Advice for Rich Uncles and Others . . .

I am going to relate an anecdotal tale that, as far as I can tell, is true. The actual story matters much less than the lessons it teaches, clearly enunciated at the end of this post.

Several years ago, I helped a firm develop a new Distressed Debt/CDO department. The history of the group that I brought in was a strong ability to trade distressed paper, and the expertise to package and resell it institutionally.

Initially, this worked out well for the firm. They managed to do a number of deals, getting their names on the offering books as co-leads with the likes of Merrill Lynch and Goldman Sachs. Very prestigious, huge fees, all good stuff.

After I left, I kept hearing all sorts of sketchy tales about the group: big turnover amongst staff, disagreements about costs, fights with the bond desk, issues with compensation. I chalked this angst up to the usual Wall Street "eat what you kill" philosophy. 

Then I heard several stories: That the CDO desk was pitching their product to retail brokers, that this debt was getting placed in the accounts of individual investors where it had absolutely no business going into. Distressed debt and CDOs are sophisticated complex instruments that require a great deal of expertise to understand, and I was sure neither the retail brokers nor the clients knew these things.

Then, I hear tales that a retail broker from a rather disreputable shop joins the firm. He takes to the CDOs like a fish to water, placing them everywhere and earning huge fees. The rumor I keep hearing is that he even placed a $10 million block with a family member.

You can see where this is going: The $10 million dollar investment is now worth, best as anyone can figure, about $3 million — assuming you can find a bidder. The commission on that one placement was a cool $700,000. The relative/client has gone postal, litigation threatened, all manner of ugliness. You just know this is going to end badly . . .

Now its time for your 3 lessons to learn from this misadventure:

1. Advice for Investors: Never buy anything you do not understand. This is a very simple rule, regularly ignored by all too many people. If you don’t understand what a company does, DO NOT BUY IT. If an  offering doc comes with a 157 page set of disclosures, unless you understand all the risks it contains, stay far far away.

2. Advice for Brokerage Firms: Never place institutional products with retail investors:  As a rule, they do not have the sophistication to understand the product (see rule #1). More importantly, when this stuff gets offered to retail clients, it likely means INSTITUTIONAL CLIENTS HAVE REJECTED IT. Hence, the need to stick it somewhere other there where its supposed to go is likely proof that its got some bad mojo attached.

3. Special Advice for Rich Uncles: Don’t give money to relatives, instead buy them a new Rolex. This sounds like a quite odd bit of advice, but follow my logic. When you give, oh say, $10M to a relative, you are making a major financial decision based not on their skill set and experience, but rather, on a coincidence of a blood relation.

This is not a good basis for making a significant financial planning decision.

Next, speak to your nephew/niece/relative, with their parents present (one of whom is likely your sibling). Explain to the young ‘un that your money has been very carefully placed in the hands of top notch professionals you have painstakingly selected after great study of their long term track record (which the kid obviously does not have).

However, you want to help the kid become a success in their chosen career. So here is a small bauble to help get you started on that road to success: This Rolex Watch (I suggest this one).

Tell them to wear it with pride: It will subtly convey how successful they are to their employers, let their peer know they are a man of substance, and most importantly of all, convince their sales prospects of their status. It reeks of their soon-to-be inevitable success. Wish the best of luck in their new career!

And walk away knowing that the $5,000 you just blew saved you untold millions in losses, and no end of grief at all future family gatherings

You’ll thank me . . .

 

Buying this watch can save you $7 Million dollars:

Sea_dweller

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  1. jz commented on Aug 10

    hedge fund bankruptcy contagion

    = high end real estate melt 6 month lag

  2. Jdog33 commented on Aug 10

    With the FTSE getting it’s a$$ handed to it today, it is now down over 10% from its high made on June 15th. Japan’s Nikkei looks to be down right at 8.15% since July 13th.

    S&P, NAZ and DOW are down 6.44, 6.03 and 5.21% since July 19th. I would say we have another 5 – 7% left in this “credit crunch” correction.

    This ensures that the 10% correction Barry has asked for and talked about NOT happening since ’03 will probably happen worldwide.

    I do believe the overseas central banks in Asia, as well as the ECB again stepping in, tell me the end is getting closer than the beginning to this situation however.

    Also, can someone tell me why the packaging of the sub prime loans (CDO’s/CLO’s) will impact earnings at companies like GE, INTC, CSCO, IBM, etc? I’m still not sure I understand how this has an impact beyond the Financial stocks (obviously), the Mortgage stocks (not buying CFC anytime soon) or the fact that some Hedge Funds around the world are blowing up (I can see the liquidation of stocks and the unwinding of leverage hit the market for a while, but is this really a long-term event)?

    Thoughts?

  3. matt m commented on Aug 10

    Well said on all three notes.

  4. alexp commented on Aug 10

    >when this stuff gets offered to retail clients, it likely means INSTITUTIONAL CLIENTS HAVE REJECTED IT

    It’s always amazed me that “axe to grind” is such a well known term on Wall Street. If proprietary Goldman traders are dumping a security, and pressuring sales people to get it off the books, how is it that Goldman clients willingly buy these “axes”?

  5. johntron commented on Aug 10

    waiting to see what the last two weeks of August brings as the redemption window opens (for funds that will allow redemptions).

    will lock-ups only worsen forced sell as everyone redeems at the same week?

    As for watches, I’d say give them a Patek Phillipe or an IWC….but alas a Rolex is a Rolex.

  6. mrkcbill commented on Aug 10

    “Also, can someone tell me why the packaging of the sub prime loans (CDO’s/CLO’s) will impact earnings at companies like GE, INTC, CSCO, IBM, etc?”

    Wouldn’t it reason that if we get pushed into a recession, that Joe Six-Pack holds off on the new computer, wireless router, microwave……How much leveraged 3 card monte can we endure.

    When the Dot.com bubble busted and NYC was bombed— The Mantra was go buy a new TV, RE-FI your house and take that vacation you always dreamed of. House of cards.

  7. New Yorker commented on Aug 10

    House of cards indeed. I found this site looking into the “negative personal savings rate” which we entered last year to see what the hell that meant exactly and I think, especially based on recent events, it means Joe Six-Pack ain’t buying much of anything the next year or 2.

    Here’s the page that came up in my search: http://bigpicture.typepad.com/comments/2006/06/james_altucher_.html

  8. steeliekid commented on Aug 10

    Great stuff. Back in a previous life as a retail rep. (early 90’s), I was introduced by my firm to “inverse floating rate CMO’s” as a good deal for my muni bond clients. Even though the psa’s were fast on the first round and were homeruns, thereafter the deals with t low coupon collateral turned these into the “toxic waste” that eventually sunk Orange County – Merrill. NO ONE, and I mean NONE of the retail folks could grasp the concept of how these things worked. Advice to retail buyers – don’t be the bagholder!

  9. Fred commented on Aug 10

    Re-post — as no one seems to have noticed this:

    Here’s a reality check on the Alt A loan situation….I suggest reading this piece:

    http://www.bankstocks.com/article.asp?type=1&id=9881476

    …Yesterday, Standard & Poor’s put out its long-awaited ratings update on the $455 billion of Alt-A securitizations it rated between October 2005 and December 2006.

    …After reviewing all $455 billion of Alt-A MBS the S&P rated over the time period in question, the agency put on CreditWatch all of $914 million. That’s roughly 0.2% of the reviewed bonds outstanding. As to the 99.8% of MBS that had their ratings affirmed even after S&P ran its stress test, credit quality looks awfully strong

    So, again what we’re dealing with here is a confidence issue in market bids, as over levered HFs meet panic redemptions….meanwhile the underlying assets are in fine shape — bonds and stocks for that matter.

    Thoughts Barry?

  10. Crash up derby commented on Aug 10

    I m backing up the truck today. I believe we close positive at 4:00 today. The ppt has already been active this morning in the futures markets. yawhoo! bring it on!

    Creamer on the national news last night clarifying that he is concerned not about his hedgie friends but concerned about the homeowner and that is why the fed should cut. Now that that is cleared up, the fed now can go and cut rates.

  11. Steve C commented on Aug 10

    I’ve always thought high yielding debt instruments are more risky than conservative equities, in general. In the end it never turns out well for higher risk debt.
    Besides equities, I never buy anything other than money market funds, treasuries, solid muni funds, the AGG, IEF, and TLT. I use debt as a place to store my funds until a good buy appears in the equity markets…looks like we’re coming up to that point.
    The VIX has doubled; on average when this occurs the DJIA is up 12.6% over the next 6 months.

  12. Crash up derby commented on Aug 10

    who wears a watch these days anyway? just pull out your blueberry or cell phone for the time.

  13. Andrew Schmitt commented on Aug 10

    Barry:

    Great idea. Strap on a overpriced 95% gross margin piece of titanium. Instill the importance of having a $5000 watch rather than working hard and being unique. When someone tells them they are full of it, just show them the watch. I have this therefore I am smart.

    Maybe this stuff flies in Manhattan but in the rest of the world you are just a materialistic *sshole.

    And right now the rest of the world is circling back on Manhattan.

  14. Barry Ritholtz commented on Aug 10

    The tongue-in-cheek advice was for the Uncle, who gracefully gets out of losing million of dollars while maintaining peace in the family.

    Besides, that watch runs about 60% margins — and its Stainless Steel, not titanium.

    C’mon, Andrew, get a sense of humor . . .

  15. jake commented on Aug 10

    bernanke should do a “seinfeld”..”im there.. for you”

  16. dukeb commented on Aug 10

    Barry:

    Andrew does have a sense of humor!

    He said “Maybe this stuff flies in Manhattan but in the rest of the world you are just a materialistic *sshole.”

    You know, “the rest of the world” where there is no marterialism, no war, no poverty or famine, where nobody overpaid for their houses, where they don’t have a negative savings rate or debt or credit cards, where the food is always healthy and everybody is underweight, and they live in harmony and peace and love…where heaven is on earth…and where they understand a higher form of satire and never soil somebody else’s blog with displaced hostility.

  17. David Hall commented on Aug 10

    I think there’s something strange and insidious happening in the stock market. William Shakespeare said “Neither a borrower, nor a lender be; for loan oft loses both itself and friend, and borrowing dulls the edge of husbandry.” This borrowing is going to get out-of-hand and I hope there will be some self-restraint on the part of the FED.

  18. michael schumacher commented on Aug 10

    remember the gold watch in Pulp Fiction???

    That was’nt a Rolex……

    and it was’nt on his wrist..

    Ciao
    MS

  19. Andrew Schmitt commented on Aug 10

    Barry – not meant as a personal attack. Sorry about that.

    I will concede I do not inhabit the mainstream… aside from leaving hostility on other peoples blogs.

    I just didn’t get the humor.

  20. Andrew Schmitt commented on Aug 10

    Duke – your comments remind me of Lake Wobegon.

    That’s it… this is (was?) the Lake Wobegon market.

  21. Jdog33 commented on Aug 10

    well, jumped into the SDS trade I had been thinking about. This means most should go long and strong as I am a terrible, terrible market timer.

    This trade is really just meant as a hedge. If we go up (finally) I will be making money (albeit only 2/3rds of what I would have made). If we go down, I only lose 2/3rds of what I would have lost.

    My thinking is that we probably still have another 5 – 7% downside from this “contagion”.

    I think it will be easier to sleep with this hedge in place. Anyone else hedging their portfolio’s these days?

  22. johntron commented on Aug 10

    to crash up derby:

    no girl ever tells his ladyfriends….”my new boyfriend has a blackberry”….but she does say my boyfriend wears a rolex (again alas, she won’t brag “my boyfriend has a patek phillipe” or IWC….unless she’s in-the-know with high-end swiss timepieces).

    so there you have it….conspicuous consumption so that we can further our DNA.

  23. Michael Donnelly commented on Aug 10

    Barry,

    What in the Hell is going on? Is this a liquidity problem where no one is willing to buy the crap so we don’t have a market. In theory the stuff is then worthless right?

    Or is this a credit issue, as evidenced by the Fed, ECB, and Japan stepping in and dumping billions on the market. Cause nobody is lending?

    ‘course it could be both, but which is the bigger problem?

    I know you’ve been beating the drum for a long time on subprime (and Jim Cramer stepped up last Friday) but really how silly does the Fed’s Tuesday statement look just 3 days later. There is no way they can or will reverse themselves in 3 days. Rates are stuck at 5.25% cause the Fed willingly threw on a straightjacket.

  24. techy2468 commented on Aug 10

    jDog33….i have not invested anything in the stock market yet…..

    but i feel that at this moment of uncertainity, investing in the equities is sort of a gamble and its better to remain in cash, is this wrong?

    i know in the long run, one has to have a diversified investment so as we can beat the inflation (since the f****g governments dont care about the inflation much, worst part they dont have report the correct number since they will have to pay up for it…)

  25. SPECTRE of Deflation commented on Aug 10

    h the FTSE getting it’s a$$ handed to it today, it is now down over 10% from its high made on June 15th. Japan’s Nikkei looks to be down right at 8.15% since July 13th.

    S&P, NAZ and DOW are down 6.44, 6.03 and 5.21% since July 19th. I would say we have another 5 – 7% left in this “credit crunch” correction.

    This ensures that the 10% correction Barry has asked for and talked about NOT happening since ’03 will probably happen worldwide.

    I do believe the overseas central banks in Asia, as well as the ECB again stepping in, tell me the end is getting closer than the beginning to this situation however.

    Also, can someone tell me why the packaging of the sub prime loans (CDO’s/CLO’s) will impact earnings at companies like GE, INTC, CSCO, IBM, etc? I’m still not sure I understand how this has an impact beyond the Financial stocks (obviously), the Mortgage stocks (not buying CFC anytime soon) or the fact that some Hedge Funds around the world are blowing up (I can see the liquidation of stocks and the unwinding of leverage hit the market for a while, but is this really a long-term event)?

    Thoughts?

    Posted by: Jdog33 | Aug 10, 2007 8:11:29 AM

    We are about to relearn the lesson that liquidity/DEBT ain’t money stock. Welcome to 1929. You are seeing the scramble to dump assets to all types get cash, but there is no cash. It’s just digi-dollars which can’t buy you food, healthcare, prescription drugs or anything else you must have in a world that suddenly wants cash. Cash is king.

  26. Bonghiteric commented on Aug 10

    I love how lately when the CNBC anchor (pick one) throws it to trading floor correspondents (pick one) and the reporter practically apologizes for the market going lower. As if. This morning Quintenilla outright apologized for the futures dipping lower.

  27. wunsacon commented on Aug 10

    jdog33, I’m a terrible market timer, too. Five minutes after I went to 20% cash, the market started shooting up. (Maybe those stocks I sold were “ballast”.)

  28. Marc Haber commented on Aug 10

    Last year, my partner and I won a $6 million arbitration award against Deutsche Bank based on exactly this set of facts. The broker invested around 25% of three newly wealthy brothers’ assets in various illiquid speculative “alternative investments” including the equity tranche of CDOs. The broker pitched the investments as like bonds, but with a higher yield. It was clear that he had almost no understanding of the real risk of the products, while the clients had none at all.

    Deutsche Bank’s defense was that the private placement memoranda said that the investments were risky, so the three brothers should have known better. Clearly, that defense did not work.

    As far as I can tell, this was the first (and only) securities arbitration dealing specifically with CDOs sold to individual investors. Needless to say, we expect to be handling many more in the near future.

    Referrals are always welcome. :)

  29. michael schumacher commented on Aug 10

    The biggest threat to cash is the brokers insistence (ala Morgan this morning) calling for a rate cut THIS month.

    If that is allowed to happen I cannot imagine what message other countries will take from that—I know what they will do (and most of you do as well) but how do you sell that many dollars and bonds at the same time???

    That’s panic…….right after the euphoria induced melt-up it will cause here.

    Ciao
    MS

  30. halbhh commented on Aug 10

    “Now, it’s time for your 3 lessons to learn…”

    heh heh….hope there are only 3!

    lol

  31. Charles Butler commented on Aug 10

    Crash Up Derby —

    You’re going to back up the truck? So today’s the day that they all get together and liquidate their short hedges and hope nobody notices. Ah!

  32. michael schumacher commented on Aug 10

    If the Fed does cut rates I still find it laughable that it will help fund managers figure out how to value all the loans (about $250 billion of them) sitting on the books, much less be able to actually sell them to someone.

    OT: what about all the loan professionals that will be showing (or not showing) up on the unemployment claims. How do they account for that?? We all know that every single loan broker/mortgage bank is shedding personnel……Should’nt we start to see that fairly soon?? One would think that we should be seeing those almost overnight…..but somehow (up to this point) it has escaped scrutiny.

    Unemployment claims are about to cause another “issue” methinks.

    Ciao
    MS

  33. RW commented on Aug 10

    Liabilities are probably at least several orders of magnitude greater than cash available to pay them off right now so lack of confidence means liquidity crunch which the central banks are addressing.

    Even if the additional liquidity works as planned it doesn’t bode particularly well for equities and I consider the short-to-intermediate risk/reward ratio poor: Not much better than a coin-flip, heads I lose up to 20-30% and tails I win maybe another 5-10%. Those less loss-averse and/or with a much longer time horizon (>10yr) than I might want to go for that 5% but investors earn compound interest, not simple interest, and the math of fully recovering from even one significant loss is inexorable.

    IOW, I am fully hedged — primarily midcap, nasdaq, emerging markets, real estate and financial indexes — w/ longs primarily in defensive sectors, treasuries, cash. There may very well be some opportunity cost to that; so be it.

  34. Winston Munn commented on Aug 10

    The worldwide central banks are not stepping in with cash held under the mattress for a rainy day – this is paper printing at its finest – more like Weimer Light.

    The actions show the greatest fear of all central banks is not inflation – as inflation is a necessary component of fiat finacial ponzi schemes – the great fear is and always has been deflation.

    The question is can the central banks pump in debt fast enough to match the debt coming out of the bubble – and when it is over, who is going to pay the bill?

  35. dukeb commented on Aug 10

    WOW. Slight topic drift, but the CNBC Panic Buttons (aka In-House Talking Heads) have really really lost it.

    My friend is a psychologist and she has to actually have her own sessions with other psychologists (it’s part of their professional mandate) to ensure she keeps her center of gravity lest she get caught up in the whirlwind of her patients. I think everybody at CNBC (especially the big idiot w/his own buzzer show) should be subject to daily sessions of reality outside the company of each other. Contagion in the markets? The real contagion is in their anchor room. It’s become rather shameful. It makes me embarassed to even watch. Thank goodness for blogs!

  36. VJ commented on Aug 10

    On the McLaughlin Group, Pat Buchanan told Maria Bartiromo:

    You’ve been hanging around with Kudlow too long

    HEH HEH.

    Kickin’ the Purple Kool-Aid addictions are the absolute worst.
    .

  37. Francois commented on Aug 10

    “..After reviewing all $455 billion of Alt-A MBS the S&P rated over the time period in question, the agency put on CreditWatch all of $914 million. That’s roughly 0.2% of the reviewed bonds outstanding. As to the 99.8% of MBS that had their ratings affirmed even after S&P ran its stress test, credit quality looks awfully strong”

    Pray tell, why should anyone believe Standard & Poors ratings anymore? They have proven that they are NOT impervious to the bias-induction effect generated by a steady stream of juicy fees coming from rating CDOs, CFOs CEOs and what have you.

    Instead of relying on ratings coming from the judgment of faillible beings, I’ll monitor the only rating that matters in the market: the price.

  38. Francois commented on Aug 10

    “The actions show the greatest fear of all central banks is not inflation – as inflation is a necessary component of fiat finacial ponzi schemes – the great fear is and always has been deflation.”

    And it is the worst kind of deflation possible: dearth of buyers. When you break buyers’ confidence one time too many with constant half-truths, dubious pricing/rating of risk and complete lack of regulatory overseeing , you’re begging for big trouble boom-boom-long-time to barge at your door.

    How much “liquidity” does one needs to reverse that?

    Francois

  39. Norman commented on Aug 10

    RE: 1. Advice for Investors: Never buy anything you do not understand

    If the world took this advice no one would buy an annuity or any form of a whole life insurance policy.

  40. Broker A commented on Aug 10

    Funny story, yet sad.

  41. Po commented on Aug 10

    Nice piece (not just the watch).

    I think I will get one for myself- in Chinatown for $20.

  42. Max commented on Aug 10

    Never buy anything you do not understand how to SELL.

  43. David Merkel commented on Aug 10

    Points 1 and 2 are very important. I’ve seen too many people harmed by inappropriate investments jammed on them by so-called professionals. Thanks for posting this.

  44. Mitch&Murray commented on Aug 10

    Max! Great line. Alec Baldwin’s character in Glengary Glenross shoulda said it!

  45. dustin commented on Aug 11

    IN THE ROLEX ARTICLE— The one you recommend in the article is a Submariner Date.. then the one you show on the bottom of the article is actually a Seadweller.. just an observation

    ~~~

    BR: Thanks!

  46. Jeffrey commented on Aug 12

    My Rolex is the best gift I’ve ever received. If you don’t see the value in a Rolex, don’t get one. If you have one, though, you know what I mean.

    Newcomers– this is the rare gift that comes once every couple years–the clear buying opportunity. I have been through about 10 or so in the past 20 years as an investor, and after awhile they all look the same. Great fundamentals, and world-wide panic. The more panic, the higher the payout in 12 months. Take the gift, buy the Rolex yourself.

  47. Don commented on Aug 13

    JDod, GE has a substantial financial division (lending, leasing) in addition to the industrial component (the consumer goods segment was sold off years ago and uses the name under license) so it would make sense for the stock to be whacked amid concern about financials and about the ability of businesses to finance capital projects.

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