Archive for December, 2011

The Occupy movement has been going on for some time now. I’m probably late to the game by only now deciding to write a post on it.  No matter; the movement seems to be reaching a pivotal point so let’s just use that as cause enough for pontificating on the topic now.

The movement is interesting and relevant from a business perspective because it started as Occupy Wall Street in particular.  The protesters seemed to blame the financiers of Wall Street for a wide variety of the problems in our world today.  As a former member of the Wall Street cadre, one who worked directly with many of the acronyms that brought the financial system to its knees, I am sympathetic, though not entirely in agreement with their grievances.

The Occupy blame-game was more than a bit overstated.  Nonetheless, I think the Wall Street example highlights a broader need for companies to act in recognition of their social obligations, obligations that go well beyond what Milton held.

Finance or Farce

One thing Occupy got right, based on my personal experience: the figurative place known as Wall Street is driven by greed, and we as a society have suffered because of it.  The titans of Wall Street justify their pay with notions of efficient capital markets, pricing risk and facilitating the optimal allocation of resources.  It’s all bullshit.  Don’t be fooled.

Yes, the capitalist system requires financiers to help allocate and reallocate resources.  Yes, the US capital markets do provide a sort of competitive advantage when compared to the rest of the world.  Yes, when regulated appropriately, markets for derivatives and other exotic financial instruments can help price and manage risk.

But the same aforementioned titans of finance actually fight regulation (with all their substantive resources), extoling the virtues of unfettered market forces.  The social goods they claim to provide through their services are only realized by accident, if at all.

I Gots to Get Paid

No one really goes into finance because they want to help create efficient capital markets and facilitate the optimal allocation of resources.  I only wish that they did, that people felt compelled by the social contract to which every person and (yes) company living and operating in an organized society is implicitly a signatory.  But there’s a reason the physicists writing trading algorithms have those PhD’s.

You go into finance,of the Wall Street variety, because you want to get rich.  Or if not rich, at least to be well paid (and maybe, like me, to find an analyst program with resources to invest in your professional development).  That doesn’t make you evil.  It makes you pretty normal, and no one can really fault you.

But that’s also why the system needs to be regulated.  You don’t optimize a system by optimizing the parts, and you don’t realize social goods, like efficient capital markets and clean drinking water, by leaving it to self-interested individuals alone to figure out.

Left to their own devices, people collectively driven by greed will not try to find the right price for risk or the best allocation of resources; they’ll look for the one that will make them the most money, and the two are not always congruent.  If people will not conform to the implicit social contract, then they must be forced to conform with the explicit laws governing society.

Greed Ain’t So Good

Much of the money that is made on Wall Street is information rents.  That’s why insider trading is such a problem. There’s very little real value creation.  I, Mr. Wall Street Banker, have a better idea of the price you can get for this asset than you do so I’ll buy it from you for a slightly lower price than I intend to resell it and keep the difference.  They use a fancy name for it, arbitrage, probably to help obfuscate what is really going on, and obfuscate they do.

If my business is charging information rents, the smarter I can make myself and more in the dark I can keep you, the more profit potential there is for me.  That is an inefficient market, by definition.  With modern technology, information wants to be free and the need for brokers who charge for these information rents is quickly diminishing.  Nonetheless, information is valuable so

So you see, Wall Street doesn’t actually do what Wall Street claims to do when defending itself against critics, and that’s why the system needs to be reformed.  Done right, regulation could actually help create a more efficient capital market.

Wrong Incentives, Wrong Skills

The real culprit here is not a nefarious 1% but a gross distortion of incentives in the system.  Chasing people down and locking them up after the fact does little to correct that problem.  We’ve seen how people underestimate risk so jail time is not an effective deterrent or solution to the root cause.

Wall Street makes far too much money relative to the value it creates.  That money funds wildly inflated payrolls, with the side effect of creating a brain-drain out of other value creating industries.  I’m all for people getting paid millions if it is commensurate with the value they are creating in the world.  Asset bubbles are the antithesis of value creation.

These distorted incentives are also contributing to the high unemployment at present.  People fret about the high unemployment rate, but in Silicon Valley, there is a talent shortage.  It’s not that there are no jobs; it’s that people haven’t learned the right skills for the jobs available in the modern economy (read: math and science).  We’ve raised a generation with a sense of entitlement but none of the skills they need to earn it.

We Owe It

The way out of this mess is large scale investment in education, training and infrastructure, financed by those with the means, the have’s, the so-called 1%.  The logic is thus:

When I’m poor, the marginal value I derive from an additional dollar is much greater than the value I derive from it when I am rich.  I can use it to buy food, essential sustenance, maybe something on McDonald’s dollar menu (for better or worse).

When I am rich, with my basic needs already satisfied, that additional dollar goes toward luxuries, like a new yacht.  Of course, most luxuries cost a a lot more than just one dollar so I might just store away that dollar a bank account, accruing interest, waiting for me to accumulate more dollars like it, while poor-me goes hungry.

Conversely, I suffer from losing a dollar much more when I am poor than when I am rich.  I might go without a meal or needed healthcare.  If I’m rich, maybe I just stop shopping at Prada in favor of Zara so I can save more of those dollars for my yacht.

Compare this marginal value of a dollar to the benefits rich and poor people derive from living in a stable, well-functioning society.  I am not talking about benefits from direct social services, like welfare. I mean the more general benefits for which we give up some individual liberties to organize ourselves into a society in the first place.

As a rich person, it is society that gives me the property rights to own my yacht and all my other toys.  Poor-me barely has enough to eat, and those same property rights mean rich-me can evict me from my apartment if I don’t make rent.

Viva La Revolucion

People forget that when the income disparities become too pronounced, that’s when revolutions happen.  It used to be when poor-me got too hungry, too desperate, he stormed into rich-me’s house and dragged me out to the guillotine.  In the US, we act as though a revolt against our social and political status quo is no longer possible, but the Arab Spring is testament to the fact that it surely is not.

It is in the self-interest of the rich to guard against revolt by funding the social goods necessary for cohesion and stability.  It just makes sense that if I am getting the most benefit and feel the pain the least, I should bear a disproportionate portion of the burden.  Taxes are really just a fee for the benefit I get from living in our society.  The more benefit, the more you should pay.  (Mind you, this is also why I am in favor of a consumption tax, not an income tax.)

Be the Change You Want to See in the World

We can either do this the hard way or the really hard way, but change is coming.  The US has lived beyond its means too long.  What’s needed isn’t just for have’s to learn to share more with have-not’s here in the US.

The US itself, its companies and its citizens, need to learn to share more with the other nations who are exposed to all our conspicuous consumption over the internet and left feeling envious and a little resentful.  That is the way to sustainable world peace.

If I’m the 1%, I’m inviting the protesters to occupy my dinner table next, understanding their pain, and looking for solutions that are favorable to me as well, maybe paying my lobbyists to work on that consumption tax so I don’t end up on that proverbial guillotine.

When I helped manage an SRI fund, my investing thesis was essentially that companies employing CSR best practices were better able to influence inevitable regulation, faced lower compliance costs when regulation did come, and avoided more black swan losses from negative social, environmental or governance shocks.

Companies were better off getting out in front of change, shaping it.  See Apple’s planned obsolescence techniques or read The Innovator’s Solution if you need more proof points for why it’s better to embrace change.


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