Think Before You Double Down on an Investment

A new heart attack is available at KFC! The Double Down features two pieces of fried chicken, bacon, an indistinguishable mixture of cheese, and an unidentifiable sauce to now bring you a sandwich as close to toxic as the American fast food business has ever been. Unfortunately KFC neglected to complement the Double Down with a side of Lipitor. Nonetheless, don’t expect the Double Down to be a big hit at Goldman Sachs.

Like KFC, Goldman is in the business of selling cutting-edge poisonous products – not purchasing them – all to add a few extra zeros to the bottom line. Fortune Magazine reported that Goldman raked in mere $1 billion in fees from its sale of collateralized debt obligations (CDOs) last year, which pales in comparison to its $12 billion in profit for the year. Rather than including a disclosure of the true risk behind these securities, Goldman went ahead and sold them with a Triple-A rating. I hate when they forget to put the toy in with the Happy Meal.

While Goldman was wrong for not fully disclosing the true risk behind the CDOs, the financial giant is not in the wrong for having put them on the market. As it should, the SEC has filed charges of fraud against Goldman, which, however, should not to be confused with charges against Goldman for the actual sale of CDOs and other now-worthless mortgage-backed securities. Creating a product that people want and selling it to them – so long as they know what they are getting themselves into – is perfectly acceptable, and it falls on the individual to make informed consumption decisions.

Take the tobacco industry for example. In the past, consumers were buying cigarettes under the false understanding that cigarettes had no long term health effects. When it came to light that cigarettes were in fact dangerous and caused cancer, Big Tobacco faced class action lawsuits and multibillion dollar settlements due to its inadequate disclosure of the health risks of smoking cigarettes. In a very similar fashion to that of Big Tobacco, Goldman now faces a lawsuit for its own misleading statements and marketing materials regarding the financial risk of investing in CDOs.

Although it may be considered unethical, Goldman cannot be blamed for the actual selling of CDOs and other mortgage-backed securities. Like the fast-food and tobacco products, financial investment products carry a certain level of risk, and consumers electing to purchase the product assume the attached risk. Although firms may be frowned upon for selling the above-mentioned products, it is ultimately the choice of the consumer to make the purchase. Without buyers, there would be no sellers, and businesses cannot be blamed for making a product that consumers want to buy.

Had Goldman provided truthful and accurate information as to the true risk of the financial products it was selling, it would not be in the wrong and very likely not facing any charges from the SEC. Just as cigarettes may give you lung cancer and fast food may cause you to gain weight, financial investment products may cause you to lose money. So long as the customers are fully aware of any and all risk associated with their purchasing and consumption decisions, transactions involving these types of products are completely allowable.

It is the function of businesses in an economy to provide a wide variety of goods and services, and consumers ultimately must make informed purchase decisions for themselves. Others can always be blamed for incorrect or poor decisions, but at the end of the day, it is the individual who gives the final stamp of approval. Although investors are right in pointing fingers at companies like Goldman in this situation, it is important to remember to be very careful going forward. Read the side of the cigarette carton, read the nutrition facts before going through the drive-thru, and thoroughly research before making investment decisions.

Stop the Banker Hate!

It is increasingly irritating to see politicians speak of making major changes to business, commerce, and the economy without a true understanding of the implications of the changes. Whether a politician actually lacks an understanding of business and economics or whether he or she is merely reacting to that which is under the political spotlight, a vast majority of the time the changes are either unfair or unfounded, which can lead to problems down the road.

Bloomberg reported last week that U.K. Prime Minister Gordon Brown promises to implement new curbs on the bonuses of bankers if he is re-elected next month. Although it needs to reminding, keep in mind that the financial sector and bankers in particular are under the gun in light of the credit and financial crises of 2008-2009. People are pissed off about how much employees of financial firms made during and after the recovery from the crisis. After all, it was the people’s tax dollars that were used to bail out and rescue nearly all of the major financial firms of the world. The people want change, and they want this to never happen again. However, the actions Brown promises to carry through are unfair.

As mentioned in the post regarding CEO compensation, it is common that companies within specific struggling sectors of the economy come into the public spotlight, appearing in the news and on front pages of newspapers, and invariably the negative sentiment finds its way to Washington. Congresspersons and Senators have an angered demographic, and change or punishments need to be executed to appease constituents. Unfortunately, different sectors struggle at different times, and it is unfair to attempt to place strict restrictions on compensation structures or firm profits.

Recall Obama before he was elected President of the U.S. During his campaign, while oil prices were high and oil companies were raking in massive profits, he vowed to tax profits and put a limit how much money these firms could make. In the end, oil prices fell, gas prices came down, and the public forgot about how much they hated big oil companies. This sounds eerily similar to that which Brown is saying now. Perhaps both used it to gain the support of those upset and requesting change?

When U.S. automakers began outsourcing labor and auto construction in the 90s, many U.S. workers lost their jobs and turned to government to make change. In a similar fashion to that of the automotive industry, this fell by the wayside as new material found its way into the news and at the top of the broadcast.

It is unfair to focus on just one sector and try to specifically reform, overhaul, or place strong restrictions upon it. As mentioned above, politicians may promise this in an effort to get elected or re-elected, or they may promise change during their tenure in order to appease the people. However, different sectors are targeted at different times, and serious change should not be enacted merely in reaction to public distaste. It may have been the automotive industry in the past, the financial firms today, or even the healthcare insurers and companies in the future, but politicians, make sure you know what you are doing.

Critique the Focus

In an episode of Seinfeld, George Costanza built a small bed and napping area beneath his desk at Yankee Stadium where he worked. I have a sneaking suspicion that Seinfeld is a huge hit at the SEC. I pose a question to the SEC very similar to that posed by audiences to Costanza: Do you actually do anything constructive at work?

In all fairness, SEC regulators actually do something. They watch porn. How does that sound for a job? Get paid to watch people screw, and in the same act, screw the people.

The focus of SEC regulators is in entirely the wrong place. SEC employees aim to satisfy their boss, the U.S. government, under the false assumption that if the boss is happy, the customers – U.S. citizens – are happy as well. However, the SEC must aim to please in exactly the opposite fashion. Please the customers first, and your boss will be happy (eventually, if not at the time), allowing you to keep your job and pursue your interests. In other words, the SEC should focus on what is best for the people, and in so doing, will satisfy the U.S. government.

Unfortunately, this has not been the case over the past few years. Whistleblower Harry Markopolos – who, in the context of our story, we can call a customer – submitted a report to the SEC back in 2005, describing the financial impossibility of Bernard Madoff’s returns and ultimately concluding Madoff was running the largest Ponzi scheme in history. A college junior with knowledge of the basic fundamentals of finance and investment strategies could have arrived at such a conclusion, given Madoff’s SEC filings. It seems apparent the securities and regulation “experts” at the SEC must have forgotten these elementary principles, or at least, did not come across this material at thedailybabelog.com.

When, of course, it was revealed that Madoff was running a Ponzi scheme, customers were unsurprisingly upset, and many had lost their life savings. This could have been prevented had the SEC been focused on its customers rather than their boss, who was content at the time. SEC regulators pulled a Constanza and hit the snooze button when the customers needed them the most.

In that brief example, the customers were dissatisfied, while the boss seemed to be content. A similar negative outcome is experienced in the converse situation in which the boss is upset and forces change not in the best interest of the customers.

Facing an upset superior, the SEC recently enacted curbs on short selling in an attempt to appease the pressuring U.S. government. Whether the boss was pleased or not aside, the focus was not on the customers. The customers are mad that their houses are worth nothing, their investment portfolios have crumbled, and they have been laid off, not that investors are utilizing short selling as a legitimate investment strategy. Focus on the customer!

Sure, the customers are angry and want the SEC to do something. But why short selling? The merits of short selling and the uselessness of this SEC regulation was discussed in a previous post. The customers know they have little understanding of financial markets and the forces that move it. That is why they pay taxes to the U.S. government, who has hired the SEC to implement policy in the best interest of the people. Get out from under your desk, close the browser window for hiboobs.com, and open up a real financial textbook.

Over the past couple of years, suffice it to say there has been a fan with some poop involved. The SEC, had it more carefully regulated mortgage-backed securities and financial derivatives trading, could have prevented or at least ameliorated the magnitude of the economic crisis and Great Recession. However, that is all in the past, and what needs to be determined is how such severe mistakes can be avoided in the future. The focus on the content boss, causing neglect for the telling signs of a major economic fallout, is to be blamed. Focus on the customers, what is best for the customers, and do not sleep on the job, and next time we might be able to avoid a $700 billion bailout. Oh yeah, keep the web-browsing clean while you're at it.