I must return one more time to the Journal today to highlight yet another interesting opinion piece by Charles Schwab, the founder and CEO of the popular brokerage house that bears his name. In the column, Schwab complains that banks and brokerage houses like his are being unfairly targeted by excessive government regulation and litigation. He asserts that this will result in a heavy cost to amateur investors and possibly prevent their participation in the market altogether. I mostly agree.
In his piece, Schwab is writing about self-directed investment accounts. Those are amateur investors who make their own decisions, rather than relying on professional experts to make investment decisions for them. Schwab worries that new proposed regulation would result in less opportunity for such investors and higher fees, since brokerage houses might be held responsible for losses associated with even self-directed accounts.
Schwab does a good job of explaining the essential issue:
The issue at stake here is whether independent investors should be allowed the freedom to choose what they are allowed to buy, sell or hold. Or should the government try to enforce a guarantee against market risk through regulation or lawsuits like the attorney general has brought against us?
Case-in-point: auction rate securities. New York Attorney General Andrew Cuomo is suing Schwab and others because they allowed amateur investors to purchase these securities, which are now highly illiquid. Schwab writes:
Though this market operated smoothly and reliably for over 20 years, it is a market that we had no direct involvement in establishing or maintaining. It's a market where roughly 90% of the clients who invested in these securities came to Schwab asking us to locate and make available these investments for them. We did not create the products, actively market them, and had no involvement in the events that led to the collapse of the Auction Rate Securities market.
Assuming its veracity, his argument seems pretty strong to me. That's kind of like suing 7-eleven for selling the cigarettes that gave you lung cancer. As the middleman in the process Schwab, like 7-eleven, didn't mean to do any harm. It just wanted to facilitate a transaction that its customers requested.
Personally, I'm not sure why the government ought to save amateur investors from themselves. Maybe from complex derivatives they can't understand, there's some argument for this. But even then I still think that if they're buying something they don't fully understand, they deserve whatever they get. Moreover, at what point does the government decide an investment isn't too risky for the average American? I worry that this creates a sort of slippery slope. So does Schwab:
If Schwab is going to be held responsible for guaranteeing every decision an investor makes, we'd need to severely limit what they purchase. Would we tell them they couldn't buy Google or IBM stock because regulators or politicians don't think they are smart enough to assess the risks and could hold us accountable for any losses? The logical outcome would be that individual investors would be constrained to a small set of plain vanilla investments--Treasurys for all--or would be forced to pay us a fee to manage their account.
I have mixed feelings about this, because I find it very unlikely that the average investor can really make much money investing. Even brilliant professional investors are often wrong, so I am unconvinced playing the stock market, or worse the derivatives market, will turn out better for most amateur investors than rolling the dice at the craps table in the Bellagio. Jeffrey Goldberg had a great piece addressing the problems in amateur investment strategy in the May edition of the Atlantic Monthly.
Yet, I'm also troubled by the idea of only allowing professional investors into the market. That just seems wrong on some fundamental level when I think about what a free market should be. And holding brokerage houses or banks accountable when self-directed investments go bad is certainly a weak alternative -- that will just make it even harder for amateur investors to turn a profit on their investments after paying excessive fees that the brokers would have to charge.
So what's the solution? I'm not sure, but I'm leaning towards the idea that the current system is best. Just like with so many other products, with investments, "buyer beware" should be the motto. There should be some degree of Darwinian selection involved with investing. If you don't have the time or intelligence to do so better than the next guy, then you'll lose. And that's okay; after all, that's how life works. I'd rather be subjected to the possibility of losing than have no option of winning.