Defending Wall Street

In Defense of Wall Street
Jack Bogle, the Vanguard founder, has it wrong: The financial-services industry does add value to the economy.
Bloomberg, November 13, 2018





As a vocal critic of the financial service industry’s excesses, I sometimes am surprised to find myself arguing on the industry’s behalf. I have railed against excessive fees, the manipulation of investor emotions, the pursuit of alpha at the expense of beta, the failure to place clients’ interests above their own via a fiduciary rule. I even wrote a book detailing the evils of privatized profits and socialized losses.

So it is with some amusement that I find myself defending Wall Street from some critiques. The most recent version was via Jack Bogle’s statement that the “financial system subtracts value.” That was a line from the Vanguard founder’s 2010 book, Enough: True Measures of Money, Business, and Life.[i] But a lot has happened in the ensuing years, sufficient for us to revisit this statement – and find it wanting.

Usually, I am sympatico with Bogle’s philosophy. Sure, we can find little things to disagree about, like investing overseas and the value of ETFs. But his claim that on balance the system subtracts value is one of those things where he and I disagree. When a vocal critic (like myself) defends the subject of their criticism, can be an exercise fraught with danger. Let’s see if I can escape from today’s task unscathed.

A few caveats: Bogle and I agree more than we disagree. I’m with him that finance is way too expensive; this is true for alternative investments like hedge funds and for many active mutual funds, too. Finance clearly is suboptimal in terms of the services it provides relative to the costs. That said, even at the prices charged, the benefits outweigh the costs — especially if you are one of the savvier consumers of financial services.

On balance, Wall Street is additive. Consider these three broad areas of services:

  • Capital for new ideas and inventions: The genius of Wall Street is its ability to use the marketplace to steer capital to inventions and companies. Funding improbable new technologies and businesses that manage to change the world has been a key source of U.S. economic power. From the light bulb to the iPhone, finance has driven technology and the economy forward.Funding of ideas and companies that go bust is the nature of the marketplace. This does not mean the system is a failure or broken, but rather that the bias is toward risk-taking. The false positive of funding companies that go bust is a better alternative than the false negative of not funding companies that produce world-changing inventions.Of course, these kinds of gambles lead to excesses. From unicorns to dot-com to other bubbles, the bias toward embracing more risk is that there will always be big, splashy failures. But this is to be expected. Besides, even bubbles serve a purpose. Expensive new inventions become available on the cheap after a bubble pops. Look no further than broadband, computers and even railroads as benefits of malinvested capital.
  • Credit: It is hard to argue with the simple truism that the credit provided by the financial industry is the lifeblood of the U.S. economy. From retail sales to homes to durable goods, credit has allowed consumers to enjoy goods they might not have been able to afford if an all-cash purchase was required.That’s the problem: Unrestricted or unregulated credit invariably gives rise to financial problems, from mere bubbles to total systemic collapse. The solution is a well-capitalized system with reasonable regulations restricting excessive risk-taking. At the very least, aggressive risk-taking should be pushed toward private investors who choose that approach and there is no taxpayer liability. This means away from depository banks where the Federal Deposit Insurance Corporation is guaranteeing losses and the Pension Benefit Guaranty Corporation protecting worker retirement accounts.But be cautious about arguing from an outlier. People manage their credit responsibly (for the most part); they buy as much home as they can afford, and don’t go crazy with plastic or other forms of credit. While some people abuse credit, for the most part it works exactly as it is should. The Great Financial Crisis was a reminder (in part) of what happens when we fail to regulate lenders appropriately.
  • Investing and retirement planning: The financial-services industry plays an important role in how we plan for retirement, fund philanthropy, and engage in generational wealth transfer. It’s how we take advantage of the power of compounding.Because of the ingenuity of some smart Wall Streeters, there are low-cost index funds and exchange-traded funds that you can purchase with pretax dollars in your 401(k)s and IRAs. All that cash growing pretax adds up to a pretty penny. So long as you avoid being a guinea pig in other people’s experiments with new financial products, you can take advantage of innovations without shouldering an undue burden.

Sure, there is a near-infinite number of problematic practices on Wall Street, including fees buried in fine print, mandatory arbitrations, and undue influence in Washington. But by and large the financial-services industry does what it is supposed to. It may be expensive, but the good news is the trend is toward lower prices for financial services.

I cannot disagree with Bogle’s admonition that investing should be “simple” and “cheap.” Where we part ways is whether Wall Street, warts and all, is additive to America. It is. Let’s hope it keeps trending in the right direction.


I originally published this at Bloomberg, November 13, 2018. All of my Bloomberg columns can be found here and here

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