Financialization As A Symptom
August 16, 2016 ~ Written by: W.B. “Bud” Kirchner
“They who are of the opinion that Money will do everything, may very well be suspected to do everything for Money”. – George Savile, Complete Works, 1912
“When the rate of return on capital exceeds the rate of growth of output and income, as it did in the nineteenth century and seems quite likely to do again in the twenty-first, capitalism automatically generates arbitrary and unsustainable inequalities that radically undermine the meritocratic values on which democratic societies are based.”
This quote from Thomas Piketty’s classic Capital in the Twenty-First Century as translated by Arthur Goldhammer sets the stage for the next couple blogs.
One of the current ‘hot’ topics for behavioral economist is ‘equality’ – specifically how do people rate the inequality they experience – and what do they think is the current distribution of wealth.
Dan Ariely has drawn the following conclusions from his research: “Americans Want to Live in a Much More Equal Country (They Just Don’t Realize It)”.
- The first is that we vastly underestimate the level of inequality that we have in America.
- Second, we want much more equality than both what we have and what we think we have.
As a sidebar from, “How much equality would you like?” – S.M.
American society is staggeringly unequal: the top 20% hold 84% of the wealth, while the bottom 40% have just 0.3%.
Given the current political environment in the US – I feel compelled to share another excerpt from Ariely:
“Polarized and derisive rhetoric flying back and forth between Democrats and Republicans, one would think there was an insurmountable gap between their positions. So how is it possible that we found so little difference between them in our study? One reason for this could be our inability to separate our ideology from our current state of wealth.”
At this point I will focus on the symptoms while the next blog will look at cause. As you might imagine numerous scholarly tomes have been written on this topic. However – I don’t know of many books that have struck a chord with me like Makers and Takers – The Rise of Finance and the Fall of American Business by Rana Foroohar.
Let me state it simply – the subtitle says it all!
As an aside: One, (me) can’t help but get excited (not to mention pleased) when an articulate and credited journalist put their finger (tourniquet) on a sucking chest wound that one (me) had been concerned about for some time.
I will rely heavily on a this book since I think it does a good job of diluting some of the ideas down to the components that I deal with every day – people/jobs/individual companies/private equity/venture capital etc. etc.
Laying it on the Table
By way of full disclosure – I must declare that this is a very personal topic for me. More than three decades ago I founded Kirchner Group on two premises:
- Every business should contribute to a positive human future
- Every business and portfolio of businesses can be made more valuable.
To put it another way – our entire team and I have committed our careers to creating real value – not using our talents to create the perception of value or short term versions of value which has resulted in our unwavering commitment to the thoughtful integration of ‘earning and returning’.
To sum up my disclosure – I am firm believer in creating value the old fashioned way (heavy lifting/long term view) – in my opinion while ‘financial engineering’ can be a tool – it is a dangerous one and one that is used far too often.
Having said that – this is clearly a complicated issue(s) – with many nuances and even more opinions. As with all things in business (in life!) it is not as simple as one vs. another. So while financialization may be a convenient scapegoat it would not serve our purpose to assume we had the problem figured out or what the cause may be.
It is with real world perspective that I approach this topic. I have a unique vantage point as Kirchner Group often finds itself at the interface between the financial sector and operating companies (i.e. business).
Just by way of context – I believe it fair to say – we are ‘up close and personal’ with numerous businesses across our broader platform especially in contexts such as operations, advisory, enterprise development and investments. We deal with over 50 companies per year across the entire lifecycle, from birth-maturation-crystallization-liquidity and are involved in all the processes that enable them to move from one to the other.
While the bulk of our involvement is not with public companies or real estate – we have sufficient exposure to relate to the situation in general so I can confirm a lot of what Foroohar says in her book – from the trenches.
Why should we be concerned?
Just to set the stage here are 7 particularly salient points I quote from “Makers and Takers” to get the discussion going.
- Rather than funding the new ideas and projects that create jobs and raise wages, finance has shifted its attention to securitizing existing assets (like homes, stocks, bonds and such), turning them into tradeable products that can be sliced and diced and sold as many times as possible
- How did finance, a sector that makes up 7 percent of the economy and creates only 4 percent of all jobs, come to generate almost a third of all corporate profits in America?
- Virtual enterprises prosper while real ones, with real workers, struggle. Innovation is falling to cash management, long-term to short-term tricks. Risk in the financial system continues to rise, even as risk capital to real businesses declines.
- As a sign we have not figured it out: Every recovery of the post-World War II period has been longer and weaker than before
- Finance would rather invest in areas like real estate and construction which are far less productive but offer quicker more reliable short-term gains (as well as collateral that can be sold in a crisis or secure ties in boomed times)
- The move from “retain and reinvest” corporate model “to a down size in distribution” one is in large part responsible for a national economy characterized by economic inequality employment instability and diminished innovative capability.
- In 2030, is when the largest demographic group in US history “the baby boomers” will have nearly depleted the social security trust fund. It is also when the older generation X’s will begin to move out of the work and into retirement.
Lest you think this picture is unbalanced in that it only deals with larger assets/situations – let me share with you another perspective from a recent book (Chaos Monkeys: Obscene Fortune and Random Failure in Silicon Valley by Antonio Garcia Martinez).
“You’ll have to trust me on this: the story of just about every early-stage startup is peppered with tales such as mine. Backroom deals negotiated via phone calls to leave no legal trace, behind-the-back betrayals of investors or cofounders, seductive duping of credulous employees so they work for essentially nothing.” – Antonio Garcia Martinez
As I end this introduction to the topic I would be remiss if I did not point in the direction of some of the early skirmishes this topic has stimulated:
- “Imagine an Economy Without Wall Street” – Nitin Nohria
- “How Finance Ruined Business” – David Sax
- “Why America Needs Finance That Works for Business” – Rana Foroohar
- “Sure Wall Street Add Value, but For Whom?” – John C. Bogle
- “Companies Find A New Allure in Going Private” – Fortune Editors
- “’Financialization’ as a Cause of Economic Malaise” – Bruce Bartlett
- “Wall Street And The Financialization Of The Economy” – Mike Collins
- “71% of Americans believe economy is ‘rigged’” – Heather Long
“I’d like to live as a poor man with lots of money.” – Pablo Picasso
About the Author: W.B. “Bud” Kirchner is a serial entrepreneur, philanthropist and sponsor of impact activities with more than 50 years of business success. He is the Founder and CEO of Kirchner Group, a traditional merchant bank and Founder of the Kirchner Impact Foundation that aims to harness the positive power of enterprise to make a difference in addressing some of the most important issues in the world today.