Mum and dad investors cop economic tough love

'Investment safety net', by Chris JohnstonIn Australia we can't lay claim to a financial scam the size of Bernie Madoff's ponzi scheme in the United States.  But we have had our fair share of financial disasters that have affected thousands of mum and dad investors. Westpoint, Opes Prime and Storm Financial have ruined many people.

The Australian media has been flooded by stories of individual investors adversely affected. Some have lost their homes. Many must rely on the aged pension rather than the comfortable retirement they had planned. Some retirees have been forced to return to work.

Most of the media coverage has skirted around the fact that the Storm Financial investors were expecting to increase their wealth exponentially by investing with money they didn't have and couldn't afford. There seems to have been almost a sense of entitlement to amass wealth out of proportion to one's financial standing. This is echoed in the corrupt activities of former Queensland minister, Gordon Nuttall. 

Following this materialistic version of the 'fair go' spirit we have reacted to this devastation as we do to other disasters. We demand that the government bail out the hapless investors and look to regulators and financial institutions for compensation.

In the Storm Financial case we expect that investors, many owing more than what their share portfolios are worth, will be compensated by the financial institutions that provided the mortgages and margin loans.

In the United States it is different. There, investors have been hit, not just by Bernie Madoff, but also by a string of other collapses. Although in the Madoff case many investors were extremely wealthy, many were also mum and dad investors. Many have seen their life savings and retirement funds disappear. As in Australia, homes have been lost and retirees wrenched out of retirement.

But even though the SEC was clearly inactive and had failed to act on complaints it received for years about the Madoff operation, there isn't a loud chorus calling for government bailouts.

In some cases, the investors have access to the Securities Investor Protection Corporation, a compensation scheme for investors caught up in brokerage firm failures. But the anger and sense of betrayal rightly felt by investors has been directed against Mr Maddoff himself, his wife and family and, more recently, against his trustee in bankruptcy.

Judging by the stories in the media, people in the United States expect personal responsibility for investment decisions. They express guilt, anger, disbelief and heartbreak but rarely claim that investors didn't know what they were doing or that the government should have somehow prevented them from entering into their contracts.

In this free market world, your investment decisions are your own. An investment ethos of tough love balks at taxpayer subsidies for anyone foolish or unlucky enough to make the wrong investment decision.

The response even to the large scale predatory lending practices that led to the sub-prime mortgage crisis and the GFC was unsympathetic. If you bought a house with money you didn't have and couldn't afford, of course you were going to lose it. Those who did are seen to have gambled on the property market and lost. That the odds were stacked against them from the start was not reason enough for the government to make good that loss.

In Australia we prefer to see people as victims. We do not expect they will exercise even basic common sense when they enter into financial transactions. A fair go means you must have a safety net when increasing your wealth. Our calls for government bailouts and compensation cement our perception of mum and dad investors as financially illiterate children. The parent government is required to rescue people and to clean up the mess.

We won't be able to stop financial collapses from occurring and dragging mum and dad investors down with them. Bt we can reduce their likelihood by improving the financial literacy of investors and by making it clear that there is no safety net. A bit of tough love, after the style of the United States, might be the answer.

Catherina TohCatherina Toh is a lawyer specialising in legal and regulatory compliance for the financial services industry. She is based in Melbourne.

Topic tags: global financial crisis, sub-prime mortgage crisis, bernie madoff, ponzi, Storm Financial, Gordon Nuttall



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Existing comments

This is all well and good, I suppose, as long as mum and dad were not misled and/or not given all the facts...sometimes, I think, 'tough love' means turning a blind eye. Tough love is not passive compassion...
Andrew | 03 August 2009

Tough love isn't justice either. The government, which most people trust, encouraged the 'bubble economy' and the belief that the economy could be managed to be always growing and prospering. Would tough love mean running things so that 30% of the population could live lives of unimaginable wealth, luxury and glamour, while saying to another 30% "Sorry, you're poor, despite all those advertisements telling you to buy it 'because you're worth it - you're not worth it". Too bad.
Russell | 03 August 2009

Thanks Catherina for a very useful contribution to the ongoing debate about the role of government in supporting individuals in need. In Australia, as you point out, we have tended to look to government to wipe away our tears, even when those tears are the result of taking on high risk in the hope of high return. We like to privatise the profits, but shift the losses on to other taxpayers.
David de Carvalho | 03 August 2009

Catherina, You make some good points, but you are a pretty tough lady!! Surely, if someone is selling a flagrantly bogus investment ie as you say one that cannot possibly make money, and to people who demonstrably cannot afford it, or indeed understand it,then that is fraud. And the community, through the government, does need protecting against carnivorous financial spruiksters who dewp unsophisticated people...and if the government fails to do their regulatory job, then yes...those poor people should be compensated. There should also be a scheme funded by the reputable financial services industry to indemnify against their more crooked co-freres and that would be a way of the industry itself taking an interset in keeping out the patently fraudulent...because sophisticated insiders do know about these people!!
Eugene | 04 August 2009

For an educated individual, Catherina seems to have missed some very important details.

1. Storm investors were seeking 'average market returns' ... not more, not less, and certainly not 'exponential'.
2. Mum and Dad investors who didn't know any better sought professional help (and paid dearly for it) for securing their financial futures.

3. Australian banks are as guilty as their US counterparts for "sub-prime" lending practices.

4. Given that Catherina is a lawyer specialising in regulatory compliance why was margin lending left as an unregulated product for so long? Why was the sub-prime lending practices allowed to be maintained without compliance audit detection for so long?
Luke Vogel | 04 August 2009

An interesting article and comments to go with it. Surely there are two cases to be considered? If an investment has been sold in such a manner that its expected range of customers are not able to make a competent judgment on the risks they are taking on then there is an element of deception involved that ought to be regulated for and prevented with the concomitent penalties. Possibly some form of compensation is appropriate for victims of the deception - although I doubt the ethical finance industry would want to fund it as one commentator suggested.

However, where the investment risk is fully disclosed and people are capable of making in informed decision, then they take on both sides - up and down - of the risk and should not expect compensation nor retribution if their expectations are not met.

The key element is financial literacy of investors as Catherina says in her closing remarks. This is a subject for both the industry and government to tackle.
Richard Wilson | 04 August 2009

Ms Toh confines her comments to Storm et al, but the real issue
is the GFC where millions of people lost their savings, not their 'bets' on unaffordable homes or investments. Financial relief to these people who are the majority of unfortunates is not aid to "illiterate children".
Brian Larsson | 05 August 2009

Investors not understanding basic economics is akin to a businessman not understanding book keeping so that sadly while investment by some is considered to be like gambling pot luck many more fools will be parted with their money. To avoid the worst excesses governments have to be vigilant over their watching responsibilities. Australia has thankfully gone part of the way as part of their microeconomic reforms so as to avoid some of the more adverse aspects in the US; where reactionary forces have had too much sway for too long.When investment is carefully planned and risks correctly weighted the whole of society is benefited. More discipline is required of investors, authorities and professional associations to achieve this.
Stephen Coyle | 10 August 2009


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