Karma on Wall Street

Earlier this year, and not unlike any other time during any other year, the investment bankers on Wall Street had their way with retail investors.

The means? Facebook's (Nasdaq: FB  ) now infamous IPO.

Not to belabor the point, as I trust many of you know the story, but it's alleged, and convincingly so, that investment bankers rigged the process to essentially guarantee that ordinary investors like you and me would lose our shirts.

And -- surprise, surprise -- we have. Since going public two months ago, shares in the social-networking giant have lost nearly a quarter of their value.

Wall Street's mea culpa
Now, I'm not saying this is all Wall Street's fault, as the investment bankers haven't taken up arms to pilfer our pockets yet. But I am saying that some of it unquestionably is.

While ordinary investors admittedly choose to invest in imprudent things like Facebook's IPO, they should nevertheless be able to do so in a market that doesn't predetermine their failure. In this regard, it's important to remember that our equity markets aren't a craps table in Las Vegas; they're a means to allocate capital for the largest and most powerful economy in the world.

For this reason, the second-quarter earnings of the major investment banks -- not to mention the jobs bloodbath in lower Manhattan -- could easily be interpreted as an unwitting mea culpa for the industry.

Corporate collateral damage
On the corporate level, the brunt of the immediate damage from Facebook's debased IPO was felt by companies such as Knight Capital Group (NYSE: KCG  ) , one of the largest institutional brokerages and equity traders in the United States.

According to the company's chairman and CEO, Thomas Joyce: "Losses resulting from the trading of the Facebook IPO had a direct EPS impact of minus $0.23 [$26 million in total] in the second quarter and it severely degraded the profitability of market making, while swinging institutional sales and trading to a loss." He went on to note that the company is "evaluating all legal rights and remedies in connection with the Facebook IP." In case you're wondering, he identified Nasdaq as the singular target of his ire.

Yet, as I mentioned above, in addition to Nasdaq's mishandling of Facebook's listing, the real culprits are the investment banks that both underwrote and allegedly rigged Facebook's offering and listing: Morgan Stanley, JPMorgan Chase (NYSE: JPM  ) , and Goldman Sachs, among others. Knight Capital just happened to get caught in the crossfire.

It seemed like a good idea at the time ...
With the benefit of hindsight, and the last few weeks of quarterly earnings, we now know that Wall Street's attempt to make a quick profit from Facebook's IPO has backfired.

Over the following months, the IPO market withered away. Between 2004 and 2011, there was an average of 18 IPOs each June. This year there were only eight, amounting to the worst June since the Internet bubble burst -- outside the financial crisis, that is.

And with the IPOs went the lucrative investment-banking fees -- nearly $1 billion worth, if last year's results from the five major equity underwriters are any indication. In the second quarter of this year, every single major Wall Street bank saw revenues from equity underwriting plummet, with JPMorgan Chase, Bank of America (NYSE: BAC  ) , and Citigroup (NYSE: C  ) hit the hardest.

Bank

2Q 2011 Equity Underwriting Revenue (Millions)

2Q 2012 Equity Underwriting Revenue (Millions)

Decline

JPMorgan Chase $455 $250 45%
Bank of America $422 $192 55%
Morgan Stanley $419 $283 32%
Goldman Sachs $378 $239 37%
Citigroup $272 $167 39%
Total $1,946 $1,131 42%

Source: Quarterly financial supplements.

While the banks -- not to mention the press -- have laid the blame for this at Europe's feet, the reality is that it's Wall Street's to own. They made this bed by creating, at the very least, an appearance of impropriety with their handling of the most anticipated IPO in a decade. And they must now sleep in it.

Looking beyond Wall Street and IPOs
In testimony before the Senate Banking Committee, my colleague Ilan Moscovitz intimated that as they are currently set up, IPOs simply aren't appropriate investment vehicles for the ordinary investor. Are they exciting? Yes. Are they cool to talk about? Certainly. But will they make you any money? Probably not.

To make real money in the market, you need to act like a long-term, risk-averse investor who's simply trying to get fabulously rich. Think Warren Buffett, not your overly exuberant day-trading neighbor who lives in fear that his wife will uncover his losses.

Instead of Facebook, the type of stocks that will help you accomplish this goal are those identified in our free report: "The Stocks Only the Smartest Investors Are Buying." Because this report may not be available much longer, I urge you to download a free copy instantly.

Fool contributor John Maxfield owns shares of Bank of America. The Motley Fool owns shares of Bank of America, Facebook, JP Morgan Chase, and Citigroup. Motley Fool newsletter services have recommended buying shares of Goldman Sachs Group. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


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