I am the son of a plumber, who was the son of a plumber. My wife gives me a bemused look when I go off to fix a plumbing problem, usually minor, when she asks, “Can you do it?” and I say, “Son of a son of a plumber.” Truly, my statement means nothing, though I worked with my Dad for two summers that I enjoyed a great deal. He installed sewers all over southeastern Wisconsin, and was known for doing quality work. He never got sued once in his 35-year career.
So, I can appreciate plumbing. Most of us never think about it. Open the spigot — water! Flush the toilet — waste gone! Simple. Beautiful. As my Dad, a happy man, would say, “I have brought civilization to southeastern Wisconsin.” A good man, my Dad.
Figuratively, plumbing exists in many areas of life. People don’t want to think about the mechanics of how something works; they just want it to work when they need it. More people drive cars than are mechanics. More people listen to music than can sing well. (I love to sing.)
The sad aspect of plumbing for the financial markets today is that we are drawn to the front end of investing processes. This man looks successful. He has a great story; a way to make money that others do not know about. There are documents showing his track record — impressive, though he doesn’t solicit publicly; investing with him is a family affair. Do you want to be part of the family and gain the benefits thereof?
There are questions to be asked, particularly of nonstandard ventures:
- How are the returns earned?
- Who checks the results? (Auditing — should not be a small firm.)
- Who has custody of the assets?
- Is the trustee a reputable third party?
- Is liquidity proportionate to the asset class invested in?
- Is this under US law?
- Do the returns look too good to be true, either in absolute amount, or always positive with low volatility?
- Is this marketed to everyone, or just a select few suckers?
- Is the profit motive of the sponsor obvious and standard?
- How are asset values calculated each accounting period?
Whether we are talking about Madoff, Stanford, or any of the other recent frauds, an attention to the details of how the financial plumbing works can pay off in terms of avoiding situations that are too good to be true.
When the next bull phase comes, be aware, and avoid slick talkers who have a good private game going, unless it can be verified by many competent independent third parties. The bear phase is here now, revealing the slick talkers, and those that were taken in by them. Be aware; you are your first and best line of defense.