The free enterprise system, like its consumers, seems now too focused on financial products and not focused enough on “making and trading”. We are in danger of becoming insatiable gamblers. [more]
I just finished John Bogle's latest book titled "Enough." I recommend its reading if you are like me: trying to decipher what has gone wrong with our financial system.
Bogle opens his book with a wonderful story about Kurt Vonnegut and Joseph Heller (author of Catch 22) at a hedge fund manager's party. Vonnegut says to Heller, "Our host made more money yesterday than you made in your entire best selling lifetime."
To which Heller answers, "Yes but I have something he will never have."
Surprised, Vonnegut asks, "What could that be?"
Heller says, "I have enough."
I like that opening because it seems to me most of us will be better off when we simply decide we have enough.
It also strikes me because our current mess was caused primarily by those who can never get enough.
Near the end of a very long housing boom, the market overheated. It seems there were two primary reasons for this:
The first appears to be well-intended but mistaken legislation. Congress loosened consumer mortgage requirements in 1994 with the intention that the poor could reach the American dream of home ownership more quickly. This led to a category of borrowers and mortgage products (subprime lending is the nominal blanket) that were unsustainable. By 2007, 30% of all mortgage lending was "subprime."
Secondly, since equity markets were also overheating in the mid-2000s, the housing market became speculative to the point that "everyman" became an "investor." No one, it seemed, could get "enough." In places like Arizona and Florida, even retirees and government workers were buying new housing and flipping them for a profit a few months later.
Bogel's book, though, drives much more deeply into the financial system itself, sometimes in hard-to-read detail. To me it was worth the read to learn some basic principles.
His overall theme is that speculators and financial engineers have become more prominent than producers and traders. Worse, since it's our money that they are using to engineer and speculate, the financial system is in jeopardy due to self interest.
Put in gambling terms, the "house" has created more ways to bet than there are games to play. And when that happens, only the casinos win since they make money on every bet that's made.
Back to Bogle's more sophisticated explanation. He starts with this 19th century British epigram:
"Some men wrest a living from nature and with their hands; this is called work.
Some men wrest a living from those who wrest a living from nature and with their hands; this is called trade.
Some men wrest a living from those who wrest a living from those who wrest a living from nature and with their hands; this is called finance."
It would seem that the first two should dominate our economy, but this is no longer so.
In 2006, $215 billion of the $711 billion earned by S&P 500 companies were financial sector companies. This means that over 30% of our total production as an economy was in moving money around, not producing more.
In 2007, we paid over $620 billion in fees and transaction costs for mutual funds, investment banking, hedge and pension fund management. This is an extraordinary - in fact dangerous - cost for just moving around money that's already been "made" and "traded."
Bogle says this frenzy is stoked by market makers who promote that speculation is good.
Consider this: in 1951 annual stock turnover rate was 25%; in 1998 it exceeded 100%; by 2007 we turned over stocks 284%. That means on average every share of stock changed hands almost three times that year.
What happens each time a stock is bought or sold?
Right, the intermediaries make money.
How'd that work out for the people whose work and trade created the money?
Not so well.
But the people who encouraged the speculation did pretty well.
Charles Prince, CEO of Citicorp, Stanley O'Neal of Merrill Lynch and James Cayne of Bear Stearns collectively were in charge of an 80% decrease in value of their companies from 2003 to 2007 and collectively took home just under $1 billion during those same years.
In 2007, the top 50 Hedge Fund Managers together earned over $29 billion! Those making less than $360 million that year didn't even make the top 25. Since 2007, hedge fund values have toppled by over half in value but there doesn't appear to be any volunteers for returning that $29 billion.
Seem a little excessive?
I don't know but I keep on coming back to my Mom on these kinds of things. She was a woman who could read and write great poetry but couldn't tell a home mortgage from a credit card.
About money, she'd say, "Like work, it's the price you pay for living, but don't let it get a hold on you."
I think that's what happened. I think we forgot to tell our financial bartenders to stop pouring.and now we've got a massive hangover.
Hopefully, we'll learn to tell our bartender enough.