Investors who bought auction rate securities are the latest victims of Wall Street’s oldest ploy.
Actually, let me clarify that point, since “victim” and “ploy” carry connotations, respectively, of innocence and guilt. In the case of the ARS mess, I am afraid that the true picture is grayer than it is black or white.
The unfortunate holders of auction rate securities certainly warrant sympathy. Each owner is stuck with thousands, or hundreds of thousands, of dollars (or more) of securities that were billed as being as good as cash but are now floating in limbo or are worth less — in some cases much less — than their face value.
Though I feel sorry for ARS holders, there is a small part of me that thinks they doth protest too much. If I can be blunt, what the hell did they think they were getting when they bought these Rube Goldberg financial contraptions?
If the prevailing returns on safe certificates of deposit and money market funds were low, what kind of alchemy could create vehicles that generate higher returns with money fund risk? Moreover, who did the ARS buyers think cooked up these things — Boy Scouts?
As in the limited partnership and dot-com scandals that burned individuals in the past, investor cupidity and unwillingness to question or sidestep investments that were incomprehensible or too good to be true fed right into Wall Street’s skill for tarting up prosaic products with lots of gimcrackery.
What it all comes down to is the economic principle known as Cooper’s Law: There is no money in broccoli.
Simply, the law states that most of what is good for us — whether it is food, investments or anything else — is pretty simple. Unfortunately, there isn’t much money to be made in supplying the basics, so many businesses take simple products and goose them.
With food, some enterprising agri-giant can take a spear or two of plain old broccoli, add fake cheese and a lot of salt, and presto, you have Mama Mia’s Old-Fashioned Broccoli Au Gratin. Thanks to the fat and sodium, the tasty product, when packaged in a visually appealing box and promoted by Mama herself on TV, becomes a successful seller that is more expensive, more fattening and not as good for you as broccoli au natural.
Are agri-giants criminals for foisting high-calorie broccoli derivatives on unsuspecting innocents? No.
But they aren’t nutritionists either, which means that buyers have to be smart consumers.
The same holds true for financial products.
Wall Street is in the business of selling financial products. If it can add a few low-cost ingredients to some commodity product and package the creation in a spiffy container, presto, they have created a Mama Mia product of their own.
That is why approaching Wall Street with the skepticism of a crafty peasant isn’t a bad idea.
I can imagine my late grandmother being sold an auction rate security and not being ashamed to ask, “What happens if there are no auctions?”
Unfortunately, too few investors asked that question. And expecting Wall Street to raise that question in the middle of a sales pitch (I can hear firms saying, “We disclosed all the risks in the prospectus, so what is he complaining about?”) is like expecting a lion to eat broccoli.
Evan Cooper is the senior managing editor and online editorial director of InvestmentNews.
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