Lame man banking

By now, all visitors to this site will be keenly aware of the bankruptcy of Lehman Brothers - the highest profile failure since the US junk bond specialist Drexel Burnham Lambert succumbed in 1990.  Slightly less in the media, AIG have asked the US government for a bailout, indicating significant structural problems, as evidenced by the closure of their offshore arm trading in the UK.

Interestingly, we were receiving marketing materials from Lehman Brothers for their structured investments as late as the afternoon of Friday 12th September.  Their email made it clear that Lehman's proposed sale of a majority interest in their Investment Management Division did not include their UK structured products.  This left me wondering why, so I looked at the technical detail in the brochure for their 'Kickout Performance Plan'.  The text contained the following words: "The Securities will be issued by a major financial institution, with a minimum credit rating of Fitch A+ / S&P A as at 18th July 2008. There is a risk that the Hedge Provider may fail to meet its obligations, or withhold, defer, reduce or even terminate payments, as a result of which you may receive less than you would otherwise or may have to wait for the proceeds. It is you the investor who faces these risks rather than the Plan Manager, Defined Returns Limited."

For the absolute avoidance of doubt, please note that the Lehman Brothers' website, as at 15/09/2008, boasted of the bank's 2008 'A' rating from S&P shortly before this was replaced by a notice concerning the bankruptcy filing.  Thus, minutes prior to filing for bankruptcy, Lehman Brothers would have been able to use their own securities as asset-backing for Defined Returns Limited's 'Kickout Performance Plan'.

Which brings me back to something of an obsession of mine.  What do we do, as financial planners, to help our clients through this kind of mess?

1. We avoid using, as far as possible, the kinds of structured products which evidence the 'interconnections' that we see in the above example. 
2. If the client is intent on using these kinds of investment, then we conduct our due diligence as thoroughly as we can - using Future Value Consultants as a default part of the process, and making our risk warnings obvious, clear and explicit.
3. More constructively, as financial planners we should be emphasising a selection process which focuses on simple, discrete financial products which do not suffer from the kinds of complex interconnections which might come back and cause nightmares at some point in the future.
4. We use these kinds of differences as an essential USP to define ourselves in comparison with the main competition.  The highstreet banks still use structured products with relative abandon - in our experience, rarely factoring in the client's real risk-tolerance.  Here is an obvious way for IFA firms to reposition themselves during periods of significant upheaval.
5. Be proactive!  If we have clients in ASI (or AIG - your call) - write to them immediately with guidance.  Don't wait for the client to contact you.  If the newspaper headlines are all about the failure of major banking institutions or insurers - organise a client seminar to focus on safe alternatives, or risk-reduction strategies - anything to show that you have an informed, considered perspective on such issues, and that you are a 'safe pair of hands' for clients to deal with.
6. And remember - if as financial-planners, we've been careful to avoid using structured products, then none of this mess is our responsibility!  That may seem an obvious comment, but again it helps to distinguish us from the mass of retail markets which appear to function in a manner that is oblivious to potential or actual risks.

All of this crisis, incidentally, has been comprehensively, articulately and scathingly predicted and explained by Bill Bonner and Addison Wiggin in their two books "Financial Reckoning Day" (2003) and "Empire of Debt" (2006).  These books are worth reading, if only because they do very effectively expose the smoke and mirrors nature of the economy - and thereby help us to better protect our clients.

And finally...

What the heck do these S&P ratings actually mean in practice?