By Rex Nutting, MarketWatch
Nov. 1, 2013, 5:40 a.m. EDT
Commentary: Conflicts of interest could cost investors $1 billion a month
WASHINGTON (MarketWatch) — Democrats and Republicans seem to be falling over each other trying to prove who can best help Wall Street loot the Treasury and the pensions of the American worker.
This week, the House passed two bills with bipartisan support that would benefit the financial services industry and hurt almost everyone else. Both bills are pure giveaways worth billions of dollars.
One of the bills would roll back some of the protections put in place by the Dodd-Frank Act to keep the banks from gambling with their insured deposits on very profitable but risky derivatives known as swaps.
Once it’s fully implemented, Dodd-Frank would force the banks to put most of their risky trades outside the bank into a separately capitalized subsidiary, where losses would not be guaranteed by the Federal Deposit Insurance Corp. Nor would these affiliates have access to cheap money from the Federal Reserve.
Letting the banks use insured deposits to fund these swaps lowers the banks’ costs now, and it puts the financial system at risk by giving the impression that the FDIC (and ultimately the Treasury) could protect creditors if the trades go sour, as they often do. Beneficiaries of the bill would include Citigroup C -0.04% , J.P. Morgan JPM +1.29% and Bank of America BAC +0.64% .
The bill passed by the House on Wednesday would allow the banks to trade almost all complex derivatives without quarantining them in a separate affiliate. If you don’t think that’s potentially dangerous, remember what happened to Bear Stearns, Lehman Brothers and Merrill Lynch when their derivatives trades flopped.
A similar bill passed the House last year with little notice. Everyone knew it was dead on arrival in the Senate. What’s different this year is the revelation by the New York Times that key provisions of the bill were written by a lobbyist for Citigroup.
The House swaps bill won’t become law. The White House and the Senate won’t go that far. But the fact that 70 Democrats in the House voted for the bill (as did 22 Democrats on the Financial Services Committee) shows that we can’t rely on the Democrats to protect us from the banks’ influence. The campaign cash they offer lawmakers is too intoxicating.
As Democratic Rep. Jim Himes of Connecticut told the New York Times of the cozy relationship between Wall Street money and lawmakers’ need for campaign cash: “It’s appalling, it’s disgusting, it’s wasteful and it opens the possibility of conflicts of interest and corruption.” Himes was a co-sponsor of Citigroup’s swaps bill.
The bank lobbyists and lawyers are working the Securities and Exchange Commission as well, delaying and blocking the new rules on derivatives. If they have their way, the rules will be watered down, and enforcement will be lax. And someday, a huge financial corporation will fail because Washington didn’t draw the line, putting the global economy at risk again.
The other bill passed by the House this week doesn’t have quite that much potential for global mischief, but it would be much worse for individual investors.
The bill would delay a rule the Department of Labor is preparing that would require mutual-fund companies and other companies that operate retirement plans such as IRAs and 401(k)s to start working for investors and stop working for themselves.
The rule would require that trustees of retirement accounts act as a fiduciary on behalf of the investors in the plan, rather than acting in their own self interest. The SEC is working on a parallel rule that would require that brokers also act as a fiduciary on behalf of the investors they advise.
To be a fiduciary means to put the interests of your client first. You can see why Wall Street would fight that rule, because if you put your client first, then you can’t help yourself his life savings.
Current law cheats investors by allowing their plan trustees or financial advisers to steer their retirement savings into funds owned and operated by those very same advisers. One study found that one-third of $10 trillion retirement assets are invested in poorly performing funds that are financially connected to plan trustees.
Christopher Carosa figured that these conflicts of interest cost individual investors about $1 billion per month in reduced earnings.
That doesn’t count the cost of taking conflicted advice from brokers about investments in non-retirement accounts.
Thanks to the magic of compounding, poor performance and high fees can cost a typical retiree hundreds of thousands of dollars over a lifetime.
Most of us don’t have hundreds of thousands of dollars to squander on bad advice.
Since the 1980s, we’ve increasingly told people that they are responsible for their own retirement savings. Defined-benefit pensions are gone, so retirement security depends on individuals’ prowess at investing over the long haul.
But most people are terrible at investing: they don’t save enough, they don’t know what to invest in, they don’t pay attention to yields or to fees, they are easily tricked and cheated. They need professional help.
It’s not asking too much for those professionals to act in their clients’ best interest.
Unfortunately, the financial services industry and its employees make more money when they treat customers like sheep to be shorn. They make so much money, in fact, that they could afford to buy every politician in Washington if necessary.
Rex Nutting is a columnist and MarketWatch’s international commentary editor, based in Washington.