Betting Against The House Is Never Smart

Just when it looked like the financial system is coming back under control I discover that the term “Large Sophisticated Investor” is an oxymoron.

When you gamble with the Big Dogs, normal practice is that you have to show your stake and throw some money into the pot before each hand.

All Dogs, But Some Are Big And Some Are Stupid

It’s exactly the same thing in the world of High Finance, but of course we don’t call it gambling, we call it investing. And although the SEC is supposed to have regulations to protect the little guy, the Big Dogs have found many ways around it.

One of the easiest ways for sellers of speculative investments to avoid the regulations is to limit their customers to large sophisticated investors who are called “qualified” simply because they have lots of money. The assumption is that they can do their own ‘due dilligence’ on the investment, and besides we don’t care if they lose all their money.

So far so good, but who are these guys? Well, turns out they are the investment advisors all [we] ‘little guys’ give our money to in hopes these savings will grow in time for [our] retirement. They include among other groups,

• a bank, insurance company, registered investment company (generally speaking, a mutual fund), business development company, or small business investment company;
• an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;
• a charitable organization, corporation, or partnership with assets exceeding $5 million;

And how have they done for us, over the past few years? Well, it turns out that in addition to the well-documented carnage in the stock market there is a brand new twist to the story that’s just emerging.

Because some of [our] advisors had lots of money, but not lots of brains they hired the nation’s big investment banks to cook up some extra special investments for them; something called Synthetic CDO’s. The very obliging Big Dogs at the investment banks not only did what they were asked, but they went one better.

After creating these Synthetic CDO’s the Big Dogs went into the market and began selling these same investments short. By selling short they were betting that the investments they had just created would blow up, and they could make money at the expense of their clients.

In other words the Big Dogs stacked the deck, dealt the cards, and then bet against the Stupid Dogs at the table holding those cards. And yes, of course the Stupid Dogs paid the Big Dogs for the priviledge of sitting at their table; these are called fees and commissions.

From the NY Times

Pension funds and insurance companies lost billions of dollars on securities that they believed were solid investments, according to former Goldman employees with direct knowledge of the deals … Goldman … peddled these complex securities — known as synthetic collateralized debt obligations, or C.D.O.’s — and then made financial bets against them, called selling short in Wall Street parlance. Others that created similar securities and then bet they would fail, according to Wall Street traders, include Deutsche Bank and Morgan Stanley …

And while the SEC would have us believe that it was all OK, because the folks who got fleeced were Large Sophisticated Investors, the truth is something else if you were an investor in one of the funds that Bet Against The House and lost.

Oh, and by the way, the Stupid Dogs collected their fees also.