April 3, 2008
In the overall scheme of things, I like
to fancy myself as free of a free-marketer there is. But even I have my
limits. One of the hottest issues of the day right now is whether retail
investors in non-bank asset backed commercial paper should be treated
differently from institutional investors in the same bad paper.
In my humble opinion, they should. They should be made whole now, and
have the cost of doing so borne by the non-retail community, i.e.
institutional investors and the dealers themselves.
To put it in numerical terms, there are approximately 1,800 retail
investors owed between $300 million and $400 million in principal amount
of the affected paper. Taking the higher of these two numbers, absorbing
$400 million into the $32 billion rescue plan rather than jeopardizing
it and risking years of lawsuits is peanuts ó especially when only about
$100 million of that would represent a top-up, with the balance being
backed by realizable security.
Itís also not the point. No matter how much or how little money is
involved, either in aggregate or proportionally, it is irrelevant if the
retail investor is culpable in their own losses. If retail investors
contributed to the problem, they would have nothing to complain about.
And to take it a step further, we must respect one of the most important
tenets of the capital markets, which is that your word is your bond.
That tenet is how a retail investor can buy or sell tens of thousands of
dollars, millions even, in investments with a simple phone call. No
lawyers, no paperwork, just a voice on the phone can move money and
securities from one place to another. It only works in a world where
your word is your bond.
Some would argue that by the retail investor agreeing to buy the
commercial paper in the first place, they agreed to accept the risk of
the paper. Therefore the retail investor doesnít deserve to be repaid in
full now that things have gone sour, any more than the institutional
investors deserve 100 cents on the dollar for their damaged paper.
Most times, as a free-marketer, I would agree with that sentiment.
ďDonít whine to me now, just because you didnít do your homework
beforehand,Ē is one of the best arguments in favor of a wealth transfer
from those who did their due diligence to those who didnít. But in this
case of faulty ABCP, that argument doesnít hold.
Thatís because, although the tenet of Ďyour word is your bondí is common
to both retail and institutional investors, the two camps are different
in that thereís a huge informational advantage held by the industry
players over their retail charges. Let me put it this way: if an
investment advisor told a retail client last winter or spring that
investing in commercial paper was a very safe thing to do, how would a
retail investor know any different? The investment advisor wouldnít have
known any different. And if the retail investor somehow was able to ask
a professional institutional money manager how safe ABCP was to invest
in, they wouldnít be told anything different, because at the time
institutional investors didnít know any better either.
So no matter how much due diligence retail investors might have done,
they still would have made the investment. The industry should therefore
not hold the retail investor to account for doing something the industry
didnít know was wrong to do.
The retail investor has already lost by not having access to their money
for the past seven months. Donít make them wait another nine years. Pay
them off now.
And if the $100 million stings the industry a little bit, maybe that
will spur them into doing a better job of teaching product knowledge to
their people before licensing them.