned out to be a gross understatement. At Citigroup, there was no such warning. The public deserves to know why. (Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.) Excerpts from 2010 Baupost Annual Letter

Two problems are upon us at once: short-term stimulus that is unaffordable over the long run and runaway entitlements that must be reined in. But restoring fiscal sanity will be bad for the economy and financial markets. What Treasury official or politician would want the cash spigot turned off before a recovery is certain? Recipients of government handouts – a large percentage of the population – would grumble at the termination of policies that offer them outsized benefits. So prepare for a chorus of “but not yet.” One already sees this in editorials and commentaries, such as the ones saying it’s time to close down bankrupt Fannie Mae and Freddie Mac, but not yet, because doing so would harm the still-weak housing market. There will never be a good time to end housing support programs, reverse quantitative easing policies, end fiscal stimulus, or reduce massive budget deficits – because doing so will restrict growth and depress share prices. Nor will there be a good time to cut entitlement programs or to solve Social Security or Medicare underfunding. All will agree the stimulus cannot go on forever, that excessive entitlements must be reined in, “but not yet.

The financial collapse of 2008 highlighted our national predicament. The sudden decline in consumer activity that followed the plunges in the housing and stock markets represented a reasonable – indeed a desirable – response to overindebtedness. Yet the federal government saw this well-advised retrenchment as cataclysmic, because the national economy had grown dependent on our living beyond our means. The imagination of our financial leaders remains so shallow that their response to a crisis caused by overleverage and excess has been to recreate, as nearly as possible, the conditions that fomented it, as if the events of 2008 were a rogue wave of financial woe that can never recur. It is only in Fantasyland that the solution to vastly excessive debt is more debt and the answer to overconsumption is less saving and more spending. Worse still, we have yet to see a serious assessment by policymakers of the causes of the 2008 financial market and economic collapses so that we might take action to ward off a repeat performance. The government’s knee-jerk response to contraction was to prop up economic activity by any and every means possible; the hole in consumer activity had to be materially repaired on the government tab. While Treasury Secretary Timothy Geithner ingenuously professes a belief that the U.S. will never lose its AAA rating, Moody’s recently warned that, absent a change, a downgrading could be just around the comer. Or, in the words of David Letterman, “I heard the U.S. debt may now lose its triple-A rating. And I said to myself, well who cares what the auto club thinks.”

Most of us learned about the Great Depression from our parents or grandparents who developed a “Depressionmentality,” by which for decades people shunned leverage, embraced thrift, and thought twice before quitting their secure jobs to join risky ventures. By bailing out the economy rather than allowing the pain of the economic and market collapses to be felt, the government has endowed our generation with a “really-bad-couple-of-weeks-mentality”: no lasting lessons are learned; the government endlessly intervenes in the economy, and, ironically, the first thing to strongly rebound from the 2008 collapse isn’t jobs or economic activity but speculation.

Benjamin Graham’s margin-of-safety concept – to invest at a sufficient discount so that even bad luck or the vicissitudes of the business cycle won’t derail an investment – is applicable to the economy as a whole. Bridges intended for ten-ton trucks are overbuilt by engineers to hold vehicles of 30 tons. Responsible investors assume their best judgments will sometimes go awry and insist on bargain purchases that allow room for error. Likewise, an economy built with no margin of safety will eventually implode. Governments that run huge deficits, promise entitlements that will be next-to impossible to deliver, and depend on the beneficence of foreigners to stay afloat inevitably must collapse – perhaps not imminently but eventually, as Greece and Ireland have recently discovered.

It is clear, both in the financial markets and in government policy, that no long-term lessons have been drawn from the events of 2008. A friend recently posited that adversity is valuable not for what it teaches but for what it reveals. The current episode of financial adversity reveals some unpleasant truths about the character and will of our country and its leaders, and offers an unpleasant picture of the future that awaits, unless we quickly find a way to change course.

The Demonization of Short-Seller

While we rarely sell securities short – both because of the degree of execution difficulty and theoretically unlimited risk compared to limited potential return – we do believe that short-selling serves a vitally important function. Markets, of course, fluctuate; driven by human emotion, greed, and fear, they can reach significantly overvalued levels. This is bad, both because it can induce some who cannot afford losses to speculate, and because it can lead to an improper allocation of society’s resources. The recent housing bubble illustrates the problem: excessive home prices led to excessive home building, eventually resulting in a price collapse, large loan losses, and great personal hardship. In addition, the decline that follows periods of market overvaluation is bad for the broader economy, for confidence, and for rational decision making; it also frequently triggers government intervention in markets, with all of its inevitable distorting effects. Just as value buyers can dampen downside volatility, short-sellers can dampen the upside excesses. They don’t actually change the eventual outcomes, just help us get there sooner. This makes short-sellers unpopular, as the uninformed masses enjoy high and rising securities prices for the short-term profits they produce, without understanding the societal costs of the future reversal. The less you understand valuation, the more that overvaluation seems like a free lunch – which of course it isn’t.

From our experience, much long-oriented analysis is simplistic, highly optimistic, and sloppy. Short-sellers, by going against the long-term tide of economic growth and the short-term swells of public opinion and margins calls, are forced to be crackerjack analysts. Their work product is usually top-notch and needs to be. Short-sellers shouldn’t be reviled or banned; most should be celebrated and encouraged. They are the policemen of the financial markets, identifying frauds and cautioning against bubbles. In effect, they protect the unsophisticated from predatory schemes that regulators and enforcement agencies don’t seem able to prevent.

Moreover, the short-seller who is fundamentally wrong, who mistakenly sells short an undervalued security, will lose money and, if the pattern continues, will eventually go broke. Short-sellers, like long-only buyers, need to be right more than they are wrong; when they are right, their actions are socially beneficial, not harmful. The only exception to this point, the only danger short-sellers pose to society, is when, in the equivalent of yelling “fire” in a crowded theatre, they spread false rumors that prevent a company that needs regular financing (such as brokerage firms) from being funded. Then, their predictions become self-fulfilling prophecies, enabling them to profit, whether or not they were fundamentally correct; they may actually be able to change the outcome. Yet, even in this situation, one may wonder whether any company – or highly leveraged government, for that matter – should employ a funding model that depends on perpetual access to the capital markets, which are notoriously fickle, volatile, subject to the influence of malicious gossip, and short-term oriented. In any event, mechanisms such as the uptick rule and rules against market manipulation already exist to prevent such misbehavior by short-sellers.

A Framework for Investment Success

Two elements are vital in designing an investment approach for long-term success. First, answer the question, ”what’s your edge?” In highly competitive financial markets, with thousands of very smart, hardworking participants, what will enable you to reliably outperform the field? Your toolkit is critically important: truly long-term capital; a flexible approach that enables you to move opportunistically across a broad array of markets, securities, and asset classes; deep industry knowledge; strong sourcing relationships; and a solid grounding in value investing principles.

But because investing is, in many ways, a zero-sum activity in which your returns above the market indices are derived from the mistakes, overreactions or inattention of others as much as from your own clever insights, there is a second element in designing a sound investment approach: you must consider the competitive landscape and the behavior of other market participants. As in football, you are well-advised to take advantage of what your opponents give you: if they are defending the run, passing is probably your best option, even if you have a star running back. If scores of other investors are rigidly committed to fast-growing technology stocks, your brilliant tech analyst may not be able to help you outperform. If your competitors are not paying attention to, or indeed are dumping, Greek equities or U.S. housing debt, these asset classes may be worth your attention, regardless of the currently poor fundamentals that are driving others’ decisions. Where to best apply your focus and skills depends partially on where others are applying theirs.

When observing your competitors, your focus should be on their approach and process, not their results. Short-term performance envy causes many of the shortcomings that lock most investors into a perpetual cycle of underachievement. You should watch your competitors not out of jealousy, but out of respect, and focus your efforts not on replicating others’ portfolios, but on looking for opportunities where they are not.

Much of the investment business is centered around asset-gathering activities. In a field dominated by a short-term, relative performance orientation, significant underperformance is disastrous for retention of assets, while mediocre performance is not. Thus, because protracted periods of underperformance can threaten one’s business, most investment firms aim for assured, trend-following mediocrity while shunning the potential achievement of strong outperformance. The only way for investors to significantly outperform is to periodically stand far apart from the crowd, something few are willing or able to do.

In addition, most traditional investors are limited by a variety of constraints: narrow skill-sets, legal restrictions contained in investment prospectuses or partnership agreements, or psychological inhibitions. High-grade bond funds can only purchase investment-grade bonds; when a bond falls below BBB, they are typically forced to sell (or think that they should), regardless of price. When a mortgage security is downgraded because it will not return par to its holders, a large swath of potential purchasers will not even consider buying it, and many must purge it. When a company omits a cash dividend, some equity funds are obliged to sell that stock. And, of course, when a stock is deleted from an index, it must immediately be dumped by many. Sometimes, a drop in a stock’s price is reason enough for some holders to sell. Such behavior often creates supply-demand imbalances where bargains can be found. The dimly lit comers and crevasses existing outside of mainstream mandates may contain opportunity. Given that time is often an investor’s scarcest resource, filling one’s in-box with the most compelling potential opportunities that others are forced to or choose to sell (or are constrained from buying) makes great sense.

Price is perhaps the single most important criterion in sound investment decision making. Every security or asset is a “buy” at one price, a “hold” at a higher price, and a “sell” at some still higher price. Yet most investors in all asset classes love simplicity, rosy outlooks, and the prospect of smooth sailing. They prefer what is performing well to what has recently lagged, often regardless of price. They prefer full buildings and trophy properties to fixer-uppers that need to be filled, even though empty or unloved buildings may be the far more compelling, and even safer, investments. Because investors are not usually penalized for adhering to conventional practices, doing so is the less professionally risky strategy, even though it virtually guarantees against superior performance.

Finally, most investors feel compelled to be fully invested at all times – principally because evaluation of their performance is both frequent and relative. For them, it is almost as if investing were merely a game and no client’s hardearned money was at risk. To require full investment all the time is to remove an important tool from investors’ toolkits: the ability to wait patiently for compelling opportunities that may arise in the future. Moreover, an investor who is too worried about missing out on the upside of a potential investment may be exposing himself to substantial downside risk precisely when valuation is extended. A thoughtful investment approach focuses at least as much on risk as on return. But in the moment-by-moment frenzy of the markets, all the pressure is on generating returns, risk be damned.

What drives long-term investment success? In the Internet era, everyone has a voluminous amount of information but not everyone knows how to use it. A well-considered investment process – thoughtful, intellectually honest, team oriented, and single-mindedly focused on making good investment decisions at every turn – can make all of the difference. Investors with short time horizons are oblivious to kernels of information that may influence investment outcomes years from now. Everyone can ask questions, but not everyone can identify the right questions to ask. Everyone searches for opportunity, but most look only where the searching is straightforward even if undeniably highly competitive.

In the markets of late 2008, everything was for sale as investors were caught in a contagion of selling due to panic, margin calls, and investor redemptions. Even while modeling very conservative scenarios, many securities could have been purchased at extremely attractive prices – if one had capital with which to buy them and the stamina to hold them in the face of falling prices. By late 2010, froth had returned to the markets, as investors with short-term relative performance orientations sought to keep up with the herd. Exuberant buying had replaced frenzied selling, as investors purchased securities offering limited returns even on far rosier economic assumptions.

Most investors take comfort from calm, steadily rising markets; roiling markets can drive investor panic. But these conventional reactions are inverted. When all feels calm and prices surge, the markets may feel safe; but, in fact, they are dangerous because few investors are focusing on risk. When one feels in the pit of one’s stomach the fear that accompanies plunging market prices, risk-taking becomes considerably less risky, because risk is often priced into an asset’s lower market valuation. Investment success requires standing apart from the frenzy – the short-term, relative performance game played by most investors.

Investment success also requires remembering that securities prices are not blips on a Bloomberg terminal but are fractional interests in – or claims on – companies. Business fundamentals, not price quotations, convey useful information. With so many market participants fixated on short-term investment performance, successful investing requires a focus not on how one is doing, but on corporate balance sheets and income and cash flow statements.

Government interventions are a wild card for even the most disciplined investors. On one hand, the U.S. government has regularly intervened in markets for decades, especially by lowering interest rates at the first sign of bad economic news, which has the effect of artificially inflating securities prices. Today, monetary easing and fiscal stimulus augment consumer demand, increasing risks not only regarding the integrity and sustainability of securities prices but also those surrounding the sustainability of business results. It is hard for investors to get their bearings when they cannot readily distinguish durable business performance from ephemeral results. Endless manipulation of government statistics adds to the challenge of determining the sustainability – and therefore the proper valuation – of business performance. As securities prices are propped up and interest rates are manipulated sharply lower (thereby justifying those higher prices in the minds of many), prudent investors must demand a wide margin of safety. This is especially so because financial excesses contain the seeds of their own destruction. Market exuberance leads to business exuberance – production of more goods and services than demand ultimately justifies. Of course, when market and economic excesses are finally corrected, there is a tendency to over-shoot, creating low-risk opportunities for value investors who have remained patient and disciplined.

Yet another long-term risk confronts investors: the government’s fiscal and monetary experiments may go awry, resulting in runaway inflation or currency collapse. Bottom-up value investors would not wish to bet the ranch on a macroeconomic view, but neither would they be wise to ignore the macroeconomy altogether. Disaster hedging – always an important tool for investors – takes on heightened significance in today’s unprecedentedly challenging environment. Yet, as this insight is not unique to us, the cost of insurance is high. There are no easy ways to navigate these turbulent waters. But because the greatest risks are of currency debasement and runaway inflation, protection against a currency collapse – such as exposure to gold – and against much higher interest rates seem like necessary hedges to maintain.

The Young and the Perceptive

By JOSEPH T. HALLINAN

Chicago

IT has been more than three years since the beginning of the Wall Street financial crisis, yet we continue to hear about new evidence of glaring errors and widespread misdoings. Even the smartest minds in finance are left scratching their heads: how did we not catch any of this sooner?

When I hear this refrain, I am reminded of Boris Goldovsky.

Goldovsky, who died in 2001, was a legend in opera circles, best remembered for his commentary during the Saturday matinee radio broadcasts of the Metropolitan Opera. But he was also a piano teacher. And it is as a teacher that he made a lasting — albeit unintentional — contribution to our understanding of why seemingly obvious errors go undetected for so long.

One day, a student of his was practicing a piece by Brahms when Goldovsky heard something wrong. He stopped her and told her to fix her mistake. The student looked confused; she said she had played the notes as they were written. Goldovsky looked at the music and, to his surprise, the girl had indeed played the printed notes correctly — but there was an apparent misprint in the music.

At first, the student and the teacher thought this misprint was confined to their edition of the sheet music alone. But further checking revealed that all other editions contained the same incorrect note. Why, wondered Goldovsky, had no one — the composer, the publisher, the proofreader, scores of accomplished pianists — noticed the error? How could so many experts have missed something that was so obvious to a novice?

This paradox intrigued Goldovsky. So over the years he gave the piece to a number of musicians who were skilled sight readers of music — which is to say they had the ability to play from a printed score for the first time without practicing. He told them there was a misprint somewhere in the score, and asked them to find it. He allowed them to play the piece as many times as they liked and in any way that they liked. But not one musician ever found the error. Only when Goldovsky told his subjects which bar, or measure, the mistake was in did most of them spot it. (For music fans, the piece is Brahms’s Opus 76, No. 2, and the mistake occurs 42 measures from the end.)

Goldovsky’s experiment yielded a key insight into human error: not only had the experts misread the music — they had misread it in the same way. In a subsequent study, Goldovsky’s nephew, Thomas Wolf, discovered that good sight readers report that they do not read music note by note; instead, they rely on their recognition of familiar patterns and on their ability to organize the music into those patterns and dependable cues.

In short, they don’t read; they infer. Moreover, this trait is not unique to musicians: pattern recognition is a hallmark of expertise in any number of fields; it is what allows experts to do quickly what amateurs do slowly.

Goldovsky’s insight offers a useful metaphor for understanding the crisis on Wall Street: Not only did hedge-fund managers, bankers and others misread the danger involved in many of their investments, but they misread them in the same way.

As Paul E. Kanjorski, a former congressman who served on the House Financial Services Committee, put it, “Why does it appear to the general public that all the finest minds in finance missed the most obvious?”

It appears that way because they did miss it. These types of errors are most likely to be discovered by those who, like Goldovsky’s young student, look at the world with new, unblinking eyes.

In 2009, for instance, a first grader in Virginia noticed that a popular library book depicted a meat-eating dinosaur as an herbivore. A year before that, a fifth grader from Michigan discovered an error at a Smithsonian exhibit that had gone undetected for 27 years.

And in 2007, another error was caught, this time by a 13-year-old boy in Finland. The mistake involved an image of a submarine that a Russian TV company had used to illustrate a report about a Russian submarine voyage to the Arctic. The image, distributed by Reuters, was used by news outlets around the world. No one noticed anything awry. But the boy, Waltteri Seretin, did. The sub, he thought, looked suspiciously familiar. His suspicions were right: it was a film clip taken from the movie “Titanic.”

Unlike the Titanic, the stock market appears to have righted itself — even as many investors remain underwater. It may be too much to suggest that we let adolescents run Wall Street (assuming, of course, that this isn’t already the case). But it wouldn’t hurt to let them check the math.

Joseph T. Hallinan, a former reporter for The Wall Street Journal, is the author of “Why We Make Mistakes.”

PIK Bonds Stage Comeback as ‘Danger’ Ignored: Credit Markets 2011-03-09 11:14:02.519 GMT By Sapna Maheshwari March 9 (Bloomberg) -- Leon Black’s Apollo Global Management LLC and Fortress Investment Group LLC are bringing back bonds that let companies make interest payments in the form of extra debt as investors chase returns about 12 times greater than those for investment-grade securities. Apollo’s CKE Holdings Inc., owner of Carl’s Jr. and Hardee’s restaurants, was set to sell $175 million of pay-in- kind toggle notes after canned tuna maker Bumble Bee Foods LLC issued $150 million of the debt on March 7, both to fund dividends. Sales of the bonds have more than tripled this year to $1.3 billion from $375 million in all of 2010, according to data compiled by Bloomberg. “I actually thought these kinds of deals would be dead after the last meltdown because some of these PIK notes traded down to worthless,” said Marc Gross, a money manager in New York at RS Investments, which oversees $3 billion in its fixed- income funds. Investors are “going out as far as they can on the risk spectrum,” he said. Bondholders are accepting looser terms as record monetary stimulus from the Federal Reserve drives them toward higher- yielding debt and an improving economy prompts Moody’s Investors Service to project the U.S. default rate will decline by year- end to the lowest level since February 2008. The riskiest borrowers account for the biggest share of speculative-grade bond sales in three years, according to JPMorgan Chase & Co. ‘Danger Levels’ “We’re seeing all the signs of a market that’s getting very mature, a market that’s getting to danger levels, actually, in the kinds of risk-taking people are getting into,” said Tim Doubek, a money manager who helps oversee about $23 billion of investment-grade credit at Columbia Management in Minneapolis. Elsewhere in credit markets, the extra yield investors demand to own company bonds worldwide instead of similar- maturity government debt fell 1 basis point to 148 basis points, or 1.48 percentage points, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. Yields averaged 4.019 percent. The cost of insuring western European government bonds against default rose to the highest since Feb. 26 after an auction of Portuguese notes resulted in higher borrowing costs for the indebted nation. Portugal’s 1 billion euros ($1.4 billion) of bonds due in 2013 were issued at an average yield of 5.993 percent, compared with 4.086 percent at a Sept. 8 auction. Today’s sale attracted bids for 1.6 times the amount offered, compared with a so-called bid-to-cover ratio of 1.9 six months ago. SovX Swaps The Markit iTraxx SovX Western Europe Index of credit- default swaps on 15 governments rose 4 basis points to 182, according to CMA. Contracts on Portugal were 13 basis points higher on the day at 501 basis points. Credit-default swaps typically fall as investor confidence improves and rise as it deteriorates. Contracts pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a swap protecting $10 million of debt. International Petroleum Investment Co., an investment company owned by Abu Dhabi, re-organized its sale of bonds to include a pound-denominated portion as well as two euro issues, according to three people with knowledge of the matter. IPIC’s 15-year bonds in pounds may be priced to yield about 275 basis points more than gilts, said the people, who declined to be identified. A five-year euro portion may be priced at 200 basis points to 212.5 basis points more than the swap rate, while the company’s 10-year euro notes may have a 250 basis- point to 262.5 basis-point spread, the people said. IPIC Acquisition The proceeds may be used for IPIC’s acquisition of a stake in Spanish oil company Cia. Espanola de Petroleos SA, Fitch said in an e-mailed report March 7. IPIC already had a 47 percent holding in Cia. Espanola. DirecTV had the most actively traded U.S. corporate bonds by dealers yesterday, with 332 trades of $1 million or more, a day after the El Segundo, California-based satellite television provider’s $4 billion offering to help fund share repurchases. The company’s $1.5 billion of 3.5 percent bonds due in March 2016 rose 0.1 cent to 99.9 cents on the dollar to yield 129 basis points more than similar-maturity Treasuries, 6 basis points less than the spread at issue, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. Sprint Capital The most active high-yield debt was from Sprint Capital, with 86 trades, Trace data show. Its $2.475 billion of 6.875 percent bonds due in November 2028 rose 4.6 cents to 93.8 cents on the dollar yesterday. Bonds of Sprint Capital Corp. rose following a report that Deutsche Telekom AG held talks to sell its T-Mobile USA unit to Sprint Nextel Corp. The Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index fell for the fourth time in six days yesterday to the lowest since Jan. 25. The index, which tracks the 100 largest dollar- denominated first-lien leveraged loans, declined 0.11 cent to 95.78 cents on the dollar. It reached 96.48 cents on Feb. 14, the highest since November 2007. High-yield, high-risk bonds and leveraged loans are rated below Baa3 by Moody’s and lower than BBB- by S&P. In emerging markets, relative yields widened 6 basis points to 257 basis points, after contracting 19 basis points in the prior two trading days, according to JPMorgan index data. Petroleos Mexicanos Petroleos Mexicanos, Latin America’s largest oil producer, plans to sell about 10 billion pesos ($833.5 million) of bonds in the domestic market on March 10 as it seeks to refinance debt. Financing conditions “look good” and Mexico City-based Pemex, as the state-owned company is known, is determining the final size of the issue, Chief Financial Officer Ignacio Quesada said yesterday in an interview in Houston. CKE’s five-year notes may pay 11 percent in cash and about 11.75 percent if the company pays in the form of additional debt, according to a person familiar with the offering. The Carpinteria, California-based company was purchased in July by Apollo, the private-equity firm co-founded by Black more than 20 years ago. “Doesn’t it just seem wrong that a deeply junk-rated issuer should be easily selling non-cash bonds within a year of the LBO?” said Adam Cohen, founder of New York-based Covenant Review LLC, which analyzes investor safeguards included in corporate bond offerings. “The economy certainly hasn’t improved much in the past year, and some of these issuers have less net income than they did a year or two ago.” ‘Risky Deals’ Bumble Bee Foods, which was acquired by Lion Capital LLP in December, had its credit rating cut one level by Moody’s and S&P on its sale of seven-year notes. S&P downgraded the San Diego- based company to B from B+ and Moody’s changed its grade to B2 from B1. “The Bumble Bee notes are very reminiscent of some highly risky deals completed in the LBO wave of 2005 to 2007 in that they’re triple C rated from a newly-private entity and carry a PIK feature, which adds to their risk level,” said Guy LeBas, chief fixed-income strategist and economist at Janney Montgomery Scott LLC in Philadelphia. Florida East Coast Holdings Corp., the freight railroad operator owned by Fortress, sold $130 million of PIK bonds due 2017 on Feb. 9, Bloomberg data show. Proceeds were slated to pay a dividend to its owner, Moody’s said in a note the same day. The six-year bonds yield 10.5 percent if the Jacksonville, Florida-based company makes interest payments in cash and 11.25 percent if it pays in the form of additional debt, Bloomberg data show. PIK Sales American Renal Holdings, MGM Resorts International’s CityCenter Holdings LLC joint venture and American Commercial Lines Inc. have also sold pay-in-kind bonds this year. Bonds rated CCC or below, the lowest tier of junk debt, have returned 4.8 percent in 2011, compared with 0.4 percent on investment-grade notes, according to Bank of America Merrill Lynch index data. High-yield bonds have gained 3.71 percent. Companies rated CCC and lower by Moody’s and S&P account for 13.2 percent of high-yield debt issuance this year, the highest proportion since it reached 15.9 percent in 2008, according to a March 4 report from JPMorgan. The Fed, which has kept its benchmark interest rate at between zero and 0.25 percent since December 2008, announced a second round of quantitative easing in November by purchasing $600 billion of Treasuries in an effort to slash unemployment and avert deflation. That’s pushed investors into riskier securities, giving companies incentive to market deals that may not have found buyers closer to when credit markets froze. The default rate for U.S. speculative-grade companies will decline to 1.6 percent by December from 3 percent in February, Moody’s analysts wrote in a note yesterday. The global default rate will fall to 1.4 percent by the end of the year from 2.8 percent last month, according to the note. Sales Peak Sales of pay-in-kind bonds peaked in 2007 when companies issued $15.2 billion of the securities, Bloomberg data show. Offerings fell to $7.8 billion in 2008 and tumbled to $1.7 billion in 2009, the data show. The securities are risky because “there’s kind of a perverse incentive that the more it’s trading down, the more incentive a company has to PIK the note because it’s cheap financing for them,” said Gross of RS Investments. The most likely buyers of the PIK toggle notes are hedge funds because most traditional money managers won’t purchase assets with that degree of risk, according to LeBas and Gross. “You’re going to see them for a while until either the market cools off or something goes wrong on one of the names and people become weary,” Gross said. “For the short-term, I think you’re definitely going to see more. It’s a copy cat market.”

Why Isn't Wall Street in Jail?

Financial crooks brought down the world's economy — but the feds are doing more to protect them than to prosecute them

Over drinks at a bar on a dreary, snowy night in Washington this past month, a former Senate investigator laughed as he polished off his beer.

"Everything's fucked up, and nobody goes to jail," he said. "That's your whole story right there. Hell, you don't even have to write the rest of it. Just write that."

I put down my notebook. "Just that?"

"That's right," he said, signaling to the waitress for the check. "Everything's fucked up, and nobody goes to jail. You can end the piece right there."

Nobody goes to jail. This is the mantra of the financial-crisis era, one that saw virtually every major bank and financial company on Wall Street embroiled in obscene criminal scandals that impoverished millions and collectively destroyed hundreds of billions, in fact, trillions of dollars of the world's wealth — and nobody went to jail. Nobody, that is, except Bernie Madoff, a flamboyant and pathological celebrity con artist, whose victims happened to be other rich and famous people.

This article appears in the March 3, 2011 issue of Rolling Stone. The issue is available now on newsstands and will appear in the online archive February 18.

The rest of them, all of them, got off. Not a single executive who ran the companies that cooked up and cashed in on the phony financial boom — an industrywide scam that involved the mass sale of mismarked, fraudulent mortgage-backed securities — has ever been convicted. Their names by now are familiar to even the most casual Middle American news consumer: companies like AIG, Goldman Sachs, Lehman Brothers, JP Morgan Chase, Bank of America and Morgan Stanley. Most of these firms were directly involved in elaborate fraud and theft. Lehman Brothers hid billions in loans from its investors. Bank of America lied about billions in bonuses. Goldman Sachs failed to tell clients how it put together the born-to-lose toxic mortgage deals it was selling. What's more, many of these companies had corporate chieftains whose actions cost investors billions — from AIG derivatives chief Joe Cassano, who assured investors they would not lose even "one dollar" just months before his unit imploded, to the $263 million in compensation that former Lehman chief Dick "The Gorilla" Fuld conveniently failed to disclose. Yet not one of them has faced time behind bars.

Invasion of the Home Snatchers

Instead, federal regulators and prosecutors have let the banks and finance companies that tried to burn the world economy to the ground get off with carefully orchestrated settlements — whitewash jobs that involve the firms paying pathetically small fines without even being required to admit wrongdoing. To add insult to injury, the people who actually committed the crimes almost never pay the fines themselves; banks caught defrauding their shareholders often use shareholder money to foot the tab of justice. "If the allegations in these settlements are true," says Jed Rakoff, a federal judge in the Southern District of New York, "it's management buying its way off cheap, from the pockets of their victims."

To understand the significance of this, one has to think carefully about the efficacy of fines as a punishment for a defendant pool that includes the richest people on earth — people who simply get their companies to pay their fines for them. Conversely, one has to consider the powerful deterrent to further wrongdoing that the state is missing by not introducing this particular class of people to the experience of incarceration. "You put Lloyd Blankfein in pound-me-in-the-ass prison for one six-month term, and all this bullshit would stop, all over Wall Street," says a former congressional aide. "That's all it would take. Just once."

But that hasn't happened. Because the entire system set up to monitor and regulate Wall Street is fucked up.

Just ask the people who tried to do the right thing.

Here's how regulation of Wall Street is supposed to work. To begin with, there's a semigigantic list of public and quasi-public agencies ostensibly keeping their eyes on the economy, a dense alphabet soup of banking, insurance, S&L, securities and commodities regulators like the Federal Reserve, the Federal Deposit Insurance Corp. (FDIC), the Office of the Comptroller of the Currency (OCC) and the Commodity Futures Trading Commission (CFTC), as well as supposedly "self-regulating organizations" like the New York Stock Exchange. All of these outfits, by law, can at least begin the process of catching and investigating financial criminals, though none of them has prosecutorial power.

The major federal agency on the Wall Street beat is the Securities and Exchange Commission. The SEC watches for violations like insider trading, and also deals with so-called "disclosure violations" — i.e., making sure that all the financial information that publicly traded companies are required to make public actually jibes with reality. But the SEC doesn't have prosecutorial power either, so in practice, when it looks like someone needs to go to jail, they refer the case to the Justice Department. And since the vast majority of crimes in the financial services industry take place in Lower Manhattan, cases referred by the SEC often end up in the U.S. Attorney's Office for the Southern District of New York. Thus, the two top cops on Wall Street are generally considered to be that U.S. attorney — a job that has been held by thunderous prosecutorial personae like Robert Morgenthau and Rudy Giuliani — and the SEC's director of enforcement.

The relationship between the SEC and the DOJ is necessarily close, even symbiotic. Since financial crime-fighting requires a high degree of financial expertise — and since the typical drug-and-terrorism-obsessed FBI agent can't balance his own checkbook, let alone tell a synthetic CDO from a credit default swap — the Justice Department ends up leaning heavily on the SEC's army of 1,100 number-crunching investigators to make their cases. In theory, it's a well-oiled, tag-team affair: Billionaire Wall Street Asshole commits fraud, the NYSE catches on and tips off the SEC, the SEC works the case and delivers it to Justice, and Justice perp-walks the Asshole out of Nobu, into a Crown Victoria and off to 36 months of push-ups, license-plate making and Salisbury steak.

That's the way it's supposed to work. But a veritable mountain of evidence indicates that when it comes to Wall Street, the justice system not only sucks at punishing financial criminals, it has actually evolved into a highly effective mechanism for protecting financial criminals. This institutional reality has absolutely nothing to do with politics or ideology — it takes place no matter who's in office or which party's in power. To understand how the machinery functions, you have to start back at least a decade ago, as case after case of financial malfeasance was pursued too slowly or not at all, fumbled by a government bureaucracy that too often is on a first-name basis with its targets. Indeed, the shocking pattern of nonenforcement with regard to Wall Street is so deeply ingrained in Washington that it raises a profound and difficult question about the very nature of our society: whether we have created a class of people whose misdeeds are no longer perceived as crimes, almost no matter what those misdeeds are. The SEC and the Justice Department have evolved into a bizarre species of social surgeon serving this nonjailable class, expert not at administering punishment and justice, but at finding and removing criminal responsibility from the bodies of the accused.

The systematic lack of regulation has left even the country's top regulators frustrated. Lynn Turner, a former chief accountant for the SEC, laughs darkly at the idea that the criminal justice system is broken when it comes to Wall Street. "I think you've got a wrong assumption — that we even have a law-enforcement agency when it comes to Wall Street," he says.

In the hierarchy of the SEC, the chief accountant plays a major role in working to pursue misleading and phony financial disclosures. Turner held the post a decade ago, when one of the most significant cases was swallowed up by the SEC bureaucracy. In the late 1990s, the agency had an open-and-shut case against the Rite Aid drugstore chain, which was using diabolical accounting tricks to cook their books. But instead of moving swiftly to crack down on such scams, the SEC shoved the case into the "deal with it later" file. "The Philadelphia office literally did nothing with the case for a year," Turner recalls. "Very much like the New York office with Madoff." The Rite Aid case dragged on for years — and by the time it was finished, similar accounting fiascoes at Enron and WorldCom had exploded into a full-blown financial crisis. The same was true for another SEC case that presaged the Enron disaster. The agency knew that appliance-maker Sunbeam was using the same kind of accounting scams to systematically hide losses from its investors. But in the end, the SEC's punishment for Sunbeam's CEO, Al "Chainsaw" Dunlap — widely regarded as one of the biggest assholes in the history of American finance — was a fine of $500,000. Dunlap's net worth at the time was an estimated $100 million. The SEC also barred Dunlap from ever running a public company again — forcing him to retire with a mere $99.5 million. Dunlap passed the time collecting royalties from his self-congratulatory memoir. Its title: Mean Business.

The pattern of inaction toward shady deals on Wall Street grew worse and worse after Turner left, with one slam-dunk case after another either languishing for years or disappearing altogether. Perhaps the most notorious example involved Gary Aguirre, an SEC investigator who was literally fired after he questioned the agency's failure to pursue an insider-trading case against John Mack, now the chairman of Morgan Stanley and one of America's most powerful bankers.

Aguirre joined the SEC in September 2004. Two days into his career as a financial investigator, he was asked to look into an insider-trading complaint against a hedge-fund megastar named Art Samberg. One day, with no advance research or discussion, Samberg had suddenly started buying up huge quantities of shares in a firm called Heller Financial. "It was as if Art Samberg woke up one morning and a voice from the heavens told him to start buying Heller," Aguirre recalls. "And he wasn't just buying shares — there were some days when he was trying to buy three times as many shares as were being traded that day." A few weeks later, Heller was bought by General Electric — and Samberg pocketed $18 million.

After some digging, Aguirre found himself focusing on one suspect as the likely source who had tipped Samberg off: John Mack, a close friend of Samberg's who had just stepped down as president of Morgan Stanley. At the time, Mack had been on Samberg's case to cut him into a deal involving a spinoff of the tech company Lucent — an investment that stood to make Mack a lot of money. "Mack is busting my chops" to give him a piece of the action, Samberg told an employee in an e-mail.

A week later, Mack flew to Switzerland to interview for a top job at Credit Suisse First Boston. Among the investment bank's clients, as it happened, was a firm called Heller Financial. We don't know for sure what Mack learned on his Swiss trip; years later, Mack would claim that he had thrown away his notes about the meetings. But we do know that as soon as Mack returned from the trip, on a Friday, he called up his buddy Samberg. The very next morning, Mack was cut into the Lucent deal — a favor that netted him more than $10 million. And as soon as the market reopened after the weekend, Samberg started buying every Heller share in sight, right before it was snapped up by GE — a suspiciously timed move that earned him the equivalent of Derek Jeter's annual salary for just a few minutes of work.

The deal looked like a classic case of insider trading. But in the summer of 2005, when Aguirre told his boss he planned to interview Mack, things started getting weird. His boss told him the case wasn't likely to fly, explaining that Mack had "powerful political connections." (The investment banker had been a fundraising "Ranger" for George Bush in 2004, and would go on to be a key backer of Hillary Clinton in 2008.)

Aguirre also started to feel pressure from Morgan Stanley, which was in the process of trying to rehire Mack as CEO. At first, Aguirre was contacted by the bank's regulatory liaison, Eric Dinallo, a former top aide to Eliot Spitzer. But it didn't take long for Morgan Stanley to work its way up the SEC chain of command. Within three days, another of the firm's lawyers, Mary Jo White, was on the phone with the SEC's director of enforcement. In a shocking move that was later singled out by Senate investigators, the director actually appeared to reassure White, dismissing the case against Mack as "smoke" rather than "fire." White, incidentally, was herself the former U.S. attorney of the Southern District of New York — one of the top cops on Wall Street.

Pause for a minute to take this in. Aguirre, an SEC foot soldier, is trying to interview a major Wall Street executive — not handcuff the guy or impound his yacht, mind you, just talk to him. In the course of doing so, he finds out that his target's firm is being represented not only by Eliot Spitzer's former top aide, but by the former U.S. attorney overseeing Wall Street, who is going four levels over his head to speak directly to the chief of the SEC's enforcement division — not Aguirre's boss, but his boss's boss's boss's boss. Mack himself, meanwhile, was being represented by Gary Lynch, a former SEC director of enforcement.

Aguirre didn't stand a chance. A month after he complained to his supervisors that he was being blocked from interviewing Mack, he was summarily fired, without notice. The case against Mack was immediately dropped: all depositions canceled, no further subpoenas issued. "It all happened so fast, I needed a seat belt," recalls Aguirre, who had just received a stellar performance review from his bosses. The SEC eventually paid Aguirre a settlement of $755,000 for wrongful dismissal.

Rather than going after Mack, the SEC started looking for someone else to blame for tipping off Samberg. (It was, Aguirre quips, "O.J.'s search for the real killers.") It wasn't until a year later that the agency finally got around to interviewing Mack, who denied any wrongdoing. The four-hour deposition took place on August 1st, 2006 — just days after the five-year statute of limitations on insider trading had expired in the case.

"At best, the picture shows extraordinarily lax enforcement by the SEC," Senate investigators would later conclude. "At worse, the picture is colored with overtones of a possible cover-up."

Episodes like this help explain why so many Wall Street executives felt emboldened to push the regulatory envelope during the mid-2000s. Over and over, even the most obvious cases of fraud and insider dealing got gummed up in the works, and high-ranking executives were almost never prosecuted for their crimes. In 2003, Freddie Mac coughed up $125 million after it was caught misreporting its earnings by $5 billion; nobody went to jail. In 2006, Fannie Mae was fined $400 million, but executives who had overseen phony accounting techniques to jack up their bonuses faced no criminal charges. That same year, AIG paid $1.6 billion after it was caught in a major accounting scandal that would indirectly lead to its collapse two years later, but no executives at the insurance giant were prosecuted.

All of this behavior set the stage for the crash of 2008, when Wall Street exploded in a raging Dresden of fraud and criminality. Yet the SEC and the Justice Department have shown almost no inclination to prosecute those most responsible for the catastrophe — even though they had insiders from the two firms whose implosions triggered the crisis, Lehman Brothers and AIG, who were more than willing to supply evidence against top executives.

In the case of Lehman Brothers, the SEC had a chance six months before the crash to move against Dick Fuld, a man recently named the worst CEO of all time by Portfolio magazine. A decade before the crash, a Lehman lawyer named Oliver Budde was going through the bank's proxy statements and noticed that it was using a loophole involving Restricted Stock Units to hide tens of millions of dollars of Fuld's compensation. Budde told his bosses that Lehman's use of RSUs was dicey at best, but they blew him off. "We're sorry about your concerns," they told him, "but we're doing it." Disturbed by such shady practices, the lawyer quit the firm in 2006.

Then, only a few months after Budde left Lehman, the SEC changed its rules to force companies to disclose exactly how much compensation in RSUs executives had coming to them. "The SEC was basically like, 'We're sick and tired of you people fucking around — we want a picture of what you're holding,'" Budde says. But instead of coming clean about eight separate RSUs that Fuld had hidden from investors, Lehman filed a proxy statement that was a masterpiece of cynical lawyering. On one page, a chart indicated that Fuld had been awarded $146 million in RSUs. But two pages later, a note in the fine print essentially stated that the chart did not contain the real number — which, it failed to mention, was actually $263 million more than the chart indicated. "They fucked around even more than they did before," Budde says. (The law firm that helped craft the fine print, Simpson Thacher & Bartlett, would later receive a lucrative federal contract to serve as legal adviser to the TARP bailout.)

Budde decided to come forward. In April 2008, he wrote a detailed memo to the SEC about Lehman's history of hidden stocks. Shortly thereafter, he got a letter back that began, "Dear Sir or Madam." It was an automated e-response.

"They blew me off," Budde says.

Over the course of that summer, Budde tried to contact the SEC several more times, and was ignored each time. Finally, in the fateful week of September 15th, 2008, when Lehman Brothers cracked under the weight of its reckless bets on the subprime market and went into its final death spiral, Budde became seriously concerned. If the government tried to arrange for Lehman to be pawned off on another Wall Street firm, as it had done with Bear Stearns, the U.S. taxpayer might wind up footing the bill for a company with hundreds of millions of dollars in concealed compensation. So Budde again called the SEC, right in the middle of the crisis. "Look," he told regulators. "I gave you huge stuff. You really want to take a look at this."

But the feds once again blew him off. A young staff attorney contacted Budde, who once more provided the SEC with copies of all his memos. He never heard from the agency again.

"This was like a mini-Madoff," Budde says. "They had six solid months of warnings. They could have done something."

Three weeks later, Budde was shocked to see Fuld testifying before the House Government Oversight Committee and whining about how poor he was. "I got no severance, no golden parachute," Fuld moaned. When Rep. Henry Waxman, the committee's chairman, mentioned that he thought Fuld had earned more than $480 million, Fuld corrected him and said he believed it was only $310 million.

The true number, Budde calculated, was $529 million. He contacted a Senate investigator to talk about how Fuld had misled Congress, but he never got any response. Meanwhile, in a demonstration of the government's priorities, the Justice Department is proceeding full force with a prosecution of retired baseball player Roger Clemens for lying to Congress about getting a shot of steroids in his ass. "At least Roger didn't screw over the world," Budde says, shaking his head.

Fuld has denied any wrongdoing, but his hidden compensation was only a ripple in Lehman's raging tsunami of misdeeds. The investment bank used an absurd accounting trick called "Repo 105" transactions to conceal $50 billion in loans on the firm's balance sheet. (That's $50 billion, not million.) But more than a year after the use of the Repo 105s came to light, there have still been no indictments in the affair. While it's possible that charges may yet be filed, there are now rumors that the SEC and the Justice Department may take no action against Lehman. If that's true, and there's no prosecution in a case where there's such overwhelming evidence — and where the company is already dead, meaning it can't dump further losses on investors or taxpayers — then it might be time to assume the game is up. Failing to prosecute Fuld and Lehman would be tantamount to the state marching into Wall Street and waving the green flag on a new stealing season.

The most amazing noncase in the entire crash — the one that truly defies the most basic notion of justice when it comes to Wall Street supervillains — is the one involving AIG and Joe Cassano, the nebbishy Patient Zero of the financial crisis. As chief of AIGFP, the firm's financial products subsidiary, Cassano repeatedly made public statements in 2007 claiming that his portfolio of mortgage derivatives would suffer "no dollar of loss" — an almost comically obvious misrepresentation. "God couldn't manage a $60 billion real estate portfolio without a single dollar of loss," says Turner, the agency's former chief accountant. "If the SEC can't make a disclosure case against AIG, then they might as well close up shop."

As in the Lehman case, federal prosecutors not only had plenty of evidence against AIG — they also had an eyewitness to Cassano's actions who was prepared to tell all. As an accountant at AIGFP, Joseph St. Denis had a number of run-ins with Cassano during the summer of 2007. At the time, Cassano had already made nearly $500 billion worth of derivative bets that would ultimately blow up, destroy the world's largest insurance company, and trigger the largest government bailout of a single company in U.S. history. He made many fatal mistakes, but chief among them was engaging in contracts that required AIG to post billions of dollars in collateral if there was any downgrade to its credit rating.

St. Denis didn't know about those clauses in Cassano's contracts, since they had been written before he joined the firm. What he did know was that Cassano freaked out when St. Denis spoke with an accountant at the parent company, which was only just finding out about the time bomb Cassano had set. After St. Denis finished a conference call with the executive, Cassano suddenly burst into the room and began screaming at him for talking to the New York office. He then announced that St. Denis had been "deliberately excluded" from any valuations of the most toxic elements of the derivatives portfolio — thus preventing the accountant from doing his job. What St. Denis represented was transparency — and the last thing Cassano needed was transparency.

Another clue that something was amiss with AIGFP's portfolio came when Goldman Sachs demanded that the firm pay billions in collateral, per the terms of Cassano's deadly contracts. Such "collateral calls" happen all the time on Wall Street, but seldom against a seemingly solvent and friendly business partner like AIG. And when they do happen, they are rarely paid without a fight. So St. Denis was shocked when AIGFP agreed to fork over gobs of money to Goldman Sachs, even while it was still contesting the payments — an indication that something was seriously wrong at AIG. "When I found out about the collateral call, I literally had to sit down," St. Denis recalls. "I had to go home for the day."

After Cassano barred him from valuating the derivative deals, St. Denis had no choice but to resign. He got another job, and thought he was done with AIG. But a few months later, he learned that Cassano had held a conference call with investors in December 2007. During the call, AIGFP failed to disclose that it had posted $2 billion to Goldman Sachs following the collateral calls.

"Investors therefore did not know," the Financial Crisis Inquiry Commission would later conclude, "that AIG's earnings were overstated by $3.6 billion."

"I remember thinking, 'Wow, they're just not telling people,'" St. Denis says. "I knew. I had been there. I knew they'd posted collateral."

A year later, after the crash, St. Denis wrote a letter about his experiences to the House Government Oversight Committee, which was looking into the AIG collapse. He also met with investigators for the government, which was preparing a criminal case against Cassano. But the case never went to court. Last May, the Justice Department confirmed that it would not file charges against executives at AIGFP. Cassano, who has denied any wrongdoing, was reportedly told he was no longer a target.

Shortly after that, Cassano strolled into Washington to testify before the Financial Crisis Inquiry Commission. It was his first public appearance since the crash. He has not had to pay back a single cent out of the hundreds of millions of dollars he earned selling his insane pseudo-insurance policies on subprime mortgage deals. Now, out from under prosecution, he appeared before the FCIC and had the enormous balls to compliment his own business acumen, saying his atom-bomb swaps portfolio was, in retrospect, not that badly constructed. "I think the portfolios are withstanding the test of time," he said.

"They offered him an excellent opportunity to redeem himself," St. Denis jokes.

In the end, of course, it wasn't just the executives of Lehman and AIGFP who got passes. Virtually every one of the major players on Wall Street was similarly embroiled in scandal, yet their executives skated off into the sunset, uncharged and unfined. Goldman Sachs paid $550 million last year when it was caught defrauding investors with crappy mortgages, but no executive has been fined or jailed — not even Fabrice "Fabulous Fab" Tourre, Goldman's outrageous Euro-douche who gleefully e-mailed a pal about the "surreal" transactions in the middle of a meeting with the firm's victims. In a similar case, a sales executive at the German powerhouse Deutsche Bank got off on charges of insider trading; its general counsel at the time of the questionable deals, Robert Khuzami, now serves as director of enforcement for the SEC.

Another major firm, Bank of America, was caught hiding $5.8 billion in bonuses from shareholders as part of its takeover of Merrill Lynch. The SEC tried to let the bank off with a settlement of only $33 million, but Judge Jed Rakoff rejected the action as a "facade of enforcement." So the SEC quintupled the settlement — but it didn't require either Merrill or Bank of America to admit to wrongdoing. Unlike criminal trials, in which the facts of the crime are put on record for all to see, these Wall Street settlements almost never require the banks to make any factual disclosures, effectively burying the stories forever. "All this is done at the expense not only of the shareholders, but also of the truth," says Rakoff. Goldman, Deutsche, Merrill, Lehman, Bank of America ... who did we leave out? Oh, there's Citigroup, nailed for hiding some $40 billion in liabilities from investors. Last July, the SEC settled with Citi for $75 million. In a rare move, it also fined two Citi executives, former CFO Gary Crittenden and investor-relations chief Arthur Tildesley Jr. Their penalties, combined, came to a whopping $180,000.

Throughout the entire crisis, in fact, the government has taken exactly one serious swing of the bat against executives from a major bank, charging two guys from Bear Stearns with criminal fraud over a pair of toxic subprime hedge funds that blew up in 2007, destroying the company and robbing investors of $1.6 billion. Jurors had an e-mail between the defendants admitting that "there is simply no way for us to make money — ever" just three days before assuring investors that "there's no basis for thinking this is one big disaster." Yet the case still somehow ended in acquittal — and the Justice Department hasn't taken any of the big banks to court since.

All of which raises an obvious question: Why the hell not?

Gary Aguirre, the SEC investigator who lost his job when he drew the ire of Morgan Stanley, thinks he knows the answer.

Last year, Aguirre noticed that a conference on financial law enforcement was scheduled to be held at the Hilton in New York on November 12th. The list of attendees included 1,500 or so of the country's leading lawyers who represent Wall Street, as well as some of the government's top cops from both the SEC and the Justice Department.

Criminal justice, as it pertains to the Goldmans and Morgan Stanleys of the world, is not adversarial combat, with cops and crooks duking it out in interrogation rooms and courthouses. Instead, it's a cocktail party between friends and colleagues who from month to month and year to year are constantly switching sides and trading hats. At the Hilton conference, regulators and banker-lawyers rubbed elbows during a series of speeches and panel discussions, away from the rabble. "They were chummier in that environment," says Aguirre, who plunked down $2,200 to attend the conference.

Aguirre saw a lot of familiar faces at the conference, for a simple reason: Many of the SEC regulators he had worked with during his failed attempt to investigate John Mack had made a million-dollar pass through the Revolving Door, going to work for the very same firms they used to police. Aguirre didn't see Paul Berger, an associate director of enforcement who had rebuffed his attempts to interview Mack — maybe because Berger was tied up at his lucrative new job at Debevoise & Plimpton, the same law firm that Morgan Stanley employed to intervene in the Mack case. But he did see Mary Jo White, the former U.S. attorney, who was still at Debevoise & Plimpton. He also saw Linda Thomsen, the former SEC director of enforcement who had been so helpful to White. Thomsen had gone on to represent Wall Street as a partner at the prestigious firm of Davis Polk & Wardwell.

Two of the government's top cops were there as well: Preet Bharara, the U.S. attorney for the Southern District of New York, and Robert Khuzami, the SEC's current director of enforcement. Bharara had been recommended for his post by Chuck Schumer, Wall Street's favorite senator. And both he and Khuzami had served with Mary Jo White at the U.S. attorney's office, before Mary Jo went on to become a partner at Debevoise. What's more, when Khuzami had served as general counsel for Deutsche Bank, he had been hired by none other than Dick Walker, who had been enforcement director at the SEC when it slow-rolled the pivotal fraud case against Rite Aid.

"It wasn't just one rotation of the revolving door," says Aguirre. "It just kept spinning. Every single person had rotated in and out of government and private service."

The Revolving Door isn't just a footnote in financial law enforcement; over the past decade, more than a dozen high-ranking SEC officials have gone on to lucrative jobs at Wall Street banks or white-shoe law firms, where partnerships are worth millions. That makes SEC officials like Paul Berger and Linda Thomsen the equivalent of college basketball stars waiting for their first NBA contract. Are you really going to give up a shot at the Knicks or the Lakers just to find out whether a Wall Street big shot like John Mack was guilty of insider trading? "You take one of these jobs," says Turner, the former chief accountant for the SEC, "and you're fit for life."

Fit — and happy. The banter between the speakers at the New York conference says everything you need to know about the level of chumminess and mutual admiration that exists between these supposed adversaries of the justice system. At one point in the conference, Mary Jo White introduced Bharara, her old pal from the U.S. attorney's office.

"I want to first say how pleased I am to be here," Bharara responded. Then, addressing White, he added, "You've spawned all of us. It's almost 11 years ago to the day that Mary Jo White called me and asked me if I would become an assistant U.S. attorney. So thank you, Dr. Frankenstein."

Next, addressing the crowd of high-priced lawyers from Wall Street, Bharara made an interesting joke. "I also want to take a moment to applaud the entire staff of the SEC for the really amazing things they have done over the past year," he said. "They've done a real service to the country, to the financial community, and not to mention a lot of your law practices."

Haw! The line drew snickers from the conference of millionaire lawyers. But the real fireworks came when Khuzami, the SEC's director of enforcement, talked about a new "cooperation initiative" the agency had recently unveiled, in which executives are being offered incentives to report fraud they have witnessed or committed. From now on, Khuzami said, when corporate lawyers like the ones he was addressing want to know if their Wall Street clients are going to be charged by the Justice Department before deciding whether to come forward, all they have to do is ask the SEC.

"We are going to try to get those individuals answers," Khuzami announced, as to "whether or not there is criminal interest in the case — so that defense counsel can have as much information as possible in deciding whether or not to choose to sign up their client."

Aguirre, listening in the crowd, couldn't believe Khuzami's brazenness. The SEC's enforcement director was saying, in essence, that firms like Goldman Sachs and AIG and Lehman Brothers will henceforth be able to get the SEC to act as a middleman between them and the Justice Department, negotiating fines as a way out of jail time. Khuzami was basically outlining a four-step system for banks and their executives to buy their way out of prison. "First, the SEC and Wall Street player make an agreement on a fine that the player will pay to the SEC," Aguirre says. "Then the Justice Department commits itself to pass, so that the player knows he's 'safe.' Third, the player pays the SEC — and fourth, the player gets a pass from the Justice Department."

When I ask a former federal prosecutor about the propriety of a sitting SEC director of enforcement talking out loud about helping corporate defendants "get answers" regarding the status of their criminal cases, he initially doesn't believe it. Then I send him a transcript of the comment. "I am very, very surprised by Khuzami's statement, which does seem to me to be contrary to past practice — and not a good thing," the former prosecutor says.

Earlier this month, when Sen. Chuck Grassley found out about Khuzami's comments, he sent the SEC a letter noting that the agency's own enforcement manual not only prohibits such "answer getting," it even bars the SEC from giving defendants the Justice Department's phone number. "Should counsel or the individual ask which criminal authorities they should contact," the manual reads, "staff should decline to answer, unless authorized by the relevant criminal authorities." Both the SEC and the Justice Department deny there is anything improper in their new policy of cooperation. "We collaborate with the SEC, but they do not consult with us when they resolve their cases," Assistant Attorney General Lanny Breuer assured Congress. in January. "They do that independently."

Around the same time that Breuer was testifying, however, a story broke that prior to the pathetically small settlement of $75 million that the SEC had arranged with Citigroup, Khuzami had ordered his staff to pursue lighter charges against the megabank's executives. According to a letter that was sent to Sen. Grassley's office, Khuzami had a "secret conversation, without telling the staff, with a prominent defense lawyer who is a good friend" of his and "who was counsel for the company." The unsigned letter, which appears to have come from an SEC investigator on the case, prompted the inspector general to launch an investigation into the charge.

All of this paints a disturbing picture of a closed and corrupt system, a timeless circle of friends that virtually guarantees a collegial approach to the policing of high finance. Even before the corruption starts, the state is crippled by economic reality: Since law enforcement on Wall Street requires serious intellectual firepower, the banks seize a huge advantage from the start by hiring away the top talent. Budde, the former Lehman lawyer, says it's well known that all the best legal minds go to the big corporate law firms, while the "bottom 20 percent go to the SEC." Which makes it tough for the agency to track devious legal machinations, like the scheme to hide $263 million of Dick Fuld's compensation.

"It's such a mismatch, it's not even funny," Budde says.

But even beyond that, the system is skewed by the irrepressible pull of riches and power. If talent rises in the SEC or the Justice Department, it sooner or later jumps ship for those fat NBA contracts. Or, conversely, graduates of the big corporate firms take sabbaticals from their rich lifestyles to slum it in government service for a year or two. Many of those appointments are inevitably hand-picked by lifelong stooges for Wall Street like Chuck Schumer, who has accepted $14.6 million in campaign contributions from Goldman Sachs, Morgan Stanley and other major players in the finance industry, along with their corporate lawyers.

As for President Obama, what is there to be said? Goldman Sachs was his number-one private campaign contributor. He put a Citigroup executive in charge of his economic transition team, and he just named an executive of JP Morgan Chase, the proud owner of $7.7 million in Chase stock, his new chief of staff. "The betrayal that this represents by Obama to everybody is just — we're not ready to believe it.