Monday, January 25, 2010

What You Don't Know Can Hurt You

As we move forward into the battle to regulate the financial industry, I’d like to discuss the communications networks that the big banks are already using to sell the idea that regulating banks is bad.

Big banks and wire houses (for now one and the same thing) spend big money on generating financial information, aka marketing. This takes many forms: TV and magazine a, stock analysts’ reports, market forecasts, charts, quotes given to financial writers and commentators, articles written for financial publications, and more.
Their opinions are woven into the fabric of financial discussions in the U.S. But it goes deeper.

There are thousands of financial consultants out there who give investment advice to ordinary individuals. Most of these financial consultants operate from one-consultant offices, which means they don’t have the resources to buy or generate much financial data beyond the returns on their Bloomberg terminals.

So what do they do? They turn to the free, detailed, and polished material of the big banks. Suppose Chase has a nice pie chart of the current sector composition of the S&P 500. Suppose you want that same information for your clients. Why reinvent the wheel? Instead of going to the federal government source, why not just copy Chase’s chart?

Suppose Chase also bought historical sector data not available from the government and used it to make another chart with a very sophisticated analysis of sector proportion and subsequent market movement over the last 75 years. Wow! If you’re a small planner, you might not have even thought to do that. Why not copy that one too? Your clients will be very impressed!

For a small financial planner, borrowing data not only expands what you can provide to clients, it removes liability. Financial planners are regulated by the SEC and audited every few years. At these stressful audits, planners must show sources for the data they present to clients. How convenient to be able to cite a big, reputable bank as a source! You, small planner, are off the hook.

But there’s more. Smaller planners in the financial industry also repeat the conclusions of the big banks regarding economic assessments and forecasts. This allows the big banks to shape perception of financial action and consequences. Big banks don’t mind at all—they can promote their agenda to investors who might be suspicious of a Morgan Stanley but will trust their personal financial planner.

For example, from SEI’s newsletter last October:

The global economy will face a variety of headwinds in the years ahead that may temper long-term growth and increase the frequency of economic recessions. These headwinds include:

1) Financial reform that will limit the growth in debt

2) Private-sector deleveraging that will limit the growth in debt

3) A trend toward increased government intervention (an activist industrial policy, healthcare reform, climate change legislation, etc.) that may impose substantial costs on the private sector

4) Volatile energy markets

This newsletter asserts as unquestionable or assumes several things that are very much in dispute:

a. People paying down or paying off debt (private-sector deleveraging) is bad for the economy

b. People need to load up more debt to increase long-term economic growth

c. Any financial reform that interferes with people loading up debt is bad

d. The government requiring businesses to pay for things is bad for the economy.

e. Government reform poses dangers to the economic recovery

Most people who read this will simply absorb the whole message, the explicit and the implicit, and add it to their understanding of how the economy works. And it will be amplified by repetition in newspapers, on CNN, on, in Barron’s, Money magazine, Business Week, Time, Fox financial news, Sunday political shows, Wall Street Journal, and more. No wonder intelligent business people are afraid of government intervention. Coming from all these sources, it seems to be accepted common wisdom instead of simple repetition.

Yes, there are other voices and other opinions out there, but any other opinion is going to seem like a minority theory next to this onslaught.

Briefly, there are other consequences of letting banks lead the financial discussions.

First, there are bazillions of facts and statistics out there. Whoever is crafting the message is choosing those facts and statistics that best support the thesis. Never doubt this.

As an example, returns for the S&P 500 are unusually high for 2009 and unusually low for the last decade (about 26% vs -9%). Both of these are undisputed facts, but I can choose either data point I want—or both or neither—to support the conclusion I want my reader to take away. If I’m writing for a big bank, you will not get the whole story if it’s not in their interests that you know. You can look it up yourself, but how many investors do that? How many would know they needed to do that?

Second, financial communication consistently underplays the impact of investors on the market and of the market on the economy. Expectations play a much larger role than is usually discussed in the media. It’s a bit scary to admit that the market keeps going because we all, collectively, expect it to, but it’s the truth. If we all truly believed the market were dead—and acted on it—it would be dead.

Follow that logic to economic forecasts. Banks say financial reform would be bad for the market. If investors believe that—and there’s every indication they do—they will pull away from the market if reform passes. Banks will then blame government reform for the drop in the market when it was really the expectation set by banks that caused it.

Logically, investors should be delighted to see financial reform that protects the market from abuse. Unfortunately, investors are driven by emotion, and expectations are built on emotions.

However, at least right now, people are also driven by hatred for the big banks. People also hate being manipulated and being made fools of. The more that people realize how they’re being played, the more likely they are to resist.

Related subjects that I glossed over here but that are worth separate discussions: how financial media works, why bank$ want to promote debt (previous post), investor behavior, how the investment market really works, investor psychology

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