Five Dumbest Things on Wall Street: Aug. 22

Money Back for Being Stupid

The auction-rate securities debacle has dumb written all over it.

Dumb are the banks that allegedly tried to cover up failing auctions by supporting them with bids. Dumb are the brokers who marketed long-term bonds as having guaranteed short-term liquidity. Dumb are the regulators who waited until the ARS market froze to threaten action against such marketing and sales tactics.

But perhaps dumbest of all are the investors who poured cash into securities they didn't understand. Lucky for them, some $57 billion worth of stupid investments will be unwound by Wall Street firms, thanks to settlements or blunt-force pressure applied by state regulators and the Securities and Exchange Commission.

Merrill Lynch(MER Quote), Goldman Sachs(GS Quote) and Deutsche Bank(DB Quote) on Thursday settled with New York Attorney General Andrew Cuomo, agreeing cumulatively to buy back up to $14.5 billion in securities they had sold to retail investors and pay $162.5 million in fines.

The deals follow earlier agreements by Citigroup(C Quote), JPMorgan Chase (JPM Quote), Morgan Stanley(MS Quote), UBS(UBS Quote) and Wachovia(WB Quote).

All of this begs the question of who should be responsible for unwise -- or unlucky -- investments. It would be fair to spread the penalties for such wanton stupidity equally, but so far only the banks, institutional investors and high-net-worth individuals have taken a hit.

Smaller investors and charities, however, apparently don't need to be accountable for failing to read the fine print and making bad choices.

Financial firms obviously should have been more careful about their marketing and sales practices, but if their tactics were imprudent -- or illegal -- regulators should have cracked down before the ARS market dried up. The accountants sounded a warning, if only anyone was willing to listen.

Alarm bells also should have gone off in investors' minds when they were told that the securities were cash equivalents. Just because auction-rate securities once traded like cash doesn't mean market conditions will always allow for that liquidity. While banks once provided backup support for the auctions, they are now hemorrhaging cash from the housing mess, tight credit conditions and a lack of investor confidence.

But apparently, state regulators are under the belief that retail investors and charities are incapable of understanding those kinds of risks. So they get bailed out while institutional investors and high-net-worth clients -- who were sold the same bill of goods -- get left holding the bag.

That makes an already dumb situation that much dumber.

-- Lauren LaCapra

Dumb-o-meter score: 90. Whatever happened to "caveat emptor"?