OpINion/online appears on the web and in IN Daily every Wednesday. Comments are welcome at IN Editor@InvestmentNews.
How does that old Wall Street saying go?
Oh yes, “Fool me once, shame on me. Fool me twice, I’m taking you to arbitration.”
With the kind of hosing many customers have received from Wall Street’s biggest firms as a result of the auction-rate securities mess, I wouldn’t be surprised if the old adage gets a new twist: “No fooling me again, Wall Street, because after the lawsuit, I’m going away and not coming back.”
Readers of InvestmentNews have been following the recent auction-rate securities crisis with interest (InvestmentNews, March 17) .
The securities, which were issued largely by municipalities and closed-end municipal bond funds and sold as safe alternatives to cash, had their interest rate set by periodic auctions conducted by their underwriters — several large Wall Street firms.
But when the value of the mortgage securities held by those firms plummeted, threatening their capital base, the firms stopped conducting auctions. This left the auction-rate securities and their owners in a state of limbo, with no ready market for the shares and no way to value them.
While New York-based Smith Barney has seen an asset outflow of $1 billion in the first quarter and other wirehouses have seen inflows drop sharply, I frankly don’t know why more big-firm customers haven’t already voted with their feet.
But that may be changing. In the first quarter, for instance, advisers who use Schwab Institutional as their custodian pulled in $19.9 billion in new assets.
I always thought it was strange that conflicts and scandals hardly seem to tarnish the image of wirehouses. And except when it acts as a brake to investor exuberance, there’s little evidence I’ve seen that Wall Street advice makes a difference in portfolio performance.
But that doesn’t seem to matter much to clients. Nor does wirehouse opposition to their advisers accepting the mantle of fiduciary responsibility, which should be a clear signal to customers that the Street’s motto is “Me First.”
I guess the main reason customers are willing to play along and see the emperor as clothed is that they believe the big firms will make them money.
Probably because I’m a cheapskate, I often have wondered why so many affluent investors don’t weigh the returns they receive from a wirehouse —– the financial gains as well as the quality of the advice, performance and ease of use — against the cost of those services.
That’s how customers would see whether promises of money-making actually pan out.
But human nature being what it is (inertia, irrationality and a high value on convenience are our hallmarks), investors typically don’t do cost-benefit calculations for financial services the way they do for other products and services.
Consider how an investor might buy a high-end music system. After doing some research, a buyer might decide that an expensive Bang & Olufsen audio package offers the best combination of sound, design and features.
But even if cost never entered into the choice, the buyer would not think twice about shopping around and bargaining over the price. Yet it would never dawn on the same person to haggle over fees for an alternative investment or seek out a no-load fund in place of a load clone.
In one experiment, Wharton MBAs illogically chose from among identical index funds on the basis of past performance rather than cost.
This indifference to cost and net returns may be fine when markets are climbing and high returns mask the drag of high fees and expenses.
But when returns are modest, high costs matter and are more apparent. And when you’re paying a lot and getting little, you may start to wonder if it’s all worth it.
It’s against this backdrop that the auction-rate securities mess appears. The products were pitched as a cash substitute, but they turned out to be toxic.
Wirehouse advisers who were pressured into selling the securities now face the unenviable task of trying to explain away their firms’ actions. The failed auctions and the toll these securities have taken on client wealth could be the straw that breaks the customers’ backs, leading them to ask, “Who needs all this?”
Here’s the moral: Because investors tend to approach financial goods and services with little concern for price or cost, providers have a lot of latitude. If the markets cooperate and customers have the chance to buy into a great product every now and then, they will overlook a lot. But if you play dirty with their real money — cash — watch out. That’s supposed to be safe.
The last time financial institutions crossed the safety line we got FDIC insurance, Glass-Steagall and more regulation.
This time, with the deregulation glow dimming, who knows?
Evan Cooper is the senior managing editor and online editorial director of InvestmentNews.
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