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Brett Arends' ROI
March 23, 2010, 12:01 a.m. EDT · Recommend (1) · Post:
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By Brett Arends, WSJ.com and MarketWatch
BOSTON (MarketWatch) -- Michael Lewis' new book about the subprime scandal, "The Big Short," is a fascinating, edge-of-the-seat read.
But for everyone trying to manage their own finances these days, it's also a gold mine of valuable insights about how the modern economy really functions -- and what you need to watch out for.
Among the takeaways:
1. Never, ever invest in something you don't fully understand. Ever.
There are no exceptions to this rule. Simple, really. But it never ceases to amaze me how many people are still tempted to break it. Like all the top Wall Street bankers who were willing to bet blindly on subprime paper they didn't understand. Many banks were still buying the stuff in late spring 2007, when the fundamentals were already in freefall. With complex investments, it's hard know when to get in or get out. This never seems to happen when you invest in, say, a beer company.
GameStop understands the videogame business and its customer base. If the company merely meets its targets for the year, the stock could be at least as exciting as a good video game.
2. Don't take credit scores too seriously. They've practically become a modern religion, but they can be hilariously flawed. The subprime sharks found it easy to game them to their advantage. One example: The infamous $14,000-a-year strawberry picker who was given a $724,000 subprime home loan during the housing bubble. It was no accident, Lewis reveals. The borrower had a good (albeit thinly documented) credit rating. So when the subprime sharks included his mortgage in a portfolio of subprime loans, they raised the "average rating" of the portfolio far enough to make it a "AAA." bond. Fair Isaac? Dumb Isaac, more like.
3. When it comes to buying financial products and services, the simpler, the better. The more complex ones are mostly created by bankers just to scam you, with higher fees or worse. As Lewis relates, that was pretty much the story of the subprime industry. After all, the basic banking products that people actually need -- checking accounts, regular mortgages, and ATMs -- are nowhere near profitable enough to pay for huge bonuses. (A personal note: Many years ago a friend who used to work on Wall Street advised me always to get the simplest mortgage possible. He recounted meetings where bankers sat around thinking up new, fancy mortgage products for the sole purpose of charging customers higher fees).
4. After reading this book, I wouldn't touch the shares in the bond ratings companies with a ten-foot pole. Stock in Moody's Corp. /quotes/comstock/13*!mco/quotes/nls/mco (MCO 30.02, +0.36, +1.21%) and The McGraw-Hill Cos. /quotes/comstock/13*!mhp/quotes/nls/mhp (MHP 35.93, +0.16, +0.45%) , parent of Standard & Poor's, have doubled from last year's lows. Count me out. We all know they slapped "AAA" ratings on bonds that would prove worthless. But if Lewis' account is correct, these companies face plenty of headaches ahead. They were either the highly paid patsies of the subprime sharks, or worse.
Even at best, what's the future of their business model now?
5. I wouldn't buy shares in Wall Street banks, either. I don't trust them. They come across -- not for the first time -- as legal conspiracies organized against the customers and the stockholders.
Half the bankers don't know what they are doing, which is how they ran the ship onto the iceberg. The other half know full well what they are doing -- which is why they are squeezing every penny for themselves.
The rest of us are just the "marks."
6. Stop drinking the Kool-Aid. No, the system didn't "work." Mortgage brokers, Realtors, bankers, Wall Street, ratings agencies, financial marketing machines and international investment funds all worked together smoothly in a free market model, just as Adam Smith might have imagined: But instead of a beneficent "invisible hand" helping the economy, they were a killer school of piranhas unleashed upon it.
This is modern, hyper capitalism. Be prepared.
7. This is going happen again, too. I have little faith that regulators can stop it. They are too slow footed, and the rules too easy to circumvent (To take one simple example: What is the point of recording all phone calls in and out of a Wall Street bank? Throughout Lewis' narrative, bankers just make their dubious calls on their cellphones.). Greed is a given in life, and it will always find a way.
As the story of the subprime scandal shows, destructive hypercapitalism will metastasize into new forms and markets faster than anyone can stop it.
8. Protect yourself. One thing that really comes through from this account -- and others -- is how predatory the economy really is. So be aggressive about protecting yourself and your family. No one else is going to do it. Make sure your retirement funds and children's college funds are protected from creditors in 401(k), IRA and 529 shelters.
Likewise, take advantage of available protections for your home, such as homesteading, and (for married couples in some states) tenancy by the entirety. Know where your financial lifelines are in case hard times hit again.
9. Never ignore what the insiders are doing. During the bubble, many smart insiders at the big banks, homebuilders and subprime mortgage lenders were cashing out their stock as fast as they could. They weren't stupid. Of course, their flacks always had a ready explanation to cover their getaway.
An executive dumping stock is often "diversifying his portfolio" for example. But few people sell shares because they think they are going higher. Follow the money, not the spin.
10. Don't trust the herd. If there's a conspiracy in the markets, it's neither bullish, bearish, right wing nor left wing -- it's simply to support the consensus.
Human beings are social animals. There is a powerful, built-in bias to want to agree with those around you. The most striking thing about Lewis' story is that many more people on Wall Street should have seen this coming. The data was available, the analysis relatively simple to those employed in finance. But among the tens of thousands of overpaid whiz kids at all the hedge funds and big banks around the world, only a few actually got it right all the way along. They were generally oddballs who were able to distance themselves, emotionally, from the crowd.
Brett Arends is the author of "Storm Proof Your Money," on managing your finances in this era of turmoil.
Brett Arends is an award-winning financial columnist with many years experience writing about markets, economics and personal finance in Europe and the U.S. He has received an individual award from the Society of American Business Editors and Writers for his financial writing, and was part of the Boston Herald team that won two others. He was educated at Cambridge and Oxford Universities, and has worked as an analyst at McKinsey & Co. He is a Chartered Financial Consultant (ChFC) and Accredited Asset Management Specialist (AAMS). His latest book, "Storm Proof Your Money," has just been published by John Wiley & Co.
Maybe the economy is finally on the upswing, writes Angela Moore.
6:29 p.m. March 22, 2010 | Comments: 7
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