Sunday, December 13, 2009


By a slim majority, the US House of Representatives believes it can make all forms of securities investment safe. As perhaps Henry Higgins of “My Fair Lady” might declare, “How delightfully, na├»ve.” Staying with this musical theme to describe all of the losses sustained by investors, I say “It takes two to tango.” The buyer seeks the advantage of ownership and/or use of some asset and the seller sees some disadvantage in maintaining the position. In the language of the law, they are consenting adults. Not for one moment am I saying that there was sufficient disclosure of facts and motivations on both sides. What I do believe is that the buyers did not look carefully at the disclosures and historic backgrounds provided. In my mind it is questionable whether additional disclosure within the legalese framework would have prevented a willing and anxious buyer from completing the transaction. The seller also could have sought better disclosure on the ability of the buyer to pay for the asset, particularly if it was going to be paid for over time. The motivation and sophistication of the buyer might well have helped the seller avoid some of the after-sale problems. In truth, there was insufficient prudence around many of the transactions of the last several years. Disclosure documents, like prospectuses and instructions for most electronic gifts received at this time of year, remain in their envelopes or in their shrink-wrapped places. Think of the uplifting language that confronts voters when they are asked to vote on various bond issues. I doubt that the Congress or the Government in general will be able to produce reader-friendly documents. Further, there is a belief on the part of the drafters that they have addressed all of the issues that have caused people to lose money or to put the economy at risk. There is an old expression among the religious which states, “We plan, and God laughs, recognizing our human frailties.”

The biggest drawback to this less-than-complete legislation is that it is meant to generate the feeling that both individual transactions and the economy will now be safer. From my standpoint, this is unlikely to be true. Just think of all the scandals that occur after each of the so called “reform” laws or movements. I believe the Romans got it right when they enunciated “Caveat Emptor,” which translates to “buyer beware.” We will be at great difficulty to prevent greed-driven buyers from over extending themselves. Many of the factors that drive buyers are discussed in my book MONEY WISE, now available in paper-back edition, and in e-Book versions on Kindle and Nook. Knowledge however, is rarely a driver for investors.

There is something novel in the legislation as currently presented, which is to attack the compensation of employees of large investment banks and other enterprises, supposedly to prevent them from putting the economy at risk. There are a couple things wrong with this approach. First and foremost, most of the large losses were not contemplated as possible before the series of transactions began. If you will, this is the “Black Swan” risk of an unanticipated event. Normally we count on greed and fear to keep prices in some appropriate plane of equilibrium. In the heat of the cheap money- driven frantic dance, there was little fear expressed by either the buyers or sellers. Clearly at the end of the musical chairs, one did not want to wind up with cash and its depreciating value. Second, the cap on compensation and bonuses are focused on employee agents. These are often highly paid people representing very large financial and industrial organizations that are successfully playing with the house’s money. A good bit of the so-called “shadow banking” participants are organized in some form of partnerships, where the partners are participating in the trading gains of the partnerships. A number of these partnerships have capital bases larger than many of the banks that received “TARP” money. Most of these groups are hedge funds, and they remained solvent without any taxpayer assistance. (Caveat Emptor: I manage a small financial services hedge fund.) As someone who owns shares in many publicly traded brokerage firms, I see a significant risk that talent is moving from these large, visible firms to smaller and often private groups, thus escaping the salary and bonus limits.

As unfortunate as it may be, a prudent investor should assume the passage of both of the so-called reform bills on Healthcare and Financial Regulation. There are two safe bets one could make on the outcomes. First, expenses for the buyers will rise, and second there will be large scandals in time, as some will learn how to play the new game ahead of the regulators. Changing conditions always create opportunities for wise and legal investments. Some of these opportunities are likely to be overseas where money is regulated differently, and there is a rise in the need for financial services, particularly in Asia. Domestically, a sure bet is that in the aftermath of Healthcare and Financial changes, there will be legitimate confusion, which will put a premium on groups that can guide affluent users. Intermediaries that possess bureaucratic and communication skills and are trusted, are likely to increase their share of revenue and profits. The sales forces of some brokerage firms and a few insurance companies come to mind.

What are the opportunities that you see?

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