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Wednesday, November 13, 2002
If you're in financial services, take a look at More Than Zero, which has a great write-up about the unintended secondary effects of regulation in the brokerage industry. There is a requirement that brokers consider the suitability of an investment for each particular client. In theory, this should mean looking at the client's risk tolerance, tax situation, investment goals (besides making more money), need for current income or capital appreciation, and all the stuff you see in the money magazines. Instead, it meant that there were lists of approved investments at the brokerage houses and investors were funnelled into a narrow set of choices, thereby increasing their risk.

There are a few other things, though, that should be considered. The crash happened after several years of do-it-yourself portfolio building that drained investment dollars from both full-service brokerage houses and mutual funds, which had earlier been the immediate winners from the IRA and 401(k) inflow of investments. In other words, there was comparatively less money available to channel into this small set of approved investments. I should have mentioned this in my previous thumb-sucker on 11/10, because this was driven largely by the dramatic reduction of transaction costs for direct, unaided investment through Internet and other discount brokerages. This frothy investment climate in the late 1990's was what I refer to as a brother-in-law's market, where any damned fool can and does make money and can't stop bragging about it. I'd love to see his COMPLETE set of trade tickets now.

With transaction costs so far down, people were opening and closing positions quickly, with day trading being only an extreme of what was going on everywhere else. Institutions did the same thing. This was no more than momentum investing, which should really be called speculation. Investors, both individual and institutional, were buying things just because they were going up, then hoping to get out before anyone else if things went bad. If they were focused on a small set of equities, I would have said it was voluntary. We all know the names: Henry Blodget, Mary Meeker, Abby Joseph Cohen ... The analysts became stars because they told us what we wanted to hear. No one made us buy JDS Uniphase, CMGI,or

I don't doubt that brokerage lists had something to do with the screwed-up market, but the effect would have been too small to do anything but add to the downhill acceleration.

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