10 inviolable rules for dealing with the sharks on Wall Street
Barry Ritholtz
August 31, 2012



Back in 2001, a very curious deal was struck between the government of Greece and Goldman Sachs. It was an exotic dollar/yen swap for euros. What possessed Greece to do such an unusual — and expensive — financial transaction? It needed help to hide its large and rapidly growing debt in order to maintain its status as a euro-zone member in good standing.

Both parties had something to gain. Greece created the false appearance of being in compliance with the Maastricht Treaty. This mandates that European Union member states with high debt levels must reduce their debt-to-gross-domestic-product ratio. And Goldman Sachs scooped up a ridiculously large 600 million euro fee. According to Bloomberg News, this accounted for “about 12 percent of the $6.35 billion in revenue Goldman Sachs reported for trading and principal investments in 2001.”

Once again, a new group of rubes got rolled by The Street.

I know what you are thinking: Those silly Greeks. Something like that could never happen here. Before you begin tsk-tsking, allow me to point you to the latest group of suckers to get taken in by The Street’s three-card monte: the Poway Unified School District in San Diego. It took a page from the Greek school of bad finance, agreeing to an exotic and costly bit of Wall Street shenanigans. Despite the district’s strong tax base and good credit rating, its officials bought a complex Wall Street-originated exotic loan offering.

Reminiscent of the bubble days of exotic mortgages, this debt deal makes no payments for 20 years. Over the course of the 40-year financing, it pays a very rich tax-exempt interest of 6.8 percent. Had the district done a straight-up school bond offering, it would have paid 4.1 percent. Over the course of 40 years, this interest rate differential is enormous. Poway borrowed $105 million. Instead of paying $300 million for a normal bond offering, the townspeople are going to pony up nearly $1 billion.

I learned of this festering financial debacle courtesy of the investigative reporting of Will Carless at the Voice of San Diego.

It appears there are no good actors here. What motivated this absurdity appears to be an attempt to avoid increasing real estate taxes on the school district residents. Rather than live within their budget, the district is trying its level best to become the next Detroit. The worst part of all is that by the time the bill comes due, everyone associated with this awful deal will be long gone. It’s a classic case of “I’ll be gone, you’ll be gone” financing.

It is astonishing to think that anyone involved in this mess thought that the big investment firms would help them come up with “creative financing” to resolve their budget issues. If only they’d had a helpful guideline, a set of rules for dealing with the sharks on Wall Street.

So I present “The Inviolable Rules for Dealing with Wall Street”:

1. Reward is always relative to risk: If any product or investment sounds as if it has lots of upside, it also has lots of risk. If you can disprove this, there is a Nobel Prize waiting for you.

2. Asymmetrical information: In all negotiated sales, one party has far more information, knowledge and experience about the product being bought and sold. One party knows its undisclosed warts and risks better than the other. Which party are you?

3.Good advice is priceless: I know, easier said than done. The Street buys the best legal talent, mathematicians and strategists that money can buy. Make sure you have expert advisers and lawyers working for you as well.

4. Motivation:Always ask, what is the motivation of the outfit selling me this product? Is it the long-term stability and financial health of my organization — or their own fees and commissions?

5. Legal documents are created to protect the preparer (and its firm), not you or yours: In the history of modern finance, no large legal document has worked against its drafters. Private placement memorandums, sales agreement, arbitration clauses — firms use these to protect themselves, not you.

6. Performance: How significantly do the fees, interest rates commissions, etc., have an impact on the performance of this investment vehicle over time? Determining for yourself what the actual cost of money is will avoid more heartache in the future.

7. Shareholder obligation: All publicly traded firms (including investment banks and bond underwriters) have a fiduciary obligation to their shareholders to maximize profits. This is far greater than any duty owed of care to you, the client. Always ask yourself whether this new product benefits the shareholders or your organization. (This is acutely important for untested products.)

8. Reputational risk: Who suffers if this investment goes down the drain? Who gets fired or voted out of office if this blows up? Who suffers reputational risk?

9. Keep it simple, stupid (KISS): It’s easy to make things complicated, but it’s very challenging to make them simple. The more complexity brought to a problem, the greater the potential for things to go awry — not just astray, but very, very wrong.

10. There is no free lunch: Repeat after me: There is no free money, no riskless trade, no way to turn lead into gold. If you remember no other rule, this is the one that will save your hide time and again.

If you wondered why the biggest financial firms are fighting tooth and nail to avoid having to maintain a “fiduciary standard,” just look at the fees and expenses in deals like this. There is always big money in the ongoing attempts to turn lead into gold.

The never ending parade of stock scandals continues unabated. As history has shown us — from Mexico to Orange County to analyst banking crisis to derivatives — when the Street comes a-knockin’, best you hide your wallets.


Ritholtz is chief executive of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, The Big Picture. On Twitter: @Ritholtz.

Category: Apprenticed Investor, Rules

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

15 Responses to “10 Rules for Dealing with the Sharks on Wall Street”

  1. Good advice, Barry…thx and enjoy your weekend! My Nobel Prize will come in remembering that everything is risky and to try and pick those paths that have the highest probability of succeeding with the least risk. :-)

  2. Expat says:

    The Greek/Goldman deal was not done because the Greeks were naive or ignorant. The deal was done because the Greeks were as venal and corrupt as Goldman. It is highly likely that Greek politicians and bureaucrats were handsomely rewarded financially for this deal. More obvious is that the politicians bought themselves more time in power, a corruption often more alluring than gold.

    Who is more guilty in this deal? On one hand you have Goldman, a private company with no allegiance to any principle or national law. On the other, you have elected and appointed Greek officials who directly serve the Greek state and have likely sworn oaths to that end.

    The Greeks who signed the deal should be tried, waterboarded and executed as traitors.
    Goldman should be banned from operating within the European Union for ever.

    And finally, your advice is good, but Wall Street is ubiquitous and more powerful than ever. Either you use bits of gold or barter for all your economic activity or you suck it up, bend over, and deal with the Street.

  3. you know, from nearby thread.. http://edge.org/conversation/what-is-value

    dude asks a Good Q:

    maybe, instead of..”…I know what you are thinking: Those silly Greeks. Something like that could never happen here. Before you begin tsk-tsking, allow me to point you to the latest group of suckers to get taken in by The Street’s three-card monte: the Poway Unified School District in San Diego. It took a page from the Greek school of bad finance, agreeing to an exotic and costly bit of Wall Street shenanigans. Despite…”

    (not that that, itself, is Incorrect…note, explicitly, “I know what you are thinking..”)

    The *Problem is, quite, that Ritholtz Is Correct.

    and, for ‘Us’, We should be thinking (again, from the Link..”…Now for the third condition: the first two are size and resolution. The third one, which is the hardest one, is for data to be big on scope…”) in a more ‘Macro-’ Scope..





    LSS: The American People have been, done, Rolled–in Spades–it happened, for sure, nearly 100 Years Ago..

    (Maybe, one of these Daze, We’ll, actually, realize it..)

  4. theexpertisin says:

    This list should be posted beside any retail investor’s trading appliance. Or, better yet, memorized.

  5. Bob A says:

    11. no matter what, they are going to try to f*(# you

  6. the patriot says:

    It’s more complicated than that. This is a conspiracy between Wall Street and politicians to serve their own interests at the expense of countries, states, cities, and, ultimately, taxpayers and citizens. The politicians sell future tax revenues in order to have cash while they’re in office, and they’re willing to sell it for a discount because they don’t own it and won’t be in office when the bill comes due. Wall Street is willing to buy it at a discount because they don’t give a damn about the health of these societies. These 10 rules won’t protect anyone from this conspiracy, and neither will ordinary market forces. The only solution is for the government to step in and make such conduct illegal, and punishable by jail time. The failure of the government to protect citizens from this kind of theft is a tragedy that will have far-reaching and long-term consequences.

  7. newyorkchris says:

    Wall Street likeLas Vegas was designed to take your money not make you money.

  8. Michael G says:

    I am always surprised that I have survived to retirement without losing my shirt several times over. I put it down to just two rules
    1) Avoid anything complicated. The more complicated the product, the more people need a cut. Each extra party increases the risk and reduces the reward (another version of Barry’s rule 9).
    2) Avoid anything you can’t get out of. The better the deal, the less need to tie you in.
    But perhaps this is ignoring the third rule.
    3) If you think you will never be taken in, you’re an idiot.

  9. Good rules Barry. The investment world is infested with sharks and non-insiders should keep their eyes wide open. Cupidity in full gear. All small investors (and governments) should remember your rules.

  10. ToNYC says:

    My grandmother came from the Old Country as a teenager in Archduke Franz Ferdinand’s last years with no education and knew better than 90% of college grads not to give her money to a stranger who is supposed to come back with that much and much more. The 3% the local savings bank was a stretch. The Bernank snapped even that shut on his march back to serfdom and debt bondage with flash crashes embedded in the system.
    Go Iceland! They got geothermal in the bank; we got natty gas off the road. Go Boone Pickens!

  11. carleric says:

    Excellent article which in the end underscores the inhereent stupidty of public officials or it that venality

  12. 873450 says:

    Same gimmicky financial products sold to thousands of state and municipal governments convinced they could cover up decades of failing to make required pension fund contributions by borrowing at lower rates than the pension funds’ earning projections.

    How Plan to Help City Pay Pensions Backfired
    By MARY WILLIAMS WALSH -September 3, 2012


    “Among the places where the strategy has failed miserably is New Orleans, which sold about $170 million of such debt in 2000 to produce cash to finance the pensions of 820 retired firefighters.

    City officials based the deal on the expectation that the bond proceeds would be invested in assets that would pay 10.7 percent a year — an unusually aggressive assumption, but one that made the numbers work. New Orleans’s credit was weak, and its borrowing rate was expected to be 8.2 percent. To get the rate on the bonds down as much as possible, New Orleans also issued variable-rate debt, combined with derivatives in an attempt to hedge against rate increases.

    But instead of earning 10.7 percent a year, the bond proceeds the city set aside for the firefighters’ pensions lost value over the years, first in the dot-com crash and then in the financial crisis. And instead of hedging against interest rate increases, the derivatives failed, leaving New Orleans paying 11.2 percent interest. The city also has a $115 million balloon payment coming due on the debt in March. “

  13. DeDude says:

    Just hand them a simple piece of paper that state: “All potential adverse outcomes that could reasonably be predicted has been explained above and this deal represent the best of the clients interest”. Tell them to fill it in and sign it – or you will find someone else to deal with. If they refuse or want the language softened then you know that you are dealing with a Wall Street scamster.

  14. socaljoe says:

    There are some who believe that endgame is to revalue the currency or inflate away the debt, in which case 6.8% over 40 years may yet turn out to be a good deal for the borrower.

  15. Defining Quality says:

    “The Inviolable Rules for Dealing with Wall Street”: Only needed one rule –
    If you want to gamble with your money – Go to Vegas
    This ain’t over!