August 17, 2007

Sector madness

Back in the 80s Fidelity Investments (among others) was flogging sector funds like crazy. These were mutual funds which were designed to invest only in companies within specific parts of the economy (telecomm, pharmaceutical, medical supply, health care, etc.). The broader the sector the more leeway the investment manager had within it; thus somebody who had healthcare as his purview could invest in pharma, medical devices, biotech, and even hospitals, whereas telecomm meant essentially phone companies and their suppliers.

One of the sectors was finance, which often meant banks, mortgage companies, and anything else which moved money around. I felt then and I still feel that banks and lenders in general should not be anybody's choice as an investment. My reasoning was that they are often perceived as conservative with other peoples' money, but they really aren't. They tend to chase higher returns by following trends, and we've seen that recently.

The whole concept of lending money to people who can't afford to repay it goes against everything most of us ever learned in our economics or accounting classes, and yet that's precisely what the mortgage industry and the banks have done over the past few years, which is why we have a mess on our hands today. They were able to do this because they could make a mortgage loan and immediately offload it to somebody in Wall Street who'd package a bunch of similar loans and turn them into something called Mortgage Security VI, or MtgSecVI for short, and then offer that package to brokers who'd turn around and sell it to investors both large (mutual funds) and small (individual investors). The pitch was that "these are mortages! People will stop eating before they stop repaying their loans!"

Right. Since MtgSecVI was made up of nothing but subprime (read: shaky) loans, the chance that the borrowers would be unable to repay was much higher than it would have been had the loans been at prime plus one to people whose incomes were substantial and secure.

Moral: do not invest in publicly traded banks; their managers are as stupid as anybody else.

Posted by Linkmeister at August 17, 2007 01:36 PM | TrackBack
Comments

It's easy to call people stupid on this one, too. No, make that easy to call people susceptible. And subprime lenders -- evil scum -- are just helping the unfortunate, right?
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Posted by: Peter at August 20, 2007 09:53 AM