Michael Lewis — author of Moneyball and The Blind Side: Evolution of a Game (previous post here) provides this particularly lucid Bloomberg.com op-ed regarding the implications of the Bear Stearns affair to investors generally:

All of this raises an obvious question: If the market got the value of Bear Stearns so wrong, how can it possibly believe it knows even the approximate value of any Wall Street firm? And if it doesn’t, how can any responsible investor buy shares in a big Wall Street firm?

At what point does the purchase of such shares cease to be intelligent investing, and become the crudest sort of gambling? [.  .  .]

To both their investors and their bosses, Wall Street firms have become shockingly opaque. But the problem isn’t new. It dates back at least to the early 1980s when one firm, Salomon Brothers, suddenly began to make more money than all the other firms combined. (Go look at the numbers: They’re incredible.)

The profits came from financial innovation — mainly in mortgage securities and interest-rate arbitrage. But its CEO, John Gutfreund, had only a vague idea what the bright young things dreaming up clever new securities were doing. Some of it was very smart, some of it was not so smart, but all of it was beyond his capacity to understand.

Ever since then, when extremely smart people have found extremely complicated ways to make huge sums of money, the typical Wall Street boss has seldom bothered to fully understand the matter, to challenge and question and argue.

This isn’t because Wall Street CEOs are lazy, or stupid. It’s because they are trapped. The Wall Street CEO can’t interfere with the new new thing on Wall Street because the new new thing is the profit center, and the people who create it are mobile.

Anything he does to slow them down increases the risk that his most lucrative employees will quit and join another big firm, or start their own hedge fund. He isn’t a boss in the conventional sense. He’s a hostage of his cleverest employees.

As noted in this earlier post, nothing is wrong with having compassion for Bear Stearns employees who lost much of their net worth as a result of the firm’s demise. But the reality is that the ones who suffered large losses in their nest egg when Bear Stearns failed were imprudent in their investment strategy. They should have diversified their holdings or bought a put on their shares that would have allowed them to enjoy the rise in the company’s stock price while being protected by a floor in that share price if things did not go as planned. Even though most of those Bear Stearns investors carry insurance on their homes and cars, relatively few of them elected to hedge the risk of their more speculative Bear Stearns investment. Most likely, many of these investors simply did not understand how Bear Stearns created their wealth in the first place. Absent a better understanding of investment risk and how to hedge it, such investment losses will continue in the future, regardless of whatever ill-advised regulations are devised in an attempt to prevent them.