Michael Lewis writes,

The millions of dollars that mutual funds have, in effect, stolen from their small customers are dwarfed by the billions they have wasted for them.

In his just-published book, “A Random Walk Guide to Investing,” Burton Malkiel shows that over the past two decades index funds have outperformed 88 percent of managed funds. That is, investors paid the vast majority of mutual-fund managers to grow their capital more slowly than if they had simply invested it in market indexes.

Lewis argues that the current mutual fund scandal is a distraction, and that new scrutiny and regulations will not benefit investors.

Just the reverse: Larded with even more regulation, more legal costs, more cover-your-butt provisions, mutual funds will see their costs rise. The added costs will be passed along to investors. Mutual-fund returns will be even less likely to justify fees.

A second, equally perverse, effect of this scandal will be to drive what talent there is in the mutual-fund industry out. In the wake of the scandal, the mutual-fund industry will become an even deeper drainage ditch for financial mediocrity than it already is.

Read the whole piece. Thanks to Zimran Ahmed for the pointer.

One of the magazines that rose and fell during the dotcom boom was called Upside. I remember that they had a cover story called “The Great IPO scam.” It turned out to be about the fact that because stock prices for initial public offerings often went up by 100 percent or more on the first day, that this meant that investment bankers had underpaid venture capitalists and entrepreneurs for the initial stock.

I wrote a letter to the editor, which they published, in which I said that this was a minor story. In the grand scheme of things the real IPO scam was that companies with no earnings were being taken public at all. I argued that in the long run, the venture capitalists and entrepreneurs would turn out to be the scammers, not the scammees. History proved that to be the case.

The point of all this is that many journalists and lawyers seem to get the story wrong when they look at financial shenanigans. They see trees of misbehavior, but they miss the forest of what really lowers the return to the average investor.

For Discussion. Many economists would agree with Lewis that people over-invest in managed mutual funds and under-invest in index funds. Does this raise a public policy concern?