To the ever-patient shareholders of Sophocles Value Fund:
I recently wrote to you bemoaning the lack of investment opportunities since the subprime mortgage crisis leveled every market outside of US Treasuries.
Now we’re ready to start nibbling at some common stocks and convertible preferred shares that seem to have been beaten down to less than their intrinsic value.
That presents us with a new problem: Which Wall Street firms can we trust to handle our investments? Morgan Stanley? Citigroup? Merrill Lynch? Goldman Sachs?
The quick answer seems to be: none. Big-name firms hawked mortgage securities backed partly by loans so risky that they eventually saddled investment banks with losses totaling more than $500 billion.
Clearly, the subprime business was out of control. The bosses at UBS AG, Lehman Brothers Holdings and the rest hadn’t a clue. The only people who knew what was going on were the traders themselves and the risk-management people, according to Robert Rubin, Wall Street veteran.
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I guess that will have to serve as an excuse for the industry. The whole investor populace seems to have gone naive, too. Who could have predicted that 42 per cent of subprime loans underlying mortgage bonds sold in 2006 would be delinquent on Thrusday, which is what Standard & Poor’s reported last week.
Following the warnings of Ernie Nicker, our chief trader, we were smart enough to avoid mortgage securities. But we did buy Merrill Lynch stock late last year after Temasek Holdings, the Singapore government investment fund, bought a $5 billion stake. Ernie figured that deal and the sale of equity by other firms signaled a bottom of the subprime debacle.
Not so. Merrill shares kept falling. Merrill recognised Temasek’s losses, giving the Singapore company a break when it later bought more shares. Ernie and your fund weren’t so lucky.
Wall Street proved no more trustworthy in the peddling of auction-rate debt, where the interest rates reset every so often. State regulators and the Securities and Exchange Commission have alleged that the banks told investors the securities were as liquid as cash.
In February, the market for the securities froze. Eight of our finest institutions, including JPMorgan Chase & Co. and Wachovia Corp., have settled the allegations, agreeing to buy back debt and pay fines.
Ernie tells me none of this should have surprised me. It wasn’t long ago that Wall Street was caught publishing phony stock research and letting favored chief executives in on hot initial public offerings. Mutual funds, the refuge of small investors, let some big investors trade after hours to the detriment of the little guys.
The gloating on Wall Street after the fall of New York Governor Eliot Spitzer had less to do with his hiring a hooker than his pursuit of the banks when he was the state’s attorney general. Ernie and I still think there are some bargains out there. To execute our orders, we’ll just have to hold our noses and call some brokers.
Imus Keepup, Manager, Sophocles Fund (David Pauly is a Bloomberg News columnist.)