Wall St Gone Wild! (Part I)

Hello everybody. Welcome back to Breaking the Dollar. I'm your host, Everett Millman. We've got a really exciting show for you this time that I am calling Wall Street Gone Wild. This topic has really been culminating for several months and there is so much to say about it that I've decided to break this episode into two parts. So in the first part, I'm going to explain what shenanigans are going on on Wall Street and you will find that this is essentially a recap of many other topics that I've already discussed on previous episodes. We are just finally seeing the signs that yes indeed these things are going on and we should be worried about them. So Part One, I will lay all those things out. Part Two, I will take it a step further and kind of discuss what can we do about this? What is the Fed doing? What can we as investors and consumers do or at minimum? What should we all be aware of?

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So I want to start by saying that although these are topics that I have covered in the past, mainly having to do with the Fed and debt and corporate shenanigans, I still want to point out that a recent article in the Atlantic magazine as well as a columnist for Bloomberg News named Matt Levine or Levine. I apologize if I'm butchering his last name. These are my two main sources to update this topic and to really bring everything together because what you find in finance, the economy, the banking system, although these are all separate entities, they're all interrelated. So for instance, the rising level of debt in the private sector may require some sort of policy or response from the central bank. So now monetary policy and banking as well as credit markets, they're all interacting. They're all interconnected. And so what's especially troubling about a lot of these issues that I'm going to be bringing up is that they're not isolated problems. They leak over into other areas and sectors of the economy and our lives. But I just want to give some credit to Levine. He is really the captain of snark at Bloomberg. He is always covering everything, finance and banking related. I believe he's a former Goldman Sachs guy, so he has a bit of an inside perspective. But as a columnist, he essentially just makes fun of all of this stuff. Yes, I do find a lot of this ridiculous behavior by banks and Wall Street to be entertaining and to be comical, but at the same time, it is pretty scary and troubling.

So let me just pick things up where the Atlantic article begins and I'll give you a quick summary so that we're on the same page. Essentially, this article warns that a banking crisis is somewhere on the horizon. And the main culprit that it cites as causing this future banking crisis is our good old friend, the CLO. And again, we did an entire episode a few months back on CLOs. So be sure to go check that out if you need a refresher. But CLO stands for collateralized loan obligation. In the simplest terms, you can think of it as a way of packaging debt so that it can be resold to someone else without that debt seeming as risky or as toxic as it normally would because it has been packaged together, it has been collateralized. Now certainly since the last financial crisis, CLOs have become increasingly popular. But one of the things that is concerning about CLOs right now, something that has kind of changed the present situation as I described in my previous podcast episode, is that banks have found some creative ways of accounting for the CLOs that they hold on their balance sheets. In other words, they're trying to find ways to keep this debt off of their books. Really, this is just creative accounting. In some ways, you could say that it's unethical. Even if you don't go that route, it still is true that the practice of keeping CLO debt off of a bank's books is a way of hiding the actual financial health of that bank or their balance sheet. If you have some separate place off the books where you are recording all of this toxic debt, well, that's not a fair representation of how much debt that bank is holding relative to its deposits or its assets. To put it in the simplest terms, keeping CLOs off the books as the Atlantic article describes is really just hiding the debt.

So this brings up two related problems. The first is just the basic financials of the bank if they have a lot of CLO debt. In many cases, there is so much of this debt that if they actually put it on the books, the banks would be insolvent, meaning the amount of debt load they have exceeds the amount of assets they have. Under normal circumstances, that type of situation would call for a bankruptcy. However, that is not the world that we live in right now. We live in an economy and in a financial system of kick the can down the road. In other words, through this creative accounting and through all of the stimulus and support that the Federal Reserve has offered to the banking system, these banks and these financial firms are able to stay afloat and they're able to do that basically by ignoring the debt and by putting this debt off of its books as I described.

But that means that these companies really are zombies and this applies to many types of corporations, not just to banks. If you are a company in any other industry and you have too much debt and not enough cash flow or not enough assets to cover that debt, then you should be bankrupt. The fact that more companies aren't declaring bankruptcy is a sign that they are essentially zombies. By zombie, we mean they are literally walking dead, that they are still alive and operating as a business, but that technically they shouldn't be alive and this whole idea about zombies was the main conclusion from my previous episode on CLOs. That type of vehicle for repackaging debt is disguising how poor of a health these companies' financial situation is in. As I pointed out, in many cases, the amount of CLO debt held by these companies exceeds the entire value of their enterprise. That's what I mean when I'm talking about bankruptcy, is that theoretically, even if you liquidated the entire company, in a case like this, even if you sold off every asset, every last share of stock, it still would not be enough to cover the amount of debt that is held in the form of CLOs.

Now, of course, I'm not saying every single company in America or in the world is going through this, but it is a significant amount, really an alarming amount. Enough that the mainstream press is writing articles about it, okay? But even more so, CLOs and these types of practices are part of a broader problem on Wall Street. I continue to call it creative accounting. Some people might say it's taking advantage of accounting loopholes, but probably the most accurate and technical term for what I'm describing is non-GAAP accounting. So non-generally accepted accounting practices. So although those types of accounting practices have really always been with us, they're becoming much, much more prominent now. Really I suppose it's not difficult to see why non-GAAP accounting is more popular now, because you can make a business that is perhaps not in the best health or not actually that profitable. And through accounting shenanigans, you can make it look like that business is booming. So it really is a case of if you can get away with doing this, why wouldn't you? And the high profile examples of creative accounting basically covering up fraud so we can talk about the ethics, the business ethics of this type of accounting, but in some cases, it has even risen to the level of outright fraud, and there have been many, many examples of this recently where the company has gotten caught. Of course in each of these cases, they tend to claim that it was simply an accounting mistake and not to say that accountants never make mistakes, but I'm pretty sure those people are fairly OCD about getting things right or at least knowing what they're doing. I mean, that is literally what the accountant is for at a company. So color me skeptical that these were simply oversights or mistakes.

So as we go down the list, one prominent example is Wirecard. Wirecard is or was a German payment processing company, and it turned out recently that for years, Wirecard has not honestly been reporting a lot of its financials. Like I said, honest mistakes happen, nobody's perfect, so even in healthy markets, you will see some amount of fraud and deceit. But it strikes me that this went on for three or four years before anyone bothered to notice. That's especially surprising because Germany has pretty stringent financial regulators. So the fact that the Wirecard fraud got passed everybody's noses so to speak really shows how some forms of fraud and accounting shenanigans have become normalized in the financial world. Wirecard is certainly not the only one though.

Another prominent one that you may have heard of was Luckin Coffee. This was a Chinese coffee retailer, and in recent months they had this ridiculous amount of growth. Their stock price was skyrocketing, and the reason there was so much hype around Luckin Coffee was that they had these incredible sales numbers that they supposedly controlled a huge part of the Chinese coffee market, which with over a billion and a half people in China, You can imagine that's a pretty big coffee market. There was all this talk about how Luckin was going to compete with Starbucks and lo and behold, when some investors started doing some digging, they found that Luckin's numbers really did not add up. It turned out what they were doing in order to inflate their sales numbers. Another accounting trick was to jump between order numbers. So at a normal restaurant, you go in, you place your order, you get a number on your ticket, let's say 57. The next person in line who orders gets the next number, 58. And it's obvious why restaurants or businesses do this. It's a way to track every sale. Well, in all of their brilliance, Luckin figured out that if they just skipped a few hundred or a few thousand numbers a few times a day, people were only going to look at the final number. How many sales did you make today? So even though maybe they were only serving 200 cups of coffee at a particular location that day, by skipping the numbers intermittently, they could make it look like they served 2,000 or 10,000 customers that day, just something ridiculous. But again, until some curious investors literally went and sat at a Luckin Coffee location all day and counted the number of people who came and bought something until they went and did that first hand research themselves for months and months, nobody knew that this was a fraud.

Now my inclination being a skeptic is that some of the people who were buying the stock and profiting off of it, such as the executives at Luckin Coffee, they obviously knew it was a fraud. But once that unethical behavior gets revealed and the stock price went down, that's harming shareholders. Now those two examples came from Germany and China. But if you think that this sort of behavior is isolated to foreign businesses, you would be dead wrong. Very recently, you have two cases with pretty storied American corporations. First you have Hertz Rent-a-car, which has been around for a very long time. People of a certain age may remember that Hertz commercials featured famous celebrities like OJ Simpson and Arnold Palmer. So they have been around the block a few times. However, especially during covid, Hertz's business have struggled to the point where they were almost a penny stock. So eventually the company declared bankruptcy. But before that, a lot of day traders and stock investors were buying up Hertz stock because it had fallen so low. So in fact, what Hertz decided to do was issue some more stock, which is something that you once you enter bankruptcy proceedings, you obviously can't start issuing shares of your company. Because the whole point of bankruptcy is that you need to find a way to pay back your creditors before you can even run your business or take on more debt. Nonetheless, that's what Hertz tried to do because they saw, hey, everybody's interested in buying our stock. Let's sell them more stock.

Again, if you didn't know anything about business ethics, you might think, well, yeah, why not? It's really logical, right? If people are willing to hand you their money, why wouldn't you take it? Now the answer to that is that they're entering bankruptcy proceedings and they're not a viable business. But nonetheless, the SEC, the Security and Exchange Commission, stepped in, said, no, you can't issue stock while you're going through bankruptcy. And in fact, they uncovered some accounting inconsistencies at Hertz, surprise, surprise. But perhaps more egregious than the Hertz saga was what we've seen in recent weeks with Kodak. Now, again, people of a certain age will remember that Kodak is a photographic film company. You know, they processed film and they sold cameras and that type of thing, right? Photography. But somehow Kodak is apparently restructuring its business to be like a medical company, I guess, because the news was that they had earned or received a government contract to make a COVID vaccine for something related to that. It was some sort of medical chemical thing that Kodak was going to be doing.

Now if you think that's weird, you might want to know that back when the cryptocurrency craze first really hit the ceiling back in 2017, you had a lot of companies that would make a quick buck by seeming to insert themselves in the crypto space, even though they had nothing to do with it. The most prominent example was Long Island Iced Tea Blockchain Company. This was literally a company that made tea or drinks. They slapped the word blockchain on the end of their name and suddenly people were buying their stock just because they saw the word blockchain. Kodak was one of those companies, obviously having no connection to blockchain technology or cryptocurrency. Kodak tried to create their own crypto coin. They called it Kodak coin. I forget all the details but needless to say, it didn't really pan out. But I tell you this just to give you a sense that Kodak is certainly active in trying to rebrand itself and trying to jump on some of these trends and shenanigans that I've been describing this whole episode. So back to the present day, Kodak gets this government contract. Their stock price is soaring. And though I'm pretty sure it wasn't, I mean it was a significant amount of money. It was $750 million or something. But with all of the billions floating around, it just didn't make sense for Kodak's stock to increase quite as much as it did just because it got this government contract.

That's not the end of the story though. Apparently Kodak executives leaked this information to the press a day early. They told reporters, hey, we're getting this government contract. We're not going to announce it until tomorrow, but we're really excited. We want you guys to have this information so you can report on it. Unfortunately Kodak forgot to put an embargo on that information they shared. In other words, they had intended to tell reporters with the understanding that there's an embargo. So you can start writing an article, but you cannot tell anyone or report this for X amount of days. Kodak forgot. They forgot to file the embargo. So that information went out in news articles a day ahead of time. You could chalk that up as just a dumb mistake on the part of Kodak, but in fact that does sort of run up against the issue of insider trading and best practices when it comes to releasing material information about your business. Then putting that aside, it means that the insiders at Kodak screwed themselves over because they made public all of the inside information that ultimately led to the stock price skyrocketing. Now in the time since then, there has been some controversy over the government rescinding the contract, everything I described with insider trading possibly. And ultimately, the stock of Kodak went right back down.

But I want to emphasize that this isn't happening exclusively with obscure companies you've never heard of. It's not always some guy in a basement in some country far away. A lot of these shady accounting practices, whether it has to do with CLO debt or issuing new stock or reporting earnings, any of those things, they're not just happening in the back corners of the economy. They're happening with some pretty prominent companies. And although this is a pretty bold claim and a pretty cynical claim, I think the more that you look around, the more you will find that this really has become the new normal. Creative accounting is so normalized that even the biggest companies you can think of, Apple, Microsoft, Amazon, these trillion dollar companies, virtually all of them engage in some questionable accounting. The issue with Amazon is that it gets a bunch of tax breaks, so it doesn't have to pay its tax burden. The issue with Apple is that it does these tax inversions where it lists its headquarters in another country, usually Ireland. So that way it's paying a more favorable tax rate.

So as I said at the top, all of these things are interconnected. And I just want to emphasize that it's everyone. It is almost every major company and obviously some small ones you never heard of, but it is also the big ones. And that is a big problem. So of course there is even more to say about all of this. And I want to save that for episode two. So we're going to wrap it up here. Be sure to check out Wall Street Gone Wild Part Two, where I will be tackling a few more examples of all of the shenanigans that I'm describing, but I will also explore what are we doing about it? What is the Fed going to do about it? And are they actually contributing to the problem? Should be exciting. You don't want to miss it. Tune in next time.