"Risk On!" Has a Downside?

John-Charles Hewitt
Wave of Investor Fraud Extends to Ordinary Retirement Savers

Regulators across the country are confronting a wave of investor fraud that is saddling retirement savers with steep losses on complex products that until a few years ago were pitched only to the most sophisticated investors.

 The victims are among the millions of Americans whose mutual funds and stock portfolios plummeted in the wake of the financial crisis, and who started searching for ways to make better returns than those being offered by bank deposits and government bonds with minuscule interest rates. Tens of thousands of them put money into speculative bets promoted by aggressive financial advisers. The investments include private loans to young companies like television production firms and shares in bundles of commercial real estate properties. Those alternative investments have now had time to go sour in big numbers, state and federal securities regulators say, and are making up a majority of complaints and prosecutions.

I praise Nathaniel Popper for making the connection between this investor behavior and ZIRP.

I doubt that this is the result of a sudden outbreak of fraudulent behavior. There may be a rash of complaints and lawsuits (which always spring from business failures in the US), but not necessarily fraud. It's probably a more human mixture of screwy accounting and ordinary small business SNAFU.

Lending to marginal businesses carries substantial risks. Investment advisors and their clients aren't forensic accountants or loan officers, so they lack the ability to vet the exotic investments that they're selling.

From the perspective of the econometric wizard in Washington, these people and their suffering are positive indicators. They look good on paper. They're driving investment activity. They're dishoarding, creating jobs producing Latino internet television, managing commercial real estate, and running luxury vehicle fleets.

The trouble is that people just looking for yield go hunting for it in all the wrong places. Neither the advisers nor the clients have the necessary operating experience to conduct this sort of lending successfully, over the long term. They're also not sufficiently capitalized to lend in quantity and absorb failures, like banks are (theoretically) supposed to do. They also lack the ability to determine the difference between investments that sound good and investments that are actually sound.

According to the SBA Quarterly Lending Bulletin, small business lending has continued to trend down since the financial crisis. [1] These untrained investors may be filling the gap that used to be performed by professional loan officers.

As far as the government's concerned, these people are just ZIRP roadkill. They're eggs to break to make their 'recovery' omelette. They're also probably people that you know, and folks that real communities rely upon to remain financially hale.

The marginal speculators are the first to fail. What group is next?