An Object Lesson in Investing

Every year, ordinary Americans put billions, indeed trillions of dollars into Wall Street. Even if we do not directly own a single share, our pension funds and our insurance companies pour our money into the financial markets that are, as we are often told, the secret of our success as the world's largest economy.

Adam Smith, the father of modern economics much-quoted by conservatives, once said, "People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices." It's a description that fits today's Wall Street to a tee.

They may not be the evil capitalists favored by those Soviet cartoons of yore, sitting in smoke-filled rooms in their top hats. They may not be scheming to take over the world, as some in the anti-globalization movement would have you believe. But the current workings of the finance industry are, in sum, a giant conspiracy to loot ordinary investors for the benefit of its members and their friends.

The sources for my paranoia on this point are not loony Leninists, but the financial sections of major newspapers. The Wall Street Journal and the Financial Times look increasingly like a cross between the National Inquirer and a criminal court docket, with Captains of Finance pictured daily doing a perp walk across their pages.

While adding the throwaway caveat that there are many sincere and honest people in the finance sector, we should note that in order to stay honest, they almost have to buck the system. To prove my point, let's trace the progress of your hard-earned dollars through the financial food chain.

Let's say an unwitting investor goes to a broker, who then recommends a mutual fund. Hitherto regarded as unassailable, the mutual fund's virtue is now under question thanks to the investigation launched by New York's attorney general Eliot Spitzer. To begin with, your broker may be receiving kickbacks from the fund managers for steering you in the "right" direction. So your money is going to the fund that gives the broker the best returns rather than you.

To add insult to the proverbial injury, not all investors are made equal in the eyes of a mutual fund. They often offer special deals to major investors, who are allowed to trade after the markets have officially closed for the day. It's a bit like allowing people to bet on a horse race after the winners have gone past the finishing post.

The funds are also tied to the brokers' interests in other ways. The "sell-side" of brokerage firms is made up not just of stock sales teams, but also of analysts. These so-called independent researchers recommend which companies to buy -- always an overwhelming majority of those on offer -- and which to sell, a number that is all too frighteningly small.

There is usually a strong correlation between "buy" recommendations and whether or not the brokerage house has a stake in the contract for new stock issues -- or hopes to acquire one in the future. While analysts are supposed to be protected by a "Chinese Wall" from such temptations, bonuses and commissions often make up a large part of their remuneration. I have spoken to several who confess to netting $100,000 for making one phone call.

Many mutual funds took a beating in the last two years because they followed the sell-side analysts' recommendations and pumped their money into the bubble stocks that were being touted by the brokers and bankers. It is the average investor, however, who paid for their abysmal performance. The mutuals either took a percentage of your money up-front, or charged you a management fee for losing your money.

Here are your choices then. Invest in a mutual fund or invest in the companies recommended by your broker -- and in either case end up as a victim of the same bad advice.