2009 Sequel:  Script exposes diabolical cover-up conspiracy.
Flash forward: Real life, Wall Street, Washington, Corporate American CEOs, always new leaders, always same old wizardry. Be forewarned: No matter who’s president, America will soon see a massive statistical curtain pulled back, exposing a con game of historic proportions. And when that happens, you and I will suffer another ear-splitting global meltdown, bigger than today’s housing-credit crisis, dragging us deep into a recession and bear market for years.

Cast:  New ‘leading man’ from ol’ Nixon political machine.
Yes, the lead character pulling back the curtain is none other than Kevin Phillips, a former Republican strategist for Nixon, and today America’s leading political historian. In Phillips’ bestseller, Bad Money: Reckless Finance, Failed Politics & the Crisis of American Capitalism, you’ll find eerything you need to know about the 2008 credit meltdown, and how the “numbers racket” is adding jet fuel on the next one … coming soon.

Scene One:  Numbers racket hiding behind Washington curtain.
Opening shot: Phillips pulling back the curtain, exposing charlatan Wizards in a brilliant Harper’s Magazine article: “Numbers Racket: Why the economy is worse than we know.” Far worse. This is essential reading if you really want to understand the depth of today’s political as well as economic impending meltdown, and the harsh realities facing Washington, Wall Street, Corporate America, and Main Street in 2009 and beyond … harsh because we cannot cover-up the truth much longer.

Scene Two:  Statistics, Washington’s new WMDs, a time bomb.
“If Washington’s harping on weapons of mass destruction was essential to buoy public support for the invasion of Iraq, the use of deceptive statistics has played its own vital role in convincing many Americans that the U.S. economy is stronger, fairer, more productive, more dominant, and richer with opportunity than it really is. The corruption has tainted the very measures that most shape public perception of the economy,” especially three key numbers, CPI, GDP and monthly unemployment statistics.

Scene Three:  Backflash, ‘It’s always the cover-up, stupid!’
As I read further I couldn’t help but think about similar traps politicians get themselves (and us) into. Remember nice guys like Scooter Libby and Bill Clinton: The crime wasn’t their original stupidity, but their lying during the cover-up. Here, Phillips reviews endless statistical cover-ups since the sixties and concludes there was no “grand conspiracy, just accumulating opportunisms.” I call it plain ol’ greed. And every step of the way the media went along with the con game played by politicians and economists.

Scene Four:  Real numbers torture us … like water-boarding! |How bad is it? “The real numbers … would be a face full of cold water,” says Phillips. “Based on the criteria in place a quarter century ago, today’s U.S. unemployment rate is somewhere between 9% and 12%; the inflation rate is as high as 7% or even 10%; economics growth since the recession of 2001 has been mediocre, despite the surge in wealth and incomes of the superrich, and we are falling back into recession.” 

Scene Five:  Most economists hushed, work inside conspiracy.
Compare that to the phony stats Washington feeds the press and public: Unemployment 5%, inflation 2% and long-term growth at 3-4% (actually more like 1%). For example, just last week the LA Times reported that while “gasoline prices are up more than 20% from a year ago and food prices have risen 5%,” Washington says “inflation was fairly mild last month.” A Wells Fargo economist shook his head in disbelief: That report isn’t “worth the paper it was printed on.” Most economists work for conspiracy, keep quiet.

Scene Six:  No integrity, they cannot be trusted to tell truth!
The same can be said of any government report, every speech made by today’s leaders: All hype, lies and propaganda intended to deceive us. Treasury Secretary Paulson’s clearly playing the game: Remember what the former Goldman Sachs CEO told Fortune last July as our credit meltdown was metastasizing into a worldwide contagion: “This is far and away the strongest global economy I’ve seen in my business lifetime.” He has no credibility. He knew the truth. He knew the government’s “numbers racket,” after all, he helped create the problems years earlier at Goldman.

Scene Seven:  There’s enough Kool-Aid for everyone to drink.
The plot’s unraveling: The lies accumulate and compound one on top of the another … get passed on … keep mounting … forcing successive new generations of politicians to drink the same poisonous Kool-Aid … keep the lies alive … going strong … till everyone believes the lies are really “the truth,” or at least an inconvenient truth … as the hoax becomes the conventional wisdom … not only by Washington, Wall Street, Corporate America and the media, but also 300 million Main Street Americans.

Scene Eight:  Inflation statistics are now America’s new “guillotine.”
The biggest of all lies is with inflation. Understating inflation “hangs over our heads like a quillotine,” says Phillips. Yet, if Washington told us the truth “it would send interest rates climbing and thereby would endanger the viability of the massive buildup of public and private debt (from less than $11 trillion in 1987 to $49 trillion last year) that props up the American Economy.”  So we keep sipping the Kool-Aid.

Scene Nine:  Washington and Wall Street delusional in “Land of Oz”
“Were mainstream interest rates to jump into the 7 to 9 percent range—which could happen if inflation were to spur new concern—both Washington and Wall Street could be walking on quicksand,” warns Phillips. “The make-believe economy of the past two decades, with its asset bubbles, massive borrowing, and rampant data distortion, would be in serious jeopardy.” 

Scene Ten:  Cover-up failing … king really has no clothes.
Yet everyone still acts paralyzed, unable (or unwilling) to do anything to stop this lethal musical chairs charade … till it’s too late, or a catastrophe wakes us. Meanwhile, we act as if we had no choice but put up with the crashes of 1987 and 2001 and 2007. Just “normal” bull/bear cycles. So like lemmings driven over a cliff, we’ll blindly accept the next crashes, as each increases in frequency and intensity. Next in 2011? As war debt piles? As reforming healthcare, Social Security and Medicare are delayed? As we deny and deceive ourselves, perpetuate the lie … except notice, out of the corner of your eye, at the edge of the screen, a curtain’s being pulled open, slowly, our once-mighty statistical king, the Wizard of Washington really has no clothes on. 

Scene Eleven:  Millions of co-conspirators in massive cover-up.
Still, we let ourselves be conned. Why? “The rising cost of pensions, benefits, and interest payments—all indexed or related to inflation—could join the cost of financial bailouts to overwhelm the federal budget,” says Phillips. But it’s heads-we-lose-tails-we-can’t-win bet. “As inflation and interest rates have been kept artificially suppressed, the United States has been indentured to its volatile financial sector, with its predilection for leverage and risky buccaneering” Yes, Wall Street and the rich love playing this game. So do we! 

Scene twelve:  Rich get richer hiding under “statistical camouflage.”
So who really “profits from the low-growth U.S. economy hidden under statistical camouflage?” he asks rhetorically? Certainly not the masses: “Might it be Washington politicos and affluent elite, anxious to mislead voters, coddle the financial markets, and tamp down expensive cost-of-living increases for wages and pensions?” Yes, yes, yes, a voice screams off-camera! Then a gun shot rings out … dull thud … silence … haunting music builds, filling the theater … signaling the end of this tragi-comedy … although like Sartre’s No Exit, you know this drama will never end … until … the sequel …

Roll credits:  Who was that masked man?
Kudos to the masked curtain-puller. Yes folks, it’s the same Kevin Phillips who wrote American Theocracy, The Peril and Politics of Radical Religion, Oil, and Borrowed Money in the 21st Century; The Politics of Rich and Poor: Wealth and Electorate in the Reagan Aftermath; American Dynasty: Aristocracy, Fortune, and the Politics of Deceit in the House of Bush and others. In his Wealth and Democracy: A Political History of the American Rich Phillips warned us that “most great nations, at the peak of their economic power, become arrogant and wage great world wars at great cost, wasting vast resources, taking on huge debt, and ultimately burning themselves out.” Slowly, fade to black ….

original: MarketWatch May’08

For example, when a poor performing fund is closed or merged out of existence, its statistics also disappear, that makes the survivors and their category look better than they are. Halloween’s my wife’s favorite holiday, the biggest of the year around our house. We start early. Suddenly, right after Labor Day, vampires, ghosts, witches, black cats, mummies and zombies return from the underworld to haunt us, purge our darkside. They take over the house. Just lotsa statues, icons, scenes, cobwebs. Okay, so there’s a kid in all of us. We even have a one of the entire Peanuts gang waiting for the immortal “Great Pumpkin” to arise once again from the patch.

Night of the Living Dead haunts $12 trillion of your money

Halloween, the Night of The Living Dead, is also a great metaphor for the darkside of America’s $12 trillion mutual fund industry, a time to descend into the gory cemetery of long-dead funds. This frightening tale paralyzes investors, forcing us to bury our fears deep in the dungeons of our brains. Investors are blind to the fact that historically as many as one third of all funds “die” and become cold cases. The losers, the weak ones, the low-performers are systematically exterminated by assassins, yes, actually killed off by their own parents, the fund company’s owners. Then, all records of their deaths and autopsies are expunged from databases, as if they never existed. It is an ancient story that rivals the best horror films, Friday the 13th, Scream and Halloween.

But theirs is sweet revenge. The dead come back to haunt the living, the survivors. Nothing’s sacred in the financial world. Not even the cold, hard statistics from those saintly mortals at Lipper and Morningstar. When funds die, sadly, those “saints” bury them.　But then, in an act of revenge, like true vampires, ghouls and zombies, they return from the dead, coming back to haunt us, not just on Halloween, but all year long, every year, for all eternity.

Losers buried in unmarked graves

The script’s right out of Tales of The Crypt. Hiding evidence of wrong-doing may be criminal in the eyes of law.　But in the monstrous mausoleums of mutual funds, the “evildoers” get away with it. They have immunity with the law. Survivor funds live on, making the fund industry look better than it otherwise would. Get it? These vampires actually suck the blood out of the averages Wall Street sends to you—making them appear lots better than they really are. For example: If you have six funds in a category, and five are returning 10%, but the one loser is returning only 1%, then the average is 8.5%. But if the loser gets a Soprano whack-job and its statistics are buried anonymously in a concrete vault off the end of the pier, then you have only five funds left. And as if by black magic, the peer average of the five “survivors” is now 10%, not 8.5%!

So how bad is it? How much is it hurting the living?

In a study published by Savant Capital/Zero Alpha Group, Survivor Bias & Improper Measurement: How the Mutual Fund Industry Inflates Actively Managed Fund Performance, they ask: “Who is impacted when data providers publish biased returns? Everyone: Mutual fund companies often compare their funds’ returns to the class average or use peer group rankings (of only surviving peers). And investors often buy actively managed funds on the premise that managers in certain categories appear to add value (prior to adjusting for survivor bias). Investors assume that the average manager in such biased categories must deliver better than index returns based on inaccurate peer (category) group returns. Of course, they buy such active managers under the presumption that such funds will do better than average in the future.”

Warning, so-called “independent” data-trackers are at war too

This study concluded that survivorship bias exists in 41 of 42 categories over a 10-year period, and “is cumulative in nature, becoming more pronounced as time passes.” Moreover, it “is not as insignificant as Morningstar would like us to believe,” but has “the effect of systematically and significantly overstating the performance of actively managed mutual funds relative to their related indexes.” Savant says the actively managed funds in all nine of Morningstar style-box categories lagged their indexes. And by “purging the weakest funds [they] boosted apparent returns by an average 1.3% per year over the 10-year period.” A little 1.3% may not seem like much, until you start compounding: “For example, over the 10-year period (1995-2004) studied, the Mid Blend category returned a whopping 72% less” than shown in the database. “The largest evidence of survivor bias exists in the Aggressive Growth Fund category at 116%!”

Yes, dead live on and on, haunting Main Street’s future

Their bottom line is very simple: “When the class average is overstated, the public makes buying decisions on a false premise. Investors are duped. Mutual fund companies promoting active management gain assets (and income) by remaining silent on the matter. Data providers publish incomplete data. No one is left unscathed.” Within weeks, Morningstar took issue with the accusation that they have “blinders on.” And the truth is, they aren’t hiding anything. They’ve openly discussed the impact of survivor bias many times. They say there’s “absolutely no evidence that survivorship bias has prompted investors to shy away from index funds,” citing the success of Vanguard’s index funds.

Over the years survivor-bias has been hotly debated going back to the nineties. Princeton’s Burton Malkiel, author of A Random Walk Down Wall Street, published his research in the Journal of Finance: “Ghosts of Dead Funds May Haunt Results.” And Jason Zweig wrote in Money magazine: “The Truth About Zombie Funds.” Looking back over the prior three decades they noted:

· Huge graveyard: Out of 2,071 equity funds, over one third (725) were killed off between 1962 and 1995. Dig the vampires out of the graves and the average category returns sink 1.3% below their indexes.
· Big risks: A higher percentage of Aggressive Growth funds were buried, about 40% (242 of 614). Resurrect them and their 13.5% returns drop to 11.6%; just one percent higher than the S&P 500, and only slightly higher than 10.4% from less risky Growth funds.
· Higher expenses: Operating expenses of the 725 vampires were 33% above the average. And during the final five years before burial, they under-performed surviving relatives by 20%, while many naïve investors remained painfully loyal to those funds through their slow, agonizing funeral procession.

Even back then Morningstar was analyzing the terrible truth: “What this means to you is that past performance comparisons won’t tell you everything you need to know about a fund. It’s a sad fact, but numbers do lie.” So please, never forget that truth, or you too will be buried in an unmarked grave along with the vampires, zombies and ghouls.

“Script” never changes—next time, new stats, new characters, same plots

Here’s our bottom line: In spite all the shouting by Malkiel, Zweig, Savant, and all the other indignant researchers, the harsh truth is … nothing’s ever going to change! So stop fighting city hall. It’s a waste of your time, money and energy. In spite of all the rumors of dark-side secrets, greed and corruption in the mutual fund industry, America’s 95 million investors are doomed to live with survivorship bias, for all eternity … or until Morningstar removes survivor-bias from their database, which they tell me they’re in the process of correcting.

Meanwhile, you can beat the system. Yes! How? Stop play their game by their rules! Forget about all their actively-managed funds. You never have to buy one, never! Remember, only one actively-managed fund has ever beat the S&P 500 over the long-term. Instead, quietly create a well-diversified portfolio of low-cost, no-load index funds. That way, dead funds can’t come back to haunt you ever again. And you’ll live in peace—even near a cemetery!

Index funds are the only living survivors who are real, immortal and strong enough to face the evil ones. The rest belong as extras in films like Night of the Living Dead, Friday the 13th, Scream and Halloween. Go index: You’ll have no fear of the blood being drained out of your retirement portfolio by vampires, ghosts, witches, ghouls, zombies … and fat cats!

FirstPubDate: Oct’06

The Supreme Court decided by a 9-0 vote Tuesday to send a lawsuit challenging high mutual fund fees back to a lower court, a move that both sides hailed as a victory. In Jones v. Harris Associates, the plaintiffs alleged that Chicago-based Harris Associates overcharged shareholders in the Oakmark funds, which Harris manages. The plaintiffs, three Oakmark shareholders, said that Harris charged Oakmark shareholders nearly twice what it charged big institutional investors for essentially similar services. … The court ruled that courts must use the guidelines set out in a 1982 case, Gartenberg v. Merrill Lynch Asset Management, to determine whether fund fees are excessive. In Gartenberg, a lower court found fees must not be so large that they bear no relationship to the services rendered and could not have been the result of arm’s-length bargaining.

So your mutual funds can keep charging you as much money as they darn well please, as long as they can manipulate the numbers and don’t get caught. Fund company owners love the decision. Some contrarians note that the high court added: “Fund boards should take into consideration fees charged to institutional investors,” which are lower. But don’t count on it. For more, read Anna Prior’s article, “The Hidden Costs of Mutual Funds,” in The Journal. Like Bogle, Prior exposes more about the fund companies’ endless numbers game:

“Portfolio managers can rack up steep expenses buying and selling securities, but that burden isn’t reflected in a fund’s standard expense ratio. How much does it cost you to own a mutual fund? Probably a lot more than you think. Read the complete Investing in Funds: A Monthly Analysis report. In selecting mutual funds, most investors know to check the expense ratio, the standard measure of how costly a fund is to own. U.S.-stock funds pay an average of 1.31% of assets each year to the portfolio manager and for other operating expenses, according to Morningstar … But that’s not the real bottom line. There are other costs, not reported in the expense ratio, related to the buying and selling of securities in the portfolio, and those expenses can make a fund two or three times as costly as advertised.”

Today, Adam Smith’s “Invisible Hand” is the crooked hand of your fund’s “casino croupier!”

Prior points to one way you can check on the trading costs funds are hiding from you: “While you can’t find a fund’s total trading-related costs, you can get a clue from a standard and imperfect measure of how much trading the fund is doing, called ‘turnover.’ Turnover, expressed as a percentage, shows at what rate stocks in the fund have been replaced. A stock fund that sold half its stocks and replaced them with an equal value in new stocks would have turnover of 50%,” thus hiding excessive trading costs.  

But the real bottom line is simple: America’s mutual funds are cheating 95 million investors by hiding information. And the SEC and Congress are in on the scam. As a result your funds really ‘are two or three times more costly than advertised.’ That’s not capitalism’s “invisible hand” at work, that the greedy hands of Wall Street and your fund owners and managers.

“Many investors realize stocks have been among the worst investments of the past decade. But they may not realize quite how bad the decade was because most forget about the effects of inflation. Despite its 2009 rebound, the Dow Jones Industrial Average today stands at just 10520.10, no higher than in 1999. And that is without counting consumer-price inflation. In 1999 dollars, the Dow is only at about 8200 and would have to rise another 28% or so to return to 1999 levels. Using today’s dollars and starting at 10520.10, the Dow would have to surpass 13460 to get back to its 1999 level in real, inflation-adjusted terms.

“Controlling for inflation takes extra work and makes stock gains look punier, so it is easy to see why stock analysts almost never do it. The media almost never do it either. But other things do get measured in real dollars. When economists report whether the economy is growing, they account for inflation. When analysts judge long-term gains in commodities such as gold or oil, they often adjust for inflation, noting that gold hit a record this month in nominal terms but remains far from its 1980 record in real terms. Because analysts almost never do the same with stocks, it leaves investors with an exaggerated view of their portfolios’ performance over time.

So you can bet you’ll hear more and more investors screaming about gold. Across the world, not just here in America. And not just buying and hoarding that heavy clumbersome metal. How about returning to the gold standard of measuing value? Yes, unwinding the mistake Nixon made when he took America off gold. Here are some ideas from Browning in The Journal:  

Lately, some investors have gotten interested in measuring the Dow in gold rather than dollars. Gold has rebounded since 1999, and the fascination with the yellow metal has made investors start thinking of it again as a currency. Ned Davis, the founder of Ned Davis Research, referred to gold as “real money” in a recent report and published charts of bonds, home prices and stocks measured in gold rather than dollars. Even with gold’s swoon in recent days, the Dow looks a lot weaker over the past decade measured in gold than in dollars.

Of course, it is possible to find a hot investment that dwarfs the Dow’s gains over any period, which makes many analysts question the value of adjusting the Dow for gold’s gains. Such skepticism doesn’t stop gold’s supporters from pointing out how much weaker the Dow looks when measured in ‘hard’ money. In 1997, the Dow looked strong at 40 times the dollar value of an ounce of gold, notes John Hathaway, who oversees the Tocqueville Gold Fund at New York’s Tocqueville Asset Management. With gold’s rebound since 1999, the Dow now is worth about nine times an ounce of gold, meaning simply gold has performed a lot better than the Dow.

Gold a better investment than the good ol’ American Dollar? And what if it stays up there forever, unlike it did in the 1980′s? Scary isn’t it. As Dorothy would say: “Toto, I don’t think we’re not in Kansas anymore,” nor is the new capitalism.