The Derivative Project

Lessons from 2012 Show Congress a Clear 2013 Road to Sustainable Economic Growth for the Middle Class

Lessons from 2012 Show Congress a Clear 2013 Road to Sustainable Economic Growth for the Middle Class

Hindsight provides a perfect vision for the future.  Here is our vision for a sustainable economic recovery for 2013 for middle class retirement savings. 

Paramount to each of these points is a request for a renewed focus by Congress on the big picture that values society overall, over an obsolete Wall Street profit model that is hindering sustainable economic development in the U.S. 
Impact of Transparency in OTC Derivative Markets and Understanding of Role of CDS Contracts by Wider Population

The Derivative Project posted this Blog Post, May 2012, on the most ridiculous role of the International Swaps Dealers Association willingness to payout on a technical default of US debt on outstanding credit default swap contracts.  One can note during the current shenanigans on the “fiscal cliff”,  speculation on credit default swap contracts on US debt is now a mute point.  It was simply a way for CDS traders to make a buck to the detriment of society overall.
A larger share of the public is now understanding the stupidity of speculating on sovereign debt. Credit default swap contracts belong on regulated exchanges, along with its speculation in such. U.S. taxpayers should not pay a cent to monitor systemic risk resulting from credit default swap OTC contracts where there is not adequate day to day collateral postings as markets move. Speculation, with daily mark to market belongs on regulated exchanges with well established position limits to prevent market distortions for end users, such as farmers hedging wheat crops, that require a normal convergence between cash and futures prices.
Congressional Action:  All speculative credit default swap contracts must trade on regulated exchanges, with daily mark to market collateral postings.  Customized OTC credit default swap contracts were and are a sham and are not a necessary end user hedge.  Speculative limits on commodities are requisite for smooth functioning markets and should be closely monitored in mutual funds and ETF’s or pump and dump schemes are too easy for hedge funds to manipulate markets with today’s computerized trading.
Further, it is now evident with ICE’s purchase of the NYSE, the money to be made is in derivatives, not traditional equities.  An understanding and appropriate safeguards on postition limits, volumes and role of derivatives in “pump and dump” schemes is paramount to maintain market integrity.
Self-Regulation in the Securities and Futures Industry is an Abject Failure
The Derivative Project posted this Blog Post, “Retail FX Has Largest Ponzi Scheme in History: What SIFMA Did a Few Days Later.”  The SEC, FINRA and NFA (National Futures Association) were all complicit in the major Peregrine fraud, as were CNBC, PBS and other media outlets that allowed a platform for the fraud to gain “credibility” and a sales platform to lure innocent victims of a fraudulent scheme.  A simple review of all the NFA claims by investors in years preceding the fraud shows the abject failure of self-regulation by all three regulators, NFA, FINRA and the SEC.  See Blog Post above.
Congressional Action: A private right of action is the only resolution for futures and all securities complaints by investors. Congress, hold a hearing with retail investors who have been harmed by FINRA’s kangaroo court. You have a duty to understand why this is indeed an obstruction of justice. It is a clear breach of every American’s constitutional rights for equal justice and right to a court hearing. All arbitration must be voluntary.  Self-regulation has proven to be a failure from Bernie Madoff to Alan Stanford to Peregrine Capital to MF Global.  It is not just investors, our nation’s farmers’ livelihoods are impacted, through this rogue and reckless attitude of regulators towards Wall Street shenanigans. 
The “Financial Advice” Model for Retail Retirement Savers is Obsolete and A Sham

The largest profit center for Wall Street, in terms of a steady dependable income stream, is IRA’s, a market now larger than 401K’s.  According to a 2012 Investment Company Institute report over $4.7 trillion are invested in mutual funds through IRA and defined contribution plans. According to the ICI report:
“The growth of individual retirement accounts (IRAs) and defined contribution (DC) plans, particularly 401(k) plans, in conjunction with the important role that mutual funds play in these plans, explains some of households’ increased reliance on investment companies during the past two decades. At year-end 2011, 9 percent of household financial assets was invested in 401(k) and other DC retirement plans, up from 7 percent in 1991. Mutual funds managed 55 percent of the assets in these plans in 2011, up from 13 percent in 1991 (Figure 1.4). IRAs made up 10 percent of household financial assets, and mutual funds managed 45 percent of IRA assets in 2011. Additionally, mutual funds managed $982 billion in variable annuities outside of retirement accounts, as well as $4 trillion of assets in taxable household accounts.”  Further, 
“From 1997 to 2011, fund industry employment in the United States grew 39 percent from 114,000 workers to 159,000 workers (Figure 1.12). Based on results of an ICI biennial survey, employment peaked in 2007 at 168,000.”  Further,
“In 2011, distribution and sales force personnel together accounted for 24 percent of the workforce. Employees in these areas may be involved in marketing, product development and design, or investor communications and may include sales support staff, registered representatives, and supermarket representatives.”  Further,
“IRA assets, with $4.9 trillion at year-end 2011, accounted for 27 percent of U.S. retirement assets. Mutual fund assets held in IRAs were $2.2 trillion at year-end 2011, down slightly from year-end 2010 (Figure 7.12). Assets managed by mutual funds were the largest component of IRA assets, followed by securities held through brokerage accounts ($1.8 trillion at year-end 2011). The mutual fund industry’s share of the IRA market was 45 percent at year-end 2011, compared with 46 percent at year-end 2010.”  Further,
“At year-end 2011, mutual funds accounted for $4.7 trillion, or 26 percent, of the $17.9 trillion U.S. retirement market. The $4.7 trillion in mutual fund retirement assets represented 40 percent of all mutual fund assets at year-end 2011.”
The outcome, Americans cannot save for retirement when they are losing over 30 percent of their savings to unnecessary fess. IRA and 401K administrative fees, marketing fees (sometimes called 12-b1 fees), investment management fees and trading costs are combined a drain on a viable retirement for most everybody.  Mutual funds have been rendered obsolete thorough the greed of their creators. There is a better model to assist Americans in growing their retirement savings, particularly when there is talk of limiting Social Security annual increases.  A new retirement savings model must supplement this potential loss in Social Security income. 
The “advice” industry that developed with the advent of 401k plans and IRA’s i
s a sham and must be reconstructed.
Congressional Action:  Dodd Frank required a new SEC Office of the Investor Advocate.  As The Derivative Project described in this Blog Post, “President Obama’s Most Critical Appointment to Restore Economic Growth”, Wall Street blocked appointment of the SEC Advocate for retail investors.  Why?  Wall Street does not want their profit model train for useless fees on American’s retirement savings to end.  They do no want the average American to understand how their savings is going directly to Wall Street’s pockets, without returning any value to the saver.  The SEC must balance the needs and requests of the retail retirement saver for a new paradigm of retirement investing, with the overwhelming force of a Wall Street lobby that represents a small sector of society and does not represent the common good.

The Derivative Project submitted this April 3, 2012 request for Rule Change to the SEC as the most viable option to a proposal for a fiduciary standard for a stock broker.  A stockbroker is a salesperson whose goal is to sell, not to provide fiduciary advice.  It is that simple.  They cannot do both.
Insist that the SEC restore the dichotomy, under the Investment Advisers Act of 1940,  between salesperson and investment adviser, so retail retirement investors are receiving bona fide “advice”, not from snake oil sales men, but bona fide “pension consultants”, CFA’s; in short a retail investor is entitled to the same level of “investment advice” as that provided to a sovereign wealth fund or university endowment. (Excluding the type of investment advice that Goldman Sachs gave Libya’s sovereign wealth fund – see below.)  In sum, Congress must eliminate “shoddy advice” to Americans trying to save for their retirement.  Even if their savings are not yet a large amount, they deserve the same quality of professional advice.  Wall Street says if the Department of Labor insists on an ERISA fiduciary standard for stock brokers they will no longer be able to provide advice to IRA investors.  This would indeed be progress for IRA savers.
What is the Wall Street Profit Model for Retail Retirement Savings?

Garner as many assets under management and charge excessive fees for administration and asset management with no competition.  Wall Street has created a government controlled monopoly, that Congress, the Department of Labor and the SEC and FINRA will not interfere with.  This must come to an abrupt end.  
Individuals have no right to private action and cannot go to the Federal Courts when Wall Street has broken the law in their IRA account.  Wall Street decides what is right and wrong for a retail investors’ IRA, through mandatory arbitration, so the egregious law breaking never sees the light of day.  This must end.
Performance is Irrelevant – Wall Street Gets Paid if they Have Gains or Losses

Reference The Derivative Project’s Blog Post, “President Obama’s Most Critical Appointment to Restore Sustainable Economic Growth.”
Wall Street is free to charge excessive fees and lose retail retirement savings in poorly managed funds and still retain their fees.  There is no competition.  TIAA-CREF sits on the Advisory Board of the Department of Labor.  For one non-profit, who offered its employees a TIAA-CREF mutual fund option, a retirement investor lost double the index for TIAA -CREF’s retirement investments in a TIAA-CREF International fund.  In this instance, the international index lost 12 percent and TIAA-Cref’s fund lost 25 percent.  Yet, the investor is stuck in the plan and has no alternative.  There is no-recourse or consequence to TIAA-CREF for delivering such poor results.  They still get their investment management fee, despite abysmal investment management performance.
“Voluntary Recapture” or the perfect example of why the retail investor will never get ahead

Charles Schwab’s money market “voluntary recapture” program for its administrative fees in money market funds takes the cake in hubris.  
Here is an excerpt from Schwab’s SWIXX prospectus: “Voluntary Expense Waiver/Reimbursement”:
“In addition to the contractual expense limitation agreements noted above, Schwab and the investment adviser also may waive and/or reimburse expenses to the extent necessary to maintain a positive net yield for the fund. Schwab and the investment adviser may recapture from the fund any of these expenses or fees they have waived and/or reimbursed until the third anniversary of the end of the fiscal year in which such waiver and/or reimbursement occurs, subject to certain limitations. The reimbursement payments by the fund to Schwab and/or the investment adviser are considered “non-routine expenses” and are not subject to any net operating expense limitations in effect at the time of such payment. This recapture could negatively affect the fund’s future yield. There were no prior year amounts recaptured. “
Here are The Derivative Project’s comments to the SEC on systemic risk in mutual funds and inappropriate role of “voluntary recapture” programs.

Congressional Action:  Mandate the Department of Labor and the SEC ban mutual fund companies “voluntary recapture” programs for administrative fees for any retail retirement account money market fund.  Mandate the Department of Labor and the SEC review costs and benefits to retail retirement investors of investment advisers receiving only performance based fees for retirement savings vehicles.  If the Investment Adviser’s mutual fund loses more than the comparable index, that IA loses his total annual investment management fee from the retail retirement investor.  
Mandate that all retirement savings be placed in FDIC insured money market sweep accounts, until the money market mutual fund industry eliminates the shadow lending that prohibits the retail investor from seeing what they are investing in.  Contrary to reports from certain SEC Commissioners that assets in money market mutual funds are now transparent, we can attest that is false.  FDIC sweep accounts pay a higher return and the fees are less.  It is currently a breach of fiduciary duty for any 401k provider to not put clients savings in FDIC money market mutual funds due to the known systemic risks in non-insured money market mutual funds.  The Department of Labor must take a role in this determination.
The Role of Momentum Trading in Distorting Smooth Functioning Markets

Momentum trading has distorted fundamental analysis, the backbone of all equity markets.  It is a form of front running and pump and dump.  The most egregious example is occurring right now with Apple Stock.  Here is a view from the Financial Times in a December 20, 2012 article,
“Time to Stop Addiction to Momentum Trading”:  Hedge F
unds Need to Go Back to Investing Basics.
“But after the disaster of 2008”, momentum trading and “amateur economics” came to rule. “Managers paid increasing attention to the ‘big picture’. Risk on, risk off – adjusting exposure – [has] become an almost daily practice.” In other words, portfolio churning based on market timing has replaced any focus on fundamentals.
This article does not go far enough.  Momentum trading is a breach of U.S. securities laws of front running, of pump and dump, in the case of Apple now, dump and pump.  The hedge funds have predicted a technical drop of Apple from 702 to 460.  They are selling Apple, along with media reports to “justify” the momentum, buying call options, and then will pump it back up over 700 after January earnings, 2013.  It is just that obvious, based on Apple’s underlying fundamentals, earnings projections, products, and cash position.  Apple’s move in 2012 was not based on a tech frenzy, “irrational exuberance” such as during the tech bubbleas many media reports are touting.  Apple’s stock movement was based on earnings, product delivery and sound fundamentals, not irrational exuberance, like the Facebook IPO debacle.
Congressional Action:  The Senate and the SEC must immediately authorize independent investigations of the ‘combined media’ reports on Apple stock, option trades, volumes, hedge funds’ purchases and sales and option positions from February 2012 to January 2013.  What are future limits that must be placed on media companies and hedge funds and others that perpetuate this dump and pump schemes that are distorting equity markets and making it treacherous for individual retirement investors to hold high-quality American company stock for long-term development of their portfolio and the U.S. economy?
2012 Postscript
Finally, Congress, it would be great if you could ask two questions and find rational answers for us all in 2013: 
  • Why did Goldman sell call options on Banks, that invested heavily in Bernie Madoff’s portfolios, to Libya’s sovereign wealth fund?  This was a winning trade for Goldman. What did Goldman know about Mr. Madoff’s ponzi scheme?

          Dissecting the Goldman and Libya Trades: How They Impact Your 401k

  • Why did Warren Buffett sell or write long-term puts on the S&P index for Deutsche Bank, that exposes Berkshire Hathaway to incredible risks until 2018?  What did Mr. Buffett know about Deustsche Bank’s financial condition at this point?  How do his views tie in with the Whistleblower’s claims on Deutsche Bank’s alleged misrepresentative accounting practices?
The answers to these two questions will help solve the concept of fiduciary, trust and what really happened to cause the 2008 financial crisis.  Without understanding history, it is difficult to chart our future course.