The poisoned portfolio
UPTON SINCLAIR’S muckraking classic, “The Jungle,” details the disgusting world of early 20th century meatpacking. The offending practices include the exploitation of immigrant workers and the creation of unhealthful food. In one passage, a worker falls to his death in a caldron worthy of Macbeth’s witches and is packaged for sale along with rotted bovine noses and intestines, thus taking the mistreatment of workers and customers to its logical extreme.
One hundred years after “The Jungle,” the United States continues to package and eat meat, but our economic advantage now rests in more ethereal areas, such as Hollywood movies -- or financial services. In “Wall Street Versus America,” investigative reporter Gary Weiss argues that the 21st century factory that produces stocks and bonds is every bit as foul as Chicago’s stockyards were a century ago.
Weiss advocates reform analogous to the Meat Inspection Act of 1906, which resulted from the firestorm caused by “The Jungle.” With the moral equivalent of workers’ compensation, health insurance and 100% certified beef, Wall Street’s products can be made fit for human consumption. Weiss is mad as hell, and he wants us to yell with him.
The book opens and closes with the story of Rand Groves, an investor who has an unpleasant and unprofitable tussle with Wall Street. When his tale begins, in the heady days of the Nasdaq bubble, Groves owns several million dollars’ worth of technology stocks. He seeks the advice of Wall Street and is told that his stocks are winners. The saga ends the way many did in that era -- with tears and a voyage to litigation.
After Groves’ tale opens the gates, we tour the financial factory and discover its horrors. We learn that analysts sell stocks instead of analyzing them, that regulators collaborate rather than regulate, that hedge funds speculate more than they hedge.
There is substance in Weiss’ dirty details. The accidental (and temporary) millionaire Groves learns this only when it is too late. For example, brokerage firms require investors to forgo juries and agree to use arbitration in legal disputes. Weiss reveals a less than perfect process that sometimes includes brokers arbitrating the alleged misdeeds of other brokers.
Weiss entertains as he excoriates, but sometimes at a cost. Bold, unqualified statements provoke, but also confuse when necessary nuances are removed. Weiss proclaims that “Wall Street is part of your life whether you like it or not,” and on the next page states with equal vigor that what happens at the New York Stock Exchange “is of no consequence to you whatsoever.” Another side effect of choosing entertainment over information is that occasionally the writing would make even Howard Stern push the censor button (at least back in his pre-satellite-radio days, when the Federal Communications Commission lurked). What other investment book repeatedly refers to oral sex and feces?
The most glaring weakness of “Wall Street Versus America” comes in describing financial theory. Any effort to provide financial advice requires taking a position, implicitly or explicitly, on the rationality of stock prices. There are two camps in this battle: Neoclassical economists promote rationality in the form of the Efficient Market Hypothesis, which says that stock prices accurately reflect all information. In sharp disagreement, behavioral economists argue that crazy people often create crazy markets, with prices that are sometimes far too high or far too low.
Weiss loves the EMH but misrepresents it and demonstrates that he does not understand its implications. In praise of it, he declares, “Apply its principles and you can never be ripped off in the stock market again.” Soon thereafter he writes, “Markets are random, irrational, and inexplicable,” a position that is almost precisely the opposite of the hypothesis. To add to the confusion, he describes the stock market rallies of the late 1990s as “tulip-craze-type,” apparently forgetting that stock market crazes and crashes are not supposed to exist in the rational EMH world.
Flawed theory or not, Weiss exposes Wall Street practices that most readers will find surprising and inappropriate. One has to wonder if, in doing so, he has identified the cause of our financial difficulties. If we cleaned up Wall Street exactly as Weiss suggests, would our investment woes be over? A clue to the answer lies in one simple fact about the Groves story: Throughout his millionaire days, Groves never told his broker to sell his highflying stock. So who’s to blame for Groves’ poverty? A growing line of research comes to the opposite conclusion of from that of Weiss.Sophisticated brain-scanning technology shows we are built to make money-losing moves, influenced by the older, more primitive parts of our brains.
The financial enemy, in this perspective, lies not in the arcane rules of arbitration but inside our heads. Every one of us comes with a built-in opponent, often lurking off the conscious stage. This enemy within is so powerful that a recent study, published in the journal Psychological Science, concluded that brain-damaged people -- as long as the damage is in the specific brain regions that host the internal enemy -- make better investment decisions than people with undamaged brains. This portion of our brain may have helped our ancestors navigate the African savanna, but it is downright dangerous when it takes control of our money.
“We have met the enemy and he is us.” So penned Walt Kelly in identifying the source of global environmental problems, and this is the neuroeconomic conclusion for many self-limiting choices. In contrast, there are lawsuits that blame McDonald’s for obesity. Readers who favor the “Big Mac made me do it” worldview may agree that Wall Street was at fault for Groves’ inability to say, “Sell my stocks now.”
When he turns to giving advice, Weiss warns that investors who attempt to outmaneuver professionals are more likely to eat cat food than caviar in their golden years. This is sound, regardless of whether the enemy is corrupt brokers or a hunter-gatherer brain lost in a new savanna. Weiss also recommends that readers take to the picket lines to force regulatory change. Using laws to bar the windows in this fashion is unlikely to succeed if the enemy is already inside the house.
“Wall Street Versus America” concludes that it is a financial jungle out there. Readers will have to choose whether their time is best spent changing the world or changing themselves.
