In the wake of the subprime meltdown, numerous reports have detailed the manipulation and predatory tactics employed by brokers and others who sold unsuitable mortgage products to those who ultimately couldn’t afford them.
No doubt some borrowers knew exactly what they were doing, and have only themselves to blame for decisions that went bad. However, in many cases, it turns out that prospective home buyers and refinancers were not worldly-wise, or found it hard to understand the intricacies of modern day mortgage lending.
As a result, they relied on the advice of the brokers, many of whom did little to dissuade clients from believing they were impartial experts. Adding to the confusion was the fact that they were often introduced by real estate brokers, suggesting that they had been vetted in some way.
In reality, the majority were nothing more than commission-based salespeople who stood to benefit from originating lots of loans, with the most lucrative deals — that is, the riskiest from the point of view of the borrowers — offering the highest payouts.
Conflicts of interest are rampant in the financial services industry. More often than not, they are unavoidable, but that does not necessarily mean they are bad. The real problem is when such conflicts are left unsaid, papered over in some way, or actively hidden from view.
Unlike in some retail businesses, for example, where you know the person behind the counter is there to sell you something, the financial services industry is full of smoke and mirrors. Firms that operate in this space are notorious for trying to keep this aspect of the relationship out of the realm of consciousness.
That is why, for example, many mortgage brokers, payday lenders, and stockbrokers — and the firms that employ them — like to call themselves “consultants,” or “financial advisors,” or “relationship managers.” That gives the impression they are mainly interested in looking after your interests and are there to help you achieve lasting prosperity.
But compensation structures usually belie that. If intermediaries are paid on the basis of turnover, like mortgage brokers and stockbrokers, they generally benefit when you transact, regardless of whether it really makes sense from your perspective. Although they may be genuinely sympathetic to your needs, if you prefer not to buy (or sell), they would prefer that you go elsewhere.
This perspective invariably colors their recommendations, regardless of whether they have high ethical standards or are subject to rules regarding fairness and suitability, as stockbrokers are. Like it or not, a commission-driven structure naturally favors investments that offer the highest rewards.
It also favors those who generate the highest turnover, who may just be individuals who are very good at manipulating others.
Although common in the financial services industry, the mirage of benevolence is also employed in other settings. High end automobile retailing, for example, makes ample use of this smokescreen. Salespeople paint themselves as experts on the technical characteristics and design features of the luxury cars that are on offer, and they convey the sense that they are mainly there to please their discriminating clientele.
However, if prospective buyers might be better served by going elsewhere, most of these salespeople won’t give them that advice. And if they can't convince enough prospects to sign on the dotted line, their technical competence and empathy for the customer won’t be worth all that much while they are standing in line at the unemployment office.
The point is that most transactions that are framed as advisory are in fact straight-up sales relationships, where an individual is getting paid for making something happen, often by somebody other than the customer.
Given that, the next time you are talking to a salesperson — er, financial advisor — and he or she tells you one thing or the other is the “best” option, it might be a good idea to first figure out which types of investments benefit the broker most. Then try to ascertain how the money from the sale eventually finds its way into his or her pocket.
It might just help you avoid being stuck with the "best," but ultimately the most unsuitable and costly option.
Comments