The Financial Post profiled six of the estimated 1,600 retail investors whose savings were frozen when the asset-backed commercial paper market froze last summer. These retail investors have hundreds of thousands of dollars, often their life savings, tied up in paper they can’t sell anymore. The rest of us learn some valuable lessons from the unfortunate investors who invested in ABC paper:

  1. There is no such thing as a free lunch. If a broker claims that a better return than t-bills can be had with no risk, it’s time to fire her on the spot. No offence to Royal Bank of Scotland or Barclays Bank but they are not the same as a guarantee by the Government of Canada. Money that cannot absolutely be risked belongs in t-bills or high-interest savings accounts covered by CDIC.
  2. Know what you own: All the investors profiled in the story invested through a broker but it is mind-boggling that many didn’t seem to check how the broker actually invested the money. Financial institutions send transaction confirmations, monthly statements etc. and a cursory glance would have indicated that a big chunk is invested in unfamiliar products.
  3. Get a Good Adviser: The story is not a good advertisement for brokers. Three of the six investors say they specifically instructed the broker that they want secure investments or government bonds and the other three were told that they could get a higher return with a “safe” investment. Here’s the irony though: To tell a good adviser apart, you need at least a basic grounding in investing but if you have a good idea of investing, you probably don’t need an investment adviser.

This article has 15 comments

  1. Great post – I feel sorry for those people.

    I blame the rating agencies as well.

    Mike

  2. Canadian Capitalist

    Mike: I’m not so sure. We know rating agencies make mistakes (Enron bonds were rated investment grade almost till the very end) and brokers should know that. When a client says it’s capital they can’t lose, how can it be invested in anything but t-bills?

  3. The brokers and brokerages are definitely the number 1 culprit in this mess by far – however the rating agencies did play their part.

    Those investors would have been better off putting the cash under their mattress.

  4. I think the lesson in this is that you should learn about investing and do it yourself. I could easily lose money the same way, but at least I’m not paying someone else to do it. There does seem to be a lot of brokers that are dishonest, incompetent or a mixture of both, and how can you tell? I had a buddy that sold investments before I met him. He showed me a formula that proved that you can borrow at a high interest rate and invest at a lower rate and come out ahead, which had been taught to him by a manager. I showed him the formula was wrong and he was shocked. He honestly believed he was giving good advice which made him more effective at ripping people off.

  5. What on earth is a 61 year old retired teacher with total life savings of $50,000 doing taking a mortgage to buy his dream home? And since he lost his $50k he takes a $30k LOC? Why not just back out of the deal on your dream home until things get worked out? Talk about financial ignorance.

    And how about this guy:
    “Last week, someone sent him a copy of the nearly 400-page document that outlines how the ABCP restructuring will work. “I’m not even going to read it.” he says. “I just want my money back.”"

    He has $210k riding on the deal and he can’t be bothered to read a 400-page document?!? This guy deserves to lose his money.

    Something tells me a lot of these people actually asked to make the extra lift that ABCP was supposed to provide over guaranteed products. Totally uninformed and reckless. I think everyone involved in the fiasco is to blame, from retail investors all the way up to the ratings agencies.

  6. The FP article alludes to it but what happened was that all the financial institutions entered into a stand-still agreement (an agreement that no one triggers their legal rights against one another). After they hammered out a deal to protect themselves, they decided to put the trusts in restructuring and try a “cram down” (a legal bankruptcy term which is pretty much self-explanatory) on the individual investors.

    As a pure aside, the reason why financial institutions did this is not necessarily because they sold the product. Financial institutions, depending on the terms of the paper, provide “liquidity support” which means, in plain English, they have to put money into ABCP in certain case (such as cash shortage). I cannot speak for the paper involved here but this is why the financial institutions got freaked out in general globally. Depending on the terms of the agreements, some financial institutions are on the hook to inject cash to keep the paper afloat. They sold bad paper and now they are re-arranging the game to avoid their obligation as both seller and liquidity support (depending on the deal terms).

    No one seems to be focusing on this point. The financial institutions NEVER indicated they would put the trusts in receivership when the stand-still agreement was entered into (and the media quietly played along or missed the boat). They painted this all along as trying to put stability into the market and then, once they all agreed to terms in which their cash and legal obligations would be capped or eliminated, then they put the trusts in restructuring and broke the bad news.

    What really stinks is if the individual investor votes against the restructuring plan, they probably get cents on the dollar whereas if they vote for it, they get dimes on the dollar.

    Perhaps the lesson to be learned is never invest in a structured product, the house is stacked against you.

  7. Canadian Capitalist

    Tony: I didn’t want to fault these individual investors too much because they took the advice of ‘professionals’ who are paid to look after their clients’ interests. They’ve lost a big chunk of their savings and are now bitter and irrational. Still, your point that individuals should take responsibility for their actions is well taken.

    Thicken: The latest saga does seem to be another instance where the little guy gets screwed. It’s a tough choice: give up the right to sue and get something or risk everything by voting against the deal.

  8. “Perhaps the lesson to be learned is never invest in a structured product, the house is stacked against you.”

    I think the most important lesson in finance is don’t invest in something you don’t understand. That applies equally to individual investors and fund managers. Warren Buffett has harped on that point in the past, and the current mess illustrates it. If you don’t know why company X or security Y is beating the average, you have no idea about what it will do in the future.

    I actually may have come close to getting snagged by this myself. Last year I opened a Credential Direct account specifically to buy short-term bonds as an alternative to a GIC. I was disappointed by the lack of selection and the hassle of having to do the trades over the phone before 11am Pacific, so I put my money in PHN’s bond fund instead. PHN was ahead of the curve making sure they had no ABCP or sub-prime CDOs, whereas I’ve heard about a couple people here on Vancouver Island who invested with Credential Direct and got their money tied up in ABCP.

  9. Canadian Capitalist

    Aleks: Many investors may have done just that – invested in something they don’t understand. Check out this quote in a Globe and Mail article (Link):

    “I’m just a farmer, I don’t know about big dollars and big stuff,” said Murray Candlish, who along with his wife Cindy owns about $350,000 of ABCP, “our entire life savings.”

    He is talking about the restructuring, of course, but I’ll wager that he didn’t understand ABCP when it was pitched to him either.

    Whether investing through a broker or on our own much heartache might be avoided by simply passing on any investment we don’t understand.

  10. You’re all talking like ABCPs are 100% writeoffs. You have to realize that this story isn’t over yet. And despite the bad name and black eye that they’ve received, you have to realize that underneath it all, you have real assets and real people paying real money on the interests on those real assets… Like car loans, office equipment leases, mortgages, you name it… Eventually, some of these actual real people will actually pay off their car loans or mortgages and so the investors in this asset class will actually recover their money.

    Due to the credit crunch and now endemic credit risk aversion, it is somewhat concerning that all of these loans in the future will only come from one source. And that one source will only be the chartered banks – then they can turn off the taps and only loan money to people who don’t need it at very high interest rates – just like in the old days…

  11. He is talking about the restructuring, of course, but I’ll wager that he didn’t understand ABCP when it was pitched to him either.

    Absolutely, and I’d argue that the person pitching it to him didn’t understand it either, especially the risk. There’s no such thing as “risk-free higher returns”.

    Of course, part of the blame has to be placed on ratings agencies. Mish has a great series of posts tracking a specific tranch of non-subprime mortgage CDOs of which 92.6% were originally rated AAA. One year later a quarter of them are delinquent or in foreclosure. But that just highlights the need for investors to personally take responsibility for their own money. In this case, the investors didn’t understand what they were buying, but trusted that their advisors did. The advisors didn’t understand either, but they trusted the ratings agencies. The ratings agencies, from what I understand, trusted the people selling the debt, which is a dumb thing to do in my book. But the bottoms line is, no one cares as much about your money as you do.

  12. Canadian Capitalist

    Phil: It depends on what happens after the restructuring deal is approved. Investors may get their money and interest back if they held the medium-term notes to maturity (at least per my understanding of the terms). If they want to cash immediately, analysts say the notes may only fetch 20 cents on the dollar.

  13. Pingback: Thicken My Wallet » Blog Archive » What we can learn as investors from subprime/ABCP

  14. Pingback: Money Writers and Weekend Reading | Million Dollar Journey

  15. Canadian Capitalist

    I guess Phil was right. The Globe is reporting that Canaccord has announced a buyout of retail investors at par.

    Link

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