The never ending parade of stock scandals seems to continue unabated, the stock lending scam being only the most recent. As history has shown us — from Mexico to Orange County to analyst banking crisis to Derivatives to etc., when the Street comes aknockin, best for you to hide your wallets.
For reasons we are all too familiar with, many of you rubes have no choice but to deal with the sharpies from the finance division of America. Whether its floating a bond issue to build a new bridge or hospital, managing a pension fund, or simply handling cash flow, for county, city and state execs, non-profit organizations, and private companies, you will eventually “get serviced” by Wall Street.
Those of you who have to interact with the sharks should learn the following rules:
1. Reward is ALWAYS relative to Risk: If any product or investment sounds like it has lots of upside, it also has lots of risk. (If you can disprove this, there is a Nobel waiting for you).
2. Overly Optimistic Assumptions: Imagine the worst case scenario. How bad is it? Now multiply it by 3X, 5X 10X, 100X. Due to your own flawed wetware, cognitive preferences, and inherent biases, you have a strong disinclination "“ even an inability — to consider the true, Armageddon-like worst case scenario.
3. Legal Docs protect the preparer (and its firm), not you: Ask yourself this question: How often in the history of modern finance has any huge legal document gone against its drafters? PPMs, Sales agreement, arbitration clauses — firms put these in to protect themselves, not your organization. An investment that requires a 50-100 page legal document means that legal rights accrue to the firms that underwrote the offering, and not you, the investor. Hard stop, next subject.
4. Asymmetrical Information: In all negotiated sales, one party has far more information, knowledge and data about the product being bought and sold. One party knows its undisclosed warts and risks better than the other. Which person are you?
5. Motivation: What is the motivation of the person selling you any product? Is it the long term stability and financial health of your organization — or their own fees and commissions?
6. Performance: Speaking of long term health: How significantly do the fees, taxes, commissions, etc., impact the performance of this investment vehicle over time?
7. Shareholder obligation: All publicly traded firms (including iBanks) have a fiduciary obligation to their shareholders to maximize profits. This is far greater than any duty owed to you, the client. Ask yourself: Does this product benefit the S/Hs, or my organization? (This is acutely important for untested products).
8. Other People’s Money (OPM): When handing money over to someone to manage, understand the difference between self-directed management and OPM. What hidden incentives are there to take more risk than would otherwise exist if you were managing your own assets?
9. Zero Sum Game: If I am winning, who is losing? And who wins if I lose? Does this product incentivize any gunslingers to make bets against my investments –or my firm?
10. Keep it Simple, Stupid (KISS): Its easy to make things complicated, but its very challenging to make them simple. The more complexity brought to a problem, the greater the potential for things to go awry "“ and not just wrong, but very, very wrong.
11. Counter-Parties: Who is on the other side of your trade? Any income/revenue/dividend hedging you do means there is a party that stands to win if you lose. Who are they, what are their motivations?
12. Reputational Risk: Who suffers if this investment goes down the drain? Who gets fired or voted out of office if this blows up? Who suffers reputational risk?
13. New Products & Services: The rules of consumer technology also apply to finance: Never buy 1.0 of anything. Before buying a new-fangled service, is there a compelling reason not to wait an upgrade cycle? Why not let some other schmuck be the guinea pig?
14. Lawyer Up: The people on the street buy the best legal talent on the planet, with money no object. Make sure you have damned good lawyers working for you as well . . .
15. There is no free lunch: Repeat after me: There is no free money, no riskless trade, no way to turn lead into gold. If you remember no other rule, this one wills ave your bacon time and again.
The list above will help prevent you or your organization from becoming financially disadvantaged by bad financial advice, excessively expensive services or inappropriate/unsuitable products.
Don’t say you were not warned . . .
Great selection of topics on your blog this morning, Barry. Way to go.
[...] Inviolable Rules for Dealing with Wall Street" – epic. (TBP) [...]
Excellent piece. No matter how much time goes by, investors/buyers still believe the documents are written for their benefit and not to protect the seller. It is also amazing that they continue to not ask the hard questions when approaching an investment. This same piece is very appropriate for real estate investors when approaching a mortgage or those buying from a real estate from a sponsor or developer.
The Other Rules:
1) When you are using OPM, most of the above rules don’t apply. After all, you will always be paid, even if the cash provider loses. The only risk is “how much”.
2) If you are investing your own cash, read the above and ask yourself “do you feel lucky?” If the answer is “Huh?”, then just go for safe, not free cash off the pavement. If you’re young and have another income, then go for it, if you feel lucky.
3) Don’t expect any regulator to look out for your best interest, unless you are investing OPM. Then you own the place.
4) Just as there is always someone richer, handsomer, more clever, or smarter, there will always be someone who brags about their excellence on making the right calls while you didn’t. Especially if they get paid by commission using OPM.
5) Everyone on Wall Street makes money by either taking it from someone else or by taking some of what the Fed prints. Your gains came from someone else or from the printing press. You losses went to someone else who is probably laughing at you right now.
[...] When dealing with Wall Street its worth taking precautions. Here are 15 to start [...]
“Reward is ALWAYS relative to Risk”
Not when you’re TBTF.
One more rule:
The Fed is Wall Street’s personal bitch. Anything that looks to the contrary is scripted to maintain appearances. A secret PPT was only the beginning. Now they don’t even bother to hide what they do (cash to primary dealers, where it ends up in minutes in the markets on a regular basis, several time per week)
QE2, if it occurs as expected, will turbocharge this cycle. Wall Street will be the beneficiary, as will be all commodity investors. Losers will be wage slaves, people with savings accounts, bond holders, and anyone who does not put cash into hard assets as an investor (not as a consumer), except for housing, although even housing will probably benefit from a big enough QE2. The Fed has blessed ‘price targeting’ which is also known as inflationary expectations, although they will probably go ballistic if this inflation starts causing wages to rise. Rising interest rates will only beget QE3.
The Fed is an organization of bankers. So even if they are not out to screw the public, they very much have a bias. Should be no wonder that the primary mission of the Fed is to protect/save the banks, even if it is at the expense of the greater economy. Maybe they honestly believe this is the right thing to do… but even if that is the case, it doesn’t much matter.
Wall Street To Fed:
“Bitch, print me some money. Don’t look at me like that, I’ll slap your ass into next week. Now, give Daddy some sugar.”
These can all be distilled down to one rule:
“Everyone on Wall Street is out to screw you, every day, in every way possible. Act like you know you’re the prey.”
A used car salesman in an expensive suit, is still a used car salesman.
last post:
oops: I just proofread a post above.
if QE2 happens and is large enough, winners will include people who put cash into commodities as investors, not as consumers. Somehow, I wrote the opposite.
Excellent list. It should be stapled to the forehead of every kid graduating high school
I like to multiply by the square root of 2 or pi when dealing with overoptimistic assumptions. Somehow tthrowing in an irrational number helps me remember where these things come from.
Now you tell me.
“Bitch, print me some money.”
Seeing words written which will never come out of any person’s mouth in a certain sequence in an entire life time makes me laugh like nothing else.
Thank you, Mr. Hobo: you’re damn good.
An excellent list, Barry. Thank you for posting it.
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