Stocks just ended their worst quarter since the financial crisis. The Nasdaq and S&P 500 each lost more than 12%.

It's becoming increasingly likely that Greece will default on its current debt obligations. Germany just doesn't seem to have the will to continue with bailouts. 

Another day, and still no agreement on a 2011 budget in Congress. Surprisingly though, the stock market is not really being affected by the impasse. Sure, the major indices are down slightly again today, but I think we can all imagine that it could be much worse.

Treasury bond prices have been choppy, with big $3 price swings on the chart of the iShares Barclays 20+ Year Treasury Bond ETF (TLT) in July. But overall, bonds are holding up well, and this tells us clearly that no one expects the U.S. government to default on its bond payments.

The stock market failed to build on the rally from Friday. The S&P 500 fell below support at 1,050 yesterday.

Right now, sentiment is just awful across the board. And we're heading into what's traditionally the worst two months of the year for stocks: September and October.

Volume in the stock market has been extremely light. This suggests that individual investors are not buying stocks. And we can see that in mutual fund flows. In July, bond funds attracted $25 billion dollars. And investors pulled $12 billion out of U.S. equity funds.

Senate Banking Chairman Christopher Dodd is all set to put his latest banking regulation bill up for a vote. The bill would put an end to proprietary trading, lend transparency to hedge fund trading and derivatives, and give the Federal Reserve the power break up companies if they pose a “grave threat” to the economy.  

 

Dodd’s proposal would also create a nine-member “Financial Stability Oversight Council” of regulators, led by the Treasury Secretary. According to Bloomberg, “…the council can make recommendations to the Fed to impose “strict” rules for capital, leverage, liquidity and risk management to make it difficult for firms to grow so big and complex that they endanger the financial system. It could require the Fed to regulate non-bank financial firms that threaten financial stability, ensuring that “the next AIG would be regulated” by the Fed…”   

 

It’s clear what Dodd is trying to accomplish here. He’s trying to make it so that financial firms can’t engage in trading activities that could ultimately destabilize the entire economy. I’m not sure these proposals, as I understand them, accomplish the objective. 

It’s hard to believe that just a year ago, the Dow Industrials were trading around 6,500. It’s easy to look back and see this as an obvious buying opportunity, but it sure didn’t feel that way at the time.  

 

Of course, I was recommending stocks in SmallCapInvestor PRO, because valuations were incredibly low. But I was mitigating the risk by taking profits quickly.  

 

For instance, we took profits on SXC Health Solutions (Nasdaq:SXCI) in April with a 19% gain. That stock has gone on to post some fantastic gains. Conversely, we made a quick 33% on Arena Pharmaceuticals (Nasdaq:ARNA) between March 3 and March 11, 2009. That stock is now much lower than our exit price.  

 

In light of the anniversary of the market lows, the AP ran a great article over the weekend that included a bunch of interesting stock market stats. I’d like to share a few...

There is an article at Slate.com making the rounds in the financial press. Warren Buffett's partner at Berkshire Hathaway, Charlie Munger, penned a parable about America's rise and fall, called "Basically, It's Over."

The article details how a young, fiscally responsible country called Basicland got caught up in the "casino" of speculation, ignored its export economy, and essentially went bankrupt.

While perhaps a bit simplistic, Munger's piece is intended as a warning about rising government debt and an over-reliance on risky financial speculation. This speculation is intended to make up for the lack of manufacturing as a major component of GDP.

Some of the statistics he throws out are a bit scary. He says "The winnings of the casinos (investment banks) eventually amounted to 25 percent of Basicland's GDP, while 22 percent of all employee earnings in Basicland were paid to persons employed by the casinos."

I haven't verified those numbers, but they certainly suggest an economy that's out of balance.

As I read Munger's article, I thought immediately of yesterday's story about how Goldman Sachs and other investment banks may knowingly used mortgage-backed securities and CDOs to set-up AIG.

I'm sure we all believe it is any company's right to take advantage of another company's weakness. At the same time, however, it seems to me that at some point, a company must ask itself "at what cost?"

In the case of the housing bubble, investment banks knew the mortgage-backed securities they were selling were junk. Not only did they set AIG up for a fall, these casinos, as Munger calls them, essentially cannibalized America to make a buck.

Munger's answer? Listen to Paul Volcker. Keep banking separate from investing. And "…produce and sell items that foreigner's [are] willing to buy."

Let's hope that our elected officials are not so ensnared in the casinos' tentacles that they can make the changes that America needs.