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Financial crisis hits the small investors most. By Tan Kin Lian.

Protecting the small investors

Tan Kin Lian / Columnist

Lehman Brothers filed for bankruptcy on 15 September 2008. Together with the problems faced by Merill Lynch and AIG, this event caused a sharp drop and turmoil in the global stock markets.

Many conservative investors in Singapore thought that this was a problem only for equity investors. They were in for a bigger shock.

Credit linked securities

These investors had been convinced by their bank relationship managers to invest their hard earned savings in credit-linked securities, such as the well advertised Mini-bonds, Pinnacle notes and High Notes. These securities offered a higher rate of return, compared to the 1% interest on fixed deposit.

The relationship managers told the investors that these securities have relatively low risk, as they are linked to several strong financial institutions.

The relationship managers did not explain the working of the credit linked securities. They probably did not understand anyway. These structured products were so complex to be incomprehensible, even to the experts.

The structure was described in unclear terms in a prospectus and supporting documents, comprising of more than 100 pages. Many of the key explanations were presented in small print.

Several hundreds of millions of dollars were invested by these conservative investors in the credit linked securities.

Unwinding the structure

When Lehman Brothers went bankrupt, the credit linked securities managed by them had to be unwound, according to the terms of the structure.

The investors were told that several of the credit linked securities had no value. The investors had lost nearly all of the capital that they had invested.

Investors in credit linked securities managed by other investment banks wanted to get out now, before they face the same fate as the Mini-bonds.

They were not that lucky. The Pinnacle Notes managed by Morgan Stanley now have a market value of only 35%. 65% of the principal has disappeared.

Bewildering

Many of the investors were dumbfounded and bewildered. They thought that they had invested in safe securities. They were assured by the relationship managers that these securities were very safe.

What happened? Even the risky stock market fell by only 40% during the past year. Why should these safe investments lose all of their capital? Where did their money disappear to?

If their losses exceeded those of the underlying assets, who profited from their misery? Are there any winners in this episode – people who made gains on the losses of the hard earned savings?

Protecting the small investor

Two months ago, the New York State Attorney took action against several financial institutions for marketing the "auction rate securities" to retail investors on the representation that they are liquid investments and can be redeemed at any time.

During the liquidity crisis, these securities could not be redeemed. The financial institutions had to buy back these securities at no loss to the investors.

I hope that the Monetary Authority of Singapore or the Attorney General can take similar action on behalf of retail investors in Singapore, who had been misled into investing in the Mini-Bonds and similar structured products. These investors were clearly misled by the relationship managers into investing in these products on the advice that these investments were safe.

It is time to hold the financial institutions accountable for their mis-selling activities and for our regulators to be pro-active.
Views of the Public

I posted my call to MAS in my blog www.tankinlian.blogspot.com. I received many views from my readers. Here are some of these views.

David said...

I bet MAS won't do that. Singapore laws are and will be pro-business, pro-rich, pro-foreign talent and not pro-ordinary local folks. That's why "talent", capital and investment flows readily here and with high economic growth and as a financial hub. Never mind the wide income gap or even suffering for ordinary folks.

Melvin said...

I am not a risk taker. Recently I was convinced by fund manager to put my money in mini bond series 9.

I invested $150,000 and I do not know how Lehman Brothers involved in this series 9. I was told by her it only based on 6 baskets which I found to be okay. Will I be getting some money back or nothing?

ym said...

These Mini-bonds are effectively hidden credit-default-swaps - the instrument that brought AIG to their knees. Even AIG, as a sophisticated insurer misjudged the risk. How about the general public?

Ordinary citizens were sold on the premise it was a safe bond, but its not. Effectively, the investor has become an insurer of the credit of the reference companies in return for 2% more interest. The public should never sell these products because they cannot evaluate the risks, and they evidently cannot rely on the marketing banks or credit-rating agencies to do it for them.

mx said... I feel that consumers have too an onus to find out for themselves what products they are getting instead of placing total blame on the financial institutions who sold them the product.

I am very sure that the prospectus or factsheet would have mentioned that there is a chance that the instrument may have risk of becoming worthless. It is $10,000 or $100,000 that they are investing here.

Won't be it very silly to listen to some relationship manager about where to put their money without reading or finding out the risks themselves? You are responsible for your own money, and should not go about blaming others when you lost the money.

Conclusion

Over the past year, I have posted many warnings in my blog about the risks of these credit linked securities. In my view, the return on the product does not commensurate with the risk. I feel that consumers are given a raw deal.

I am surprised that MAS allowed these products to be marketed to the retail public. I hope that MAS will now take pro-active action to help these retail investors minimize their losses.

Tan Kin Lian also blogs here.

Picture from Reuters.