Conservative Investors Betrayed by Wall Street Excesses

These are chaotic times on Wall Street. With each passing day, it’s becoming more and more evident that conservative “Main Street” investors — both businesses and individuals — have been profoundly damaged by the deceptive and speculative excesses that have plunged Wall Street’s major brokerages into a wide and deep crisis.

The rub is so raw because many of the investment products that have been contaminated by the subprime mess and ensuing credit crisis were marketed and sold to investors as ultra-conservative and safe “cash equivalents.”

This is a complete betrayal.

This betrayal is more egregious than what we saw with the Wall Street analyst cases and the bursting of the inflated tech bubble earlier this decade. We knew that tech stocks, the new economic growth stocks of the day, represented the fast lane.

The people hurt in the crisis today are people who were led to believe they were in the slow — and safe — lane.  As a result, this crisis is really hurting people who didn’t intend to put their money at risk.

These are retirees and folks saving for retirement who carefully guarded their nest eggs. These are small business owners and corporations that carefully guarded their operating funds.  These are funds of charities and churches earmarked for future use to help those in need and the less fortunate among us. Regardless of any perspective or bias, virtually all would agree that these are people who didn’t deserve to lose their principal or have their liquid funds frozen.

In the last year, thousands of investors have lost more than $1 billion in Schwab’s YieldPlus Fund, which Schwab billed as a cash equivalent and likened its safety to that of one and two-year certificates of deposit.  Equally disturbing is the almost surreal debacle that’s played out in the $330 billion auction-rate securities market that seized up in February and has left tens of thousands of investors unable to readily access their money.   These are just examples of some of the “safe” products that have performed far differently than advertised.

State securities regulators, most notably New York Attorney General Andrew Cuomo, have stepped in on behalf of investors to force the Wall Street firms involved to buy back $70 billion worth of auction-rate securities from investors. But with the market at $330 billion before it froze, a substantial hole in the economy remains.

Recently, federal regulators stepped in to save Fannie Mae and Freddie Mac,  and more recently AIG, but these actions have not prevented investors in those behemoths from being devastated in ways similar to those who invested in the now-bankrupt Lehman Brothers.

Certainly, there will be more calls for reforms.  Hopefully, lawmakers will recognize that the failure exposed by the current crisis is not that there are too few regulations or too few regulatory bodies.  With the exception of areas that operate outside the current regulatory system — such as credit default swaps which may need to be brought within the regulatory system as insurance or futures products — lack of regulation and lack of regulatory agencies are not the problem.  Rather what we’re seeing is widespread amoral behavior by Wall Street combined with a failure by regulators to regulate effectively — especially on the federal level.  This appears to be due to both the under-funding of existing regulatory agencies and the apparently cozy relationship between Wall Street and some regulatory bodies, specifically the Securities and Exchange Commission and the industry’s self-policing organization, the Financial Industry Regulatory Association or FINRA.

Much is at stake for the financial future of Americans in the coming weeks and months.  As we see the most recent misdeeds of Wall Street play out in the press and the political arena, investors need to understand that state regulators have been the most effective in protecting investors’ rights and federal regulators the least effective.  Adding another regulatory body on the federal level or transferring additional regulatory powers from the states to the federal government is unlikely to improve the situation.

Additionally, while the current mess is being cleaned up through litigation, arbitration, and possible reforms, investors need to be wary of Wall Street’s claims that firms’ amoral behavior is an anomaly.  Combined with Wall Street firms’ actions of the past — such as the limited partnership mess of the early 1990s and the analyst debacle early this decade — recent events appear to be part of a familiar pattern.

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