ZT: The 5 biggest lies on Wall Street

These are the tenets you counted on for years, like 'buy and hold' and heed the advice of 'experts.' Keep these whoppers in mind as you plan your financial future.

By Michael Brush    2/19/2009

MSN Money

If you had any money in stocks in the past few years, you might be feeling pretty dumb right now -- since you're down more than 40% on those "investments."

But stop being so hard on yourself. Yes, you probably should have pulled more money out in time.

But on the other hand, you were probably suckered by any number of big lies foisted on you by Wall Street and market players who stood to profit.

Here are the five biggest lies that probably hurt you the most and will be worth remembering in the future.

Big Lie No. 1: The market will take care of everything

Remember Ronald Reagan's line, "Government isn't the solution to our problems; government is the problem"? The Gipper may have had some great political insights, but the train wreck in the market shows this one wasn't one of them.

During most of this decade, Wall Street lobbyists persuaded would-be regulators in the Bush administration to lay off. "The markets" would find the best solutions to any problems on their own.

In the free-for-all that ensued, the Wall Street Masters of the Universe made untold millions -- and left us with huge problems. The damage caused by all the tricks, scams and skullduggery has cost more than $7 trillion in market losses so far, not to mention millions of jobs and a deep recession.

We convinced ourselves that the inmates could regulate themselves, and obviously that was wrong," says Christopher Whalen of Institutional Risk Analytics, a financial consulting firm. "If we are going to let people buy public policy, then we are going to get stupid things."

Perhaps the biggest gaffe was allowing a multitrillion-dollar market in credit default swaps -- a kind of loan insurance -- to develop with no oversight or regulation. This was just plain dumb, and we'll continue to pay the price. Too much CDS exposure helped take down Lehman Bros. (LEHMQ, news, msgs) and American International Group (AIG, news, msgs). They lost big by insuring complex securities backed by bad home mortgage loans.

Of course, none of this could have happened if regulators hadn't looked the other way as mortgage originators handed home loans to anyone who could fog a mirror. They didn't care because the loans could be sold to Wall Street banks, repackaged as securities and sold again to investors.

"A shadow banking system developed to originate and sell mortgages outside the regulated banking system, and we ignored it," says William Isaac, a former chairman of the Federal Deposit Insurance Corp. and now head of the Secura Group, a division of national consulting firm LECG.

Even regulators who were supposed to be policing the market often did a lousy job during this "free market" era.

One example: Early this decade, a statistical wonk named Harry Markopolos had figured out that the investment vehicle that Bernard Madoff was promoting to well-heeled investors was a classic Ponzi scheme. Markopolos alerted the Securities and Exchange Commission, which failed to act until investors had lost billions.

Big Lie No. 2: The 'experts' will help you

Many of us rely on the "experts" for guidance in the market, and they failed us miserably.

Most mutual funds are down as much as the market -- or worse. The geniuses running hedge funds did little better. A few commentators managed to forecast the market disaster; most missed it.

There's a simple reason why they missed the coming carnage, says David Loeper, the CEO of Wealthcare Capital Management in Richmond, Va., and author of "Stop the Investing Rip-off: How to Avoid Being a Victim and Make More Money," due out in June.

The "experts" have conflicts of interest. Mutual funds, hedge funds and brokerages want to keep you at the table so that they can continue to earn fees from your nest egg. "They don't care if you win or lose, they just want you to keep playing the game," Loeper says.

They often pitch whatever is hot -- commodities and emerging markets come to mind -- at exactly the wrong time. "They'll market it until it falls apart, and then they will find something else," Loeper says.

At worst, the conflicts of interest seem downright blatant, says investor Jim Rogers. Among the biggest lies, he says, were the high-grade "AAA" stamps of approval put on faulty mortgage-backed securities by the debt ratings agencies -- which were paid big fees to rate those securities by the very banks who created them.

The media don't get a free pass either. Loeper says media outlets such as CNBC, and presumably this Web site, regularly fall short in guiding investors because their real priority is to provide entertainment -- and that they have to dumb things down too much to keep content interesting.
 

Big Lie No. 3: Buy and hold

Anyone who has followed this advice since the late 1990s now feels deceived. "Buy and hold" once seemed so obvious. Over the long haul, stocks advance 10% to 12% a year, goes the mantra. So you can't ever go wrong adding money to stock funds -- as long as you don't act like a wild day trader.

The problem was that investors and financial advisers use an assessment of risk tolerance to determine exposure to various asset classes like stocks, bonds and cash.

Then the level of risk in the stock market changed violently. But investors -- or their financial advisers -- didn't adjust their portfolios away from stocks toward safer assets like cash, says Axel Merk of Merk Mutual Funds in Palo Alto, Calif. "If the risks in the markets change, your investment allocations must also change," he says.

But how were we supposed to know that the risks of owning stocks had increased?

One early signal began to emerge in 2007, when market volatility started to increase rapidly, Merk says. Another sign was that excessive debt throughout the system had driven corporate profits to abnormally high levels, setting up investors for a big fall, says money manager John Hussman, the president of the Hussman Investment Trust.

Hussman warned investors of this risk early on. But, he says, because of Big Lie No. 2, many experts and Wall Street professionals "were unwilling to entertain any concern that threatened to stop the gravy train."

Big Lie No. 4: Overpaid CEOs are worth the money

Whenever I write about greedy CEOs who get paid too much, company PR machines trot out the old saw that pay has to be so high "to attract the best talent."

Oh, really?

Then why are we suffering such a deep recession and huge market losses? After all, the CEOs at the banks that got us into this mess were paid like kings. Let's take a look at some of the consequences -- and predictions -- brought to us by the supposed "top" talent purchased with all that money:

An extreme underappreciation of his problems. At Lehman Bros.' very last annual meeting in April 2008, then-CEO Richard Fuld opined that "the worst of the impact of the financial markets is behind us."

In June, he told investors the investment bank was "well-positioned" because of efforts to strengthen its balance sheet.

Fuld was supposed to be a "top talent"; Lehman had paid him more than $186.5 million in salary, bonuses and profits from stock options in the prior three years, according to Equilar, an executive compensation research firm.

Yet by autumn, Lehman vanished, setting off the October 2008 market crash. It had been killed by mortgage-backed securities and other investments made on Fuld's watch.

The cost of moving too fast. On Sept. 15, Bank of America (BAC, news, msgs) CEO Ken Lewis announced that the banking giant was buying Merrill Lynch, saying the deal -- cobbled together over a weekend -- was "a great opportunity" for shareholders because together the companies would be "more valuable" due to synergies.

Lewis had taken home $98.6 million from 2005 to 2007, so you'd think he would know what he was talking about. So far, he's been terribly wrong.

Bank of America reported a $21.5 billion fourth-quarter loss. The government responded by injecting $20 billion in new capital Jan. 16 and guaranteeing $118 billion in potential losses from the Merrill Lynch deal.

The stock has been crushed. Bank of America closed at $33.74 the Friday before the deal was struck. It fell to $26.55 on Sept. 15. It dropped to as low as $3.77 on Feb. 5 before recovering to $5.57 on Friday.

What seems clear is that these executives were blissfully ignorant of the growing risks to their businesses or simply chose to ignore them.

And despite all the bad press about CEOs raking in millions for lousy performance, the tricks continue. D.R. Horton (DHI, news, msgs), the nation's largest homebuilder, lost a whopping $8.34 per share in fiscal 2008, which ended Sept. 30. The stock has fallen 79% since July 2005.

Yet Chairman Donald Horton and CEO Donald Tomnitz collected $5.4 million and $4.4 million, respectively, for the year, including $1.8 million each in performance pay. They were rewarded for hitting benchmarks on cost cutting, pretax income and operating cash flow.

None of this is new. CEOs have been collecting big bucks for lousy performances for years.

Big Lie No. 5: Buy a flat-screen TV, save the economy

Maybe the biggest lie about to be foisted on people is that they should go out and shop to save the economy. Wall Street wants you to spend to pump up the economy. Much of the federal stimulus package enacted this week entails tax breaks and handouts to get people spending.

But it's really just another big lie to tell people they'll make a difference if they go out and shop.

The problem is that the economy is going nowhere -- no matter how much anyone spends -- until someone comes up with a plan to give the banks enough of a capital cushion so they start lending again. So far, we haven't seen that happen.

So play it safe. Hold on to your money. Most of you need to save more for retirement, anyway.

According to McKinsey Global Institute, two-thirds of baby boomers are unprepared for their golden years. Most of the boomers who are unprepared have a net worth of less than $100,000 even though they are just years away from retirement.

If you are younger, don't smirk. You need to save, too; otherwise you'll end up like them.