– Wall Street’s Latest Retail Fleecing Product Exposed – Structured CDs:
Ms. Bailey, the Citizens Bank customer in Massachusetts, had sold a condo in Maine in 2013, a year after the death of her husband, who she says had handled their finances. She went to a Citizens branch in Arlington, a suburb of Boston, to deposit the money. She says bank employees pressured her not to just park the money in a savings account.
She says she was directed to Citizens broker Andrew Jurkunas, who steered her to a CD called the GS Momentum Builder Multi-Asset 5 ER Index-Linked Certificate of Deposit Due 2021. It is one of a series of CDs based on a Goldman Sachs-designed index that tracks the performance of up to 14 exchange-traded funds and a cash-like holding. The index aggregates the performance of different combinations of some or all of the underlying funds, relying on a complex formula designed to smooth volatility.
When Ms. Bailey received her first statement showing that the value of her CD had dropped by more than $4,000, she complained to Massachusetts state securities regulators. This January, the office filed civil charges against the bank alleging that Mr. Jurkunas, who wasn’t named or accused of wrongdoing, didn’t adequately disclose the risks of the market-linked CD.
– From yesterday’s excellent Wall Street Journal article: Wall Street Re-Engineers the CD—and Returns Suffer
Wall Street is an industry that should have been allowed to go down in flames back in 2008. Bailing out these career criminals and sociopaths was one of the gravest errors in American history. An error that we as a nation continue to suffer from to this day.
As an example, yesterday’s Wall Street Journal reported on the industry’s latest scheme to pocket the hard earned savings of those dwindling Americans who still have a few pennies left — structured CDs.
What follows are some key excerpts from this must read article, Wall Street Re-Engineers the CD—and Returns Suffer:
Mary Bailey, a 79-year-old widow in Arlington, Mass., made a big deposit for her grandchildren at her Citizens Bank branch when a financial adviser there sold her on a newfangled $100,000 certificate of deposit. It would, he said, double her savings in six years, according to a later state enforcement action.
So she was irate when her first statement showed the CD’s value had fallen to $95,712, thanks to upfront fees. “This was not a CD as I know a CD,” Ms. Bailey says.
Traditional certificates of deposit offer better interest rates than normal savings accounts for customers who agree to lock up funds for a period of time. Since the 1960s, they have been among the most popular products retail banks offer. Now Wall Street has re-engineered the most bread-and-butter of investments in a way that leaves many investors with lower returns, and facing losses if they have to cash out early.
Returns on such CDs, known as market-linked or structured CDs, depend on the performance of a basket of stocks or other assets instead of a flat interest rate. CD holders get their original money back when the CD matures, usually after three to 10 years, plus a return based on the performance of certain assets or benchmarks.
Sounds good, but as always, the devil is in the details.
Most issuers of such CDs don’t publicly disclose any performance data, so it is difficult for would-be investors to assess how good a deal the products are. The Wall Street Journal obtained from an investment adviser returns data on hundreds of market-linked CDs created by Barclays PLC, a leading player. The data show that many underperformed conventional CDs, in part because their design puts a limit on the upside from gains in the underlying assets.
Of the 325 Barclays CDs reviewed by the Journal, 239 had announced at least one annual return payment. More than half of those returns were lower than an investor would have earned from an average five-year conventional CD. Of the 118 structured CDs that were issued at least three years ago, only one-quarter posted returns better than those of an average five-year conventional CD. And roughly one-quarter produced no returns at all as of June 2016.
A Journal analysis of 147 market-linked CDs issued since 2010 by Bank of the West, part of French bank BNP Paribas SA, revealed a similar pattern. Sixty-two percent produced returns lower than an investor would have received from a five-year conventional CD, while almost a quarter have yet to pay any return at all, the analysis found.
A Barclays spokesman said in a written statement the structured CDs market has “seen significant evolution over the last few years to meet the needs of clients, investors and distributors seeking to navigate the continued challenges of a low interest rate environment.”
The unusual CDs have been around in some form since the 1980s, but sales have taken off since the financial crisis. That is partly because, at a time of rock-bottom interest rates, investors have been desperate to find anything that appears it might generate higher yields.
Banks, for their part, are looking for inexpensive sources of funding. In addition, such CDs generate fees. Fee income, in particular, has been hard hit, leaving banks looking for new products yielding more than conventional savings accounts and CDs.
Market-linked CDs don’t have to be registered with the Securities and Exchange Commission, so there are no official sales data. Bankers and other experts on the product estimate sales of $5 billion to $15 billion a year. U.S. investors held about $22.7 billion of market-linked CDs last month, up 36% from 2012, according to StructuredRetailProducts.com.
I suppose it doesn’t matter how many times the public gets scammed by Wall Street, they keep coming back for more. In this particular case, this is partly due to the fact that these products are created by the TBTF banks, but then marketed at the retail level by local bank branches.
The CDs are sold to customers of regional banks and brokerages by bankers and brokers, who receive commissions. Brokers say each month they receive lists of new market-linked CDs created by Wall Street firms, including Goldman Sachs Group Inc., J.P. Morgan Chase & Co., Barclays and others.
Typically, everyone in the sales chain—a wholesale broker, a financial adviser and a bank teller—gets paid more for selling a market-linked CD than a conventional CD or a mutual fund. The adviser who actually sells the CD, for example, can get commissions of up to 3% of the CD’s value, according to information sent to brokers reviewed by the Journal.
“Banks have to be delighted with these structured products,” said Steve Swidler, a finance professor at Auburn University. “There’s virtually no risk to them, and [the banks] sit back and rake in fees.”
The Barclays CDs reviewed by the Journal generally are linked to underlying “baskets” of five, 10 or 20 stocks. Most pay income based on an “adjusted” version of the basket’s actual return, calculated by applying a cap and floor to each stock’s performance.
Now here’s how the sausage is made…
Suppose a basket of 10 stocks has a cap of 5% and a floor of 20%. If eight of the stocks go up 20% and two go down 20%, the average actual performance would be 12%. But because each increase is capped at 5%, while up to 20% of each decrease is counted, the adjusted average performance is zero—a much worse return for the customer.
For the 247 Barclays CDs analyzed by the Journal that used this method, the adjusted overall stock performance tended to be worse—on average, 28 percentage points lower—than the actual performance of the underlying stocks. Investors in the CDs also forfeit the dividends they would have received by owning the stocks outright.
One Barclays six-year CD due to mature in October is based on 20 stocks. The shares’ average values had more than doubled as of June. But the CD was designed to cap positive returns at 6% and negative returns at 30%. That translated into an adjusted performance of negative 4% for the whole basket.
As a result, four of the annual coupons the CD has paid were zero. A fifth was 0.04%. That means a $100,000 deposit would have generated a $40 return over five years. A conventional five-year CD, by contrast, would have generated an average of $8,100 in interest, according to Bankrate.com.
Other structured CDs from Barclays and other issuers fared better, including some that track a stock index.
“I’ve worked in the kitchen and seen how it’s made, so I’m not interested in consuming them,” says Keith Amburgey, who used to design market-linked CDs at Morgan Stanley and now runs Tampa-based financial advisory firm Rutherford Asset Planning. Morgan Stanley declined to comment.
One series of CDs from HSBC Holdings PLC is called “Industry Titans” because the instruments are pegged to brand-name stocks. The 10 stocks underpinning a 2012 version of the CD, including Tiffany & Co. and ConAgra Foods Inc., were up by 46%, on average, at the end of July, according to FactSet. But a 6% cap on positive returns and a 30% floor on negative ones reduced the CD’s adjusted performance, which determines the amount paid to the investor, to negative 1.1%. The CD paid a zero return in July, for the fourth year in a row, according to HSBC.
In 2013, a broker at Fifth Third Securities Inc. advised an 88-year-old customer to put about $200,000 from his retirement account, nearly 80% of the total, into market-linked CDs, according to the customer’s lawyer, Howard Rosenfield of Farmington, Conn.
The investor had to sell the CDs early, in part to make the minimum withdrawals required under retirement-account rules—a cash need that was foreseeable at the time Fifth Third sold him the CDs, Mr. Rosenfield says. His client lost more than $20,000 on the sales.
Ms. Bailey, the Citizens Bank customer in Massachusetts, had sold a condo in Maine in 2013, a year after the death of her husband, who she says had handled their finances. She went to a Citizens branch in Arlington, a suburb of Boston, to deposit the money. She says bank employees pressured her not to just park the money in a savings account.
She says she was directed to Citizens broker Andrew Jurkunas, who steered her to a CD called the GS Momentum Builder Multi-Asset 5 ER Index-Linked Certificate of Deposit Due 2021. It is one of a series of CDs based on a Goldman Sachs-designed index that tracks the performance of up to 14 exchange-traded funds and a cash-like holding. The index aggregates the performance of different combinations of some or all of the underlying funds, relying on a complex formula designed to smooth volatility.
A spokeswoman for Goldman, which hasn’t been accused of any wrongdoing in relation to the case, said the bank was “not a party in the customer’s complaint or settlement, and had no direct relationship with the investor” and that the product’s risks were “clearly explained” in its documents.
Indeed, here’s how the Vampire Squid “clearly explained” the product…
Documents related to the CD, including a description of the methodology behind the Goldman index, run to 266 pages and feature calculus, hypothetical backtested data and flowcharts. Ms. Bailey says she didn’t read the documents.
When Ms. Bailey received her first statement showing that the value of her CD had dropped by more than $4,000, she complained to Massachusetts state securities regulators. This January, the office filed civil charges against the bank alleging that Mr. Jurkunas, who wasn’t named or accused of wrongdoing, didn’t adequately disclose the risks of the market-linked CD.
At this point, Wall Street is essentially a purely parasitic industry. It adds virtually nothing of value to the U.S. economy or society, it just constantly rips off the public and redistributes wealth to itself.
Still don’t believe me? Chew on the following excerpts from an article published yesterday at Naked Capitalism, Does Wall Street Do “God’s Work”? Or Even Anything Useful?
In the wake of the 2008 crisis, Goldman Sachs CEO Lloyd Blankfein famously told a reporter that bankers are “doing God’s work.” This is, of course, an important part of the Wall Street mantra: it’s standard operating procedure for bank executives to frequently and loudly proclaim that Wall Street is vital to the nation’s economy and performs socially valuable services by raising capital, providing liquidity to investors, and ensuring that securities are priced accurately so that money flows to where it will be most productive. The mantra is essential, because it allows (non-psychopathic) bankers to look at themselves in the mirror each day, as well as helping them fend off serious attempts at government regulation. It also allows them to claim that they deserve to make outrageous amounts of money. According to the Statistical Abstract of the United States, in 2007 and 2008 employees in the finance industry earned a total of more than $500 billion annually—that’s a whopping half-trillion dollar payroll (Table 1168).
There’s just one problem: the Wall Street mantra isn’t true.
Let’s start with the notion that Wall Street helps companies raise capital. If we look at the numbers, it’s obvious that raising capital for companies is only a sideline for most banks, and a minor one at that. Corporations raise capital in the so-called “primary” markets where they sell newly-issued stocks and bonds to investors. However, the vast majority of bankers’ time and effort is devoted to (and most bank profits come from) dealing, trading, and advising investors in the so-called “secondary” market where investors buy and sell existing securities with each other. In 2009, for example, less than 10 percent of the securities industry’s profits came from underwriting new stocks and bonds; the majority came instead from trading commissions and trading profits (Table 1219). This figure reflects the imbalance between the primary issuing market (which is relatively small) and the secondary trading market (which is enormous). In 2010, corporations issued only $131 billion in new stock (Table 1202). That same year, the World Bank reports, more than $15 trillion in stocks were traded in the U.S. secondary market– more than the nation’s GDP. Yet secondary market trading is fundamentally a zero sum game—if I make money by buying low and selling high, it’s money you lost by buying high and selling low.
So, what benefit does society get from all this secondary market trading, besides very rich and self-satisfied bankers like Blankfein? The bankers would tell you that we get “liquidity”–the ability for investors to sell their investments relatively quickly. The problem with this line of argument is that Wall Street is providing far more liquidity (at a hefty price—remember that half-trillion-dollar payroll) than investors really need. Most of the money invested in stocks, bonds, and other securities comes from individuals who are saving for retirement, either by investing directly or through pension and mutual funds. These long-term investors don’t really need much liquidity, and they certainly don’t need a market where 185 percent of shoes are bought and sold every year. They could get by with much less trading—and in fact, they did get by, quite happily. In 1976, when the transactions costs associated with buying and selling securities were much higher, fewer than 20 percent of equity shares changed hands every year. Yet no one was complaining in 1976 about any supposed lack of liquidity. Today we have nearly 10 times more trading, without any apparent benefit for anyone (other than Wall Street bankers and traders) from all that “liquidity.”
So, what does Wall Street do that benefits society? Doctors and nurses make patients healthier. Firefighters and EMTs save lives. Telecommunications companies and smart phone manufacturers permit people to communicate with each other at a distance. Automobile executives and airline pilots help people close that distance. Teachers and professors help students learn. Wall Street bankers help—mostly just themselves.
Thanks for playin’ America.
For related articles, see:
Video of the Day – Bernie Sanders Says “I Think the Business Model of Wall Street is Fraud”
Chart of the Day – Wall Street vs. Main Street
In Liberty,
Michael Krieger
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