Auction Rate Securities Failures Lead to Lawsuits and Deja Vu

Last Thursday, Massachusetts regulators filed a lawsuit against UBS alleging that the bank gave conflicted advice to customers in the auction-rate securities market.  As it became increasingly apparent that the auctions were going to fail when institutional investors started bailing in droves, UBS cranked up the sales pitch to retail customers, attempting to steer them into these "safe and liquid" securities.  Massachusetts has obtained emails where the auction-rate securities were referred to as a "huge albatross" coupled with emails urging managers to "mobilize the troops" to shovel the securities down unsuspecting individual investors' throats.  According to the Financial Times, many more lawsuits related to auction-rate securities will follow.  Anyone who is shocked by these obvious conflicts of interest was more than likely born in the 80's and busy with prom plans the last time Wall Street settled charges for conflicts of interest. 

At the turn of the century we had analysts like Henry Blodget and Jack Grubman.  The former slapped "strong buy" ratings on stocks that he thought were dogs, while the latter rated telecom firms a "strong buy" to get his kids into exclusive pre-schools.  The enthusiastic ratings were concocted solely for the purpose of winning more investment banking business from the companies.  They clearly were terrible investments as nearly all of the stocks that these crack analysts rated as "strong buys" went bankrupt.  Investors were mad.  Regulators produced conflicting emails, and fines were paid.  

When economists talk about cyclicality of markets, they are usually referring to the business cycle.  Investment banking is a cyclical business in the sense that banks typically perform very well when the economy is doing well, and poorly in a recession.  What I find fascinating about Wall Street is that it suffers from regulatory cyclicality as well.  Part of this must stem from the compensation structure.  Bankers, traders, salesmen and analysts are paid extremely well in good times and therefore are easily susceptible to crossing ethical boundaries in order to squeeze the last penny out of their bonus checks.  When you are paid millions of dollars in bonuses over the course of the boom in the cycle, it is much less painful when you are laid off, particularly if the bank ends up paying the fines.  While the good times are rolling, investors are happy.  All of the giddiness grinds to halt when the market turns and investors starts losing their shirts.  They hire lawyers, and file lawsuits.  Regulators don't want to look stupid, so they follow with their own lawsuits and enforcement actions.  Banks appoint scapegoats, fire them, pay the fines and swear they will never do it again.  The slate is wiped clean and the cycle begins again.  Will Wall Street ever change?  Or will we be experiencing deja vu all over again after the next bubble bursts?