More On Legal & Compliancefrom The Advisor's Professional Library
- Client Commission Practices and Soft Dollars RIAs should always evaluate whether the products and services they receive from broker-dealers are appropriate. The SEC suggested that an RIAs failure to stay within the scope of the Section 28(e) safe harbor may violate the advisors fiduciary duty to clients, so RIAs must evaluate their soft dollar relationships on a regular basis to ensure they are disclosed properly and that they do not negatively impact the best execution of clients transactions.
- Agency and Principal Transactions In passing Section 206(3) of the Investment Advisers Act, Congress recognized that principal and agency transactions can be harmful to clients. Such transactions create the opportunity for RIAs to engage in self-dealing.
Editor's Note: This column, published as "Who's Kidding Whom?," won a 2014 Excellence in Financial Journalism Award from the New York State Society of Certified Public Accountants (NYSSCPA).
Bubbles can be dangerous in both finance and politics. In markets, the bubble metaphor typically refers to overblown enthusiasm for a particular asset class or sector.
Examples range from 21st-century real estate and Internet bubbles back to long-ago episodes such as the South Sea Bubble that capsized investors in a British trading company in 1720.
Bubble terminology can signify much the same thing in politics as well—excessive confidence in a candidate, idea or institution.
The rapid rises and falls of contenders in the 2012 Republican presidential primaries had such an effervescent quality. ABC journalist Matthew Jaffe defined a “Bubble Primary” as “a race in which candidates’ values become artificially high before inevitably deflating back to their intrinsic values.”
Discussing European integration in a speech last year, George Soros said “the European Union itself is like a bubble,” something that once enjoyed a “boom phase” that was “unreal but immensely attractive,” but which now faced instability amid the euro-zone crisis.
In politics, though, the bubble metaphor often has a different wrinkle, referring to being insulated from feedback and evidence. Presidents, for example, are sometimes said to live in a “White House bubble” in which they are surrounded by deferential aides and lose touch with the concerns of ordinary Americans.
Both types of bubble metaphor—the bubble as inflating unsustainably, and the bubble as thick or opaque—have an underlying similarity in that they involve perceptions being distorted; moreover, in both cases, a rude awakening occurs when, sooner or later, the bubble bursts.
Since the November election, there has been increased discussion of a “conservative bubble,” whereby pundits and activists on the right rely excessively on shared ideology and shared information sources. (This criticism sometimes uses other metaphors, such as “cocoon” and “echo chamber,” but these convey essentially the same point.)
Such a bubble seems to have shaped expectations among some conservatives that Mitt Romney was going to win—and even win in a landslide—despite polls indicating he was likely to lose. A conservative following grew around UnskewedPolls.com, a site that purported to uncover polling bias. “All the vibrations are right,” Wall Street Journal columnist Peggy Noonan wrote just before the election, predicting a Romney win.
At this point, I should make some disclosures. First, I too predicted that Romney would win, back in the August issue of Research, taking a position contrary to that indicated by polls and prediction markets at the time. My reasoning, that the October debates would give Romney a decisive boost, later seemed prescient, but not for long.
Second disclosure: In retrospect, some wishful thinking surely was involved in my prediction, as I am a longtime Republican who voted for Romney.
Third disclosure: During the Obama presidency, I have been one of those internal GOP critics—sometimes derided as RINOs or Republicans In Name Only—who argue for the party to move more toward the political center. A prominent proponent of such a stance is CNN and Newsweek commentator David Frum, with whom I’ve collaborated in blogging ventures.
Having said all that (and, I hope, helped readers take my biases into account) let me now suggest that indeed it’s true: There is a conservative bubble, or tendency to disregard or distort information that doesn’t match conservative desires and expectations. Let me suggest as well that such a tendency is not unique to conservatives, but also afflicts people belonging to other ideological persuasions and interest groups.
Consider Romney’s widely noted comments, leaked from a fundraising event, about the “47%” as a group that “will vote for the president no matter what” and “are dependent upon government” and “pay no income tax.” His remarks conflated several distinct (though overlapping) groups, overlooked that some GOP voters also pay no income tax and/or receive government payments, and ignored that people with zero income tax liability may still pay the federal payroll tax and various other taxes.
Romney’s campaign was buffeted by the leak. What he had said was inaccurate and—once exposed to a wider audience—impolitic. However, it also reflected a line of thinking that had gained momentum in conservative circles—in particular, a celebration of the “53%” (who pay income taxes) as a counterpoint to Occupy Wall Street’s claims to represent a supposedly victimized “99%” against a supposedly culpable “top 1%.”
Occupying a Bubble
So, Romney’s comments were a product of the conservative bubble—but that was not the only bubble involved in their genesis. Occupy Wall Street was a bubble, too. Indeed, that protest movement conformed to both types of bubble metaphor: the rapid, enthusiastic expansion that can’t be sustained; and the insularity of relying on dubious information.
Occupy’s animus against the top 1% of income earners, for instance, obscured who was actually in that percentile. From movement rhetoric, one would have thought the pinnacle was crowded with bankers. Yet one academic study, using 2005 tax data, found that financial professionals accounted for just 13.9% of the top percentile, lagging behind medical professionals (15.7%) and non-financial executives (31%). A category called “Blue collar or miscellaneous service” had a 3.8% share.
Leaving aside such technicalities, in retrospect it also seems the protestors occupied a bubble in thinking that their encampment-based movement, intensely anti-capitalist but vague in its demands, would enjoy lasting popularity and attention.
Wall Street’s Bubble
Many in the financial sector, including financial advisors, were blindsided by the rise of Occupy Wall Street. One reason for this may be that, if you work in finance and spend much time in financial circles (or with clients who tend to be satisfied with your performance), it is easy to misread broader public opinion about finance—and in particular, to underestimate popular dislike and distrust of the sector.
As an antidote to such a possible bubble, let me cite a few poll numbers. A June 2012 Gallup poll found that Americans’ confidence in banks had fallen to a record low, with only 21% saying they had “a great deal” or “quite a lot” of confidence in banks, while 35% said they had “very little” or “none.” By contrast, the positive responses stood at 53% in 2004.
A December 2012 Gallup poll asked respondents to rate the honesty and ethical standards of people in different fields. Stockbrokers fared poorly, with just 11% rating them “very high” or “high” while 39% said “very low” or “low.” That put brokers in a dead heat with advertising practitioners and ahead of only two other categories: members of Congress (10% very high or high) and car salespeople (8%).
Nurses, by contrast, were the top-ranked profession, getting 85% positives. Bankers (28%) were behind chiropractors (38%) but ahead of journalists (24%).
Remember such numbers in the future when you see politicians, regulators or demonstrators take an oppositional stance toward financial services industries. In so doing, they are tapping into a rich vein of popular discontent.
Being open to disagreeable information can be a valuable asset in politics, finance and more. Beware of bubbles. The one you need to worry about may be your own.