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Parasites Who Would be Fiduciaries

In the breakfast meeting that I reported on in this issue's first article, Ron Rhoades, almost as an aside, made an astounding statement. He said that 30-40 percent of the profits that are generated in this country go to financial services firms. Naturally, I checked on this statistic, and found an article written by Simon Johnson, former chief economist of the International Monetary Fund, which confirms the figures and takes them a bit further. "From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits," Johnson wrote. "In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent."

(You can find the article here:

This is a number we should meditate on for a moment. Think of all the manufacturing plants all over America. Think of the aerospace and defense firms that make up the so-called "military-industrial complex," the pharmaceutical firms, oil companies and electric utilities. Think of the agricultural sector in its entirety, the food and beverage industry–including soft drinks and beer, wine and all the restaurants, everything you see in the grocery store and the grocery stores themselves. Consider the housing construction industry, all the mining and drilling operations, every TV and radio station and network, the movie industry, cell phone manufacturers and the computer industry, and then layer on top of that the entire health care industry.

All together, they and others I haven't mentioned (printing and publishing, the automotive industry, airlines, retail and internet sales) generate a little over half of all the profits in the U.S.–59% all taken together. The other 41% comes from the financial sector, and Johnson makes it very clear that your local banks and the lending institutions that service your home mortgage are only a small piece of that figure.

Most of it–very nearly all of it–is Wall Street.

In the debates over a fiduciary standard, the financial planning profession seems to be missing a bigger picture, a much larger issue that Rhoades was trying to introduce into the discussion. We've been talking about protecting the individual consumer from being misled into thinking somebody with a sales agenda is actually sitting on their side of the table. But bigger picture, shouldn't we also be thinking about how to protect the American economy itself?

When you look at this bigger picture, it's easy to see that Wall Street has become a cartel that is far more powerful than OPEC ever was. You want to bring your company public? There are a limited number of firms that can and will handle this chore for you–for a hefty 7% of the total money raised. Same if you want to float a bond issue. Plus, when a new stock comes on the market, the company will price it at, maybe, 50% to 70% of its expected value, taking the difference (measured, often, in billions of dollars) into its own account or passing it on to cronies and prospective customers. This underpricing is so common that everybody deemed the Facebook IPO a failure because, a few days after the stock came on the market, it was trading at the same price it was issued at. What a disaster!

Of course, these companies also buy and sell for their own accounts, and there is no incentive for the company analysts to tell customers what they've learned ahead of the company's internal traders; in fact, there is every indication that brokerage firms routinely recommend, to unwitting customers, the stocks that the company wants to unload out of its own account before the price tanks.

And then you have the whole derivatives market. Is anybody reading this willing to bet that the brokerage firms don't have billions and perhaps trillions of dollars worth of hidden–and highly-profitable–derivatives-related guarantees that will turn on shifts in interest rates or currency flows? The regulators and the government have no way of assessing the extent of these obligations–to hedge funds, European banks, corporations, private investors–because, even after the debacle in 2008, they are not tracked by any agency or regulator.

I think Rhoades is right to suggest that our fiduciary argument is a small piece of something much larger. The core activities that are performed by the banking sector are as necessary to the functioning of our daily lives as the activities of the electric utilities. We need the orderly flow of currency and credit the same way we need the orderly flow of power through our appliances. But ask yourself: what would happen if your local electric company was permitted to withhold electricity or conduct bidding wars for who should receive it? Suppose utilities were allowed to speculate in oil or coal futures markets for their own profits, or charge exorbitant fees to any oil driller who wanted to sell fuel on the open market. How long would it take before these companies were raking in half or more of the total profits in the U.S.? Who would be able to deny them whatever they asked for?

Of course, we would never allow such a thing to disrupt the orderly flow of electricity through our economy. But why should we allow these activities to intrude on the orderly flow of credit and financing that is just as vital to our economic system?

There was a time, with the Glass-Steagall Act, when lending institutions were required to be lending institutions, and perform their necessary function in our society without mixing in a lot of other activities. There was a time, in the decades after the Investment Advisers Act of 1940 and the Securities Exchange Act of 1934, when stock touts, brokers and securities salespeople represented a distinct profession from investment advisors, and held themselves out accordingly. It may be too long ago to remember, but there used to be broad competition for IPO business, rather than the cozy cartel arrangement we have today. So it is not impossible to imagine ways in which we could stop Wall Street from engaging in a lot of activities that are unrelated to its primary function in society.

The fundamental argument is easy to frame. Back in the days when the financial sector was earning 16% or less of the profits of the American economy, it was doing a fine job of performing its essential function. Today, Wall Street is engaging in activities which are clearly not enhancing America's competitiveness or overall prosperity. A brokerage firm trading for its own account or speculating on the direction of interest rates, I would argue, is taking valuable human capital and using it in a way that is not benefiting society. Any transaction where the broker is paid extra to recommend expensive, crappy funds that have paid for shelf space doesn't represent a net gain for America either.

A shorter version of this elevator speech would describe Wall Street as a growing parasite on the productive activities of our economy, diverting some of the smartest minds in the country away from all those other industries I listed at the top of this column, so that they can creatively, innovatively, sneakily suck as much money as possible out of our wallets and pocketbooks into the largest bonus pools ever created.

These are the organizations that want to rewrite the 6,000-year-old definition of a fiduciary standard to conform to their business model. They seem to have gotten whatever else they want from Congress and the regulators. Does it make sense to let them have this too?