Reverse Converts Ignites the Blogosphere

On Tuesday, Felix Salmon wrote about the reverse convert scam, commenting on this story in the Wall Street Journal.

The story is about a complicated financial product, which is sold like a bond instrument, but is more like a Put option.

If I understand the product (reverse converts) correctly, it offers you a fixed coupon payment, provided the price of an underlying stock stays above a certain price. But, if the price of the underlying stock goes down below a certain threshold, you are stuck with the stock.

The WSJ story, talks about an 85 year old radiologist who lost 20% of his money in the reverse converts sold to him by Citi, and complained against Citi, when he was left holding stock of Yahoo, Hess, Cemex and Sandisk, which were worth $75,000 less than what he had invested.

He said he had no idea that he could be left holding these stocks and says his broker talked him into shifting his money from preferred stocks into reverse converts.

The blogosphere was indignant with this story and Salmon’s post generated quite a bit of buzz. James Kwak picks it up here and asks (quite rightly):

“What the hell is the point of this product?”

Then Mike at Rortybomb explains the fail of reverse converts in detail and explains a quite a lot of fails of the product in his post.

On the other hand, there are two posts that defend reverse converts, here and here.

Reading through the comments on these posts and the posts that defend reverse converts, it seems to me that the primary defense of reverse converts is that they are sold to smart people with plenty of money, so if these smart guys can’t protect themselves, it’s their fault for getting screwed.

The WSJ story featured a Radiologist and surely he must be smart enough to understand what he is getting into.

I don’t think that is a fair assumption.

A Radiologist must be a really smart and educated person, but why should he be expected to research a complicated financial product and be expected to understand what an embedded put is, or what its right price is? Especially, when the broker is calling it a bond and all the features and sales pitch are aimed at making it sound like a bond.

How would a broker like to die of radiation because a radiologist used a machine, which had a rare chance of killing someone during an X-Ray?

I assume brokers (like the rest of us) assume that X-Rays are safe and don’t ask questions about it before getting one. And, hey, if you didn’t ask, it’s your fault that you are dead.

The point is that on a typical day, there are several people who have the opportunity to screw you, and if you have to run background checks on each of them, nothing will ever get done.