STAFF NEWS & ANALYSIS
Bogle: Faith-Betrayed Markets
By Staff News & Analysis - January 21, 2010

It is time institutional investors exerted control over publicly held companies. 'Investing is an act of faith." So I wrote in 1999, the very first sentence of my book, "Common Sense on Mutual Funds." But as 2009 ended, writing in the updated 10th anniversary edition after the passage of this turbulent decade, I concluded that "the faith of investors has been betrayed." How so? Because the returns generated by our corporate stewards have often been illusory, created by so-called financial engineering and produced only by the assumption of massive risks. What's more, too many of our professional money managers have failed to act as vigilant stewards of the money that we investors entrusted to them. In short, far too many of our corporate and financial agents have failed to honor the interests of their principals-the mutual fund investors and pension beneficiaries to whom they owed a fiduciary duty. The ramifications were widespread-for the failure of money managers to observe the principles of fiduciary duty played a major role in allowing our corporate managers to place their own interests ahead of the interests of their shareholders. – Wall Street Journal

Dominant Social Theme: We must redeem investors' trust.

Free-Market Analysis: John Bogle (pictured left) is back at it again. The pioneer in the area of low-cost funds, Bogle always beats the drum for the small investor and positions himself as Wall Street maverick tilting at the windmills of greed and avarice. Bogle in this Journal opinion piece makes the case once again that buy-and-hold is a great deal more sensible than treating the stock market (especially the American stock market) as a casino and trying to cash out when stocks are high. He sounds so sane and comforting, does Mr. Bogle. He has it all figured out, in fact. And he is not one to shy away from discomfiting conclusions. Here is what he suggests be done by institutional biggies on behalf of equity consumers everywhere:

The process of restoring the faith of investors must begin with a demand that the agent/owners of investment America stand up for the rights of their principals/beneficiaries. What we need is congressional action to establish a federal principle of fiduciary duty- encapsulated by the phrase "no man can serve two masters."

This principle will require institutional managers (1) to act solely in the interests of their shareholders and beneficiaries; (2) to observe due diligence and professional standards in their investment practices; (3) to honor their responsibilities as owners by active participation in corporate governance; and (4) to eliminate conflicts of interests in their activities. Together, these standards would require the giant financial institutions of investment America to behave as owners of corporate America, actively voting proxies in the interests of their principals; playing a role in dividend payouts and executive compensation as well as in mergers and acquisitions; limiting (or even eliminating) excessive stock options; and demanding the independence of directors from management (including the separation of the roles of chief executive and board chairman).

In addition, policy makers ought to be considering structural changes that would enhance the role of investors and diminish the role of speculators. For example, granting longer-term (say, two-to five-year holders of stock) extra voting rights and/or a higher dividend; a federal transfer tax on securities transactions; or a tax on short-term realized capital gains (say, shares held for less than six months), applicable to taxable as well as tax-exempt investors such as IRAs. As the new year and the new decade begin, it is time to restore the faith of investors in our interlinked corporate and financial systems. This is not a task for the fainthearted, or for the impatient.

Early in 2002, I called for the creation of a Federation of Long-Term Investors, in which institutional investors-including the giant index fund managers who alone hold some 15% of U.S. stocks-would join together to force these long-overdue changes and exert their ownership power over our publicly-held companies.

We will hand it to Bogle that even at what must be a fairly advanced age he understands that American markets have been hit with a considerable loss of investor confidence. All across America, especially, there is no sense that Wall Street will treat small investors with anything other than disdain and rapine. The last time that investor confidence was so low was probably in the 1930s and 1940s, and it took a determined decade-long dog and pony show by the NYSE to gradually pry investors away from bonds and back into stocks. We wonder how long it will take this time.

We're not going to imply that Bogle is out of touch, but we wonder if the average consumer is going to buy off on his idea that institutional investors can form a magic priesthood– abetted by Federal regulation — that will alleviate cynicism and comfort those who are fed up with the stock-promotions of Wall Street. Bogle wants us to believe that those on the "buy side" can be shoved into a level of responsibility never achievable on the "sell side" – Wall Street. Of course he is pleased to ignore what is an obvious insight – that they are part and parcel of the same enterprise.

It is all a tad overcomplicated from our point of view. Used to be you bought into a venture, usually a small private one, and if the company did well, so did you. In 21st century America, you may purchase an interest in a global firm through a Wall Street broker or financial planner and the firm's share price is controlled, if not manipulated, by gigantic private and public funds. The connection between the investment and the entity has certainly been lost. This Bogle understands well enough. But there are even deeper problems.

The biggest problem from our point of view, and it is one that Bogle has never dealt with in his entire investing and publishing career, is that the American stock market especially is prone to giddy waves of buying and selling depending on how much fiat money the Federal Reserve is pumping out. Bogle's response would be that, over the long-term, the market is immune to fiat money inflation – that value inevitably wins.

Our response would be that the system is so fragile and manipulated at this point that it is remarkable it is still standing at all. From our perspective, the modern, consumer-driven stock market is merely an outgrowth of central banking money stimulation. Without the perfervid waves of paper notes washing over the economy in regular cycles, people would never notice the stock market. But it is hard not to notice an entity that, on occasion, mints millionaires overnight, as if operating a conveyor belt. During the "boom" phase of monetary stimulation there is nothing like being in the right stock at the right time. You can make a killing so long as you get out with your profits before the inevitable bust.

The casino-like mentality that Bogle decries is actually a perfectly rational response to the business cycle itself and the central banking stimulation that drives it. Of course this is not for Bogle, who deals in the purity of marketplace that is somehow uninfluenced by money manipulation – or should be, anyway. Dear old Bogle has decided (as of course he would) that serious, substantive, additional regulation is needed to "fix" the equity markets. Only legislation can save the day.

For Bogle, you see, it's all a question of market structure. Form follows function. It's just like building a house. The trouble is, however, that Bogle is not dealing with architecture but with a deeply devious monetary system that is designed to create repeated collapses while continually centralizing the world's wealth. Bogle doesn't see it this way. He wants the wise men of Congress to demand that institutional money managers don the white hats he knows they are capable of wearing.

After Thoughts

Everyone has a plan you see. If you just pass more laws – and tell people clearly how they must behave (and put them in jail if they don't) – then all will be well. It never occurs to any of them, even Bogle, that it is the abolition of market forces on Wall Street and the mercantilist blending of government with the securities industry that has created the mess in the first place. A better cure to the problems that Bogle continually perceives on Wall Street would be the creation of a market environment in which a private gold and silver standard could flourish, as it has before. If the market's money was rationalized, the free-market itself would likely take care of the rest of the difficulties. Then what would Congress do?

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