Tuesday, October 25, 2011

Re-Writing the Investment Compact

Being raised in New England, my history of the American Experience tends to begin with the Mayflower Compact.

This is a very short document, signed by the Pilgrims as they disembarked to found their colony at Plymouth, evidencing the agreement of all to "combine ourselves together in a civil body politic, for our better ordering and preservation and furtherance of the ends [of forming a colony in the New World] and by virtue hereof to enact, constitute and frame such just and equal laws, ordinances, acts, constitutions and offices from time to time as shall be thought most meet and convenient for the general good of the colony".

Thus began the rule of law by common consent that we, as American, cherish to this day.

This notion of a compact, and of "combining ourselves together" is a quintessentially American experience that permeates virtually every aspect of our commercial as well as governmental and community activities.

It's how we allocate our resources, and decide what work is going to get done, and by whom.

Many of these decisions are arbitrated by the financial markets, and those markets also operate on the basis of a fundamental compact between Enterprise and Capital regarding investment and returns.

The essence of this compact is that Investors will be allowed to realize returns by selling shares in the public markets.  I call it the Wall Street Compact

This Compact served us well for some while, but it is increasingly showing signs of no longer being so well-suited to our needs as we now experience them.

Increasingly, we feel the need for an investment compact that allows us, as a community, to balance financial returns with non-financial choices: the environment, society, governance.

The Wall Street Compact doesn't meet that need.

When an Enterprise agrees with Capital to adopt Gain On Sale as the primary strategy for investment return realization, that Enterprise commits to always being up-for-sale.  Running the business is not about either the Enterprise, or its Investors.  It's about the next would-be buyer, and the drive to support a rising stock price to continually attract those buyers.

This effectively erects a wall that keeps the Enterprise from reaching agreement with its Investors on the proper balance of financial returns, environmental concerns, social decency and sustainable prosperity.

It doesn't have to be this way.

One small change can take down this wall, a small adjustment in the agreement between Enterprise and Capital on the strategies employed to realize investment returns.

The change requires financing solutions that stay within the four corners of the Enterprise, offering Investors cash-flow based strategies for realizing investor returns by taking positions in the cash flow waterfalls of the Enterprise.

These solutions are available and widely used today in Real Estate, in Energy and Infrastructure, and in Tax Benefit Monetization (where I learned how it is done).  

Why not apply them more generally, to finance any Enterprise that has strong enough customer support from within a stable enough competitive context to generate stable, steady cash flows, at least sufficient to repay principal to investors, with additional opportunity for earning incremental returns as well?

There is reason to believe Investors will respond to such an innovation.  It can be found in the themes of Investor Activism, Socially Responsible Investing and Impact Investing that are current today within the Institutional Investment community.

Investor Activism is a return to the original theory of the investor as stockholder.  In the strictest legal sense, a corporation is owned by its stockholders, and the values and practices of the corporation are established and enforced by those stockholders.  The stockholders elect a Board of Directors, who then appoint Officers who, in theory, are supposed to execute the decisions of the Board, taken as an expression of the will of the stockholders.

When, however, Investors are really stock traders (not holders), this structure loses its integrity.  The market in which stocks are traded is really the holder of the shares, defining the values of the corporation, and the market really only values one thing: transaction volume.  That's how the market earns the commissions and profits that it exists to earn.

Socially Responsible Investing is an effort being made by many very large institutional stock traders to act like true stock holders, and demand that the corporation share their values - or at least not make market-driven choices that are too much at odds with the Greater Good, as articulated by these large investors.

Impact Investing pushes the envelope one step further, and attempts to align the programmatic and financial objectives of the institutional investors, by seeking to make investments that pay returns but are also aligned with the underlying beliefs and values of the investor.

Unfortunately, the impact of all this, to date, has been small.  What sounds good, in theory, is proving difficult to realize in practice.

The problem is the wall.  As long as investors, institutional or otherwise, are required by the available mechanisms of finance and investing to adopt Gain on Sale as their strategy for realizing investment returns, it is the motivations of the next new buyer that will shape the values that drive decisions being made within the Enterprise, not the values of the current holders.

If we are going to change the way Enterprise values get set, and decisions get made, we are going to have to change the way investment returns get realized.  Not just on the margin, with those few special businesses that also align with the public good, but right at the center, at the very core of our economy, with those businesses that meet all the different needs and wants of the community, at the scales required to be both effective and efficient within the competitive context as it applies.

We are going to have to re-write the Investment Compact.


Friday, October 21, 2011

Can We Make Wall Street Socially Responsible?

A current theme among institutional investors - especially public pension funds - is socially responsible investing.  Sometimes referred to as ESG, for Environment, Society and Governance, this movement seeks to improve the non-financial impacts of investments made by these investors on the world at large.

It is a noble undertaking, much to be encouraged.  But my point is this.  If we really want to get serious about socially responsible investing, we have to get serious about providing the enterprise with a choice in addition to Wall Street as a solution for getting financed.

Wall Street dominates finance today, and Wall Street has one, single mission - to trade stocks, and other financial instruments.  Stocks trade when prices change, and prices change when the market perceives that enterprise value is going to increase (or decline, but increases are better!).

So, once an enterprise enters the Market, it commits itself to a constant campaign, 24/7, to generate investor perceptions of increasing enterprise value.  Every strategic decision the enterprise makes from that point, forward, has to be made with an overarching concern for how it will affect share price.

For an enterprise in the midst of rapid organic growth - Apple Computer in these heady days of iPods, iPhones and iPads comes to mind - this in not a problem.  The choices they want to make for business and social reasons are also choices that will drive up share price.   Their business is naturally aligned with the Market.  But what about companies whose business is more stable, more mature, more steady state?  These companies may want to make choices that are socially responsible, but they can't.  Not if they got money from Wall Street.  Social responsibility does not drive share price.  Growth does, and so they have to do whatever they can to manufacture growth.  This they do through a variety of choices.  Some of the most effective are not what can be called socially responsible.

We can't change these choices by telling an enterprise they're being bad managers.  They're not.  They're doing what their Master demands.  Their Master is Wall Street, and Wall Street demands Growth.

We also can't change this by telling Wall Street it's bad.  It's not.  It's just doing what it was designed to do.

If we are serious about Socially Responsible Investing, we have to not so much get better at the way we manage the investments we already make, as to begin making investments in a better way.  We have to offer the enterprise another way to get funded that isn't the Wall Street way.

Wall Street is one dimensional.  Business is three-dimensional.  One dimension is growth, which Wall Street handles very well.  Another dimension is keeping on, something Wall Street simply cannot value.  A third dimension is making a change, which Wall Street really doesn't understand.

When an enterprise that should be keeping on is forced, by Wall Street, to manufacture growth, bad things happen.

To prevent these bad things from happening, we have to give these firms another way.

That's my challenge to people who support socially responsible investing; to also support the invention of new approaches to investing that will reward a business for doing the right things, at the right time: for growing when it is time to grow; for just keeping on, when it is best to just keep doing the same thing, over and over again, reliably and well; and for making a change when we really do need to make a change.

We can't ask Wall Street to come up with that invention.  It has to be done a different way.

Thursday, October 20, 2011

Free Markets and the Greater Good

There is much noise in the media today that sounds like this: “Markets are right.  Government is wrong.”

That’s ridiculous.

Governments exist to regulate markets, because markets that are not regulated cease to operate.

It’s never a question of whether we should regulate our markets, but how we want our markets to be regulated.

A market cannot be allowed to regulate itself, because the market is focused only on itself.  It will not make choices “for the greater good”.  That is why we need government.

What is Wall Street but a giant market?  It is a very special kind of market, a financial market.  Finance plays a very special role in our economy, and therefor, in our society, and our politics.  It decides in some very important ways what work gets done, by whom.  An enterprise that gets funded competes.  An enterprise that cannot raise funds, closes.  Every enterprise gets its funds, ultimately, from its customers, who pay the price for value delivered by that enterprise.  Finance anticipates customer choice.

Finance is itself an enterprise, with customers that we call Investors.  Investors participate in the formation of a commercial enterprise in anticipation that the enterprise will attract enough customers of its own, who will pay enough of a price for enough of the items of value to be delivered by the enterprise to generate a flow of cash in which the Investors then share.

Financial markets arbitrate the anticipations of Investors relative to the ability of an enterprise to deliver value at a price and in volume, over time.

This is a function of critical importance that affects far more than the private lives of individual Investors and the enterprises competing for investment.  Investments, once made, are not easily unmade.  If badly made, they generate losses that ripple through an economy and impact the whole of society. 

Mistakes are inevitable.  That is how we learn, and through learning, how we discover new and better ways to do our work, and to build for ourselves a wealth of choices for living, and living well. But the costs of making mistakes cannot be allowed to overwhelm the benefits of learning.

A well-run financial market works best, in the long run, if it operates correctly to constrain these losses. 

But markets don’t exist for the long run.  They exist to make the sale.  The customer may not always be right, but the customer is always the customer.  They get what they will pay for, even if, in a larger sense, they are wrong to be paying for it.

This short term focus on making the sale does not always line up well the broader needs of the public good.  Which is why, from time to time, financial markets fail.

When they do, we all pay the price of their short-sightedness. 

The question is not, do we pay, or even should we pay.  The only useful question to be asking is, “what is the best way to pay?”

Is it better to prevent catastrophe, or to clean up after it?

Wednesday, October 19, 2011

The Real Message of the Tea Party Movement

Like OCCUPY WALL STREET, the Tea Party started out as a gathering of citizens expressing more or less vaguely a strongly emotional sense of dissatisfaction with how things are going.
Personally, I still find the message of the Tea Party a little bit less than clear.  It feels to me like they want to debate philosophy, in general, rather than specific choices that need to be made, in the context of the lives we live today.  My problem with that is we all pretty much share the same philosophy.  The devil is in the details.
One detail that does seem to bedevil the Tea Party is taxes.  They just don't want to pay taxes.
Who does?
But if we want to live in an ordered society, we have to pay the cost of maintaining order.  So, we all have to pay our taxes.
Let’s start with a quote from a British Philosopher of Revolutionary Times, Thomas Hobbes.  Hobbes is famous for many things, including his quote that goes something liek this:  “Life in a State of Nature is nasty, brutish and – above all – short.”
His point, as I take it, is that we choose to live in civilized society, even though doing so contrains our freedoms, more or less, because the life we live together is so much better than any life we could live, if we all had to live it all on our own.
That resonates. 
We choose to live in a society of shared economics and shared politics in order to build a public quality of life that provides the context within which each of us can then build for ourselves the private life that suits us best, all things considered.
Public life is not free, and quality does not come cheap.  We need rules to regulate commerce, and we need government to enforce those rules.
Government comes at a cost, and that cost is paid through taxes.  There is no other way.
To say you don’t want taxes, is to say you don’t want government.  To say you don’t want government is to say you don’t want to live in a civilized society.
I don’t hear the Tea Party advocates really saying they want that.  They are not Anarchists.  They value order, just as we all do.  And I think they know that order comes at a price.
I think what they are trying to say, but cannot find the words to express themselves correctly, is that they want order, but not oppression.
There, they have a point.
The truth is that government is about rules, and rules have to be enforced.  So, with government, we get bureaucracy.  Bureaucracies have a remarkable ability to perpetuate themselves, and to expand their field of influence.  This is not always a good thing.  The choices a bureaucracy makes when acting in its own self-interest are not necessarily always also in the best interest of the people whose choices are being constrained by that bureaucracy.  Sometimes, there is a disconnect.
So, when I hear the Tea Party protesting “taxed enough already”, what I hear them really saying is that to them, there is a disconnect.  Government is not working right.  Not by them.
Fair enough.  We’re all in this together.  We have to build a consensus, and that takes compromise.  Let’s talk about that.
But let’s be practical.  The devil is in the details, so let’s get down to the details.  And let’s not forget that what we are really discussing are the details of the public context in which we all want to live out our private lives.  And let’s not kid ourselves into thinking that somehow, magically, we can each enjoy the private lives we want to live, without also participating publicly in the public life that makes our private choices possible. 
That’s just not practical.

Tuesday, October 18, 2011


Here we go again!
In cities all across America – and the World – young people of this generation are taking to the streets to protest…what?
They seem to have no message.  There is no one thing they are asking for, no one thing that they are mad about, or stand against.  They don’t seem to know what they want.  Kids.
But these are our children. 
We know them.  We love them.  We have raised them and cared for them. They don’t have to tell us what they want. We already know.
They want what we told them they would have.
We said to them, when they were young, “The world is your oyster.  Work hard.  Apply yourself.  Be assertive, but respectful, independent, but co-operative, and we will bequeath to you a future of your own making, one in which you and yours can live well, and be happy.”
Now, they are grown: prepared, focused, ready to take on the future, and make it their own.
But what are we giving them?
They look out on the world that we have built for them, and what do they see?  They listen to that world, and what do they hear?  “The rich get richer.  You get to muddle through. You can be free, but only if you agree. There will be no debate.  There will be no compromise. You have no say.”
It is to this that they are saying “Hey!”. 
They are not alone.  Others are joining in.  From all walks of life.  All expressing the same general sense of dissatisfaction.  Something isn’t right.  This is not how it is supposed to be.