I haven’t read Greg Smith’s book nor do I intend to read it. In another life, I was an investment banker. I know all too well the excesses and failings of that industry. I don’t need to read Smith’s book to remind myself about the toxic culture of I Banking. And even if I did want to recapture some of that insanity and greed, I’d rather read Liar’s Poker.
Still, there is an issue that I think this new book (re)raises that’s probably worth discussing here – And it’s actually an issue that I first remember Michael Lewis talking about – the ability of the financial services industry to take advantage of unsophisticated clients, such as pensions, sovereigns, endowments and foundations. Lewis referred to this as “blowing up” a client, which was another way of saying that a trader had managed to sell an unwitting investor a piece of garbage. This was perceived by the bank to be a good thing.
And, according to Greg Smith, not much has changed in the intervening years... or so I learned in this 60 Minutes video. Here’s what Smith said:
“Getting an unsophisticated client was the golden prize. The quickest way to make money on Wall Street is to take the most sophisticated product and try to sell it to the least sophisticated client.”
“And there are pension funds and mutual funds that represent people’s 401ks and retirement savings that are trading the most complex instruments out there without fully understanding them.”
“What Wall Street will do is they will approach one of these philanthropies or endowments or teachers retirement pension funds in Alabama or Virginia or Oregon and they’ll say to them we have this great product that is going to serve your needs. And it looks very alluring to these investors but what they don’t realize is that up front they are immediately paying the bank two million dollars or three million dollars because of their lack of sophistication.”
Lies!, you might be saying. Hmmmm. I’m thinking there’s some truth in there. But don’t take my word for it, in true 60 Minutes fashion the argument was brought to a second interviewee who took the side of Wall Street. And here’s what the pro-bank guy had to say:
“These institutions call up a Wall Street bank and say... We need something that’s going to juice up our returns. We need something that’s going to make us more money. And they are vulnerable when they do that.”
It’s interesting that in Smith’s account it’s Wall Street that’s calling the funds... but in the pro-bank guy’s account, it’s the funds calling the banks.
Whatever the case, these funds are extremely vulnerable. And you know whose fault that is... not the bankers. It’s the pensions, sovereigns, endowments and foundations that ultimately set the stage for Wall Street to get away with this. More specifically, it’s the plan sponsors (i.e., the politicians and Boards of Directors) that have failed to build professional organizations that are capable of operating in risky segments of financial markets. This is about governance.
I’ve said this once but I’m going to say it again because I think it’s warranted: Plan sponsors can’t ask their funds to make ridiculous returns (i.e. higher than 6%) in order to spare themselves the cost of an expensive liability. It’s not fair. It pushes the pension managers into asset classes, geographies, and strategies that they can’t possibly understand. Moreover, if these sponsors are going to ask these funds to make ridiculously high returns, then they should at least give them the tools to succeed. They can’t expect these funds to go off into the most sophisticated segments of financial markets without the resources or skills required. But that’s exactly what happens, which is how they end up getting blown up by ‘young Michael Lewis’!
So if this Greg Smith book offers anything of use, it’s a reminder that our beneficial institutions really have to raise their game. And it starts with the sponsors of those organizations equipping the funds with the tools they need to succeed.
