What I learned in 2008

As I’ve said before, 2008 was a year to forget.  In 2008, I learned that a “Triple A” rated financial product can go to zero. The financial markets were falling throughout the year but the selling intensified on September 15 when Lehman Brothers filed for bankruptcy. The filing set in motion a massive de-leveraging of various investment vehicles around the world and separated the men from the boys. I must admit my blind faith in the financial system has been shaken. I’ve realized all this talk of due diligence, corporate governance, board of directors, risk committees, auditors, regulatory agencies, etc…is all window dressing. It all sounds great in a marketing pitch or a PowerPoint preso, but in reality it’s just words. Below are several examples showing how severely broken the system is. 

Washington Mutual (WaMu)
WaMu was a bank that had consistently been ranked by Fortune Magazine as one of the best places to work. Their advertising was very consumer friendly and the image they projected was of a cute cuddly dog, but in reality it was anything but. An article from the NY Times over the weekend goes into detail about the subprime lending practices of WaMu and how it was one big scam factory. The following quote sums it up:

“If you were alive, they would give you a loan. Actually, I think if you were dead, they would still give you a loan.”

Steven M. Knobel, a founder of an appraisal company, Mitchell, Maxwell & Jackson, that did business with WaMu until 2007. 

When I was living in Southern California WaMu bank branches were popping up everywhere and I wondered if there was that much money in lending money…I guess so.  I remember several of my neighbors becoming real estate agents because “everyone is doing it.” A neighbors friend was a loan processor and driving a BMW 740iL,  it made me think “what the fu%@ am I doing wrong.” However, it was all a mirage everyone in the chain had a financial incentive to get people into houses.  WaMu shares part of the blame, but the homeowners bear the brunt of the blame.

Bernie Madoff
Bernie Madoff confessed on Dec 11, 2008 that he ran a USD 50 billion ponzi scheme. What is more surprising is that someone named Harry Markopoulos had been tracking Madoff since 1999 calling him a crook.  Yet, no one listened. Some very large fund of funds got caught napping with all their talk of due diligence.  Due diligence is all a sham, I’ve been through the due diligence process at several large investment banks and it starts out with tough talk. But the minute they find out you are distributing your product via another bank they cave because they don’t want to lose customers.  They figure if Bank X is distributing then they should be safe since Bank X is a known entity.  What they don’t realize is maybe Bank X got a sweet heart deal to distribute the product and from there it just snowballs.  Fairfield Greenwich Group  (FGG) was the largest distributor for Madoff’s toxic funds.  If you read their preso (pdf) you almost feel like it’s safer to have your money with FGG then the US Government.  It seems FGG’s Chief Risk Officer Amit Vijayvergiya was eating masala dosa’s during every discussion concerning risk.

Satyam
Lastly, Satyam Computer Services has shown if you own around 8% of a company you can siphon USD 1.2 billion to buy other companies.  To recap, Satyam was started by the Raju family and lately their ownership had come down to 8%. The Raju family decided to take the excess cash at Satyam and buy two construction companies (Maytas Properties and Maytas Infra) as part of a diversification strategy – cement and C++ what a combo. The deal was announced and within 12 hours it was cancelled when everyone but the Raju family and the Board of Directors thought it was a stupid idea. Then the Board of Directors insisted there was proper due diligence and many other construction companies were looked at but Maytas had some sort of special synergy.  And what was that special synergy? The two Maytas companies were started by Raju family members where they own over 30%. 

Over the past few months I’ve realized no one is really looking out for you. After seeing what has happened in 2008 I would never invest in a fund – hedge or mutual without meeting the manager. If they are too big or too busy to meet then most likely our goals are not aligned. As we speak most of my money is in ETF’s.