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The Investor
Metrics of Deceit
Can investment decisions still be made in the face of such rampant dishonesty?
Now for some additional thoughts on the economy and markets:
* There is no science without measurement, said Lord Kelvin. Likewise, there is no meaningful study of investments without knowledge of certain measurements. These include book value, earnings per share, and revenue in stocks. They include credit worthiness and ability to pay coupons in bonds.
But if these metrics are simply fiction, if they are made up, this makes meaningful investment analysis difficult, if not impossible. If these metrics are simply fiction, but are sworn to as fact by “reputable” entities, this makes meaningful investment decisions even more difficult.
Unfortunately, this is the situation we have found ourselves in during the Drexel/Milken junk bond scam, the high tech scam, and most recently the banking and mortgage scam. In all of these cases, completely phony measurements were distributed, and these caused disaster when they were trusted. They still overhang markets and a lingering, meaningful recovery in faith in markets would be greatly facilitated by concrete steps to ensure that these metrics are real.
These would, in my view, center around meaningful enforcement of existing anti-fraud laws. Every law needed to curb every abuse that has happened in the past thirty years is already on the books: they just need to be enforced. Doing that with a will by the SEC would be far more meaningful than drastic shakeups in the financial regulatory structure. At base, all financial misconduct is fraud and laws against it are already there, once again.
* Warren Buffett has famously said that in the short run the market is a voting machine, but in the long run, it is a weighing machine. The truth that Warren Buffett is a stupendously successful investor is proof of his brilliance.
But recent events might allow for some qualification of his insights: the long run in markets is composed of an almost infinite series of short runs. For any investor with a finite time horizon, this makes investing in stocks extremely hazardous. This is perhaps why Buffett’s mentor, Ben Graham, reportedly declared near the end of his life that the stock market was simply too risky and that most people should stick with treasury bonds or high quality bonds of other kinds.
In the very long run, longer than most of us have, the market may well be a weighing machine. But what we have learned to our cost is that it is a scale that has a lot of thumbs on it. There are a lot of people in that infinite series of short runs that make up the long run who have the motive and the means to affect the weighing process. They do it whenever they can and derive great advantage from it.
You might look at this from a slightly different angle: certain big trading houses routinely report large profits on trading. This should be impossible in a really free market, just as it should not be possible to beat the house at poker in a consistent way in Las Vegas.
But if a player can see the other players’ hands, in my pal Phil DeMuth’s phrase, he has a very good chance of beating the house and the other players fairly regularly. We now know that this is happening, that certain traders are in essence trading against their clients, and that it greatly distorts the investing process. This, too, is a form of fraud, and could be punished under anti-fraud laws.
These are disturbing problems (at least to me) in a world where there are already too many disturbing problems.
Human nature, man as a frequently deceitful and larcenous creature, has a great effect on economies and on investing.
About the Author
Ben Stein is a writer, actor, economist, and lawyer living in Beverly Hills and Malibu. He writes “Ben Stein’s Diary” for every issue of The American Spectator.
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Alphred| 6.17.10 @ 6:31AM
Mr. Stein,
What do you suppose it would take for our president to take his foot off the neck of BP long enough to do a little ass-kicking at the SEC?
ENOUGH ROPE| 6.17.10 @ 11:38AM
OBAMA, THE SMILING COBRA
Shamus| 6.17.10 @ 6:40AM
I'm sorry to hear that Ben is disturbed.
JohnD| 6.17.10 @ 7:02AM
". . .certain traders are in essence trading against their clients, and that it greatly distorts the investing process. This, too, is a form of fraud, and could be punished under anti-fraud laws. "
This is something I learned from my father, and something I have been saying for years. The small, non-millionaire investor gets the bad stocks from his broker's company's own equity portfolio dumped into his account, and charged a fee by the broker on top of the fraud.
This is a breach of the broker's fiduciary duty to his client, and should be punishable by criminal prosecution. I have always argued that if investment firms want to invest for clients, they should be forbidden from having any equity position in the market whatsoever.
Brian John Murphy| 6.17.10 @ 8:21AM
Another way of looking at it is this: If an investment is really attractive, big investors as well as your own broker, have already bought it all up, raising the price and making your purchase anything but a bargain. The only way to get ahead of the big boys is to do your own homework, applying the metrics Ben Stein has mentioned above, as well as looking deeply into the present status and future prospects of the industry your investment is part of. Calling your broker is not necessarily the best way to do that.
Kitty| 6.17.10 @ 7:08AM
Ye Olde Mattress is a better vault at this point than any bank or investment institution.
TennesseeVolunteer| 6.17.10 @ 7:32AM
Ever since I have made investment decisions based on other peoples emotions, I have done extremely well. When I listened to "keep your money in the market over the long term and you'll average a 12% return, I got slammed.
I am out of the market until our country makes a sharp right turn with elections.
Ryan| 6.17.10 @ 8:32AM
And I'm making money right now. Ford, in particular.
Bill Hussein O'Stalin| 6.17.10 @ 7:41AM
The stock market is a corpse which hasn't as of yet been buried.
Douglas M Dillon | 6.17.10 @ 7:59AM
Ben Stein finally wakes up to the constant fraud occurring on Wallstreet (after completely discrediting himself and his advice losing tonnes of his reader's money). Kind of similar to republicans and conservatives. When are they going to wake up to the fact that the big issue is corruption and that regulation with integrity is one of the tools for cleaning that corruption up?
Ryan| 6.17.10 @ 8:33AM
We've got the regulation. We don't have the integrity.
JP| 6.17.10 @ 9:46AM
Douglas,
I hate to break the news to you, but most of the exotic financial products created in the last 30 years on Wall St were made by people who side with the Democrats. The revolving door of financial talent between firms like Goldman and JP Morgan and the Beltway concerned Democrats. Whether it is a Rubin, a Summers, Corzine, or Paulson really doesn't matter. And one need go no further than Bill Clinton to see how this financial incest work. Republicans may have been cheeleaders, but those cheerleaders did not influence how the Wall St investment banks operated. And this situation continues and even flourishes under Obama. The pipeline of power and money between the Beltway and Wall St has never been stronger.
Douglas M Dillon | 6.17.10 @ 9:51AM
Right, but where are Rush Limbaugh and Sean Hannity on this? Where's the republican leadership? The only republican who seems to "get it" is Ron Paul. If the republicans/conservatives want to get back in power they have to propose a solution to the problem of the banksters owning the politicians. I just don't see any of the mainstream conservatives (including the web site which I visit occasionally to see if they are coming around) "getting it" about corruption in DC or having a plan to suppress/minimize it.
JP| 6.17.10 @ 12:03PM
Douglas,
I don't listen to talk radio. And your attempt to pin this on the GOP goes against evidence that is there for everyone to see. Wall St has been a Democrat stronghold for generations. One would have to go back to the days of Al Smith to whan Wall St investors favored the GOP.
Most people don't realize it, but the calls for the deregulation of Wall St investment and commerical banks were backed by many Democrats. By deregulation, I mean the removal of the Depression Era laws that were on the books from the 1930s through the 1990s. The deregulation of investment and commerical banks was an ongoing process that began well before the repeal of Glass Stengal Act in 1999. And as I pointed out, the incestuous relationship between the federal regulatory bureaucracy and Wall St really get going with Clinton, and it appears not to have missed a beat with Obama.
Nowhere in the financial reform bills being debated on Capital Hill is there a call to return to the status quo ante of 1992 or before. There are no calls to break up the investment and commerical operations of such giants as Goldman or JP Morgan. If anything, these banks will get more powerful. And the GOP? As of now, they are powerless to do anything (that's what happens when you lose big time in 2 straight election cycles) other than bark at the moon. Was the GOP an accomplice in all of this? Sure it was; just look at the career of Phil Gramm. However, there is new blood coming to the fore. And the GOP should carefully reconsider its cheerleading of an unregulated Wall St. If anything, it should do this in the context of its own survival. For the Dems have a constant funnel cash from the banking giants that guarentee that little will change barring a financial collapse.
aware| 6.17.10 @ 5:28PM
Yes, Doug. The real problem is in the nature of the State, all States no matter what the "form". It is corruption itself and that is all it has to offer. It will never matter how many "honest" people win elections, the State will always spread corruption.
The State is not even an entity, it is a group of individuals who are designated to be above the law, and so can do things without suffering personally for it.
There is no reforming it but the insiders like you to believe you can. But the Founders were NOT "reformers" of government, they were LIMITERS. There is a huge difference that is lost on most who think they are "conservatives". Many have become team(party) players and are constantly baffled as to why things still get worse even when "our side" wins. For instance, Bush is "solid conservative" in 2000 and 2004, but is "not a real conservative" in 2008 to the SAME people!
When the frustration over this finally gets unbearable and you search for why this is, you will see that it is not a problem with individuals but with the nature of government. ALL government! Now it is to late to dis-invite government from all it controls. Either the power of government is severely limited or it is tyranny sooner or later, there is no other possibility. We moderns think we are "better" and have figured out how to have it both ways. But we really show how stupid and easily manipulated we really are by even trying.
We are too far down the road, even "conservatives" are shocked at the kind of anti State philosophy I am talking now. If I'm wrong then answer this question...is there anything, ANYTHING, that a majority would concede is NOT the business of government? Any human condition? Any disaster? Any "problem"?
From how you walk your dog to vaporizing enemy nations, its all the business of the State. And we are conditioned to believe no other possibility.
We are also bribed through various "tax credits"(think about how ridiculous this is...its YOUR money to begin with!), entitlements, welfare, and other subtle enticements from the State into participating and so doing our part to support this.
While I grant it is not AS BAD with Republicans as with Democrats, its never going to be GOOD for freedom, sanity, honesty, thrift, and the real American Way with monster State that is the Federal government. No matter who is running it.
The bottom line is that what we have, we have asked for every step of the way and soon there will be Hell to pay. And not just here either.
Anthony| 6.24.10 @ 3:10AM
Douglas, are you seriously trying to say that Rush Limbaugh and Sean Hannity make policy for all elected Republicans? Political commentators may be influential, but you should not buy into the idea that conservative political commentators represent the views of all elected Republicans, the Republican party and the GOP as a whole.
Jim O'Brien| 6.17.10 @ 8:46AM
Investing increasingly is nothing but a crap shoot. This has come about due to excessive, socialistic, and unpredictable government. Government interference has done far more damage than dishonest business managers.
"I think all the world would gain by setting commerce at perfect liberty." --Thomas Jefferson, letter to John Adams, 1785
I am sure Jefferson meant this within the context of the Constitution and the rule of law.
Ken (Old Texican)| 6.17.10 @ 8:47AM
The question truly is:
WHO WATCHES THE WATCHERS?
Why do so many otherwise bright people think that human beings "in government" (The SEC for instance) have any more integrity than the folks "on Wall street"?
Heh.
SEC attorneys work 8 hour days. Corporate attorneys work feverishly 12 hour days getting around them. Our clean honest attorney tries to protect our company from both "schools" of sharks.
AMENBRO| 6.17.10 @ 10:36AM
GOD BLESS YA SIR.
Entrenched overpaid, complacent UNION ENFORCED EMPLOYEES of our government spanking the monkey on our hard earned stolen taxpayer dime.
Matt morehouse| 6.17.10 @ 8:53AM
I have done very well over the years using no-load mutual funds and avoiding brokers and paid financial advisers.
The way to get rich is slowly.
Sean| 6.17.10 @ 9:24AM
If you can get inside tips from the FED you can truly make a ton of money.
JP| 6.17.10 @ 10:03AM
Credit Default Swaps were actually quite profitable as long as home prices on the high risk mortgages were rising. The people who owned the derivatives got a healthy cut everytime the home owner made a mortgage payment. As a matter of fact, CDSs were in such high demand that investors from New Dehli to Moscow wanted in on the action. And the complex risk models showed that these financial products would continue to reap nice profits indefinitley. It was interesting that no one ever ran a model that simulated a drop in real estate values across the board. The experts did run models simulating 1-2% foreclosure rates. But those risk models always assumed that homeprices overall would continue to appreciate. That is what got AIG into trouble, not to mention Bear Sterns and Lehman. Yet, the writing was on the wall in the form of the Mark-to-Market rule of the Sarbanes Oxley law. I guess no one took the time to read the fine print. The Mark-to-Market rule assured a domino effect in real estate valuations in the case of a market collapse. The losses came so quickly due to this rule that Lehman's ran out of operating cash in a matter of days.
I don't know how much money Ben Stein lost. But I bet he enjoyed the gravy train while it lasted. CDOs and CDSs as well as derivatives in general are very risky by thier own nature. Bean counter and other propeller heads thought that thier complex risk algorithims worked some kind of magic which converted debt into dollars (or perhaps a better metaphor, converting water into wine). They forgot one piece of wisdom - there is no free lunch. What comes up must come down.
AMENBRO| 6.17.10 @ 10:48AM
Ii may be wrong but without such derivatives/swaps many a commodity based entity would have no foil against the forces of nature.
Need we look further than the folks that donate so heavily to DEMOCRATS. LOSES are for the small people. How else did Dodd get his 20 million faux Presidential campaign warchest? Same as the walking around cash distributed on election days of yore.
Pete | 6.17.10 @ 11:39AM
That Larry Summers is not in prison, let alone functioning as part of the Obama team and pontificating on Charlie Rose, tells me that those who piloted the economy into the toilet were the first ones into the lifeboats.
sniper fire| 6.17.10 @ 8:12PM
Well, now we have it from the Investment Oracle - it is not entirely honest and the unwary investor can lose his shirt.
Unwary usually translates to dumb and greedy When they are young they fall for phony stock tips. When they are old they are victims of "pigeon drop" - both the result of greed.. If you can't play with the big boys, don't play.
Investing is just gambling with a classier name. We think more of a Warren Buffet than we do of Amarillo Slim - if that name is not familiar, he is/was a poker player. At least Slim was more honest than most brokers or investors. When he sat down at a table, he always said, "Boys, I hate to skin ya', but I need your hide."
There are crooked back jack dealers, rigged slot machines, marked cards and there are crooks and thieves in the stock market - how else could Hillary Clinton have made so much money in cattle futures? She made it because her broker decided someone else would lose it.
Not So Fast| 6.17.10 @ 8:59PM
Investing is just gambling with a classier name?! Well, for many it may well be: those expecting 20% returns every year and for those that wish to tilt the odds in their favor. We've been building our culture's appetite for get-rich-quick schemes for a long time...state lotteries, legalized gambling, etc. We've made it "normal."
No, the real idea behind investing is to build wealth. A system that allows capital to be traded in a market (ala "capitalism") frees people to invest in productive capacity without a lifetime commitment to a single opportunity such opportunity. The liquidity of the market allows money to flow freely to the most valuable investments, and as a result, provide an efficient way for a society to build its standard of living and make goods and services broadly available.
Your view of investing as gambling feeds the kind of dishonesty Mr. Stein mentions, because it rationalizes a sense of evening out the odds. Everybody finds an excuse, since "everybody else" is doing it. It's a downward spiral of depravity.
The one problem with free markets (in fact perhaps the only problem with them) is that the assumption is that information is freely and equally available to all market participants. And that the information is factual. Deceit, dishonesty, insider-advantage, bluffing, and every other type of gambling behavior is what causes the problems and kills the goose that lays the golden egg.
Gambling, sir, is exactly the problem.
Enrique| 6.21.10 @ 11:18AM
Yes! AMEN! This is exactly right, and there is no mystery to the fundamentals here, a six-year old could understand them. The advanced production of goods and services and the jobs created thereby require INVESTMENT. If investment was a Ponzi scheme, we'd all still ultimately be riding horses (at best) and growing our own food. Capitalism wouldn't work at all. How do you think technological and productivity advances are made?
Pure gambling is simply moving money around, incidentally, so is most government fiscal policy. When money is moved by force and society gains little (like funding some "green tech", that oops, was just a boondoggle), it's a dead weight loss to the taxpayer that would have saved, spent, or INVESTED those tax dollars.
Yes, you need a government to regulate (and crack down on the aforementioned fraud), but as an entity that survives by taking money rather than making it, it's usually the worst option. Intentional "fraud" or not, it was the biggest contributor to the misinformation in this bubble, as others point out above, by legally making the ratings cabal the investment gatekeeper of government pensions, and encouraging (even *mandating*) reckless loan approvals. Barney Frank explicitly said he wanted to "roll the dice" on risky, disadvantaged borrowers. Let's see...dice...that would be...GAMBLING!
Enrique| 6.21.10 @ 11:23AM
(To clarify about government usually being the "worst option", I mean for activities other than regulation and law enforcement, or for that matter, any that require unified - usually emergency - control by their nature, like the military, fire-fighting, etc.)
Jennifer| 6.25.10 @ 10:18PM
Wow I have never been to a casino that allows Russian Roulette, bails me out, does not have a pit boss...and closes before dark.
Rich Rostrom| 6.18.10 @ 12:03AM
Mr. Stein asserts that "during... the high tech scam... completely phony measurements were distributed..."
I was watching that whole market very carefully. In the vast majority of "dot-com" stocks, there was never any claim of current profits (or very small profits), only projections of future profits from some novel line of business using the Internet. Investors bought into stocks at P/E ratios of 50 and 100.
Those profit projections were usually fantastic, and collapsed when the business model didn't prove out. Then the stocks crashed - mostly. Amazon, Google, eBay, and Yahoo are still around and making billions.
As in any Gold Rush - some people found the Comstock Lode, and some people found worthless rock.
sniper fire| 6.19.10 @ 1:20AM
Well, thanks to the Gospel According to Saint Not-So-Fast, I can go forth and sin no more - in speculating that speculators speculate, which I believe is defined as taking a risky venture, in which it is hoped the outcome will be hugely profitable - much the same as putting your chips on the table and throwing the dice.
Long term, short term, it's gambling. I am not opposed to it in principle, I just don't call it what it isn't.
How does Not So Fast know that Bernard Baruch's morals were purer than the notorious Willie Sutton, who, when asked "Why do you rob banks?" replied, "Because that's where the money is."?
If I, in my skeptical view of the simon-pure motives and goals of the "investor with integrity" - if there is an investor alive who would not like the odds tilted in his favor , I hereby retract anything I may have said that would lead a first time investor to take the low road.
I invested one time in my long life - in a low performing mutual fund. I got ticked off one day because my broker did not return my phone call and I cashed it out. Two days before what they called Black Friday - sometime in the '60s. Having a short fuse proved profitable, If that isn't luck, I don't know what is. I built a swimming pool with the money - another poor investment. It cost me a fortune to keep it heated
I am glad you are not a betting man, NSF. You had a 50-50 chance of i.d.' ing me and called me "Sir". "Old lady"would have done it.
Stan Redmon| 6.19.10 @ 11:28AM
There are SURE THING investments. I am a small business owner...
Invest in your own education. Take training courses. No matter what you NEVER lose this investment and it's a good way to meet potential clients.
Invest in machinery, computers, and software. Each new release inproves my efficiency enough to pay for itself.
Invest in a good accountant. I have NEVER put my money to such a good investment.
Invest in your health
I belive the day of investing in a career for some other company is over. With the takeover of the economy by liberal central planners we will all be "contract" short term laborers. In other words, we will all be self (un)employed once the Obama (leftist) democrats are finished.
sniper fire| 6.19.10 @ 7:31PM
Stan Redmon - you sound like a solid citizen. I would invest in your mall business but you sound like the kind of man who will make your fortune small, large or just comfortable - through your own hard work and good judgment, not by reading a prospectus, keeping endless performance histories and then investing in what someone else is doing. And later whining if you were "hood-winked".
Stan Redmond| 6.19.10 @ 8:37PM
Of course I left out my bad investments. But all the good ones, were in myself and in my business. Thank you for the kind words...
Stan
sniper fire| 6.20.10 @ 9:01PM
I did not men to imply the swimming pool I built with the money from the mutual fund was a bad investment - it was just an expensive one. But it bought something really priceless.
At the time my son was crippled by Juvenile Rheumatoid Arthritis. I put in the pool so I could get n there and pump his legs for him to keep his muscles from atrophying until he was able to walk again. Keeping a pool at 90 deg. in SF Bay area - - well, you can watch your money go up in steam every foggy night! But it was worth it.
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