The Derivative Project

How Morningstar’s Rekenthaler is Wrong on Marty Bannon’s T Sale

How Morningstar’s Rekenthaler is Wrong on Marty Bannon’s T Sale

How Morningstar’s Rekenthaler is Wrong on Marty Bannon’s T Sale

March 14, 2017 the Wall Street Journal wrote, “Steve Bannon and the Making of an Economic Nationalist”

“The controversial White House counselor says his father’s 2008 financial trauma helped crystallize his antiglobalist views and led to a political hardening; ‘I’m going to be totally wiped out.”  Marty Bannon, Steve’s father, sold all his ATT (T) stock, after listening to Jim Cramer advising retirees to go to cash.

Morningstar’s John Rekenthaler writes on March 17, 2017, “Marty Bannon’s Biggest Investment Mistake (and mine)”

“Nor did those alleged culprits prevent Bannon from seeking professional help. And boy, did he need it. On his own, he was 100% invested in a single stock, while in his late 80s, and watching the investment media for guidance. That man had far surpassed his level of expertise. He should have hired out. ”

Marty Bannon stated:

Then came the 2008 market chaos. “That day, I found out how dumb the people were who I thought were smart,” he says. “They couldn’t control the situation, and it escalated during the day. I said, this thing is going so fast I’m going to be totally wiped out.”

Marty Bannon was absolutely correct.  The media failed him, the “expert” advisors on Wall Street failed him, and “Jim Cramer” failed him.  They were all exactly one year too late with their warning to Marty Bannon.  Why?

ATT (T) closed on December 31, 2007 at 42.39.  T closed on March 17, 2017 at 42.61.  If Mr. Bannon had sold in late 2007, his position would have been a cash position, almost identical if he sold ATT (T) yesterday.  Wall Street professionals and the media had a duty in 2007 to proactively discuss with retail investors the potential impact of excessive speculation, with excessive leverage, in OTC derivative markets.

Such leveraged speculation could cripple the markets, if not unwound in a prudent fashion. This was well known in 2007, by those that understood OTC derivative markets and how they traded; the unwritten rules and protocol of counter-party credit risk management in over-the-counter markets.  Asset management professionals have a duty to understand such markets.

No, one cannot market time.  However, every asset management professional had a duty to protect those near or in retirement in 2007 from a most clear-cut event, that anyone with an understanding of OTC derivatives markets and leverage could have predicted.  It was not a “black swan” event.  This could be predicted.

There was no way out, without a prudent, organized unwinding of these contracts to benefit society overall, as we wrote in the Derivatives Transparency Act of 2009, the predecessor to Dodd Frank, that we worked with Rep Peterson (D-MN) to introduce in the House in February 2009.

Steve Bannon thinks U.S. companies should once again feel more responsible to their communities. “Why can’t you revert back to a golden age?” he asks. “You can.”

What is the “golden age” that Mr. Bannon speaks of?

We wrote Charles Schwab in October 2007,  about protecting retirees and considerations of going to cash for those most at risk.  We were paying an assets under management fee to Charles Schwab to monitor certain assets.  We had a background in OTC derivatives.  We asked Schwab’s asset management team to discuss with us the impact of this excessive counter-party credit risk, excessive leverage, on the equity markets.

We wished to discuss this unprecedented risk to the capital markets and how best to manage it. What percentage might be better invested in cash to weather the storm?  Charles Schwab was paid a fee for regular advice.  They were Investment Company Act of 1940 fiduciaries.  Charles Schwab refused to discuss the most relevant concerns of the leveraged OTC derivatives positions’  impact on the equity markets.  They breached their fiduciary duty.  This unchecked counter-party risk did pose a phenomenal risk as it began to unwind in March 2008, when Goldman and other banks began to get nervous and demand collateral postings.

In 2007, Charles Schwab RIA’s had a fiduciary duty, to discuss the potential impact of these excessively leveraged, speculative  OTC derivative positions with retail investors in an informed and fiduciary manner, when asked to review the implications.  They were paid a regular fee for “investment advice”. They refused.

Charles Schwab should have issued bulletins and reports on the potential impact of excessive leverage and OTC counter party credit risk. Should retirees, such as Mr. Bannon, move a portion to cash?  They should have discussed the issue with media-from CNBC to the Wall Street Journal and conferred with Morningstar’s mutual fund analysts.  They did not.

Charles Schwab was certainly not alone in this refusal to protect their clients who could not bear such excessive risk. However, Charles Schwab, as 1940 Act fiduciaries, being paid a fee for investment advice, was specifically asked to review and discuss this market situation and the risks it posed, in their 1940 Act fiduciary role. Why did they refuse and breach their fiduciary duty?

They were either not true professionals, trained and experienced in all aspects of capital markets or they were severely conflicted and did not want to advise retirees, in a prudent fashion to move to cash, and weather an unprecedented economic storm.  Was it due to the potential impact it would have on their assets under management levels and corresponding revenues?

Schwab’s explanation for refusing to discuss excessive counter party credit risk was– since the assets were in an IRA and due to the IRS five part test, that trumped their ’40 Act fiduciary duty.  They were only subject to the suitability rule, since the assets were in an IRA.  The ’40 Act fiduciary rule, even though one pays a regular fee for investment advice, is not applicable in an IRA, with the IRS 5 part test. Schwab put their own interests over retail investors’ interests near retirement and used the IRS 5-part test for an IRA, to escape their ’40 Act fiduciary duties.

Mr. Bannon is correct.  Complex government regulations pose great harm to individuals and society, particularly due to Wall Street’s creation of such complexity to benefit them over society overall.  However, we fail to see how one’s ‘anti-globalist views’ stem from such abuse by one sector of our economy, Wall Street.

Mr. Rekenthaler at Morningstar has a CFA and an MBA.  The risks to the markets from this excessive leverage were obvious in 2007.  Where was Morningstar?  Where was the media?  Where was Goldman Sachs advising their clients in 2007?

For the record, we sold, fired Schwab as an RIA, and waited to ride out the storm of the collapse.  We invested in Goldman Sachs’ new venture into commercial banking and bought multiple Goldman CD’s, yielding 4% until 2019 and with cash, scooped up some Apple (AAPL).  “Invest in what you know.”

This is not market timing.  This is understanding the impact that unregulated, leveraged speculation in OTC derivatives could bring a market to a standstill.  It was simply, “hedge your bets” if you may need the cash within the decade. This was an understanding that OTC markets had been based on trust between commercial banks and these very banks abused that trust. Banks traded with certain counter-parties that they knew could never honor their counter-party commitments.  They chose to do these trades, for the income to them, to the detriment of society overall.

Professionals, that Mr. Rekenthaler speaks of, and the media, were not there for Marty Bannon in 2007.  Why weren’t they?

The Golden Age of Mr. Bannon’s Dreams

1.  Marty Bannon would have trust in asset managers, who read, think, and are educated, not “dumb”.  A CFA would not take on asset management responsibilities without the proper background and requisite professional training.

2.  CFA’s would go through intensive training programs in OTC derivatives, currency risk, emerging markets, etc and they would not be siloed.  They would understand the breadth and depth of all aspects of capital markets today.

3.  Retirement investors would be protected by simple fiduciary professional standards, based on the Investment Advisers Act of 1940 passed by Congress after the Great Depression.  The SEC’s and IRS’s rules that permit the avoidance of fiduciary duties and a private right of action, ( a right that serves to inform the public when there are clear-cut legal fine print abuses, like Charles Schwab’s,) would not be permitted.  The heart of our democracy is the balance of powers.

Wall Street, through FINRA and SEC regulatory capture, have permitted the elimination of individual rights to due process when securities laws are broken.  FINRA’s mandatory arbitration and the lack of private right of action have permitted the breach of securities laws from daylight, that serves to harm Marty Bannon and other retirees and retirement investors.

3.  Corporations would no longer represent to their employees that an investment product salesmen, without a college degree, is an “investment expert”.  Corporations, as in the day of Marty Bannon, would put the interest of their employees ahead of those of Wall Street.  They would truly provide independent investment selection education, not provided by Wall Street, to empower their employees to make an informed choice, particularly with the demise of defined benefit pensions.

4.  Regulations would be in place to limit leveraged speculation that may cause harm to society overall, when commercial banks  do not honor their commitments to ensure fair and orderly markets and evade basic tenets and duties to maintain orderly  markets for society overall.

Marty Bannon is very wise and spoke the truth.

Marty Bannon saw the picture very clearly.  The “professionals” were “dumb”.  “They created a situation that escalated.”  “They couldn’t control the situation.”

Mr. Rekenthaler’s solution to hire an expert is wise in that he recommends only true experts, accountants on tax issues.

Asset management professionals, particularly the intermediary “advisors”/sales personnel,  are lacking the breadth and depth of professional training to properly advise their clients. They have significant conflicts of interest, as Schwab did in 2007.  Nothing has changed.

Mr. Rekenthaler, it was the professionals that failed to protect retirees like Marty Bannon in 2007, before the situation “blew-up”.  It was the media and the mutual fund rating agencies that failed to alert the general public on what happens to capital markets when counter-parties suddenly panic and demand collateral on excessively leveraged  OTC derivative positions.

These counter-parties simply did not have that collateral due to excessive leverage.  It was the commercial banks that did not maintain orderly markets in their role of trust, in managing OTC counter-party credit risk derivative positions.  Collateral was not mandated in OTC markets, as on regulated futures’ exchanges.  Commercial banks had a duty, to society overall, to prudently manage the credit risks of their counter parties.  They failed to do so.

The “golden age” that Marty Bannon’s son dreams of today, with conflicted intermediaries, conflicted employers and conflicted academics, and a lack of professionalism and ethics,  can only be accomplished on what has driven the heart of our capitalism-transparency, separation of powers, and an educated, informed public.

No, Mr. Rekenthaler, unfortunately, “hiring out” is not a valid solution today.

Note to our readers

This is The Derivative Project’s final Post.  On April 1, 2017,  join us at Check The Ticker, the digital eLearning Retirement Solution.