How to avoid Madoff Madness

Madoff madness is our own

By John F. Wasik (Reuters)

Bernie Madoff’s failings are not the mark of some isolated monster, although his crimes are heinous. He is so much like every one of us that failing to recognize this fact will imperil us at every financial turn.

This is one of many revelations in Diana Henriques’s stunning new book The Wizard of Lies: Bernie Madoff and the Death of Trust.

The man who bilked $65 billion from friends, family, institutional investors and charities knew what he was doing. As far as we know, he wasn’t incapacitated from bipolar disorder, substance abuse, schizophrenia or some gargantuan chip on his shoulder to prey upon the wealthy. He stole and lied consistently to all and told Henriques he was fully aware of his mammoth deceit every step of the way.

Madoff was not a man conspiring in a bunker. He went to countless high-society parties, gave to charities and was admired by most who encountered him. Yet when he finally admitted his fraud, it was a surprise that ruined individuals and charitable foundations. His own son, trying to escape the shadow of his father’s foul deeds, committed suicide.

The scale of his crime can’t be overstated. As the serial falsifier of whole portfolios, Madoff claimed to manage twice as much money as Goldman Sachs, Henriques states.

“He was faking everything,” Henriques writes, “from customer account statements to regulatory filings, on a scale that dwarfed every other Ponzi scheme in history.”

Next to the mavens of the 2008 meltdown, Madoff may be the Stalin of Ponzi villains (there are always other scamsters out there). Yet any attempts to personify him as a three-headed hydra will miss the main point of Henriques’s masterful narrative. Here’s the clincher, which Henriques saves for page 345:

“The Madoff case demonstrated with brutal clarity another truth that we simply do not want to face about the Ponzi schemer in our midst: He is not “other” than us, or “different” from us. He is just like us — only more so.”

This chilling revelation illuminates human nature itself. We want to believe that someone like Madoff is “taking care” of us — and our money. When some negative vibe buzzes in our ear like Jiminy Cricket, we compartmentalize it in the part of our brain that is like a dead-letter file. We don’t question the reality of outlandish claims and can’t own up to our avarice.

I’ve seen so much investor denial in the past three decades of covering finance that I could spend the rest of my life writing about it. Some of it flies beneath the radar like high-yielding structured products that are loaded with risky and complex derivatives.

Most of the deception, though, lies in banal investments like variable annuities or overpriced 401(k)s. We’re fleeced every day, but may not know it because of our trust in our advisers, a brand name or simply a bold promise.

Here’s a short list of what we need to know about investing, but routinely fail to ask ourselves with any skepticism:

• If an adviser is pitching a six percent yield when most one-year certificates of deposits are returning one percent, what kinds of risks will you be taking to achieve that return? How much can you lose if the promise doesn’t pan out?
• Can the adviser beat a broad-market index like the S&P 500 on a regular basis? Most can’t. If they have a few good years, they are lucky, not skillful, and luck doesn’t last long in investing. Most lag the market averages over time after management expenses, taxes and inflation. It’s a fact of life.
• Is your principal really protected? Outside of low-yielding FDIC-insured product, you will pay dearly for any guarantees. How much will it eat into your principal? What are the commissions and internal fees?

How do we avoid the Madoffs of the world when we consistently trust people we shouldn’t and fail to ask the right questions?

Henriques suggests that we need mandatory financial education in school and be required to get a license after we are tested on basic money skills.

While I agree that everyone needs this skill set — and it should be taught beginning in middle school — I’m not sure if licensing is the way to go. Plain-language, gob-smacking tobacco-like warnings on investments that state “this is hazardous to your wealth” are another alternative, although crooks always manage a way around disclosure.

Ultimately, we need to turn off our brain’s belief and trust circuits to avoid hazardous investing. The truth is often not in our heads, but in our guts.

“That is the most enduring lesson of the Madoff scandal,” Henriques concludes, “in a world full of lies, the most dangerous ones are the ones we tell ourselves.”

Earth Day Gold

By John F. Wasik

The best Earth Day investments

All that’s green isn’t gold.

As we wring our hands over another Earth Week amidst the Gulf oil spill anniversary and the Japanese nuclear crisis, it’s hard to remember that we can’t buy or invest our way out of our current predicament.

We need to redefine how we can become better stewards of our planet. While I think we need a moon-program-sized clean energy and resource preservation plan, it won’t come by buying green products and investments.

Case in point: I was recently solicited by Green Alpha Advisors, LLC, which says it performs “money management for environmentally focused capital.” They manage funds in a separately managed account offered through brokers that invest in a host of environmentally friendly companies.

Since I was solicited through email via The Sierra Club, a revered environmental group that I’ve been a member of for many years, this firm has a verdant endorsement for investors like myself. All of the right keywords in their marketing materials sounded good: clean energy, smart grids, sustainable commerce and zero-carbon transportation. So far, so good.

Their “Sierra Club Green Alpha Portfolio” returned 6.44 percent from inception (Dec. 27, 2010 through Feb. 28, 2011), compared to 5.85 percent for the broad-based Russell 3000 Index, so that had a good ring to it as well. Then I started to dig into the fee structure and the picture became grayer.

Green Alpha was charging an annual minimum management fee of 2.95 percent if you invested less than $50,000; they lowered their fee to 1.79 percent if you had at least $100,000 under management. There were also additional transaction charges (through the broker Charles Schwab) for “the buying and selling of securities in your account.”

I was also piqued that, unlike an open-ended mutual fund or exchange-traded fund (ETF), I didn’t get full disclosure of all of the stocks they held in their portfolio. The manager stated in an email that “only our current clients have access to all of the securities in the portfolios,” although they seem accommodating in that “management fees are negotiated on a client-by-client basis.”

In the ETF space, you can own a lot of green stocks for a lot less. Let’s say you wanted to concentrate on solar-energy stocks, not a bad bet as we still gape at the horrors of nuclear power and the perils of oil, coal and natural gas.

The Market Vectors Solar Energy ETF, will give you a sampling of this sub-sector. Its annual management expense ratio (in addition to a brokerage transaction fee) is 0.65 percent annually.

An even better approach is to avoid betting on just one technology and to spread bets across several promising sectors. The PowerShares Cleantech Portfolio ETF invests in an index of more than 70 stocks across the world. They charge 0.67 percent annually.

Will investing in these portfolios prevent climate change or reduce U.S. dependence on fossil fuels? Not directly. Yet if you can extend your philosophy of green investing into daily practice and political activism, you may have a much more meaningful impact.

Our family not only recycles more than we throw out, we compost our kitchen waste to make soil. Although we’d like to drive less in our suburban locale, when weather permits, we take our bikes to the supermarket, library and hardware store. We patronize local farmer’s markets and try to grow much more of our own food — and freeze or can it.

Will some of this lead us to a cleaner environment? It won’t without a big, clear voice asking our politicians to support clean and smart energy policy through a renewable energy portfolio standard — literally mandating that we get away from fossil fuels by a certain date. We have the technology. All we need is the political will and the ability to price carbon and its harmful effects on the environment.

It doesn’t matter whether you believe climate change is caused by man or not. Supporting clean energy and resource conservation is the right kind of stewardship for the finite gifts of our planet. That’s an investment that keeps on paying dividends.

Fighting Wall Street: Part II

Consumer cops: Why we need Mary Schapiro and Elizabeth Warren now

Two women are fending off a vicious man-handling of investor protection.

As Congress pettily wrangles over the debt limit and the next budget, Mary Schapiro and Elizabeth Warren are fighting to protect you against the ravages of Wall Street.

Wall Street and its Republican allies would like to make the Dodd-Frank financial reforms disappear. The money trust has been pouring millions into lobbying to eviscerate the budget of the Securities and Exchange Commission and blocking the formation of the Consumer Financial Protection Bureau.

Mary Schapiro, who chairs the SEC, said she can’t kick start the myriad pro-investor rules of Dodd-Frank without adequate funding. Republicans, lead by Budget Committee Chairman Paul Ryan, want to “starve the beast” in their fiscal year 2012 proposal.

Ryan’s new budget proposal wants to cut off the SEC budget at its knees by giving the SEC $112 million for fiscal year 2012. That effectively freezes the top securities regulator’s funding at 2008 levels. The current budget deal gives the agency a slight increase in funding.

Remember what happened to Wall Street in 2008? The Obama Administration wants $308 million for the SEC to prevent another year like that from happening. The money trust has deliberate amnesia.

While the SEC gathers most of its revenue from fees and fines, it can’t seed key investor protections like an office of investor advocate without the additional funds. Its budget was supposed to double under Dodd-Frank over the next five years. The money trust wants to keep the status quo and de-fund the agency.

Schapiro, who told a group of business journalists last week that investor protection would be hobbled if she didn’t get adequate funding, said under current budget proposals “there will be fewer cops on the beat.”

Also on the chopping block is one of the most powerful investor safeguards of Dodd-Frank: fiduciary duty for brokers. This one rule, endorsed by an SEC study earlier this year, would make brokers legally responsible to put their clients’ interests first. Right now, they only have to follow flimsy “suitability rules,” which gives them leeway to sell a raft of unsuitable investments like derivative-loaded “structured products.”

Although the SEC said it is still writing the fiduciary rule, after intense industry lobbying and the objection of two of its Republicans commissioners, Schapiro told me the agency would do “more economic analysis” on the proposal and take it up again in the second half of this year.

As a long-time observer of the agency, I can tell you that once the SEC decides to re-study a proposal, it’s often a death knell or produces an indefinite delay. The agency has been sitting on a proposal to reform onerous 12(b) 1 fees on mutual funds for years, even though these are marketing expenses that needlessly eat into your returns.

Elizabeth Warren is fighting a separate battle to save the funding and independence of her consumer bureau, which President Obama asked her to start up. Republicans have proposed that another commission run the agency or answer to other regulators, which is the bureaucratic equivalent of neutering it.

The consumer bureau, Warren hopes, would curb anti-consumer credit practices in banking. Her common-sense approach is simple: Boil every credit agreement down to a plain-language form that tells you how much it will cost you, is it affordable and is it the best deal. That’s something that would benefit every American who gets a credit card, mortgage or other financing.

Not only are GOP proposals punitive to Warren’s fledgling agency, they are unfair. No other banking agency would have to answer to a commission or be hostage to Congressional appropriations. The Office of the Comptroller of the Currency, a banking regulator, has a single director and obtains its budgets from bank fees, for example.

“We’re not going down without a fight,” says Warren, who is also a proponent of making the free market work for consumers in promoting accountability and competition.

There shouldn’t even be a fight over these two agencies. After the money trust nearly deep-sixed the global economy in 2008, triggered a massive recession and unemployment, they should welcome more cops on the beat. They are like three-year-olds with a pile of money and an endless supply of finger paint. They need parental supervision or things will get messy again.

Warren and Schapiro are right. You don’t police banks and brokers by stifling oversight. Let Washington know you want to keep politics out of your portfolio.

New Budget Busts Americans

From Reuters.com

Budget wars: The middle class loses big time

John Wasik

Now that federal government shutdown has been averted, it’s a good time to examine what’s at stake for most of America in the crucial next round of budget talks.

Not doing anything to reduce the size of government debt will be catastrophic. Not much quibble there. But acting hastily and cutting the wrong things can be even more costly to social and economic welfare.

Neither the Republican nor the Democrat’s budget plans for 2012 will meet the major challenge of sustaining social programs while cutting the most egregious waste.

Since the GOP budget proposal has been published, let’s eye that first. The 2012 budget template, released by Paul Ryan, Republican chairman of the House Budget Committee on April 5, cuts $6.2 trillion from government spending over the next decade. Some clarity is needed here in the semantics of this plan. Cutting is not the same thing as “improving” or “reforming.”

One of the hallmarks of the Ryan plan — a GOP campaign document for 2012 — is cutting top personal income-tax rates from 35 percent to 25 percent. As part of his “path to prosperity” theme, he estimates that along with other cuts and a lower corporate tax, this will create 2.5 million private-sector jobs, lower the unemployment rate to four percent by 2015 and add $1.5 trillion to real Gross Domestic Product over the next decade.

That claim is not only unrealistic, it’s never been supported by any sound economic science. During and after the George W. Bush era, when tax rates were cut on income, capital gains and dividends, unemployment rose and GDP eventually fell.

Would cutting taxes again — actually reducing revenues further and creating a bigger structural deficit — make a difference this time around? This is not only wrongheaded, it makes no mathematical sense. You can’t reduce the deficit by eliminating a key and ready source of revenue.

The trickle-down theory once again rears its ugly head. The GOP plan effectively snuffs progressive taxation on the wealthy. As Joseph Stiglitz, a Nobel Prize-winning economist, says in a recent Vanity Fair piece, “there is ample evidence that something has blocked the vaunted ‘trickling down’ from the top one percent to everyone else.”

The ultra-wealthy used to pay their fair share. From the 1940s to the 1980s, the top tax rate — even during the Eisenhower Republican-dominated 1950s — ranged from 70 percent to 91 percent.

I’m not advocating a return to those lofty rates, but right now you’re a tax chump if most of your income is from wages.

It pays big time to have inherited wealth and investment income, both of which will be largely spared in the GOP’s misguided budget crusade. Stock dividends and capital gains qualify for the 15 percent rate. Additionally, estate taxes went from a $1 million exemption and 55 percent rate in 2000 to 35 percent and a $5 million exemption as of last year.

Since the GOP also wants to privatize Medicare — reintroducing expensive private insurers to the program — the middle class will be digging deeper into savings to cover premiums and larger out-of-pocket costs, especially those under 55. It’s the equivalent of turning the popular, guaranteed health program into a massive 401(k)-style boondoggle. Only private insurers will benefit. You will be on your own and likely to come up short during the most vulnerable time of your life.

The Ryan document also savages the self-funding health reform law, which attempts to reduce healthcare costs over time by allowing exchanges to introduce real competition to private health insurance.

No fewer than five glaring boxes in the Ryan report call for the repeal of self-funding health reform, suggesting that this will somehow slay the triple-headed fiscal demons of Medicaid, Medicare and job losses.

As much as I abhor the GOP plan, I’m no fan of the Obama budget, either, which leaves in place funding for a bloated military and two and half (I’m not sure what to call Libya) needless wars. Neither party even touched Social Security nor the trillions that corporations either bank off shore or avoid through tax breaks.

What both sides need isn’t more patience. They have clearly dug their ideological trenches and will battle it out at our expense. They need to curb their respective dogmas. Real prosperity comes from mutual benefit, sacrifice and universal incentives, not unrelenting giveaways for one percent of society.