I have never been an apologist for Wall Street. Quite the opposite, in
In my first book, The Gone Fishin’ Portfolio: Get Wise, Get Wealthy… and Get On With Your Life – a New York Times best-seller – I showed investors how they could successfully manage their money and meet their most important investment goals while doing a complete end run around expensive investment advisors.
Over the weekend, however, I bumped into two friends with different but
largely mistaken views of the financial industry.
The first insisted that top Wall Street executives knowingly caused the
financial meltdown and Great Recession that followed – and should have gone to jail.
The other argued that the deck is completely stacked against ordinary investors – that high investment minimums, hidden costs and imperfect knowledge prevent the average investor from getting ahead… or even getting a fair shake.
These views – while commonplace – aren’t just wrong. They could cost you
serious money in the months and years ahead.
Let me begin with the first friend’s beef…
If you’re still angry or unhappy about the Wall Street bailout, I share
I oppose government bailouts on principle. Capitalism is a profit and loss
system. It is wrong to privatize profits but use taxpayer money to bail out failing businesses.
And yet… there are times when standing on principle can get you
steamrolled – and for no good reason. Ten years ago was one of those times.
To this day, most Americans still don’t understand how close we were to the
edge of the abyss.
The world economy runs on ready credit. And when Morgan Stanley is afraid
to lend Merrill Lynch money overnight – as was the case 10 years ago – we are in a perilous place indeed.
If the banking system were to collapse, consumers and investors would
panic, the economy would go into a tailspin, and severe pain and poverty would result.
In his memoir, Stress Test: Reflections on Financial Crises, former Treasury Secretary Timothy Geithner reported that we were less than three days from customers not being able to get their cash out of ATMs.
Talk about pandemonium.
The world economy is built on trust in the financial system. Without that
trust, there can be no prosperity.
How did we wind up on the brink?
“Wall Street greed” is the easy answer. But not the best one.
Consider the role of various federal agencies in creating the housing boom
• The Federal Reserve took interest rates too low for too long, making
mortgage loans dirt-cheap and priming the real estate bubble. (The Fed also approved and oversaw lending practices, including “no money down” mortgages.)
• In a misguided attempt to promote home ownership, Congress passed laws that effectively criminalized (as “discriminatory”) the failure to lend to subprime borrowers.
• The federal government sponsored Fannie and Freddie (or, as I prefer, Phony and Fraudie) to warehouse these crummy mortgages, leaving taxpayers on the hook to clean up the mess.
• The $615 trillion market for credit default swaps accelerated the
financial collapse. These should have been traded through central clearinghouses, on exchanges that provide transparency. Who decided against this? The U.S. Commodity Futures Trading Commission and the Securities and Exchange Commission, two federal agencies.
• And who is responsible for the regulation of commercial and investment banks, savings and loans, mortgage companies, and rating agencies to make sure the mortgage market is fair and transparent? Why, the federal government, of course.
In other words, this wasn’t corporate greed. It was monumental government incompetence.
Yes, Wall Street shares some of the blame.
Some banks sold customers loans they couldn’t afford and didn’t fully
understand. Others packaged the loans into dubious financial products for mom-and-pop customers. (Caveat emptor, indeed.)
And CEOs Jimmy Cayne of Bear Stearns, Dick Fuld of Lehman Brothers and Hank Greenberg of AIG all failed to comprehend the huge risks their firms were taking.
The big banks should not have been bailed out for the sake of the bankers.
(Those folks deserved to lose everything.)
But they had to be bailed out for the sake of everyone else.
Remember, the officers, directors, managers, employees, creditors and
shareholders of Bear Stearns and Lehman Brothers lost everything. That is how it should be in a free market system.
But if the big banks here and abroad had kept falling like dominos, we
would have had a full-scale panic, a financial collapse and the Greater Depression.
Yes, government policy at the time was hurriedly improvised and highly
imperfect (as it often is). But we dodged a cannonball to the face.
The U.S. economy is healthy again – and the stock market has more than
Oh… and that TARP (Troubled Asset Relief Program) money used in the bailout? It has been fully repaid – with interest.
Why aren’t any Wall Street CEOs behind bars?
Because you go to jail for criminal behavior, not poor business decisions
and regulatory negligence.
Politicians and bank regulators knew that financial institutions weren’t
requiring down payments from borrowers. They knew they weren’t verifying income or assets or borrowers’ ability to repay the loans.
Wall Street engaged in those practices because they were perfectly legal.
As Berkshire Hathaway Vice Chairman Charlie Munger pointed out, when a lion escapes from the zoo and injures someone, you don’t blame the lion. You blame the lion keeper.
Federal regulators had all the tools they needed to protect us – but they didn’t.
Most Americans understand this. The Cato Institute 2017 Financial
Regulation Survey found that three-quarters of Americans believe regulations are politically biased and fail to have their intended effect.
More regulations aren’t the answer. Abiding by a few sensible ones is.
Canada, for instance, avoided the housing bust altogether. How? Homebuyers there are required to make 20% down payments. (Mortgagees don’t mail their keys back to the bank when they have skin in the game.)
Again… my interest is in the facts, not in defending Wall Street. I
regularly warn retail investors that if they swim with these sharks, they can expect to get eaten alive.
That doesn’t mean investment banks don’t play a vital role in our lives,
They connect people with capital to entrepreneurs and businesses that need
it. This fuels innovation. It creates jobs. And it allows companies to deliver safer cars, faster communications, and lifesaving drugs
and medical devices.
How about my other friend’s insistence that the average investor doesn’t
stand a chance competing against the big boys on Wall Street?
That, too, is the opposite of the truth. Investors today – even the
smallest ones – have never had it better.
And in my next column, I’ll explain exactly why…