There isn’t much more to say than already has been said in the unfolding Madoff scandal (read more here) that has demolished portfolios from Wall St. to Palm Beach.
What I, and other people in the world are wondering is: “how?”
- How could millionaire Palm Beach Florida residents blindly throw money at this guy? Aren’t these millionaires supposed to be smart and have smart and expensive advisors to help them?
- How could pension funds from muncipalities and companies lose so much money for their investors? Why are they even allowed to invest in hedge funds in the first place?
- How could a guy keep up a Ponzi scheme for longer than even Ponzi himself did?
The sad fact, I think is that this is another classic example of the powerful social psychology of “group think.” If a person, in this case Madoff, gets a few fat cats to throw some money in, the rest wonder if they are missing something and follow suit. Reminds me a little bit like the ‘dot-com’ stock bubble of almost a decade ago.
Since emotional intelligence - that is, the ability to not be swayed by things other than fact and principle - is the most fundamental principal of successful investing, it is only fitting that people continue to lose money in schemes like Madoff, Pets.com and others.
——————————–
60 Minutes had a great program this past Sunday. I was most intrigued by the opening piece featuring House Banking Committee Chairman Barney Frank. You can watch some of the clips from the show here.
During the piece, one of the things that Frank expressed was disappointment that Treasury Secretary Paulson had not done enough to force bailout participating banks to lend money. Note the key word there: force.
Hold on a second…Isn’t this one of the large contributing factors to the credit disaster that we are suffering through now: Government madated lending? I mean, Fannie Mae and Freddie Mac having their fires stoked by Congress and Presidential Administrations to ‘make home ownership available’ to more and more Americans - even those that were not qualified borrowers?
For those of you that want to know why banks aren’t lending money right now, I will tell you in one word: Capital.
As in, most borrowers don’t have any. There used to be an old adage in banking that went like this: “banks only lend money to people that don’t need it.” The reason for this adage are the core issues of financial market intermediation (I usually try not to use big words, sorry).
If borrowers don’t have capital to contribute to their projects, then banks don’t want to lend on them. Think about it, we just got done with institutions making ‘zero-down’ and 125% financing loans to people, effectively eliminating any financial risk (save for maybe a credit score) from the borrower - the institutions were taking all the risk - or, better yet, some investor in a convoluted mortgage pool was actually taking the risk.
Since most borrowers, businesses and consumers alike, are still leveraged to the hilt right now - think credit cards and maxed out business lines of credit - they don’t have any of their own organic capital to invest into projects. This = a ‘no-go’ from a banker with half a brain cell.
When borrowers can come forward with good capital to invest, and the project is good, banks will make loans. I am sure that this stance won’t win as many votes for Mr. Frank as the “force them to lend!” rhetoric will, but I hope and trust logic will prevail.
