perfidy

Vance at Begging To Differ explains a little about the scandal plaguing the mutual fund industry and asks what is to be done, conceding that what will probably happen is the establishment of an industry watchdog composed of industry players. Not incredibly encouraging.

When the Massachusetts District Attorney announced the names of Boston money managers accused of market timing, my heart skipped a beat. I know a couple of those names, because their offices handle my retirement savings. I'm currently in the market for a new home for my Roth IRA. All of this got me thinking.

I'm going to pull Buckethead's chain a little by posing a question. I know B is an advocate of rolling Social Security over to privately-held accounts. I'm also cautiously in favor of such a plan, and have more faith in the viability of my own modest TDA than I have in the chance of my ever seeing a Social Security check. However, scandals like this one worry me. Why is it better to trade a plan like Social Security which is poorly run and plagued with problems, for a private investment plan that also promises to be poorly run and plagued with problems, and offers a potential downside (negative returns) to boot?

Remember, mutual funds have been a fairly sleepy sector of the investment world since the Depression. Their security and the probity of fund managers have been articles of faith with many investors, especially newer and smaller ones. Of course we're all supposed to remember that "past returns are no indicator of future performance," but are we headed toward a scenario where investors cannot trust anybody with their money? That seems like a piss-poor bargain.

The arrogance of money managers, CEO/CFOs, and large investors is boundless, especially when profits are rolling in like crazy. The past few years have seen scandal after scandal after scandal from big business, banking, investment houses, and fund management firms. Each revelation further erodes the faith of the public.

I'm afraid that the net effect of these years of bad news will be to make small investors disillusioned with the market, causing them to either stop saving altogether (especially when times are lean), or to sock their money away in savings accounts, low-risk bonds, T-Bills and other low-return accounts where it really isn't doing that much work.

Of course, if the market rallies like it did in the late '90s all the ugliness of Enron, Fidelity, and Global Crossing will be forgiven, but will that really be much better? For the current scandals to bite hard at the people that caused them, some companies will have to go down in flames. If that happens, we can expect further economic chaos as the market realigns itself. That's probably a bad thing, from an investor-return and economic stability point of view. But if no investment houses learn hard lessons, no big swingers go to jail, and everything remains lovely in happy-puppy land, we're only setting ourselves up for a worse, bigger, more devastating scandal the next time.

Am I being to pessimistic in my cafeteria ramblings? Or am I just being rational and cautious like a good investor should?

[wik] Economist Alex Tabarrok posts an answer at Marginal Revolution: I'm being too pessimistic, but also not pessimistic enough.

No wonder they call it the dismal science.

[alsø wik] Alex Tabarrok's analysis gets a sound and genial fisking from ProfessorBainbridge.

Today is economic arcana day! In't the inter-web grand??