If you hang around these parts for any length of time, you will occasionally run across one of my jeremiads complaining about the Financial Services Industry.

I’ve been thinking about this more than usual lately. This has led to some correspondence with Helaine Olen, whose book Pound Foolish: Exposing the Dark Side of the Personal Finance Industry is next up in my queue. (Her appearance on the TDS yesterday is here). It is similar to the deep dive my colleague Josh Brown took in Backstage Wall Street.

My criticism is somewhat different than Helaine’s (though I am sympatico with much of her view). I break down the problems as follows:

Simplicity does not pay well: Investing should be relatively simple: Buy broad asset classes, hold them over long periods of time, rebalance periodically, get off the tracks when the locomotive is bearing down on you. The problem is its easier in theory than is reality to execute. And, it is difficult to charge excessive fees for these services.

Confusion is not a bug, its a feature: Thus, the massive choice, the nonstop noise, confusing claims, contradictory experts all work to make this much a more complex exercise than it need be. This is by design.

Too much money attracts the wrong kinds of people: Let’s face it, the volume of cash that passes through the Financial Services Industry is enormous. Few who enters finance does so for altruistic reasons.

There is a difference between normal greed (human nature) and outright criminality. This is why strong regulators and enforcement cops are required.

Incentives are misaligned: As I’ve written previously, too many people lack the patience to get rich slowly. Hence, not only do the wrong people work in finance, and some of the right people exercise bad judgment.

Too many people have a hand in your pocket:  The list of people nicking you as an investor is enormous. Insiders (CEO/CFO/Boards of Directors) transfer wealth from shareholders to themselves, with the blessing of corrupted Compensation Consultants. Active mutual funds charge way too much for sub par performance. 401(k)s are disastrous. NYSE and NASDAQ Exchanges have been paid to allow a HFT tax on every other investor. FASB and Accountants have doen an awful job, allowing corporations to mislead investors with junk balance statements. The Media’s job is to sell advertising, not provide you with intelligent advice. The Regulators have been captured.

Guess what the net impact of all this is on your investments?

The Financialized US Economy: The above list reflects nearly half a century of the financialization of the broader US economy. Instead of serving industry, finance has trumped it. This led in part directly to the financial crisis and economic collapse of 2007-09.

Human Nature: Then there is your own behavioral issues. On top of everything else, you are governed by a brain that simply wasn’t built for this.

All of these add up to a system that is flawed, and often fails to do its job.

This sort of problem used to be cyclical — they run tot he point of excess, than a crisis causes the pendulum to swing the other way. The great tragedy of Obama/Geithner/Summers was that crisis moment to undo the damage was missed, and indeed, the concentration of power amongst the banks only made it worse.

I fear we have to wait until yet another crisis for this to be repaired . . .

Category: Bailouts, Investing, UnGuru

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.

28 Responses to “What’s Wrong with the Financial Services Industry?”

  1. call me ahab says:

    “Instead of serving industry, finance has trumped it”

    undoubtedly

    “I fear we have to wait until yet another crisis for this to be repaired…”

    unfortunately, elected officials are sympathetic and beholden to the behemoths of finance ( take corporate donations out of the picture and we probably wouldn’t be sitting here now wondering why nothing happened)

  2. farmera1 says:

    BR, not to ruin your day but the problem is much bigger than just the Financial Services Industry. Similar points made above can be made for American Capitalism in general.

    John C. Bogle (founder of Vanguard) wrote a very good book: THE BATTLE FOR THE SOUL OF CAPITALISM in 2005 which covers many of the same points you made above but about all of American Capitalism. In general corporations are run to enrich the management not the owners/shareholders. Bogle calls this Managerial Capitalism vs traditional Ownership Capitalism.

    So me thinks fixing the Financial Services Industry (very difficult, but maybe possible) is just the start. The very same problems infects all of American Capitalism.

    If you haven’t read Bogle’s book, it is a worth while read.

    ____

    BR: Thanks, on your rec I ordered it from Amazon

  3. jnkowens says:

    I read one of Bogle’s books a few years back where he talked about financial services historically contributing something like 3-4% to GDP, until it started spiking upward in (of course) the 1980′s, and that it now stands closer to 7-8% of GDP. And here’s the important part: It’s all money for nothing. It adds zero value to the economy. Just middlemen skimming efficiency from the US economy.
    This is what passes for “God’s Work” these days.

  4. Petey Wheatstraw says:

    looks like the FIRE economy is now a peg-leg.

    I wonder how far we can go on an ‘I’ economy.

  5. faulkner says:

    People wonder why they have such difficulty learning and mastering the craft of trading and investing. You clearly and succinctly state what that has to be cleared away even to begin.

  6. contrabandista13 says:

    “…I fear we have to wait until yet another crisis for this to be repaired . . .”

    Really… just another…? I guess that it just depends on your point of view, but even more importantly on expectations, which are set by conditioning.

  7. MidlifeNocrisis says:

    For the average American, it does almost seem like the “perfect storm”, with the decline of pensions and the gradual shift to 401(k)s, along with deregulation and a myriad other developments over the last 40 years. Overall, I’m generally optimistic that we will turn this ship around. It will take time. People must be allowed to retire (eventually) and therefore there must be some type of system in place that allows a person to accumulate/save towards this goal without all of the gaming/skimming/stealing. That is my expectation anyway….

  8. Cato says:

    Pardon my ignorance as a non-US person, but why are 401ks dismissed as disastrous? I read some criticism before of them beign ‘investing on autopilot’; is that to say that there is no burden for the giving of investment advice etc? What other problems are there? I may have to move to the US some day so this would also be of some practical use!

    ~~~

    BR: Too many fees, too little returns. Average 401k generates 3% per year vs 11% for SPX since 1974 . . .

  9. donna says:

    We invented finance to fuel productive investment. But now, it’s just a predator.

  10. DSS10 says:

    The financial services industries is a lot like the real estate industry, They survive on a fee model based on technology from the early 70′s supported by a lack of transperency and oversight.

  11. A says:

    The other sad reality: consumer ignorance is highly profitable.

  12. streeteye says:

    Separate problem, but TBTF bank subsidy pegged at $83b per year, more than their profits

    http://www.bloomberg.com/news/2013-02-20/why-should-taxpayers-give-big-banks-83-billion-a-year-.html

    And that’s just the value of the implicit TBTF guarantee and how it cuts their cost of capital… not interest on excess reserves at the Fed, not access to the discount window.

    A big chunk of their business model is basically a franchise of the Fed… they create money backed by fractional reserves, and the Fed system backs them up in case of a run on deposits.

  13. FNG says:

    Bravo BR!

    Your critique is spot on. Imagine for a moment creating a company that minimizes to the max those “death by a thousand cuts” costs. Imagine it run by a dedicated team of individuals who believe in “treat your neighbor as yourself” and are content with fair and reasonable compensation. A company that caters to a broad economic strata not just HNW. Led by a man who understands that the system lasts only as long as a majority of people believe in it and that the specter of millions of retirees living in poverty is bad.

    Might be time to reinvent the Financial Services Industry. Might be your time Barry!

    _____

    BR: I have been thinking about the following model:

    The HNW investor (hi touch, hi minimum) pays the rent, and a sister flat fee Asset Allocation Model gives the masses the same investment model & strategy but all online,, they get good management (w/o expensive wealth planning part) for smaller accounts

  14. hankest says:

    I’m a scientist by trade. I have no interest in finance or investment, i want nothing to do with it. I know this will be shocking to most of you, but I don’t want to be rich, i just want to make sure i have enough to keep myself and my wife comfortable (housed and fed) during our retirement years.

    What i resent is that i’m i cannot do that anymore by simply saving my money in a security with a decent interest rate, or even better, have some sort of viable pension plan from my job (used to have it here, but those days are long gone). Rather, i’m forced to try and unravel the illogical nonsense, and blatant scamming that is Wall St, or trust someone to do it for me. And, as far as i can tell, the only ones who have the patience and brains to understand the industry charge more for their advice than I could ever hope to afford. Meaning, i don’t have enough investment $ for them to even look at me.

    It’s a game for and by the rich. To many of the 1 percenters, we middle class should feel lucky that we’re still allowed to get some medicare and social security.

  15. James Cameron says:

    I’m a scientist by trade. I have no interest in finance or investment, i want nothing to do with it. I know this will be shocking to most of you, but I don’t want to be rich, i just want to make sure i have enough to keep myself and my wife comfortable (housed and fed) during our retirement years

    .

    I suspect this is how the great majority of people feel . . . many simply don’t have enough money to even make it a need, and of those who do they have neither the interest nor time to devote to the subject. This will not change, and it’s the reason pensions, at least when they are being properly funded and managed, serve such a vital need.

  16. S Brennan says:

    What Hankest said speaks for me…and the overwhelming majority of Americans. Clearly, we no longer have a democratic [or representative] form of government.

  17. jnkowens says:

    FNG: That company already exists, and it’s name is Vanguard.

  18. [...] Ritholz asks himself “What is wrong with the financial services industry?” and comes up with this pretty good shortlist for an answer. • Simplicity does not pay well: [...]

  19. thomas hudson says:

    BR, I can’t really disagree with any of these points here, but I would add, depending on what type of services a financial advisor offers in conjunction with their investment advice, that there are two trends that have made the delivery of said advice more difficult.

    1. compliance – I think we could effectively argue that regulatory bodies are lax in their prosecution of the bad eggs. However, the good eggs are forced to do a lot more paperwork and training to be in compliance of the ever increasing laws and disclosure documents required to do the same work I did twenty years ago. I am not saying it is a bad thing, it is what it is. But I either pay some staff person to help me do the extra paperwork, or I work longer hours, or I service less clients. None of those increase my bottom line, but there is no way I am going to work in today’s litigious society without that model. It is a cost I choose to bear.

    2. taxes – It has become increasingly clear to me over the last ten years that it almost matters more how your dollars are taxed, than what they are invested in. The complexity of the US tax code is beyond ridiculous, with no end in sight. I just spent 30 minutes explaining to a 71 year old woman with a net worth of under 250k what the various laws were regarding taking required minimum distributions out of her IRA and 401k. I would roughly guess that 50% of the time we spend giving advice to clients is about tax planning, helping them keep as much of their money as possible while still being compliant with Mr. IRS. I am not an accountant, so I don’t get paid for preparing their return, but it is expected (or should be) in the industry that I am knowledgable enough about the tax code that they can rely on me for that advice. Again, a cost I choose to bear.

    I can only absorb so much of these costs in order to justify continuing to do what I do, so some must be passed on to the client. If they think it is too much, then they move on, and I am OK with that.

    _____

    BR: My expeirence is different from yours. When I was on the sell side (Broker dealer) the compliance dept potentially could lose its mind over anything I said or wrote.

    On the Buyside (RIA) where there is no FINRA — a SRO/scam we’ve addressed in the past — the compliance is more reasonable. Regardless, thats all outsourced these days.

    Cant address the tax issue — clients are mostly concerned (wrongly) about estate tax.

  20. Frilton Miedman says:

    These two topics bring to mind the recent decades’ changes in financials, specifically the effects TBTF’s and large fund managers have on price discovery/EMH …a return to the “bucket shop” era of 100 years ago -

    ~~~
    “• Incentives are misaligned: As I’ve written previously, too many people lack the patience to get rich slowly. Hence, not only do the wrong people work in finance, and some of the right people exercise bad judgment.

    • Too many people have a hand in your pocket: The list of people nicking you as an investor is enormous. Insiders (CEO/CFO/Boards of Directors) transfer wealth from shareholders to themselves, …”
    ~~~

    The move to self regulation that started with Clinton signing off on Gramm-Leach-Bliley and the CFMA has created an environment where massive entities with access to huge leverage are able to manipulate undisclosed quantities of futures & derivatives below public radar, which then effects input cost & margins for any sector linked to the specific material, commodity or energy future in play.

    BR knows his stuff, he’s spot on on everything he points to, but I think this problem is much more massive than most let on in the open.

    I think MS & GS played a major role in the 08 crisis by cornering oil futures, which then triggered the onslaught of sub-prime defaults to their benefit. (undisclosed, thanks to the CFMA, later “leaked” by Senator Sanders)

    The ongoing battle between the CFTC and the TBTF’s over position limits is much more important that the media attentions it’s been getting.

  21. tpadilla says:

    1. This is why strong regulators and enforcement cops are required.

    2. The Regulators have been captured.

  22. also, w..

    BR: Thanks, on your rec I ordered it from Amazon

    Good Choice. Good Book. All, too, True..

  23. Mwalsh11 says:

    BR,
    2nd comment in 4-5 years. I know your considering abolishing comments, but its dialogue like this that I find so worth while. I read the comments with every post. I hope you can find a way to make it work.

    I’ll still read everyday regardless…….

  24. kaleberg says:

    A secondary, but very serious effect, is the sector’s rank inefficiency. The financial industry requires a huge level of financial activity to provide relatively little capital. It’s almost as bad as hospitals charging $10 to provide a 5 cent aspirin to a patient. It’s bad for investors, but it has also been bad for the economy.

    I agree that we lost a great opportunity to do something after the crash, but we’ve been having a perfect storm of political corruption lately.

  25. moobycow says:

    “BR: I have been thinking about the following model:

    The HNW investor (hi touch, hi minimum) pays the rent, and a sister flat fee Asset Allocation Model gives the masses the same investment model & strategy but all online,, they get good management (w/o expensive wealth planning part) for smaller accounts”

    I would certainly be interested. I have a few more years before I have enough in the bank to open an account with a firm like yours, but I also recognize that I suck at investing as I can’t overcome my tendencies to fiddle with things.

  26. [...] part working against the interests of the investors it is supposed to serve. Barry Ritholtz at the Big Picture notes how the incentives of the financial services industry, almost by definition, lead to [...]