"It takes a great deal of bravery to stand up to your enemies, but a great deal more to stand up to your friends."
-Dumbledore, Harry Potter

. . .
In 2008-2009, the Great Financial Conflagration rocked households from coast to coast. Wall Street self-servingly dropped its reputation as "trained-killers" long enough to procure taxpayer-funded federal lifelines. If Darwin had his druthers, these firms would have died.
During the conflagration, as Wall Street burned and its overlords we're distracted by the act of saving their own behinds, we awoke from our Stockholm Syndrome. At that point, we determined to attempt an escape from Wall Street's brokerage camps. We'd been detained, tortured and reprogrammed for a decade. Such an opportunity may never again arise.
So, we planned and waited. When the opportunity arose, we crawled through the tunnel we'd dug, into the muck, filth and stink therein. We opened the angry letters from the firm. We contested the baseless claims from attorneys in New York, Louisiana and points in between. We watched our former captor insinuate that the relationships we'd brought to the firm were not, in fact, our own. We stood by helplessly as our captor released the hounds, who spoke every sort of untruth, half-truth and misrepresentation in order to convince clients that we were fortune seekers, acting selfishly on the behalf of our own greedy ends.
The truth, however, stood in stark relief to the self-serving narratives.
Following our escape, and the liberation of most of our clients (you can never save them all), we were able to objectively look back upon our experience. We may never fully recover. Yet, we will forever benefit from the cold analysis of those year's spent within Wall Street's vast, grey and dreary Marketing Machine. A world wherein interest, in all varieties, ruled. Fixed and variable rates of interest. Conflicts of interest. And self interest.
In order to understand the ways of Wall Street, one must understand its driving principle: profit.
We are not socialists, you and I. We are, in fact, proponents of laissez-faire capitalism, its benefits and advantages. However, please note the stark contrast between a publicly traded company which markets soap, toilet paper, toothpaste and detergent, and a publicly traded company which, as its core business, manages the public's money.
Soap, toothpaste and detergent? Easily grasped products. The value of which are typically judged on price and utility. Good price? Good utility? More customers. Sales. Revenue.
Financial services, on the other hand, lay outside the purview of most individuals. People find it more challenging to grasp concepts like the time value of money, price-earnings-to-growth ratios, and sector rotation. Nor does Wall Street help in this regard. Because Wall Street benefits by making the public feel uneducated in all matters financial. In fact, the dumber the public feels, the better Wall Street does.
Investors rich and poor have given their nest eggs to elegant gentlemen in pin-stripe suits and corner offices. These gentlemen could recite Alan Abelson's weekly column in Barron's, God rest his soul, verbatim. They could climb aboard an elevator and, between the second and sixth floors, opine on the markets so articulately as to convince all within earshot that the time to act was nigh.
Only, in 2000 and 2008, these elegant gentlemen lost as much money as everyone else. Sometimes more. Why? Stockholm Syndrome. And an irrational belief in their own mythologies.
You see, for years Wall Street's largest brokerage firms had hired finance oriented individuals with an interest in and capacity for investments, tax, risk management and markets. But, as most of the once venerable firms went public, or were ushered into the arms of some other publicly traded institution, the Wall Street overlords realized that the land grab was on. Only, this land grab had less to do with real property than assets under management (AUM).
As Wall Street's minions began to move from a fee-for-transaction model to an asset-management fee (generally a fee charged as a percentage of assets under management), Wall Street recognized that future sales, earnings and profits - not to mention bonuses, stock options and profit sharing, were all tied to the ability to grab larger shares of AUM. The higher the AUM, the higher the fees, the better the contribution to quarterly earnings, the better the bonus. This virtuous cycle enabled the Wall Street Overlords to garner a king's ransom each and every year.
Accordingly, the game changed forever.
Wall Street realized that the game was not about the percentage of clients helped, but the percentage of AUM.
So, a few paradigms shifted.
1) The brokerage firms realized that the quickest means of AUM growth was to simply hire the brokers from their competitors, attracting them via large upfront bonuses, in order to assimilate client assets and fees.
2) This focus on inorganic growth via broker acquisition kicked off a free-agent mentality that saw brokers being rewarded not for doing anything client-centric, but by simply agreeing to take a check, make a move, and convince clients of some inane reason to tag along.
3) This set off a wave of acquisitions, involving the purchase of individual broker's businesses, as well as the purchase of entire brokerage firms. Soon, even those brokers who'd not yet made a move, or had moved long ago, were being offered retention bonuses - large checks paid to brokers for simply remaining with the firm.
Were any of these rewards tied to anything benefiting clients? No. Yet, this has contributed to more wealth in the ranks for the brokerage firms than anything having to do with investment selection, asset allocation or financial planning.
The result was an evolutionary shift in the means by which Wall Street viewed Main Street. Yesterday's "clients" became today's "AUM." While the elegant gents on the frontlines continued to see clients as clients, their employers had left that paradigm behind, embarking on a frenetic product development binge. The kinds of products that would enable the elegant gentlemen to spend more time prospecting for AUM, and require less time for the proper management of that AUM.
At this point, the firm's began rewarding brokers for converting clients to fee-based relationships. Which wasn't a bad thing, if the next step was to reward brokers for the effective management of those assets. Which they didn't. Because the firms realized that it was more effective to incentivize brokers to market themselves and the firm's products.
So, the firms endeavored to relieve the brokers of as much responsibility as possible. They created programs that directed AUM to mutual funds, separately managed accounts and other money management vehicles whereby the broker had as little to do with the client's investment success than the client's landscaper. These programs would automatically rebalance capital, shifting funds from one asset class to another with little regard to personal concerns beyond a couple questions asked years before.
All the while, the broker could spend more time on the phone, touting the benefits of the firm's investment vehicles and due diligence resources.
Soon, most of the brokers had as much practical investment experience as their colleagues at the former residential real estate firms from which they'd been hired. Because once the firms realized that they needed better salesmen, they began hiring better salesmen.
What's more, most of the products into which the clients' AUM was being allocated, were held out as long-term, little-to-fear, buy and watch programs. The rationale of which was justified by pithy explanations learned at full-day training sessions.
"I don't know where the market will be in three to five months. But, I know where it will be in three to five years. And this program will help you benefit by the market's long, historically upward trend line in a means that is actively managed, diversified, and stewarded by some of the best minds in our firm."
Only, the best minds at the firm, let alone the brokers themselves, were not using these same programs for their own capital. They were rarely investing in the separately management accounts, money managers and mutual funds to which their client's funds were allocated. They bought individual stocks and other investment vehicles they could actively manage. As clients often assumed was being done for them.
None of which really mattered. Until it did.
Because in 2000, the market began to drop. Around 46 percent. Many clients continued holding the same worthless tech stocks, funds and vehicles all the way down.
The market recovered for a bit, and then six years later, the unthinkable happened. The market dropped again. 38 percent in 2008 alone. More than 50 percent from start to finish.
As clients called their brokers, panicked, asking what could be done, brokers confidently said that the best course was to stay the course.
Because the firms had spent more time training brokers how to talk clients off of the roof than it did training them to prevent them from wanting to jump off in the first place.
When the smoke cleared, so had much of Main Street's net worth. Wall Street? It had largely been saved. Bailed out by those same financially distressed taxpayers. Ironic, actually.
As the average investor paid the average broker around 1.20 percent to manage his assets, and then the average broker allocated that capital to mutual funds that charged another 1.10 percent. So, as Wall Street continued to get paid on AUM, even as AUM crumbled, taxpayers paid again. Via federal bailouts. So that those mismanaged firms could survive.
The valuable lessons gleaned from all of this? Seriously.
More than four years following the 2008 financial catastrophe, there has been no change in Wall Street's modus operandi. The brokerage firms continue to play the AUM game. Continue to place a higher premium on quarterly earnings than client's earnings. Continue to allocate client capital to inflexible, non-thinking investment vehicles offering no downside protection and little real effort by the broker.
What does all this mean for Main Street's investors? Those twice-burnt souls living in Toledo, Tacoma, New York and New Mexico? That, dear reader, shall be where we pick up next week...
To be continued.