Original Sin on Wall Street
John C. Bogle is a huge fan of the Classics.
Bogle, the founder of the Vanguard Group mutual fund company, is one of the dozen or so "Wall Street Elders" (as a New York Times article called them this week) who have backed Paul Volcker's proposal to re-regulate the financial industry, even as their younger peers have argued against more restrictions.
I spoke with John a couple of months ago, and got a feisty earful about not only Wall Street's foibles, but also how budding analysts, managers and other market professionals could benefit from more exposure to the writings of Dante, Homer, and the Roman philosopher and statesman, Seneca.
And it is the gaming nature of Wall Street, in fact, that Bogle finds most objectionable.
"We used to have an ownership society, in all these corporations," he said. "Ninety-two percent of the stock was owned by individual investors, 50 to 60 years ago. Institutions owned eight percent. Now, institutions own 75 percent of all stock. These are pension funds, pension managers, mutual fund managers, but they're agents for others, and they're not honoring their agency. They're not putting their clients first, their principles first. They've ignored their principles, focusing on speculation, rather than investment."
And speculation, as Bogle pointed out, is by definition a loser's game. "One short-term speculator wins, and the guy on the other side of the trade loses, and the croupier in the middle makes sure that it's not a zero sum game," he said. "It looks like Wall Street compensation is going to be very close to its all-time high this year, for doing WHAT, one asks? For creating a whole lot of 'innovation' products that are designed to enrich the marketers and not the buyers, and that's what the industry is all about."
Those might seem harsh words for the founder and former chief of one of the most successful mutual fund companies in America. But Bogle is not the first to castigate Wall Street for its speculative habits.
"Teddy Roosevelt talked about this a long time ago, in 1904, in a speech out in the Midwest," Bogle said. "He didn't begrudge wealthy people who create something of value for society. That's fair enough, that's the capitalist system. But he looked at the stock market as a casino. And he didn't think people who were gamblers should be treated the same as people who were creators of value for society."
Flash forward 50 years. We might still have had an "ownership society" in companies in the 50s, but in 1958, Benjamin Graham--a mentor to Warren Buffett--warned about the growing evil of speculative markets in a speech to the New York Society of Security Analysts. Bogle read me a section of Graham's speech:
"'In recent years," Bogle read, "'a new and major element of speculation has been introduced into the common stock arena from outside the companies. It comes from an attitude and viewpoint of the stock buying public and their investors, chiefly us security analysts. This attitude may be described in a phrase: emphasis upon future expectations. The concept of future prospects, and particularly of continued growth in the future, invites the application of formulas out of higher mathematics to establish the present value of the favorite issues. But the combination of precise formulas with highly imprecise assumptions can be used to establish or justify practically any value one wished, however high.
"Given three ingredients of: a) optimistic assumptions as the rate of earnings growth, '... seldom realized, I would add ...' b) a sufficiently long projection of this growth into the future' ... which seldom continues, I would add ... ' and the miraculous workings of compound interest, Lo! the security analyst is supplied with a new kind of philosopher's stone which can produce or justify any desired value for any "good" stock' ... and any really 'good' collateralized debt obligation," Bogle added with wry disapproval.
"Mathematics," he continued reading, "is automatically considered as producing precise and dependable results. But in the stock market, the more elaborate and abstruse the mathematics, the more uncertain and speculative the conclusions we draw therefrom. Whenever calculus is brought in or higher algebra, you can take it as a warning signal the operator is trying to substitute theory for experience and usually also to give speculation the deceptive guise of investment."
Quants, in other words, would not have won the approval of Buffet's mentor. In fact, it seems he would have consigned them to a rather low level of Dante's Inferno. For Graham wrapped up that particular scathing indictment of speculative investment by saying, "Have not the investors and security analysts eaten of the tree of knowledge of good and evil prospects? And by so doing, have they not permanently expelled themselves from that Eden where promising companies, at reasonable prices, could be plucked off the bushes?"
"Yes," answered Bogle. "And there you have it. Original sin in the financial markets." He paused. "Somebody ought to spend a little time thinking," he said, " and this gets back to the classics, about the role of business in society. It should add value. But the financial business does not add value. By definition the financial business subtracts value. In round numbers, it takes something like $600 billion out of the pockets of investors every year. That's $6 trillion dollars in 10 years."
Given all that, it's not surprising that John Bogle supports increased regulation of the financial industry. "We need to bring long-term investment back," he told me. "Logic has to prevail in the long run. All these corporations want to build shareholder value. But they define shareholder value by the price of the stock. That's absolutely absurd. The price of the stock is a momentary, transitory thing that can be reversed in a moment, or washed away or greatly enhanced over the course of years and decades. You'd be amazed how much more difficult it is to raise the intrinsic value of a company than to increase the price of its stock."
Unfortunately, the 80-year-old Bogle acknowledged, speculation and short-term thinking are "so embedded in our markets that it may be longer than the years I have left on this planet" before any such shift occurs.
As to why speculation is so hard to curb, despite repeated warnings over the years, Bogle once again dug back into a classic for his answer. "There's a quote by Upton Sinclair," he replied. "It's amazing how difficult it is for a man to understand something if he's paid a small fortune not to understand it."
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