When You Lose 99.9%, You’ve Lost More Than Money

By Anonymous

On Sept. 1, Barry Popik received a check for $35.98. That legal settlement is all that’s left of the $25,000 he invested in Lehman Brothers preferred stock in February 2008. But money is not all that Mr. Popik, and countless other investors like him, lost. Their faith in the fairness of financial markets is also broken.

Mr. Popik, who lives in Orange County, N.Y., about 60 miles north of New York City, is a respected lexicographer who compiles an online dictionary that documents the origins of such terms as “hot dog” and “the Big Apple.”

Lehman issued $1.65 billion of the preferred shares on Feb. 12, 2008, at $25 apiece, with an annual dividend rate of 7.95%, payable in quarterly installments. Mr. Popik had told his broker that above all he wanted to keep his money safe.

Mr. Popik had already inherited stock in what became Lehman Brothers, but his broker, then at Smith Barney, urged him to put even more into Lehman -- for safety’s sake.

That sounded plausible at the time. Only two weeks earlier, Lehman had reported record revenues of almost $60 billion and net profits of more than $4 billion for its 2007 fiscal year.

“You think you’re investing in a solid company and protecting your family,” Mr. Popik recalls thinking. “In some ways, this is partly my father’s and my mother’s money, and even my grandfathers’ and grandmothers’ money, and it will be my children’s and grandchildren’s money. I just want it to be safe.”

Mr. Popik earned a total of about $990 of dividend income in May and August 2008. Then Lehman declared bankruptcy on Sept. 14, 2008; the shares never paid another dividend and lost nearly 100% of their value almost immediately.

Mr. Popik had bought them in his Individual Retirement Account -- where, under IRS rules, he can’t even write off the losses against his income.

Years after signing on to a class-action lawsuit brought by pension funds and other investors seeking to recover losses on Lehman securities, Mr. Popik got a check for his share of the proceeds. That $36, he says, covers only a fraction of the commission he paid to buy the shares in the first place.

“I wanted to leave financial decisions to my financial adviser,” he says. “You go to a professional for professional advice.”

Bitter that Lehman’s management kept millions and was never prosecuted over the firm’s failure, he adds: “The system works for the banks, not for the people.”

Mr. Popik is hardly a financial fool. He has both an economics and a law degree. Nor is he some sort of socialist whining about the evils of capitalism; he once ran for Manhattan borough president on the Republican ticket and, although he is now a registered independent, describes himself as a libertarian.

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In letting a broker shape his expectations of safety based on how Lehman had performed recently, Mr. Popik was all too typical.

That’s because people overreact to salient information and expect outcomes to be more consistent with it than they really are, says Andrei Shleifer, an economics professor at Harvard University and co-author of a new book on the 2008 collapse, “A Crisis of Beliefs: Investor Psychology and Financial Fragility.”

“Suppose I tell you a person is Irish,” Prof. Shleifer says. “What are the chances they have red hair?”

You might have said 30% or more, but only 10% do, he says. Similarly, if asked what percentage of Florida residents are over the age of 65, you might guess at least a third or even half. In fact, it’s 20%.

These intuitive extrapolations govern how investors think about the financial world, too.

“The extent to which people’s expectations of future stock-market returns track the past 12 months of returns is astonishing,” says Prof. Shleifer. “If you have a period of financial stability and rising prices, people think that’s representative of future continued stability, so they underestimate risk and overestimate returns.”

No wonder, then, that Lehman felt safe to Mr. Popik in February 2008 -- and no wonder his losses shocked him so severely.

As I’ve written before, you can sum up the financial crisis in one sentence: Good things happened to bad people, and bad things happened to good people. Executives who contributed to the crisis retain enormous wealth, while many of those who trusted them have suffered life-altering losses. That result violates a basic desire shared by all investors: to believe that the rules of the game are fair.

Today, Mr. Popik owns a handful of dividend-paying stocks and doesn’t trust that any of them are truly safe. “How do I feel?” he asks. “No one is on your side. Nobody cares about you.”

Maybe such levels of distrust are what have kept this long, lumbering bull market from turning into a speculative blow-off.

Write to Jason Zweig at [email protected]