By: Frank Armstrong, III, CFP®, AIFA®
The great Wall Street houses promote the fiction that somewhere in their back room is a guru who knows when the market will go up and down, and can readily identify mispriced stocks and securities. With their vast resources they have unique and valuable insights into the world’s markets. Additionally, they will share this invaluable information with you for just a nominal cost and will assure you that their incentives are aligned with yours. To further this illusion, they spend billions each year on public relations and advertising so that they stay at the top of investors’ minds worldwide. Citicorp alone is said to spend more than the GDP of half of Africa on marketing each year.
A quick look at recent history destroys that fantasy. The crisis on Wall Street is a testament to greed and incompetence on a massive scale. The global subprime mortgage disaster is a Wall Street creation. You must be entirely delusional or choose to willingly suspend disbelief to think everything will work out O.K. when you offer credit to people that clearly do not deserve it, provide 100% financing secured by real estate that can only go up in value, and entice borrowers with introductory “teaser” rates close to zero percent with crushing escalations later.
A child should have known that when you package a bundle of garbage loans they are not going to turn into near government quality paper. But, these are not children, they are salesmen. Given a chance to sell a few hundred billion dollars of dreck, they went for it. They bundled all this good stuff up, labeled it a Collateral Debt Obligation (CDO), and then sliced it up into little tiny pieces called tranches. They sold various pieces to those oh so smart hedge fund managers, and kept some for themselves. The rest, as they say, is history.
Lots of those hedge fund managers who are just so smart they only produce absolute returns and were worth management fees of 2% per year and 20% of profits are now gone. Having been proved both mortal and exceedingly foolish, they have sold their boats and airplanes subsequent to liquidating their funds. (In all fairness, a few of them were on the right side of this bet and made huge returns).
Bond fund managers that decided to juice up their returns by buying into the sub prime mortgage offerings saw their holdings decimated. Even money market managers that couldn’t resist the temptation to boost returns by deviating from their investment policy have been burned.
The world’s biggest, smartest banks now find themselves selling off pieces of themselves at huge discounts to “sovereign” funds lest they break their capital requirements. Most of these rugged capitalist institutions sent their CEOs packing with obscene severance packages as a reward for presiding over multi billion dollar losses. The banks much vaunted risk management procedures proved to be a total sham. Not only were they poor stewards of their customer’s funds, it turns out they didn’t even understand what they owned for their own portfolios. Hopefully, the new CEOs are boning up on their Chinese and Arabic so that they can report to their new owners.
The rest of us are simply collateral damage. Central banks around the world are injecting hundreds of billions of Dollars, Euros and Francs into the system to keep markets functioning. Worthy creditors are finding funds difficult to obtain. Markets have sagged, a recession is a distinct possibility, and the dollar has declined. Wall Street may not be the direct cause of all this misery, but they sure contributed more than their share to the problem. Meanwhile financial sector stocks are the worst performing segment of the equities markets.
Meanwhile, Wall Street continues to maintain that they have the insight, competence and integrity to deserve your confidence as trusted advisors. Given the conclusive proof otherwise, it’s time to realize that the emperor has no clothes!