In a prior post, I offered a challenge to Economics to develop a reliable set of tools that can provide an early warning when the effervescence in the Capital Markets is getting too far removed from the underlying value creation in the commercial markets.
Such tools would support regulation to prevent the financial system from episodically crashing our economy.
Today, I want to look at the other possible solution to this vexing problem of booms-that-always-go-bust: competition.
Here, the people in the best position to take meaningful action are the Institutions that have emerged as the new stewards of our private wealth: Insurance, Endowments, Pensions and Annuities.
The challenge offered to these Institutions is to construct new choices for directing Investment directly into Enterprise; new choices that can provide a real alternative to investing indirectly, through the Exchanges that are popularly referred to as the Capital Markets.
This does not need to be a high-risk leap into a New Frontier. It can be a measured extension of the tried and proven architecture of Institutional Investment Partnerships into new domains.
Partnerships have long been standard practice in Institutional Real Estate. They are usual and customary in the increasingly popular asset class of Energy and Infrastructure Project Finance. They are the only way to do tax benefit monetization transactions that are a highly specialized, but widely recognized and generally accepted, form of Institutional Investment. They are commonly used in large leasing deals, where multiple investors must be assembled, as co-investors, to complete any exceptionally large financing. They are even the current solution of choice by which many, if not most, Institutions direct investment into the Exchanges. Managed Funds. Venture Funds. PE Funds. Hedge Funds. All these Funds that aggregate money for Institutions to fund different trading strategies executed over different Exchanges within the larger ecosystem of the Capital Markets, are organized and operated as Institutional Investment Partnerships.
These Funds convert cash flows expected to be generated in the commercial markets into financial assets that then can be traded as commodities, at a price, over an Exchange. In some cases, these Funds even construct financial assets based on other financial assets that are many times removed from cash flow expectations at the level of commercial exchange. Having converted cash flows into asset prices on the "buy" side, they then re-convert asset prices back into cash flow, on the "sell" side, in order to pay returns to their Investor Partners (aka LPs; mostly selling to other Funds buying for the benefit of other [the same?] Institutional LPs). All of this buying and selling between Fund Managers managing money for what is essentially the same universe of Institutional Investors, is a large part of what causes the Markets to bubble, and from time to time, to burst.
Why do all this converting and trading? Why not just invest directly into commercial value creation?
This is exactly what the Institutional Investment Partnership architecture can do, if the partnership is organized directly between Enterprise and Investment, without the intermediation of an Exchange.
This would be a new choice that promises to be better-adapted to building sustainability and shared values into the connection between Enterprise and Investment. It offers more transparency, a more complete alignment of interest between Enterprise and Investment, a more programmatic strategy for realizing Investment returns that can align more programmatically with the underlying programmatic investing goals of many, if not most, such Institutions. It is more stable, and more authentic, because it is direct.
To be sure, there will be some new learning to be done, but the basic patterns are already worked out and well understood. They just need to be applied in a wider range of commercial circumstances.
As this learning gets done, and a broader experience base is built up, these Institutions will have more choice: invest directly in Enterprise; or indirectly, through the Exchanges. Which they choose will depend on where they get the better deal, both immediately and over the longer term.
But somebody has to make the first move.