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The Myth Of Expert Advice - Part 4


"Experts" (people who make it their job to understand and forecast markets or events) are usually no better at their jobs than dart-throwing monkeys. In this series of articles, we examine why these "experts" can be so wrong.

In Part 1, Part 2, and Part 3 of our series entitled "The Myth of Expert Advice", we discovered that "experts", people who make it their job to un­der­stand and forecast markets or events, are usually no better at their jobs than dart-throwing monkeys, and we set the scene for the subprime crisis.

So, what happened???

Well . . . to summarize, we had main street mortgage brokers who had more than enough motivation to get their clients' loans approved, while avoiding any associated responsi­bility from the moment they received their commission checks. Their sole in­centive was to get each loan approved, not to ensure it was ever repaid. We had the banks (NYSEArca: KBE) and other origina­tors who loaned the money to the homeowners, but then resold the majority of those loans to Fannie (OTCQB:FNMA), Freddie (OTCQB:FMCC) and securi­tizers such as Bear Stearns and Lehman Brothers. Their incen­tive was to collect fees upon is­suance of the loan, and to make sure its structure fell within guidelines that allowed it to be resold, thereby eliminating any risk to themselves in the event of homeowner de­fault. Fannie, Freddie and the securitizers then bun­dled the loans and sold them to the end investor, such as pen­sion funds and, inter­est­ingly, banks. Those firms were able to purchase the securities for one reason - they were rated by the NRSROs as investment grade. This begs the ultimate question. If the loans were sub­prime, with many likely to default in the event of a housing mar­ket (NYSEArca: VNQ) collapse, why did the credit agencies stamp them as in­vestment grade? The answer re­quires us to circle back to ex­pose the flaw in the struc­ture of the ratings agency business.

The early 2000s saw credit rating agencies earn an ever-increasing per­centage of their revenues from, as stated by then-SEC Chair­man Christopher Cox in 2007, the "lucrative business of con­sulting with issuers on exactly how to go about getting''[i] top ratings.

So now they had two substantial revenue sources, one from charging issuers to rate their securities, and a second one from consulting with those issuers on how to structure those securi­ties to receive the highest rating. This system resulted in ob­vious conflicts of interest. If your company was looking for a strong rat­ing on a new bond (NYSEArca: AGG) issue, who would you call? . . . A rat­ing agency that's been super tough on you in the past, taking a hard line and likely to give you a low rating based on your per­ceived potential risk? . . . Or an agency that has been "kind" in the past and made things happen? Of course, firms will seek out the rating that reflects most favorably on their business. This re­sults in a "race to the bottom" in the quality of credit ratings, where each rating agency is financially motivated to appease their clients (or potential clients).

The total disregard for ethical business standards and the widespread greed that fueled this overt conflict of interest came into the spotlight in the credit crisis of 2008. The result was that the agencies were not moti­vated to rate the long-term prospects of repayment of the CMOs they had rated, but rather, in their own words, provide ad­vice that constituted a "point in time" analysis.

This financial alchemy worked wonders. According to Inside Mortgage Finance, the annual volume of mortgage securities sold to private investors tripled to $1.2 trillion between 2002 and 2005. The subprime portion of the CMOs rose fourfold, to $456.1 billion.[ii] In the opening remarks at a hearing in 2010, Phil Angelides, the Chair­man of the Financial Crisis Inquiry Commission, stated that:

"From 2000 through 2007, Moody's (NYSEArca: MCO) slapped its cov­eted Tri­ple-A rating on 42,625 residential mortgage backed se­curi­ties. Moody's was a Triple-A factory. In 2006 alone, Moody's gave 9,029 mortgage-backed securi­ties a Triple-A rating. That means they put the Triple-A label on more than 30 mortgage securities each and every working day that year. To put that in perspective, Moody's currently be­stows its Triple-A rating on just four American corpora­tions. Even Berkshire Hatha­way (NYSEArca: BRK.A), with its more than $20 bil­lion cash on hand, doesn't make that grade.

We know what happened to all those Triple-A se­cu­rities. In 2006, $869 billion worth of mortgage securities were Tri­ple-A rated by Moody's. 83% went on to be downgraded."[iii]

The experts at identifying default risk, the rating agencies, failed to see the runaway train barreling down the track.

The examples given here are just a few of the thousands available. The point is that you absolutely cannot rely on ex­perts to guide your money decisions. You must develop your own systematic plan for managing your money.

Experts do provide tremendous value, however. They and their followers push the markets out of line with the real­ity of their true value, presenting you with trading op­portunities.

We will examine why these "experts" can be so wrong in the next and final installment of The Myth of Expert Advice.

This article is excerpted from Myth #13 of "Jackass Investing: Don't do it. Profit from it." by Michael Dever.

About the Authors:

Michael Dever is the CEO and Director of Research for Brandywine Asset Management, an investment firm he founded in 1982. He is also the author of "Jackass Investing: Don't do it. Profit from it.", which is the Amazon Kindle #1 best-seller in the mutual fund and futures categories. John Uebler is a Research Associate for Brandywine Asset Management. Please visit and

[i] Smith, "Bringing Down Wall Street as Ratings Let Loose Subprime Scourge."

[ii] Smith, "Bringing Down Wall Street as Ratings Let Loose Subprime Scourge."

[iii] Phil Angelides, "Opening Remarks" (statement before the Financial Crisis Inquiry Commission Hearing on the Credibility of Credit Ratings, the Investment Decisions Made Based on Those Ratings, and the Financial Crisis At The New School, New York City" June 2, 2010).