25 Years and Then Some...

From Carter to Obama and a Sense of the 'In-Between'

The events of this very day and the commemoration of the 25th anniversary of the October 19, 1987 stock market crash gives impetus to the reflection of those of us who were there then and are alive to talk about it now with decades of perspective in hand.

THE EVENTS OF THE DAY

This evening, Americans in an uncertain number will watch the final of three presidential debates between incumbent Barack Obama and his challenger Mitt Romney. Pundits and historians both have highlighted correlations between Carter and Obama; the former presided over a morose economy and evidently was incapable of turning it around. Historians have saddled Carter with a legacy of a disastrous foreign policy despite certain accomplishments. Those paying attention see the current president's term as a sort of Carter Déjà 'vu. Never mind the 'why-fors.'

Today, Why I Left Goldman Sachs; authored by one Greg Smith, is being released at your favorite book store and online. Smith, a former mid-level 'deal-maker' that reportedly earned a half million dollars a year, created quite a stir when he submitted his story, as an op-ed, to the Wall Street Journal. The author claims the book is not meant to be a tell-all expose but rather a composite lesson meant for unwary investors. I haven't read it but critics and insiders are dismissive. Go figure.

What may overshadow both of the above is the Monday Night Football contest between the Chicago Bears and the Detroit Lions. What could be more symbolic? The president's hometown team doing battle with the city whose major industry he saved, or some say rescued, is likely to dilute the viewing audience of what is indeed a crucial debate for both men.

STARTING POINT

Ronald Reagan swept the November election in 1980 over Jimmy Carter by taking 44 states and 489 electoral college votes - a landslide. Reagan began is eight-year stay in the White House in January of 1981, the year I began my career as a stock broker with a blue-chip regional firm. The Dow Jones Industrial Average had spent 70s below the 1,000 mark and the economy had been languishing for nearly the previous decade. Back then, there weren't such things as Investment Advisors, Certified Financial Planners and other so-titled financial professionals. We were stock and bond brokers, and proud of it.

Mutual funds were just beginning to come into vogue. The old pros, our mentors then, looked upon packaged products and funds as cop-outs or short-cuts and were dismayed with the burgeoning proliferation of such. They believed that if someone wanted to be a member of their community, they had better know how to pick a stock and value it properly. The same was true of bonds.

Warren Buffet's publicly-traded Berkshire Hathaway shares traded in the open market for around $2,000 a share. My brother and I discussed putting our resources together with the purpose a buying a share. With our careers just underway neither of us felt we could afford to do so. On this Monday morning, that same share, yes one share, is trading at $133,222 each. We could have each at least put one of our kids through college, maybe one and half kids.

WALL STREET INGENUITY AND PACKAGED PRODCUTS

It was in the late summer of 1982 that the stock market and the economy began its upward climb. Wall Street kicked into high-gear. There are very smart and creative folks out there and one thing the industry has been particularly good it is creating concepts, products and financial advantage or at least the perception of it.

Do you remember Collateralized Mortgage Obligations or CMOs? They 'hit the street' sometime in 1983 and were to be the answer for investors to benefit from falling interest rates. Essentially they were complicated instruments comprised of a pool of mortgages that were purchased by Wall Street firms from their issuers, the mortgage lenders. Segregated into tranches of varying risk, CMOs took on a life of their own and were placed first in the hands of institutional investors such as pension funds and large foundations. It didn't take long though for Wall Street to sense as great an opportunity to create retail CMO products for distribution to individual investors as well. This despite the inherent risks embedded in them:

                Prepayment Risk | Interest Rate Risk | Reinvestment Risk |Default Risk

Brokers were paid well to place these investments with their clients.

A few years later, the now defunct Wall Street firm of Drexel Burnham Lambert introduced Collateralized Debt Obligations or CDOs. Similar to their predecessor CMOs, CDOs were complicated baskets of debt obligations, once again carved into tranches or varying degrees of risk. If you don't have the recollection of Drexel et al in particular, you might recall the name, Milken. Michael Milken is widely associated with the ever-popular Junk Bonds that were issued regardless of credit worthiness. These were used largely to fund mergers and acquisitions of the late 80s that culminated in the October 19, 1987 stock market crash, a crash of greater breadth and depth than the October crash of 1929. Milken, by the way, spent some time in the slammer later for various securities violations.

BEYOND THE CRASH OF '87

Those who were in the business on that October 19th date twenty-five years ago haven't forgotten it. They likely remember exactly where they were and how the Dow's free fall impacted them and their clients. Some brokers took their own lives, jumped out of windows. My guess, and it's an unfounded guess, is that those who lost the most money for their clients were those who made an extraordinary amount of money selling packaged products and the latest ingenious financial tool Wall Street had to offer. For this, Wall Street is not entirely to blame. I hold equally as responsible unscrupulous brokers, purveyors of promised high returns and investors themselves that did not take the time to carefully examine and understand what they were investing in.

THE DEMISE OF GLASS STEAGALL

The Banking Act of 1933, more commonly referred to as the Glass-Steagall Act, came into being following the stock market crash of 1929. Its intent was keeping banks from intermingling their lending operations from underwriting and selling far-riskier things like stocks.

Beginning in the early 60s however, banks and brokerage firms began to court each other once again. Thirty years later, Bill Clinton deemed the Glass-Steagall Act irrelevant for modern society and backed the bill to render it so with the Gramm-Leach-Bliley bill of 1999. With virtually all barriers removed, banks moved aggressively to participate by acquiring money management firms, brokerage companies and investment banking operations. It took only seven years for the sub-prime mortgage crisis to unfold and unfold it did. Connect the dots.

FIGHTING BACK

No one individual or administration is responsible for this. The financial markets have managed to rebound in significant ways for more than 200 years now. There are many who believe that will be the case today and in fact, if you separate the stock market from the economic reality, you'd have to admit that the stock market has done quite well since Mr. Obama took office.

What I find so interesting, however, is that given the 25 to 30 history we've consolidated here, we can't seem to uniformly grasp that capital formation and investment in entrepreneurs and those willing to invest with them has always been the precursor to a better economy.

I noticed a You Tube video on LinkedIn the other day posted that made a good attempt of explaining why Mr. Romney's 14% tax rate, given his capital investments in less than three minutes. Whether you agree with the overall purpose of LinkedIn or not, another person who evidently also viewed the video complained by inference that it had been placed on the sight for political reasons. He didn't think it should have, saying, " I truly hope the next 30 days on LinkedIn stays about business and networking."

Tax rates are integral to business, perhaps not to networking so much, but the day we separate one from the other, as of no consequence, may be the day we're all essentially working for the government. Heck, we're only five or six months a year away from that anyway!

So that's what I've been thinking about this Monday, the Twenty-second of October, Two Thousand and Twelve.

Jim Naleid is a Life-long Entrepreneur, Change-Agent and Thought Leader, Managing Director of Naleid & Associates and Regional TEC (“The Executive Committee”) Chair leading a group of executives to become Better Leaders, Making Better Decisions with Better Results. http://www.linkedin.com/in/jimnaleid