It is a scene that has repeated itself many times on Wall Street to the dismay of all but the profiteers. Financial advisors are once again leading unsuspecting clients to potential financial ruin while reassuring them that their money is safe. This time the product is junk bonds, and already the red flags are waving.
Just as with many products sold to main street investors just before they implode, junk bonds and similar products have recently performed very well for savvy speculators who invested in them when they were much undervalued. The results those investors enjoyed provide fuel for the sale and issuance of the next wave of bonds that are not under-priced and not likely to achieve the same good results. And much if not all of the risk remains.
Retirees and other Americans who have seen their incomes decline in the last year or two while their expenses remain the same are often the targets of financial advisors hawking junk bonds. Retirees have watched their incomes drop through falling interest rates and eroding principal on their investments. Working Americans have seen pay decreases.
To these investors, who now fear the risks of the stock market, high-interest bonds, private REITS, and structured notes appear to answer their need for income without significant risk. But despite the optimistic sales pitches for — and the enthusiasm with which these products are being issued and sold by those who benefit from their sale — they carry significant and often under-disclosed or undisclosed credit and liquidity risks.
Making the sales of these risky products easier for unscrupulous financial advisors is the dual misperceptions that bonds are safer than stocks and that past results are indicators of future results. Junk bonds and similar products are also being sold based on the misperception that banks are not lending, and the loans these bonds represent are the types of loans that banks would make in “normal” times. This sales pitch is flawed in many ways.
As noted recently in the blog Butthenwhat.com: The talk about a lack of credit to small and medium-sized businesses retarding recovery has been largely based on opinion or at best anecdotal evidence. Fortunately, the Atlanta Fed has taken a stab at testing the hypothesis and they come up with some results that call into question the conventional wisdom.
Although there were significant statistical limitations to the Atlanta Feds survey, it concluded that “most going concerns have been able to obtain all or most of the credit they need. What they don’t have are customers.”
Not only is the sales pitch that the credit markets remain frozen a flawed one, so too is the suggestion that these are loans that well-run banks would make in “normal” times. This is highlighted in the recent Wall Street Journal article “Yield Junkies Return to Bond Market.
According to the Journal, companies considered dead a year ago are issuing debt; private, equity-backed businesses are paying dividends using new bond issues called dividend recapitalization deals and others are repaying their existing debt so they can push back maturing debt. But unlike borrowing from banks, the loans from Main Street to these companies via junk bonds “lack the restrictive covenants of loans, which often require minimum liquidity levels, restrictions on spending and other operational metrics,” according to the Journal.
Investors should consider the motivations of the issuers and salespeople who are offering them junk bonds and step back and reflect on what they are doing to get a better return on their investments. They should consider that they are loaning money to a company that may very well be using it to cash out professional investors who came in and bought a troubled company on the cheap. These companies may be using investors’ money to pay off professional lenders, the very lenders who are no longer comfortable loaning these companies money.
Vernon Litigation Group is a Naples, Florida based law firm that represents investors nationwide who are victims of stock fraud and stock losses due to broker fraud and brokerage fraud. Vernon Litigation Group attorneys are experienced in securities arbitration and litigation. The firm is currently representing multiple Lehman structured product investors in FINRA arbitration as well as clients who have been unable to liquidate non-traded REITs, or private REITs.
The firm assists clients attempting to recover losses caused by all manner of financial fraud and negligence. It focuses its practice on complex financial litigation and arbitration as well as business and commercial litigation.
For more information, contact:
Christopher T. Vernon, attorney at law
Susan Healy, attorney at law
email: info@vernonlitigation.com
Naples, Florida