Why don’t we hear about the real financial sector scandals, which are exorbitant fees and costs that cause a continuous wealth transfer from individuals to the financial services industry?
This article follows a recent article entitled “The Financial Services Industry is Still the Largest S&P 500 Sector – Even after the Collapse of its Stock Value.” The prior article discussed how the market capitalization of the financial services industry grew for thirty years to become the largest segment of the Standard and Poors 500 composite index. Even after the stock values of many of its largest companies collapsed significantly over the past several quarters, the financial industry still remains the largest segment of the S&P500 index.
The S&P 500 Fact Sheet for the end of Q2 2007 on the Standard & Poors website indicated that the financial services industry represented 20.77% of index market capitalization in mid-2007. The next four largest sectors in order of percentage market capitalization were:
1) Info Tech at 15.45%,
2) Health Care at 11.67%,
3) Industrials at 11.43%, and
4) Energy at 10.79%.
For years, we have often heard concerns about the Technology, Health Care, Industrial, and Energy sectors
The media has extensively and broadly covered these four sectors and focused on certain negative concerns along with positive developments, including:
1) Info Tech sector — the growth, market bubble, and crash of the information technology sector with all its increasing technological marvels and productivity contributions to the world economy;
2) Health Care sector — the continually escalating costs of the U.S. health care system, the aging of the population and attendant medical costs, the growing crisis of millions of uninsured and under insured people, and the huge unfunded future obligations of Medicare and other government health programs;
3) Industrials sector — the continuing migration of industry manufacturing overseas with outsourcing, dramatic job losses, and huge balance-of trade-deficits; and
4) Energy sector — the escalating price of gasoline and other fuels, the negative impact of energy costs on consumer spending and economic growth, and record after record of energy company profits.
Meanwhile, the financial services sector has grown to be almost twice the value of the Energy sector in terms of S&P500 market capitalization. Yet, we have not heard widespread media clamor about escalating financial services costs and profits.
The media rarely focuses on the exorbitant financial costs assessed by the financial services industry – particularly on consumers. Instead, we just get “perp walks” of high profile financial fraudsters. Frankly, about all we hear about in the media are financial scandals related to frauds and scams. Even then, many of these scandals have faded from memory, as securities market values rose in the recovery following the dot com market bust.
It is as if we can just weed out some bad apples and get back to business as usual. Catch John Rigas, Ken Lay, Martha Stewart, Dennis Kozlowski, and on and on. Walk them in handcuffs or prison fatigues before the cameras, and then everything will be okay. With regulatory and judicial slaps on the wrist, everything will be OK, if we can just stop the more visible scandals of mutual fund market timing, corporate accounting funny business, broker sales incentives, soft dollar payments, Richard Grasso’s compensation, etc.
Well, things will never be okay with just a few tweaks to the regulatory system and a few perp walks. Consumers have in the past and apparently will in the future continue to pay exorbitant banking, credit card, insurance, and securities costs. The wealth transfer will probably continue unabated.
Name the one industry that has a reputation for high salaries and bonuses, which the media trumpets to you like this is somehow good news and worthy of envy. That one industry is the financial services industry and, particularly, the securities segment of the financial services industry. Even after financial services companies have paid these huge personnel expenses and even after they have paid for all those high end commercial office buildings with shiny brass, plate glass, and mahogany furnishings, the financial industry is still highly profitable.
The most important and ignored personal finance story of the past 30 years has been the continued exploitation of consumers by financial services firms
Why haven’t excessive financial industry costs been the big media story? Last summer, the financial industry had twice the market capitalization of the energy industry. The financial industry had developed convoluted products and services and hidden their true costs to consumers. Government regulators are practically dead at the wheel. Why doesn’t the financial media start looking at the price of a “gallon of financial services” with the same energy that they use track and wring their hands about the price of gasoline?
Simply put, most individuals pay far too much for financial products and services. Their continuing overpayments show up in the increasing value of financial services company stocks. People have paid far too much for years, and the industry’s excessive charges have been increasing for years. (See these related articles on The Skilled Investor website: Controlling Investment Costs )
In return, individuals have received far too little. Exorbitant and increasing investment costs, high banking fees, predatory credit card charges, and excessive insurance costs simply represent a massive wealth transfer from the personal pocket books of average individuals into the coffers of the financial services industry and into the high paychecks of its employees.
There is no reason to believe that industry self-regulation or governmental regulation will ever fix these problems. Only those individuals who become wise enough and proactive enough to seek out far lower cost financial products will stop getting fleeced.
The vast majority or individuals will just keep on paying excessive costs to the financial industry, as they receive inadequate value in return. The financial industry will continue to flood the market with endless combinations of new and supposedly “innovative” financial products and services. The industry will keep telling consumers that they are doing them a favor. Individuals will grow increasingly befuddled, and unfortunately the historical trend indicates that most people probably will keep on paying too much. (See these related articles on The Skilled Investor website: The heavy burden of recurring investment fees and The investment industry is not your investment partner )
When it comes to personal finance, only those who make money from consumers have the motivation to approach individuals to sell to them. These financial sales people have a strong incentive to spin yarns about how they will help people to do better than they otherwise would do. The financial industry will keep making promises without making any guarantees. When confused individuals pay too much for financial services, they cannot help but end up with less than they could have had, if they had sought out and bought lower cost financial products.
US consumers must protect themselves from the financial services industry
Decades of growth in the total stock values of the financial services industry raise many serious questions about the:
- the lack of effective regulation before or after the fact, and a
- woeful lack of consumer protections and enforcement.
As a result, consumers suffer from numerous widespread and unfair business practices. They pay exorbitant consumer banking, debt, and securities charges relative to the value that they receive.
This continued exploitation manifests itself in long-term grow of financial services industry stock values. Excessive financial services costs paid by individuals and businesses drive financial industry profit growth and US stock market values for the financial services segment. Compared to businesses, individuals have exhibited far more widespread lack of sophistication and naivete in their dealings with financial services companies.
In part because historically this industry has not been effectively regulated, I strongly suggest that individuals start doing a much better job of protecting themselves – by themselves. As individuals, you should become far more aware of the truly excessive costs of financial services, and you should seek much less expensive financial product and service alternatives.
Retail financial service consumers simply pay to the industry far more than they getting back in real value.
Perp walks are a side-show that diverts attention from the real problems. The real problem is financial services industry consumer charges. At this writing, the press is filled with media stories bemoaning $4 per gallon gasoline prices, and how high oil company profits have become. Well, figuratively the financial services industry’s price for a “gallon of financial services gas” has been well over 5 dollars or even 10 dollars per gallon for decades.
Given the history, there is no reason to expect any general solutions to the problems of the financial industry’s excessive fees for excessive and hollow promises and the lack of regulation and consumer protection. Instead, individuals must themselves decide not to play the game.
For too long and for too many consumers there has been a presumption that personal finance is too complex. Instead of relying on self-education and skepticism, many just trust industry representatives to do the right thing for them.
Many American consumers are like trusting, docile sheep regarding their personal financial affairs. Consumers’ naive trust has been answered by an industry that is the very manifestation of greed in nice clothing. (Oh, you also get to pay for the nice clothing.) Expensive, inappropriate, and overly risky financial products are sold with a silver tongue by a trivially regulated industry. Industry sales agents speak of your best interests, when all too often your interests are secondary.
The watchword of every financial consumer should be “verify.” You should only trust, after you have verified. Furthermore, keep on verifying. Ultimately, over your lifetime you are the one who must learn what you are doing financially. You must learn, and thereby learn to trust yourself. Carefully selected financial advisors may also help you, but only after you have verified their advice. Those who are asleep at the wheel crash.
The recent credit crunch and financial crisis has exposed the myth of supposed “smart money” professionals.
For the rich fees they obtained, the mortgage debt sector of the financial services industry lent mortgage money to just about anybody. Working hand-in-hand, the securities industry cooked up credit derivatives and repackaged high risk mortgage debt into derivative mortgage securities with supposedly high to low risk traunches. Financial garbage with a shiny veneer. Financial professionals sold these derivative mortgage securities widely to domestic and oversea banks, pension funds, trust funds, hedge funds, and many other, you know — smart investors.
These derivative mortgage debt securities were highly complex. They represented repackaged mortgage debts that were so far removed from the underlying facts about the lack of credit quality. Many professional investors did not understand nor investigate their inherent risks, as they bought and sold them.
Many in the industry really did not care to understand these derivative credit securities, if they could be moved fast enough for a high enough fee. As a result, an extremely wide swath of supposedly smart money professionals choked on their own greed. Unfortunately, these dumb smart money professionals almost took the world’s securities exchanges down with them. Nevertheless, in the process, these dumb smart money professionals have given the rest of the US and world economy an unnecessary “rough spot” or recession.
It was not just the “buy side” of the securities industry that got burned. Many investment banks were caught holding sizable long positions in credit derivatives, when the game collapsed. When industry professionals woke up and stopped trusting the credit of their trading counterparts, they almost brought worldwide markets to a far more dramatic collapse. The collapse of Bear Stearns was just a symptom of what had the potential to become a major worldwide financial panic.
The credit crisis and recession are just a temporary hiatus for the financial services industry.
You might ask why I am so cynical about the relationship between consumers and the financial services industry. The reason is that I see no reason to believe that a history of excessive consumer charges will ever change. Only individuals who get smart and stop paying too much will protect themselves. The vast majority will keep trusting and bleeding financially.
Firms in the financial services industry have axed a few prominent executives, sent some employees packing, scaled back bonuses, and eaten some of their own, e.g. failed mortgage brokerage companies, Bear Stearns, etc. During this time, however, the financial industry will refuel its tanks. The financial industry will once again rev its engines and play its the sweet siren songs to a naive public. Once again, it will tell you that “you can get something for no risk,” “debt is not really that dangerous,” “even a baby can trade stocks on line,” “you want gooooooooooold,” “this is priced under market value,” “beat the market,” and on and on.
This industry rubbish will go on, as long as foolish consumers keep forking over their money for these hollow promises. Financial consumers must get smarter, save more, and start building up more substantial investment assets. Otherwise, they will never have the resources to escape the industry, when they finally wise up or when they find themselves in one of the industry’s numerous squeeze plays.
Anywhere you look within the financial services industry, the consumer will continue to get beaten rather than beat the system as the industry suggests they can. No matter which part of the financial services industry you look at, consumers will continue to get hosed, if they do not get smart and learn more about managing their own financial affairs. Consumers need to stop trusting blindly the questionable goodwill of an industry that always seems to have at least three hands – two of which seem always to be in your wallet at any given time.
Every day, I look into the financial affairs of individuals and see them throwing away large amounts of their money to the financial services industry. They could have kept this money for themselves, if they had decided to get educated, had learned what they were really were spending, and had understand how little value they were getting in return.
Postscript: An advertising example of continuing financial industry contempt for consumers
In the run up to the dot com crash, do you remember when individuals were being exhorted to trade, trade, and day trade to get rich and to own their own islands? Well, in 2008, we have more recent evidence that parts of financial service industry just never change their tune.
All you have to look at is the recent television advertisement for on-line stock trading. Apparently, some in the financial services industry thinks that they need to advertise a vomiting day-trading baby to make the point that trading on-line is sooooo very easy to do.
Viewed another way, a puking day-trader baby might also hint at a widespread the lack of concern for the financial consumer within the industry. Didn’t on-line trading during the tech bubble damage the personal finances of hordes of naive individual investors, when their greed aligned with the industry’s irresponsible marketing pitches? Marketing campaigns such as these indicate that some in the securities industry just may not care one bit about what you do with your money – as long as they can snag some of your money, as you go down.