By DAVID MOON, Moon Capital
December 26, 2004
It doesn't take much success to go to some people's heads. Or to get
into the pocketbooks of others.
Unless something horrible happens this week, it appears that the S&P 500
is going to generate a single digit gain for 2004. Following a 28 percent
gain in 2003, it would be easy for some folks to throw out their chests and get
a bit cocky. Overconfidence leads to vulnerability. Vultures and
other preying animals can smell vulnerability. Emotional or financial
vulnerability is no different. The vultures will find you.
Earlier this month, the National Association of Securities Dealers (NASD)
announced an investigation into whether or not some stockbrokers were
inappropriately advising customers to borrow money against their houses to
invest in the stock market.
It is painful to watch someone simultaneously lose their memory and risk
their money. This sounds like a repeat of the late 1990s.
Rather than make a $15,000 cash down payment to purchase a home, a homebuyer
might pledge the $30,000 worth of securities in his brokerage account as
additional collateral to purchase a $200,000 home. His brokerage firm
would then loan him the full $200,000 purchase price, taking a lien against both
the house and the $30,000 investment account. If stock prices continue to
increase without any intermittent declines, everything is fine. But if the
value of the collateral stock account declines significantly, the broker/lender
would require that the borrower/customer put more assets in the investment
account, or risk a foreclosure on his home.
This isn't an uncommon gambit. The Federal Reserve Board recently
determined that 11 percent of the proceeds from all mortgage refinancing is
invested in financial assets.
The lines between stockbrokers, banks and insurance companies are more
blurred every day; in a practical sense, they hardly exist at all. For the
effective operation of a perfectly free market, those lines of distinction
should have never existed. But in a perfectly free market, consumers are
educated and knowledgeable. For reasons that are beyond the scope of this
column, people generally know a lot more about tires and groceries than they do
financial products and services. As a result, Wal-Mart is a bit more
successful ' from the customers' perspective - at horizontal retail integration
than are the large financial firms. The financial products that can be
commoditized don't require a consultant for the selling process. You don't
need a personal shopper to buy a skillet at Wal-Mart. But complicated
financial products can't be sold as commodities. And they shouldn't be
sold in the dark, either by unscrupulous or uneducated promoters.
I wouldn't expect much to come from the NASD inquiry. The NASD is a
self-regulatory organization. It is the chief of the foxes watching over a
henhouse full of brokerage customers. A handful of the more unruly foxes
will be hunted down and shot as a public sacrifice. But without
significant publicity, there will be few other consequences - for the brokers,
that is, not their customers.
David Moon is president of Moon Capital Management, a
Knoxville-based investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).