Gyroscopic Investing

Tortoise,

Your points go directly to questions I ask myself every day.  I don't trust so much of the "free market," so, like Doodle, I feel it "can be improved."  Further, though, I know most of my distrust lies not with the market itself, but the individual players, who are often unvirtuous and dishonest (even if it's tricky sales techniques that aren't really dishonest or wrong).

Those same individual players make up government, so how are we going to reach anything any different... part of me thinks that the lack of a profit motive in government can lead to a different dynamic that is in some ways positive.

For instance, as much as I dislike about social security, I'd probably trust a representative at my local social security administration more than a financial advisor trying to sell me an annuity.  Also, many of my interactions with local governments seem to be free of that "what do I have to do to put you in a car today" type attitudes, and really do provide honest, helpful service.  I tend to think that in markets that are 1) inefficient, and 2) provide for basic needs without which someone would be in dire straights, there may be a situation for government to improve things.

By "inefficient market," I mean one as unlike selling a widget on ebay as possible.  If one needs Lasick eye surgery, they're probably in a position to be an informed, reasonable consumer.  If one gets in a car accident and is hemmoraging, they're obviously less likely to be able to seek out a doctor for the best surgery at the best price.

I guess I see the possibility of thousands, maybe millions, of salt-of-the-earth Americans with little financial knowledge (not necessarily the "unvirtuous" but moreso "uninformed") being duped by financial wizards into bad financial plans, and maybe it's not the worst thing to have some basic level of old-age and disability insurance as social insurance run by the government.

Of course, once you say that, 80 years later you have what we have today, which is WAY too much of a wage-earners income (14% about) going to support retirees, which is just disgusting when compared to the 2% SS started as.  I'm not saying I approve of our system... simply that I think the market doesn't necessarily effectively weed out the bad players in certain circumstances.

moda0306 wrote: part of me thinks that the lack of a profit motive in government can lead to a different dynamic that is in some ways positive.

For instance, as much as I dislike about social security, I'd probably trust a representative at my local social security administration more than a financial advisor trying to sell me an annuity.  Also, many of my interactions with local governments seem to be free of that "what do I have to do to put you in a car today" type attitudes, and really do provide honest, helpful service.

Jack Bogle has an interesting comment in his book The Battle for the Soul of Capitalism that is somewhat related to your observation (boldface is mine):

"What's the bottom line?" is not only an irritating maxim used by the narrowly focused members of the business and investment fields but a revealing abstraction about our society, one that prizes money over achievement, measures our worth by how much we earn and spend, and erodes the virtuous circle of trusting and being trusted on which in the long run our society so keenly depends.

This devolution is hardly limited to the mutual fund field. It is reflected all across our society, as one profession after another has taken on the defining attributes of a business... as so many of our nation's proudest professions--including trusteeship, medicine, accounting, journalism, law, and architecture--gradually shift their traditional balance away from that of trusted profession and toward that of commercial enterprise, the human beings who rely on those services are the losers.

Bogle's explanation is that he thinks this gradual shift has had a lot to do with the gradual separation of ownership and management in our society. In other words, we are increasingly finding that the interests of the people who manage our money, our health, our corporations' balance sheets, etc., are not as closely aligned with our interests as they used to be in previous decades when trust and professionalism were more highly regarded than bottom-line metrics like profit and market share alone.

As for why management has gradually become increasingly separated from ownership... Bogle does not say. He seems to imply that it's a general moral failure, and he suggests various government solutions (new regulations, etc.). Personally, I suspect the solution is not as simple as making some policy recommendations.

moda0306 wrote: I guess I see the possibility of thousands, maybe millions, of salt-of-the-earth Americans with little financial knowledge (not necessarily the "unvirtuous" but moreso "uninformed") being duped by financial wizards into bad financial plans, and maybe it's not the worst thing to have some basic level of old-age and disability insurance as social insurance run by the government.

Of course, once you say that, 80 years later you have what we have today, which is WAY too much of a wage-earners income (14% about) going to support retirees, which is just disgusting when compared to the 2% SS started as.  I'm not saying I approve of our system... simply that I think the market doesn't necessarily effectively weed out the bad players in certain circumstances.

Agreed, but keep in mind, the "bad players" are often given an unfair advantage through government interference or connections within government. In most causes, I think unfair behavior in the market is most effectively minimized by getting the government out of the way and letting market forces sort out the situation.

Look at the "bad apples" who ran so many of our largest financial institutions into the ground a few years ago. Were it not for the government bailouts, they certainly would have been weeded out by the market. Their corporations would have been sold to more competent and prudent businessmen, but instead they were kept in business--with lavish salaries and bonuses, to boot--due solely to the government interference.

Tortoise,

I like your input on this.  I would say, though, that the "corporations" themselves that were bailed out did nothing.  A corporation doesn't fear for its survival.... it's individual employees and shareholders do.  And being fired as a CEO deosn't mean you're in the poor house... it simply means you've quit earning a salary from your financial institution.  Simply letting these corporations fail would have been the equivalent of "firing" the bad apples.  They then either go work somewhere else or live off of dividends and interest of all the wealth they have obtained by doing what took years to finally fail.  People then get a warm feeling inside because "Lehman Brothers finally got what was coming to it."

This may have to do with the "misaligned interests" you mention.

As efficient as our system of stock trading is, everyone is so disconnected from the full implications of "owning a business."  This isn't to say being a passive investor is bad or having liquid securities is bad, but that the unintended consequence of people being able to buy and sell shares so fast can lead to extremely short-term thinking by the board of directors and management.  I'm not sure of the regulatory solutions or the lassais fair logical conclusion, but it doesn't seem to me to ONLY be a function of government interference.

moda0306 wrote: A corporation doesn't fear for its survival.... it's individual employees and shareholders do.  And being fired as a CEO deosn't mean you're in the poor house... it simply means you've quit earning a salary from your financial institution.  Simply letting these corporations fail would have been the equivalent of "firing" the bad apples.

Right, it's the shareholders that get wiped out when no bailout rides to the rescue.  I, the unwise investor, lose all my money.  The CEO was my employee and he blew it, therefore I lose.  I was rewarded for years of returns that dwarfed those of the more cautious investor.  Now I should pay the price when the bill for all that risk comes due.  This is all as it should be,

The flipside is that without bailouts, the prudent investors get rewarded with increased market share and the opportunity to buy up the remaining bits of the failed companies.  When the smoke has cleared, more capital is in the hands of people that resisted the urge to take excessive risks.  Less capital is in the hands of those who were behaved foolishly.

Bailouts prevent that process from taking place.  Capitalism requires losers, not just winners.  Losses, not just profits.  When you take that away, you've got... something else.

moda0306 wrote: I'm not sure of the regulatory solutions or the lassais fair logical conclusion, but it doesn't seem to me to ONLY be a function of government interference.

Yes, I agree. In my example of the 2008 financial collapse, what I said was that the government was solely to blame for the bailouts and the resulting moral hazard--not the financial collapse in the first place. The government--particularly the Fed--did have a heavy hand in inflating the credit bubble that led up to the crash, but I agree that the market participants are far from blameless.

LW summed it up nicely by observing that capitalism requires profit and loss as motives. When the government rigs the game in such a way that the likely profits far outweigh the worst-case possible losses (because of artificially low interest rates induced by the Fed, as well as the moral hazard of guaranteed or implied bailouts), it's easy to see that many market participants have a distinct financial incentive to make "bad" choices. And when people are given incentives to make bad choices, we should not be terribly surprised when they do so.