By Michael Markowski

On September 8, 2008, I published a comment on OnlineFinancialSector.com, which stated that Bankrate (NASDAQ: RATE) would be a big beneficiary of the government’s bailout of Fannie Mae and Freddie Mac.

On September 8, Bankrate shares closed at $34.34 and haven’t traded below $34.00 per share since. Yesterday, its shares closed at $38.31 on a day that was arguably the worst in years (the Dow Jones declined by 778 points). The bottom line is that RATE shares have appreciated by more than 10% since September 8, while the S&P 500 declined by over 7% during the same period.

I believe that RATE’s shares have been among the few to go up because the traffic on its web sites is exploding. Investors and borrowers are using the site to monitor the extremely volatile interest rates that accompany the credit crisis.

Given the strength (it’s the only stock that I can find that has gone up in during the crisis) that RATE shares have had in a downright horrible market and the fact that it will most likely have a record quarter for ad revenue in the quarter ending today, I believe that RATE shares are poised to approach and could possibly even exceed their all time highs of $57.32 by the end of 2008.

I am recommending that investors “strongly” consider investing 5% of their liquidity into RATE shares at $40.00 per share or below.

Bankrate is not the only company that will benefit significantly from the worst financial crisis that the USA is facing since the Great Depression. I expect that the shares of all the companies that I am currently recommending in the online financial sector to appreciate significantly from their current prices between now and the end of 2009. Why? For the same reason that hurricanes, tornados, and other natural weather-related disasters made the Weather Channel more valuable than the major TV networks.

The ratings for CNBC—which has now become one of GE’s most prized possessions—are soaring. Content related to financial broadcasting, online financial education, and online financial information is fast becoming a permanent fixture with individual investors globally. Any business that provides online or broadcasted financial information has gone up significantly in value because of the financial crisis.

Other companies that I am also recommending:

Online Financial Sector Recommendations by Markowski
Company Symbol Industry 52 wk hi 52 wk lo 9/29/08
Price
thinkorswim SWIM Online brkr $18.23 $6.41 $8.04
OptionsXpress OXPS Online brkr $34.95 $18.55 $20.48
Morningstar MORN Online info $85.50 $52.51 $54.08
Interactive Data IDC Online info $33.68 $22.13 $24.77
TheStreet.com TSCM Online info $16.74 $ 5.52 $ 5.64
TheRetirementSolution.com TRES Online edu $ 0.29 $ 0.07 $ 0.12
Bankrate RATE Online info $57.32 $24.54 $38.31

Disclosure: Michael Markowski, the founder of OnlineFinancialSector.com and StockDiagnostics.com currently holds shares in the public companies recommended in this blog and also on the OnlineFinancialSector.com website and may buy or sell shares without notice.

By Michael Markowski

The day of reckoning will soon be at hand for the two remaining brokers, Morgan Stanley and Goldman Sachs. I believe that share prices for both of them will go down significantly. I also believe it’s highly probably that they will both go out of business unless they seek shelter from the storm by merging with a commercial bank. I also believe that if something is not done to corral these two brokers, the proposed $700 billion bailout could prove to be futile. Why? Morgan Stanley and Goldman Sachs both have assets and liabilities of over $1 trillion and net worths between $40 and $50 billion.

The two brokers currently pose a great risk to the proposed $700 billion bailout. They both employ debt to equity leverage of over 20 to 1, or have net worths that represent 5% of their total liabilities. The problem is that the brokers have little margin for error. Therefore, a 5% change in the pricing of their assets would result in a $50 billion loss for each of them, and should that happen, they would both be out of business unless they could raise additional capital.

To assume that that their assets could not go down by 5%—especially under the current market conditions—would be ludicrous. I believe that right now the brokers are doing everything they can to protect their shareholders. However, by doing so they are walking a fine line in trying to protect their shareholders from further dilution at the expense of the U.S. economy.

Should the brokers’ assets get marked down and they fail, the dumping of more than $2 trillion of their assets to satisfy creditors could have severe consequences on the U.S. and global capital markets.

Possible solutions to this potential problem:

• At least $300 billion of the bailout proceeds should go towards the equity of both Goldman Sachs and Morgan Stanley. Under this scenario, they would still be able to remain in business even if the value of their assets decreased by 15%.

• The Federal Reserve and the SEC should immediately change the reserve requirements to 12 to 1 for all brokers and deposit-less institutions or hedge funds.

Remember that the financial institutions that have depositors and deposits such as commercial banks do not pose the same problem for the economy and the capital markets as the brokers. Commercial banks have deposits and loans that are not subject to price changes or markdowns.

By Michael Markowski

The five brokers—Goldman Sachs, Merrill Lynch, Bear Stearns, Lehman Holdings, and Morgan Stanley—are the cause of the financial crisis because they were able to increase their leverage from 12 to 1 up to 40 to 1 thanks to the SEC’s rule change in 2004. While many commercial banks such as Citibank and Washington Mutual also have high leverage ratios, banks do not have the same problem with leverage as the brokers because they have deposits on hand. These deposits are actually loans that are provided to the banks by millions of depositors.

Thus, the banks have a diversified portfolio of millions of small loans (liabilities) provided to them—and the brokers don’t enjoy the same luxury. The banks also have a big advantage in that they have assets on their books that are actually loans to individuals and businesses. Unlike the brokers that have liquid (supposedly) assets that have to be priced to the market, the banks are not required to mark their loans below face value unless they are in default. Therefore, a bank’s balance sheet enjoys several advantages when compared to a broker’s balance sheet. That is why Merrill Lynch eagerly decided to sell out to Bank of America.

Falling share prices caused the demise of Lehman and the shotgun weddings for Bear Stearns and Merrill Lynch with JPMorgan and Bank of America, respectively. The decline of share prices—especially the declines to below book value—are disastrous for brokers. The brokers need a stable share price at above book value (at the very least) so that they are able to sell equity to cover the “potential” shortfalls due to unexpected markdowns of assets.

A broker must have adequate reserve capital to cover unexpected markdowns. When the share prices of Lehman, Bear Stearns, Merrill Lynch, and Morgan Stanley traded to below their book values, it triggered an alert for the board of directors of each of the brokers. The boards for the brokers knew that a low share price would make it virtually impossible for them to raise capital unless they were willing to undergo massive dilution. This is why Morgan Stanley’s CEO started actively seeking capital globally after its shares traded down to $11 in early September 2008.

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By Michael Markowski

In September 2007 (see article titled “Have Wall Street’s Brokers Been Pigging Out?” in EQUITIES Magazine), I told everyone to sell their shares in the five big brokers: Merrill Lynch, Goldman Sachs, Lehman Brothers, Bear Stearns, and Morgan Stanley. I also said that the “day of reckoning” for them was coming.

I had been monitoring their cash flow charts on StockDiagnostics.com and frankly the negative cash flow that each of them was generating was totally out of control. I have been burning the midnight oil on what is going to happen next and for the foreseeable future will be focusing my blog on the financial crisis and how it will affect all investors and consumers worldwide.

There are three major causes of the financial crisis. The first is that rate of asset and liability growth of the five biggest U.S. brokers has outstripped the rate of growth in the US and global economy over the last ten years. The five publicly traded brokers were able to accomplish this by using leverage that was accessible to them via the public debt markets. The second is that the SEC modified the net capital requirements for the brokers in 2004. This modification allowed brokers, which had more than $5 billion in capital to increase their debt to equity levels from 12 to 1 to 40 to 1. All five of the USA’s largest brokers including Bear Stearns, Lehman Brothers, Merrill Lynch, Morgan Stanley and Goldman Sachs qualified for the SEC’s Rule change. The third is that because each of the five brokers are or were publicly traded they each of the five brokers do not There level of accountability is lower than what it was when they were private partnerships.

Prior to 1971, there were no brokerage firms that were publicly traded. All of the five brokers, named after their founding partners, operated as partnerships until they each went public in 1971 (Merrill Lynch), 1985 (Bear Stearns), 1994 (Lehman) and 1999 (Morgan Stanley and Goldman Sachs).

The firms prior to their going public operated as partnerships with each of the partners owning a stake in the respective firm’s assets and liabilities. At the end of a quarter or fiscal year the partners would divvy up the spoils and start anew in the next year.

Lehman Brothers, the USA’s oldest brokerage firm, operated successfully as a partnership from its founding in 1850 to 1994 when it went public. The firm, which financed Alabama’s reconstruction after the Civil War, was able to stay in business for 158 years before declaring bankruptcy in 2008.

The key to Lehman’s and the other four brokers ability to survive and thrive for long periods in a volatile world was most likely because they each had partners who had to approve the broker’s taking on of all liabilities or risk and the purchase of all assets. Since the partners had a legal share in the assets and liabilities they paid close attention to both. This all changed after each of the five decided to forgo their partnerships and become publicly traded companies.

As publicly traded companies the former brokerage partnerships were able to lay off their risk on to the public. They also had easy access to the cheap capital that was available to public companies. The result is that the assets and the liabilities for each of the publicly traded brokerages grew by approximately by five times between 1998 and 2007. For example, between 1998 and 2007, Goldman Sachs total assets grew from $217.3 billion in 1998 to $1.11 trillion in 2007. Its total liabilities grew from $211 million in 1998 to $1.07 trillion in 2007. Goldman was able to accomplish this while actually reducing its number of shares outstanding from 424 million in 1998 to 391 million in 2007.

The public company environment for the brokers created the conditions for the perfect storm because it (1) gave them virtually unlimited access to debt, which they could use to purchase assets and (2) eliminated the risk controls that would have been in place had the former partners been still accountable for their portion of the liabilities. The ability to purchase more and more assets allowed them to generate ever-increasing returns for shareholders and bonuses for employees. This created an asset bubble for the brokers as assets grew from $1.0 trillion in 1998 to $4.5 trillion in 2007.

Next subject: Why I believe that the five brokers are primarily responsible and the U.S. Securities & Exchange Commission is indirectly responsible for the financial crisis.

08/04/08
By Michael Markowski

Investools (NASDAQ: SWIM - $7.00), a leader in the investor education industry, made a surprise announcement that sent its shares and the shares of TheRetirementSolution.com (OTCBB: TRES - $0.10) tumbling to new 52-week lows. At first blush, the announcement appeared to be a negative for these two companies. However, after much research, I have concluded that it’s really a positive development. Before I get into why, let me disclose that I hold shares in both companies.

I stumbled upon Investools in 2002, when it showed up in a screening that I ran for StockDiagnostics.com, the website that I founded. At the time, I was doing research on companies that had both high free-cash-flow-yield and high free-cash-flow-growth attributes. Investools, which was trading on the OTC Bulletin Board at the time, ranked among the top 100 out of 8,000 companies. I recommended its shares to friends and family at approximately $0.20 per share and subsequently recommended it in the OPS newsletter in 2003 after it traded above $1.00 per share. Between 2002 and 2007, its shares traded to new annual highs for five consecutive years.

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