Ben Stein is up to his old tricks. Here he gave the impression of being done for the year, having penned an article of a classic end of year type, “what I should do better next year.” But he snuck another piece in this week, “Tattered Standard of Duty on Wall Street.”
The article claims there were once halcyon days on Wall Street “for a good long time after World War II” when, “The investor’s interests always had to be superior to those of the investment bank, financial adviser or broker.” Felix Salmon has already waxed eloquent on the big error in the piece. Stein, a lawyer, seems unable to understand when financial firms have a fiduciary duty and when they don’t. And when they have a brokerage relationship, they do not have a duty of care (they do have to represent the merchandise accurately, however).
Ben, let me explain something to you. If I sell you something – whether it’s a car or a house or a stock or a ham sandwich – I have no fiduciary responsibility to you. Caveat emptor, and all that. If I am investing your money on your behalf, then I have a fiduciary duty. Sometimes, investment banks (the “sell side”) also own asset-management companies (the “buy side”). But if you’re looking for fiduciaries, you’re not going to find them on the sell side, only on the buy side.
Actually, while I’m at it, let me explain something else. If an investment bank underwrites a sale of securities, then the bank’s client in that transaction is the issuer, not the investors. In an IPO, for instance, the issuer often pays the underwriter 7% of the proceeds. The investors, meanwhile, make their own decisions as to whether they think the stock is a good buy at the IPO price. If you want to get a good idea of who a bank is working for, just look to see who’s paying them.
While I do want to get to the point of my wee addition, which is why Stein can get away with this drivel, let me briefly deal with my pet peeve with his work, which is it is only tangentially connected with fact. I’m going to mention just a couple of errors. Yes, they will no doubt seem minor, but the piece is RIFE with them.
First, in the quote from the piece above, he talks about investment banks in the post WWII timeframe as if they had investors. The investment banking industry did not become integrated until the late 1970s-early 1980s in the aftermath of the elimination of fixed equity brokerage commissions in 1974. The demise of fixed commissions worked to the advantage of firms like Salomon Brothers and Goldman, which had strong institutional distribution and trading operations (Salomon in debt, Goldman in equities).
The leading investment banks in the late 1960s and early 1970s were Morgan Stanley, Kuhn Loeb, First Boston, and Dillon Read. Of these, Morgan was dominant. And of them, only First Boston had any meaningful distribution. Morgan Stanley had no sales and trading, just the investment banking (corporate financing, M&A, and related services to large corporation) and a syndicate operation. In the 1960s, Merrill Lynch was a “wire house” (a retail equity sales firm) and Goldman was an institutional equity firm with a large commercial paper operation and a small corporate financing unit (in those days, it was called the “buying department”).
In other words, “investment banking” meant something very different in those days than it does now. And the conflicts Stein wails about weren’t possible in firms that weren’t integrated. But in those supposed glory days, the firms also charged proportionally much greater fees and had a cozy oligopoly. You can afford to be genteel when you are making easy money.
Stein segues into an attack on Goldman for its role in the “subprime mortgage mess” and thereafter refers to “C.M.O.s” Collateralized mortgage obligations are indeed a mortgage security. The way Stein uses the term C.M.O. in the piece, he clearly means to refer to all of Goldmans’ mortgage securities sales activities (Stein is upset that Goldman was short the mortgage market at the same time it was peddling mortgage-related paper.
But mortgage debt is more than just C.M.Os. it also includes simple pass throughs and collateralized debt obligations, and arguably collateralized loan obligations (although CLOs generally consist mainly of LBO debt, they can have whole loans, such as commercial and residential real estate loans) and mortgage securities included in the assets.
He repeatedly discredits himself, yet his previous, off beam piece about Goldman sparked an investigation by Senator Dodd. What is going on here?
In his latest article, Stein is tapping into the inchoate unhappiness of Americans about the service we receive generally. Airlines stink, doctors can afford only to spend a little time with patients and yet consumers have to fight our insurance companies to honor their agreements, most gas stations are self service and grocery stores are implementing self scanning. All these changes are made in the name of efficiency, but in most cases (the airlines are the prime example) the companies don’t appear to be making out like bandits.
And then we have Wall Street. They actually seem to have benefited from the broad sweep of economic and competitive changes over the last decade, grotesquely so. And the latest example of how they have done well while it seems harder for many other sectors of the economy, the specter of ever-escalating paydays at the same time when millions may be losing their homes means there must be something immoral, perhaps even illegal, afoot. And Goldman, having done the best by a wide margin, is the prime suspect.
So Stein, in talking inaccurately about fiduciary duty (and much else) accesses a desire to turn the clock back to when customer relationships meant more, when a vendor would cut his customer some slack and might even be proactive to make sure he didn’t stray. But in those days customers were faithful and margins were fatter. Is America willing to give up Wal-Mart, price comparisons on the Internet, and their Wall Street analogues, dirt cheap commissions, lower M&A fees, and (at least in plain vanilla products) competitive fees on money management products? What Stein is asking for is a return to a relationship-oriented approach, but it’s a two-way street. Customers who shop for the finest prices, by definition, aren’t loyal.