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The Paula Gordon Show |
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The Paula Gordon Show |
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Want a hot tip from a former Wall Street trader? It's the oldest one in the book: caveat emptor. Let the buyer beware. Frank Partnoy has a portfolio full of horror stories directly from the derivatives market where he worked. At the end of the 20th century, it was worth $80 trillion, bigger by far than the U.S. Stock Market. By late 2005, that market was conservatively estimated to exceed a quarter of a quadrillion (1 followed by 15 zeros) dollars. If you think the excesses of the '80s were awful, you'll find those of the 90's appalling. What's the difference according to this former Morgan Stanley "rocket scientist"? Today, when a broker "rips the face off" a client/investor, the losses are hidden in derivatives that investors often don't even know they hold. Until they loose it all. Mr. Partnoy offers a wake up call aimed at anyone who has invested in mutual funds, stocks, insurance or has a pension. Pension? Pension funds are major institutional investors. Another difference between the '80s and the '90s is that the big losers are no longer just individual investors. Buy stock in a huge company (Proctor and Gamble comes to mind) and you might well be headed for the kind of loss P&G experienced, courtesy of derivatives. Think you're at a safe distance from the Thai currency? Probably not. All kinds of instruments are tied to unlikely derivatives deals, including quasi-governmental institutions within the US government. Huge institutional investors (remember Orange County?) are just as vulnerable and have the same disaster stories as working people who wake up and find their nest eggs gone How did this increasingly sorry state of affairs in the financial world come to pass? First, there's an enormous information gap from which brokers profit, says Mr. Partnoy. What people don't know about the increasingly complicated financial world is growing exponentially. And then there are what Mr. Partnoy calls Wall Street's "perverse incentives." The commissions and fees which generate enormous wealth for investment banks and brokers have polluted the industry, he believes, leaving it what he describes as rotten to the core. Wall Street, observes Mr. Partnoy, is bilking a very vulnerable Main Street. How? The financial markets are not free markets at all -- they are heavily protected by politicians who keep barriers to entry into this lucrative world as high as possible. And fail to regulate derivatives -- the engine of today's Wall Street -- at all. Are you surprised that these same politicians also receive huge contributions from people highly placed in the financial industry? So how can a person stay out of derivatives? Buy U.S. Government bonds. That's the only guarantee. That's also where the brokers put their huge bonuses, says Mr. Partnoy. Even Blue chips and pension funds almost certainly have huge bets riding on derivatives. In particular, stay away from mutual funds, he says. Decide which industries you think will do well over the long haul -- 10 or 20 years -- and buy a diversified portfolio of stocks in them. Use an electronic broker to do it. Maybe buy some bonds and hold some of your money in cash. Any "sure things" according to Mr. Partnoy? Two. Don't give your money to some broker (even if he has hockey tickets) or a mutual fund manager you've never met. And always -- caveat emptor.
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Frank Partnoy assures Paula Gordon and Bill Russell that changes in financial markets that began two decades ago are accelerating exponentially. He warns us all that people in the derivatives market especially are waiting to bilk the unwary. He explains why the '90s have been much worse than the '80s, with scandals hidden in the bowels of investment banking. He describes technology creating an information gap. |
Virtually anyone who owns stocks or mutual funds also is -- wittingly or unwittingly -- invested in the $80 trillion derivatives market with often disastrous consequence, according to Mr. Partnoy. He defines two basic derivatives -- Options and Forwards -- with examples of the exotic ways Wall Street "rocket scientists" have complicated a simple concept. He shows how seemingly simple opportunities are in fact devilishly complicated. He explains why he is nervous when people say, " I trust my broker." He describes how our entire culture's increased willingness to gamble has infected the financial world. He calls Las Vegas' overhead "peanuts" compared to the billions of dollars Wall Street brokers make on fees and commissions. |
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The growing information gap is allowing tens of thousands of brokers to profit mightily from investors' vulnerability, says Mr. Partnoy. Wall Street -- which is very powerful -- has been bilking Main Street -- which is very vulnerable -- for a very long time, he says. He explains why Wall Street is not at all a free market, but a highly-regulated, highly protected one. He describes, with examples, people at the top of the investment banking industry giving huge sums of money to politicians to protect barriers to entry into this extraordinarily lucrative business. He declares derivatives (the engine driving Wall Street and producing the bulk of the profits) the most protected part of the financial industry, citing examples of billion dollar losses with no accompanying outcry, no legislation and no regulation. He explains "equity swaps" which are protected from regulation and allow investors to avoid paying taxes on their gains. |
Mr. Partnoy discusses globalization and shows how markets we once thought uncorrelated tend to move in the same direction because of hidden derivatives bets. He reminds us the derivatives investment market (not to be confused with the stock market) is the largest market in the world. He shows how the U.S. Treasury and quasi-governmental institutions are affected by derivatives' ability to hide things. The only way to be certain that you have not bought derivatives, says Mr. Partnoy, is to buy a U.S. government bond. He explains how Orange County, CA, lost a billion dollars and bankrupted. He describes "the vig" which investors in any financial instrument pay off the top in fees or commissions -- a fee which many derivative instruments are designed to hide. Ethics in the financial industry is, he says, an oxymoron. He gives examples of why it is foolish for investors to trust most brokers. |
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Brokers make their money by generating commissions, Mr. Partnoy reminds us, with sobering examples. Because brokers are betting OPM -- other people's money -- brokers are incented to take on much more risk than they do with their own money. (Most put their huge bonuses into Treasury bills.) Mr. Partnoy tells us how quickly brokers get away from their clients' risky instruments -- after taking their fees -- and he gives us a glimpse of the profound disrespect many brokers have for their clients. He describes Wall Street's very aggressive machismo culture, which he hopes is beginning to change with big law suits and big verdicts. Mr. Partnoy describes what he believes is really now happening in the Japanese economy where he believes companies"cook the books." He describes his own experience as a "rocket scientist" on Wall Street. |
Acknowledging he is skeptical of brokers and financial markets, Mr. Partnoy points to the financial world's good news, starting with new opportunities for ordinary people to invest. He applauds the access the Internet gives people, but warns it also creates massive opportunities for fraud. He urges investors to be optimistic that things will get better, but concludes that the financial industry's perverse incentives have utterly polluted and corrupted it. He urges investors not to give anyone discretion over their money. His final words -- caveat emptor -- let the buyer beware! |
| Acknowledgements We recorded this program in 1999. Unfortunately no lessons appear to have been learned. The amounts are larger, the products "new-and-improved," the spiel a little different, but the results are similar: resources wasted, large numbers of people being fleeced. Greed may not be good but it is ubiquitous. Mr. Partnoy took a large chunk of a beautiful Sunday afternoon to join us in conversation. We thank him and wish him and his growing family well. David Russell and Dr. Mary Murphy-Russell turned their hillside home into a studio with no prior warning and no hesitation. Bonwit, Augie and Hazel (in order of appearance) were also most accommodating. We appreciate and thank them all. |
Related Links The hardcover of Frank Partnoy's book F.I.A.S.C.O. is subtitled "Blood in the water on Wall Street" and was published by W. W. Norton & Company.
As a "shareholder activist" Robert A. G. Monks has worked to hold accountable financial institutions and the corporations which use those financial assets. His latest work, Corpocracy: How CEOs and the Business Roundtable Hijacked the World's Greatest Wealth Machine -- And How to Get It Back, will be published in late 2007. Financial services accounting for a significant percentage of American GDP. Kevin Phillips has written extensively about the dangers to America's economy and democracy of an overdependence on this industry. |
© 2007 The Paula Gordon Show.
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