"Whenever I go into a restaurant, I order both a chicken and an egg to see which comes first"

Saturday, September 1, 2012

Risky Investments–Government Protecting Us From Ourselves

An article in the New York Times (9.1.12) has lamented the demise of laws protecting investors from unscrupulous or fraudulent advertising.  While on the surface this may seem a good thing, it is another unnecessary intrusion of government in private decisions http://www.nytimes.com/2012/09/01/opinion/risky-and-getting-riskier-for-investors.html?_r=1&ref=opinion.  The argument given for the continuance of old laws that forbid any direct solicitation of individual investors is that too few people have investment experience and are therefore prey to those who wish to profit off of them.

The actual law proposed is not exactly aimed at the small, defenseless investor – the innocent retiree wishing to move some money around – but those people with already large portfolios:

It says that  the buyers of such securities must be “accredited investors,” generally defined as those with at least $1 million in net worth (not counting a home) or at least $200,000 of yearly income.

If there is a group of people that we should not worry about it is the wealthy who more than likely made their money from investments.  If all protections against the small investor were lifted then there might be some room for concern.

Such advertising would make it easier for hedge funds, venture capitalists, start-ups and other nonpublic companies to find investors. It would also make it easier for hucksters and rip-off artists to lure people into unsuitable investments and outright frauds because private offerings are not subject to disclosure requirements and other investor protections that apply to publicly held companies.

The real problem, however, is not with the protection of the small investor from insistent advertisers, it is privatizing public programs like Social Security and Medicare, thus exposing inexperienced investors to the blandishments of the managers of unregulated hedge funds, tricky stock swaps, and gold futures.  The idea of privatizing Social Security surfaced for real during the George W. Bush years when the stock market was up and hot.  Why shouldn’t the little man benefit as much from the hot equity market as the high rollers?  Why should he be content with the little widow’s mite that was being invested conservatively by the Federal Government?

The reason had always been to protect Americans from the vagaries of the market which, as New Deal planners well knew, could be catastrophic.  Better have small rates of return with a guaranteed, secured investment than the chance of higher return at higher risk.

Americans were happy with this system.  Even though we would never get rich off of our Social Security earnings, we would at least know that come hell or high water, you would have something in the bank.  When the stock market started its unprecedented rise, the cries for privatizing Social Security became louder.  Wall Street bankers simply salivated by the prospect of having billions in new investments; and investors greedily looked forward to buying that second home.  It was all illusory, of course, the paper wealth nothing but a house of cards which came tumbling down when the sub-prime housing market crumbled.

Why did that market fail? Because of unscrupulous lenders and the managers of insurance companies, banks, mortgage houses, and other investment companies who made bad loans, then pushed the securitized mortgages up the chain so quickly that no one had a chance or cared to look carefully at the initial, flawed product. Why should they? At each change of hands, flawed or not, the product made them money.  It was only when the defaults started and money began to be lost down the chain just as the securitized commodities flew up it that the realization of what they had wrought set in.

The blame, however, falls equally on the greedy prospective homebuyer who saw that there seemed to be no upper limits to housing prices and when offered ridiculous no-interest, no collateral, no-first-payment-for-years terms, jumped at the chance.  Most of them had never even been in a school which offered Econ 101 let alone taken the course.  If they had, they would have learned one of the first fundamental lessons of investment – the higher the return, the higher the risk; and perhaps they might have learned an important corollary.  Down payments and collateral not only protect the lender, but assure that the borrower has skin in the game.  Anyone who puts 20 percent down on a mortgage, pays a high interest rate, and puts the house up as collateral will be very, very careful about buying.

So Little Miss Homebuyer was asleep at the switch.  In fact she had no idea that there was a switch, let alone what to do with it.  She only thought of the rising values of her new home and of the increased equity which would be available to her as housing prices rose.  Not only would she have a nice home but she and her husband could buy that shiny new Chris Craft they had their eyes on for years but couldn’t afford.

In other words not only was Little Miss Homebuyer totally ignorant about real estate, but she was blinded by greed.  It didn’t take any hucksterism on the part of Century 21 to convince her to buy.  She wasn’t duped.  She was willingly beguiled.

Imagine, then, if Social Security were privatized.  Despite the many new regulations proposed (not enacted) to control Wall Street, no one doubts their ability to get around any an all obstacles put in their way.  Congress, despite their mea culpas and crocodile tears, will always be complicit with business and look the other way as their deep-pocket supporters continue to make oodles with shady deals, more of which will come their way.

If Social Security is privatized, the wolves will be let loose on the innocent lambs.  Well, maybe not so innocent.  And if the system is privatized, then either repressive regulations will be put in place (not a good idea because we are trying to reduce the burden of regulation not increase it) or caveat emptor will reign ascendant, and the new financial house of cards will tumble.

My vote is always with caveat emptor, especially in these times when personal responsibility and accountability have not followed the increase in so-called individual freedoms; and yet without some basic regulations another sub-prime-type fiasco is certain. 

The trick is to leave partisan zealotry at the door, and find the proper balance between individual responsibility and collective well-being.

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