The Greatest Failure

"Where are the customers' yachts?"

-Anonymous (possibly apocryphal question posed to a New York City tour guide when showing a group the dock in Manhattan where most of the yachts belonging to Wall Street executives were moored)


Apologies for my long hiatus. Many things have changed since I posted my first blog here. For starters I am married (not the most newsworthy development nationally perhaps, but that which has mattered most to me). More relevant to America and the world writ large is the incredible melt down in virtually every asset market, the ongoing deterioration in the real economy, and the election of Barack Obama as President of the United States.

As noted back in July, I have been expecting large losses to occur in the financial and real estate markets. Now it did not take any particularly keen or arcane insight on my part to see this coming as an investment professional. My entire professional life is focused on nothing but analyzing the world economy and asset markets, and then identifying particularly good places to put money to work. Conversely, I, like every other investor must also spot those areas to avoid. For reasons I will go into momentarily, it was obvious that real estate and stocks presented huge risks, with little opportunity for profit.

Therefore, I find it both startling and confounding how 95% (perhaps an underestimate) of investment professionals failed to warn their clients about the likelihood of massive declines in asset prices. From my simplistic point of view, a crash in the housing and equity markets was absolutely inevitable (and indeed necessary - a point that will have to be fleshed out another time).

There were a variety of reasons for this. The most basic being that the US has been in a lifestyle bubble for almost a decade. We have gone from a savings based economy to one predicated (precariously) on debt; from an economy that was sustained by increases in real (after-inflation) income increases to one that relies upon ongoing asset appreciation (first stock, then houses). This hit a critical mass level when financial institutions gave loans to people with little, or even no collateral, to buy houses they could not afford at interest rates that were held temporarily low. The only way this house of cards could persist is if housing prices kept rising to the sky. Ah, but the laws of gravity apply even to the ethereal realm of finance.

Could you blame people if they looked around and saw all their neighbors getting rich simply buying and selling each others' houses and did not want to get in on the action themselves? Well, maybe a little. Nevertheless, the greatest failures can be attributed to the banks, real estate agents,mortgage companies, PMI insurers, Wall Street brokers and the like who induced and encouraged THEIR clients, like lambs being led to the abattoir, into making some of the worst financial decisions imaginable. Whether that was: buying the house they really could not afford at the top of an obviously bubbleesque market; purchasing the stock of banks and mortgage lenders who stood to lose trillions collectively when the bubble burst; or refinancing homes with cash-out mortgages used to fund lifestyle purchases.

Do not get me wrong. There is plenty of blame to go around for the intractable mess in which we find ourselves. But it seems to me that there should be a special inner circle of perdition for those financial and real estate professionals, most of whom had fiduciary duties to protect the interests of their clients, who failed to wisely counsel them. Of course compounding my outrage is the fact that so many of these professionals have massive conflicts of interests. Most earn the majority of their incomes by peddling particular products, whether it makes sense for their clients to buy them or not.

Sadly, having studied financial bubbles and their aftermath for some time now, I cannot say there is a great deal of hope for an imminent recovery. Global stock markets have collectively lost more than $35 trillion from their recent peaks (making the combined $1.35 trillion government infusions from the US and China look rather anemic). Many more trillions have been lost in world real estate markets. Yet as the global economy continues to founder ever more gravely, I have heard most financial professionals urge people to stay the course. Paying heed to such advice so far has lead to 45% losses over the last 13 months in the overall US stock market. Hopefully, people are beginning to regain their senses, if only slowly and one by one.

So what is one to do? Well, a comprehensive answer is beyond the scope of this particular missive, and there is no cookie-cutter approach to asset management that works for all anyway. But everyone can and should assess the manner in which their money is being managed. Do you have a financial professional whose livlihood is connected to how your money is specifically invested (i.e. commissions for sales of particular assets)? If so, you should seriously consider either educating yourself and then managing of your own assets (a topic for another time) or at least finding a well-regarded financial advisor who charges an hourly rate. That way, s/he does not have a vested stake in steering you towards particular investment vehicles.

Finally, if you do have an investment professional that did not warn you that the stock/housing markets were at least at risk of falling precipitously by the end of 2007, you should seriously consider firing the person regardless of the manner in which s/he is compensated.

If the last year has proved anything, it is that through greed and incompetance the financial service industry has utterly failed in being good stewards of our money.