Wednesday, November 2, 2011

Banks vs. Institutions

Liquidity vs. Prosperity

Yesterday I was reading on article on Peter Victor, published over the Capital Institute blog (

Peter is an economist who thinks a lot about the challenges we are facing and will continue to face coming to grips with what he sees as our new reality of encountering the physical limits of the Earth's ecosystem.  Heady stuff!

Among his many insightful comments, Peter laments our perceived structural inability to make choices that are not driven by considerations of short term immediacy.

That set me to thinking.  I believe Peter is right in some respects, but also points the direction to places where we can make the important innovations we need to make to build and operate an economy that can deliver sustainable prosperity in a new reality that does not include open-ended possibilities for geopolitical expansion along a Western Frontier.

As Peter points out, the economy we currently live within is dominated by an intellectual ethos of Growth, but what underlies that ethos is our obsession with liquidity in the Capital Markets.

This is interesting, because many, if not most, of the actual capital providers to our Capital Markets are Financial Institutions that have a longer term view of their wealth building needs.  These include Pension Funds, Endowments and Life Insurance Companies.  All of these Institutions are mostly interested in making investments that will empower them to meet their wealth needs over the long term, out in some future point in time.  They tolerate liquidity -- and volatility -- because "that's how it's done", but do they really need it?

I would also suggest, although this I cannot prove, that most individual investors, both the wealthy and the not-so-wealthy, when they think of investing, are thinking of the future.  They want most of all to grow their wealth over time, so it will be there if and when they need it, down the road.

It's the banks -- both commercial and investment -- that value liquidity.  Why?  Because that's what they know how to do.

Commercial banks provide liquidity in the form of loans against assets and future earnings.

Investment banks provide liquidity in the form of trading in financial instruments.

Growth becomes important to investment banks, especially those making a market in corporate shares, because they depend on constantly accelerating growth in "shareholder value" to drive constantly accelerating increases in share price to constantly attract a growing number of new buyers to keep their markets liquid.

Of course "constantly accelerating growth" is the financial equivalent of a perpetual motion machine: nice, but not possible.

The result, as we all know too well, are massive disruptions of underlying economic processes that give us a prosperity of booms that always, eventually, go bust.

Interesting thing is, both the instruments that investment bankers trade and the customers they effect trades for actually share longer-dated realities.  Neither one of them really likes it when they get caught up in a boom that goes bust.

This raises the question: why are we doing this?  Why don't we just construct a Capital Market that is designed and operated to match longer-dated wealth-creating Enterprises with the longer-dated wealth-building event horizons of Investors, both individual and Institutional?

Food for thought.

No comments:

Post a Comment