A couple of things about Citi’s news release, announcing it will buy back the auction-rate securities (ARS) it had sold investors struck me as especially notable. “The capital impact of bringing these assets onto Citi's balance sheet”, it says, “is expected to be de minimis.” That’s lawyerese for, “It doesn’t make a damn bit of difference.”

It must be nice to be able to take on $7.5 billion in debt of questionable value and have it not make a difference to your balance sheet. Citi is also paying a $100 million fine to the states which had threatened to sue it, charging that it fraudulently marketed the securities as being as safe and liquid as cash. That’s not going to make a dent in Citi’s bottom line either. And that’s a problem.

For big banks and brokerage houses these are just the costs of doing business. This is why every few years they are caught misleading investors in some new fashion, not to be confused with all the old fashions in which they have mislead investors in the past. Last year it was collateralized debt instruments (CDOs), rated for safety on the basis of the firm which put together the package, not on the risk of the mortgages which were in the package. In 2002 it was questionable research on companies issued by firms with an interest in selling the company’s shares. You can go all the way back to the portfolio insurance of the 1980s, designed to take the risk out of stock market investing. It proved to be worthless in the market crash of 1987.

The other item that jumped out of the news release was the last line, “Citi neither admits nor denies allegations of wrongdoing.” Yeah, right. Have you ever heard of a broker/dealer taking back an investment that went sour out of the goodness of its heart? New York lawyer Jacob Zamansky, who represents clients who bought ARS, says “Citi got off easy.” “If Citigroup did not settle,” Zamansky told me, “it’s likely that there would have been very damaging evidence that would have come out against them. E-Mail evidence and evidence that they put their own interest ahead of their customers. That they misled customers about the risks.”

As long as the price the financial institutions have to pay for these practices is just a cost of doing business, they will continue selling investors shoddy goods. And as long as investors remain greedy and ready to grab at anything which seems to be too good to be true, there will be an endless repetition of these events.

We, that is, the investing public, can stop it. All we have to do is recognize that the basic rules of economics cannot be repealed. So here are, for want of a more clever title, Scott’s rules:

Rule one-- let the buyer beware. When is the last time you went into a store and the saleswoman said, “I’ve got this product to sell but it’s not really very good and I wouldn’t buy it myself”? So why do you believe that a broker/dealer, or anybody else with an incentive to sell you something, would give you an unbiased assessment of its value?

Rule two-- higher potential returns require greater risk and greater risk means higher potential losses. You can’t make the risk disappear; you can only try to transfer it to someone else. Putting it another way, with apologies to Robert Heinlein; there ain’t no such thing as a free lunch, at least in the long run, as in, once somebody notices. If you take chances, from time to time you will lose.

Rule three-- market solutions require markets, which I also call my “Theory of the Deer in the Headlights.” I learned this lesson back on October 19, 1987, the day the Dow Jones Industrial Average fell 22.6%. That day I stood in the Standard & Poor’s 500 trading pit at the Chicago Mercantile Exchange, which is normally packed with traders buying and selling index futures. On that day the pit was nearly empty, the stunned traders had gone home, unwilling to make a move. The sophisticated strategies which were supposed to insulate portfolios from risk could not be executed in the absence of a functioning market. The same kind of market freeze, the jargon is “lack of liquidity”, is responsible for the CDO mess, the credit crunch and now the ARS crisis.

Rule four-- If a deal sounds too good to be true... Run.

When will we learn?