Demon Investing - The Biggest Economic Loophole

When we look at the economic crash, failing companies and the blatant and foolish actions that got us here, our gut tells us that it seems like a crime. Yet other than the two or three scams that have been exposed, no other investigations have taken place. Let's face it, Madoff and Stanford hurt a lot of people but they did not crash the economy. If we do treat this crash as a crime, then we can begin to understand how it really happened, who was responsible and how to prevent another in the future. So, does this event qualify as a crime? For a crime, we need a victim or victims and a perpetrator and our perp needs a motive. The victims are those that were hurt by the crime and we therefore have plenty of those. The motive is the most common of all - money. So who is the perpetrator or perpetrator(s)? To answer this, let us first work our hypothesis of what went down.

Large companies are headed by CEOs but are really run by a Board. This board is typically made up of the largest investors. So, essentially, bug companies are run by investors. This is where the problem begins. The CEO's job is simple: make money for the investors. There are a lot of strategies and schools of thought on how to accomplish this. There are both long and short term strategies. Some work and some do not. In the normal course of business, this typical arrangement works just fine and is the heart of capitalism. So where does it go wrong? It goes wrong when demon investors get involved. These investors are guided by one principle only - greed. So what happens now?

The investor buys a substantial piece of a company. The investor directs the CEO to take actions, either directly or indirectly, that will inflate stocks. This inflation of stocks makes a lot of money for the investor. If the stock doubles, so does the investor's investment. In the housing loan market for instance, bad loans were made by the millions. The end result of these actions were known and understood by the investor and the CEO that was directed to take them. To the demon investor however, this has no impact. Once the investment they made has bloomed, they will either sell the bad loans in a package or sell their shares. In either case, the investor has made a lot of money, the CEO has made a lot of money and no one is held accountable. It gets worse. The stock that the demon investor sold at $50 / share plummets to $5 a share and he buys again to restart the cycle. The motive for the crime is clear and again it is greed. The perpetrators are the investors pressuring the CEO, the CEO who directs and pressures his subordinates and the subordinates who do what they know is wrong. All motivated by greed either in pay offs or in just retaining their job. The truth is, it is hard to fault some involved. A reputation as a guy or gal that won't play ball will get you off the playing field quickly and your name will be famous in those circles. Still, there is the option of leaving Wall Street and pursuing a career elsewhere.

So what do we know now? We know the crime. It is fraud on a grand scale. Selling packages of what they knew to be junk is fraud. Selling over inflated stock that they knew was going to crash SHOULD be fraud. We know the motive. The motive is money and greed. We know the profile of our perpetrators and we know the companies they were involved with. We also know the loopholes that exist that allow these practices to continue with impunity. In any normal criminal case, we would investigate, arrest and prosecute the criminals. If loopholes in the law existed, we would close them rapidly and continue the prosecutions and we would bestow a sentence of the same magnitude as the crime. Why aren't we doing that in this case?

The rash of unpaid taxes, the exposure of Dodd and his part in allowing loopholes like this to exist, companies still paying bonuses in the face of bankruptcy and the fact that the politician with the biggest purse usually wins are all the reasons we aren't prosecuting this case. Our list of perpetrators is growing. We are faced with yet another question. Who is the bigger criminal? Those demon investors that take advantage of opportunities like this at the sacrifice of millions of others or is it those elected to positions of responsibility that not only look the other way but aid them in these actions? I will not tackle this issue again here. Instead, I will suggest the course of action that should be taken.

First, the laws have to be changed. Any actions, attempted or carried out, directly or indirectly, taken by any person to inflate a company's value, stock value or selling value in a fraudulent manner is illegal. Such actions will carry harsh sentences and will apply to any persons involved with the company whether they are an officer, employee or investor. Real prison sentences as well as seizure of all assets will not only stop actions like this from happening in the future, but will also encourage whistle blowers rather than participants. Secondly, aggressive investigation and prosecution. We have some bright people in law enforcement in this country. If their hands are untied and they are not pressurized by politicians, I am sure they can find those responsible and prosecute them under fraud and embezzlement laws as well as some RICO cases. Third, we have to put protective laws in place that prevent companies from becoming too large to fail. This should include the Federal Reserve. The Fed is also a beneficiary of broken companies as it can use law to take over what is essentially a competitor.

These actions should be taken and failure to do so will lead us to yet another and ever larger collapse. Greed, by no means, ever gets smaller. What's more, investors can see that their strategy did work and there were no repercussions for them. In fact, it all worked out great for them. The demon investor bought stock at say $20 per share, inflated it to $50 and sold it. The market crashed but the investor was already out of the deal having made 2.5 times his or her money. The price now falls to $10 per share and the investor buys in again. What do you think he or she will do to get the price up again? We already know that hard work and doing the right thing don't apply here.